Does Fdi Bring About Positive Effects For Innovation Activities In China'S Coastal Area?

The aim of this paper is to study the relationship between foreign direct investment (FDI) and the innovation activities in Chinese coastal area from 2005-2010, which includes Zhejiang, Shanghai and Jiangsu provinces. After the analysis, we find out that FDI do have effect on patent application in manufacturing industry in coastal area, and it is beneficial for all local industries to think about how to develop innovation activity so as to increase productivity and output. Meanwhile, several factors are not foreign researchers; The third part introduces the source and type of data collected from Science and Technology Year Book in specific areas; Then the next part presents the basic methodology used and analyses the output of the study; The final included in this paper's study as the data is not complete so that the result may be not sufficient and complete. The first part of this paper will introduce the general situation of manufacturing industry and foreign direct investment in coastal area, explaining the significance of innovation in recent years; The second part will focus on controversial views about the effect of FDI on innovation proposed by Chinese and part concludes the whole paper and gives out some suggestions.

' Introduction

Foreign direct investment (FDI) means a direct investment into production or business in a country by an individual or company of another country. By buying a company in the target country or by expanding operations of an existing business, foreign company tends to seek higher economic profits outside the home country. Foreign direct investment is different with portfolio investment which is a passive investment in the securities of another country such as stocks and bonds.
Foreign direct investment is considered to be the vital factor for development of less'developed-countries like China to facilitate domestic technology level and is the important form for China to develop foreign economic exchange. China performs in the leading position of attracting foreign direct investment among all developing countries in 1993 and goes beyond the USA in 2002. 60.63 billion dollars of FDI has been attracted into China in 2004, which accounts for almost 40 percent in China's GDP. In 2009, FDI flowed in China increased to 7.899 billion yuan, with year-on-year growth of more than 18.9% and China still attracted the largest amount of FDI in the world (Gong, 2005). With location advantages of various kinds of marine products, port location and suitable weather, the coastal area is always considered to be the most developed region among all areas. Since 1980s, China's economy has developed rapidly while coastal area contributes the largest part. Coastal area owns the better development condition that adds more opportunities for larger foreign investment. For the economic development in coastal area, it is a virtuous circle that better foundation and more foreign investment will generate mutual promotion. There are slight fluctuations of economic growth since reform and opening-up, but the overall trend is keeping increasing. If taking a look at famous developed western countries like the USA, England and France, a country with advanced technical skills owns powerful economic strength undoubtedly. And this explains why almost every developing country takes economic construction as priority.

What is innovation and why innovation is significant?

Under the situation of economic globalization, innovation keeps standing as the strategic emphases and leading trends for all kinds of companies. Firstly I will explain what innovation is, what the innovation-related activities are and why innovation plays an important role in the economic development. Innovation, as its denotation shows, represents any ideas that will change current objects into a new way. It is stated by Wikipedia that innovation means something original, new, and important in whatever field that breaks in to a market or society. Innovation activities are like enterprise innovation (change for management system and operation principle), patented invention and so on. Invention only represents one part of innovation activities, which is always been quantified for research purpose. Technological innovation helps increase productivity for a company, and institutional innovation will bring benefits for managers to run the company in a more efficient way. In the country-level, China as a developing country is still attempting to catch up developed country and improve its international position. Technical innovation is the most effective and efficient way to compete in the intense global competition.

Situation of innovation activity in coastal area (especially) in manufacturing industry
China's agriculture industry is more like self-sufficient and tertiary industry mainly serves domestic market so that still cannot compete in the global market. Compared to these two, Chinese manufacturing industry have relatively larger potential to fight against foreign companies. In 2010, the output value of Chinese manufacturing industry is 1.955 thousand billion, becoming the largest manufacturer in the world (Liu, 2005). Before 2004, most coastal companies play the role as original equipment manufacturers and the coastal area has become a processing trade region (Liu, 2005). Without technology and knowledge, manufacturing industries develop slowly and have few possibilities to compete in the intensified market. Although manufacturing industry in coastal area stands in the highest level compared with other areas in China, it is vital to develop autonomous technical skill which is a determinant factor in manufacturing industry especially. With cumulated capital and experience, coastal firms then have advantages to formulate the innovative strategic plan in order to achieve longer-term development.

