Standing by the Giants or Escaping the Battlefield: The Effect of FDI on Local Firm Creation – Evidence from China

Qingqing Chen, Business Economics and Public Policy, The Wharton School

Abstract: What’s the effect of FDI on firms in cities receiving foreign investment? Agglomerating or crowding out? This paper tries to answer this question by studying local firm creation using Chinese Business Registration data. I use industry structure-based Bartik instruments to identify the effect of FDI. I find that agglomeration effect dominates locally: foreign investment facilitates firm creation, especially firms the same industry. More specifically, I find that a 10,000 yuan increase in foreign investment would induce 2.19 more firms to operate in a county, 1.3 of which are from the same industry. This agglomeration effect could provide an alternative explanation than vertical spillovers as to why local governments in developing countries are keen on introducing FDI.

Read the full working paper here (PDF).