FDI in coastal area and spillover effect of FDI
Among the FDI flowed to China in recent years, the coastal area attracts the largest part of it because of its regional advantages. According to Clark et al (2003), there are two kinds of FDI exist as vertical and horizontal ones for the two different purposes. With vertical FDI, the foreign company locates different stages of production in different countries, while horizontal FDI means transnational cooperation only setting same activities in different countries. In the coastal area, vertical FDI dominates for the purpose of chasing lower costs. Foreign companies in developed countries with professional management strategy and technology skills own comparative advantage, while their relatively high labor cost and resource shortage reflect that developing countries do have strengths in producing specific kind of goods. Depending on such advantages, most labor intensive and resource intensive industries like manufacturing industry will choose to locate in developing countries to reduce costs.
The coastal area is considered to be the most developed region in China, and its' advanced economy leads to better technology skills compared to other areas. With increasing number of FDI in these economically developed areas, spillover effects of FDI on R&D activities have been noticed. There are four main ways of spillover into the area: firstly, labor mobility means labors with advanced technology are sent to work in subsidiaries in less developed area, by which technical skills are transferred between the two regions; secondly, companies in developing countries could achieve new skills from reverse engineering, which stands for the process of discovering the technological principles of a device, object or system through analysis of its structure, function and operation (Eldad and Chikofsky, 2007); thirdly, demonstration effect is the phenomenon that local companies learn and innovate from foreign companies; fourthly, the entry of advanced foreign companies may generate a competition effect, which will bring both pros and cons for domestic company. Local companies either runs a technical improvement to compete with foreign cooperate, or fail in fierce market competition. (Cheung and Lin, 2004).
Positive and negative effects of FDI for innovation
Some researchers like Girma(2001), Haddad(19993) and Harrison insist that the spillover effect of FDI does not always influence the domestic company in a positive way. If the gap between two companies' technology is too large, it is difficult for the local company to take advantage of the transnational corporation. In this situation, no positive effect will be generated and the local company may lose competitive capacity when the foreign company becomes the monopolist in the market. In some cases the local company gets no benefits from it as it cannot sufficiently use the resource and skills. Moreover, foreign company tends not to expose their technology to the local industry in order to protect itself in the competitive market, therefore providing no opportunity for others to learn from it. This is just the transformation of labor and production, not the skills.

' Literature review

The argument about whether FDI foster positive effect for host country's spillovers is still ambiguous. Large numbers of views--both positively and negatively--present to discuss this issue in different fields and methods, and conclude that the effect will differ according to distinct location, firm level, economic power, related policy, personnel structure and so on. All the views are divided by two sides: some insist that FDI will affect innovation in a positive way while some others believe that effects generated by FDI on innovation is not obvious.
According to Cheung and Lin (2004), using OLS and panel data estimation, positive effects have been noticed using data in 26 provinces and 4 administrative cities, from 1995 to 2000. There are two reasons for choosing 1995-2000 data: first, the patent law enacted in 1985, amended in 1993 so the patent activity is quite different before and after 1993; second, after 1990s, the scale of FDI in China became large. The researchers choose to take the number of patents as the measurement of effect on innovation activity by FDI. Patents could be divided into three types: invention, utility model and external design, among which invention is the most difficult one and requires R&D costs and longer time. Science and technological personnel and expenditure are two main determinants of innovation output, however, they only affect invention. So they focus on invention especially. Meanwhile, they admit that using the number of patent application as the measure of R&D output has limitations: some firms choose not to file the result to avoid competition; quality is not concerned and no authorities in relevant area put effort on this; some even misreport the patent for tax benefits.
FDI as a channel brings benefits to host country in several ways: reverse engineering, stealing skilled workers, demonstration effect and also staff training. These spillover effects of FDI on R&D exist both horizontally and vertically. Some MNEs build plants in developing countries and skills transfer to their local supplier by staff training and technology licensing, this refers to vertical spillover. Others like labor turnover and reverse engineering are horizontal spillover.
Coastal provinces as the most developed area in China, receive the largest amount of FDI in recent years. On the basis of research, this region owns the highest growth rate but lowest sharing on invention patent application. After comparison and analysis, the relationship appears positively.
In Liu and Zhou (2008)'s research, positive relationship is noticed as well. The Chinese economy has developed largely as a positive result of FDI and cause a serious competitive threat in western countries. Foreign countries have to own outstanding managerial skills, advanced technology or other advantages to cover the high cost and risk for investing in a place with different cultures and market features. A lot of MNC's R&D centers move to less developed countries like China, i.e. 400 out of the biggest 500 MNCs have built R&D centre in China. They find that technology spillovers from FDI are generated through R&D activities of foreign company rather than competition effect. Through the labour market channel, it is a negative spillover effect while through learning-by-importing the result performs positively. In the case of China, the result examined is positive but it also implies that firms in host country need to reach the minimum level of absorptive capability and also replenish their knowledge resource rather than imitation. Another implication is for policy makers that they have to make more appropriate policies which will induce more MNC's technology advantages and set up more R&D centres. Government also needs to build a labour market with mobility of scientists and R&D personnel. There is positive effect of FDI on local firms' productivities using Taiwanese firm-level data by Chuang and Lin (1999). One percent in firm's FDI ratio will lead to 1.4-1.88 increase in the productivity. Besides this, labour quality, firm size, market structure and export orientation all affect a firm's productivity. Policy implication in this case is that in the short run, government in developing countries prefers to attract more FDI in order to foster technology transfer and knowledge spillover while more investment in R&D activity is preferred in the long run.
Ola-david and Oyelaran-oyeyinka conduct a research in Africa to examine the FDI on innovation there and conclude that firm performances on innovation activities is not affected by FDI automatically, but with the process of learning. Based on the experience in developed and developing countries, the extent of innovation could increase the productivity of domestic firms. Firms related with multinationals and foreign-owned companies enjoy more benefits brought by knowledge spillover. And with feedback system, firms could more inclusive product innovations. They use the data from World Bank Enterprise Surveys to examine the innovative activity of firms in the manufacturing sectors of Kenya and Nigeria and find out that subsidiaries of multinational firms are willing to engage in innovation activity more in the Nigerian manufacturing sector. Locations of firms (economies of clustering and industrial infrastructure) and technology licensing (technology transfer) are also the key determinants of product innovation. Apart from that, it is raised by Rettab, Rao and Charif (2009) that the openness of the firm will affect its innovation activity.
According to Zheng, Yang and Tao (2009), FDI stimulates the increase in innovation capability in Zhejiang, while the level of influence differs from industries' properties. Zhejiang is the most intensive area of FDI flows in China. There are 10366 million dollars of FDI in Zhejiang in 2007, and the average growth rate is 28.45%, which exceeds the country-level rate. This paper select 27 industry-level data from 2001-2006 and build a model to run regression tests to prove the relationship between FDI and innovation.
Waldkirch and Ofosu (2010) make a different point here that there are both positive and negative effects accordingly. The effect of domestically owned company by the existence of foreign company in the manufacture sector in Ghana is negative, however, the foreign-owned companies are influenced positively as its large ratio of equity in between. In addition, there is positive growth effect of labor productivity while the catching-up process is at least a decade. Similarly, Aitken and Harrison (1999) use the panel data of plants in Venezuelan from 1976 to 1989 and figure out that there is positive effect for joint ventures but no spillovers in domestically-owned companied.
Another case concentrating in the UK by Girma, Greenaway and Wakelin aims to find whether there is a gap between the productivity of foreign and British firms and whether the presence of foreign firms will increase the domestic firm's productivity or not. Choosing UK as the target refers to that UK is the secondary largest host country for FDI, just after the USA. Results perform like workers in foreign-owned firms enjoy the increased wage as an additional benefit of FDI. Firms with low technology gap and high level of skills and a higher degree of international competition ability are influenced by FDI positively. However, when testing intra-industry spillovers, the presence of foreign firms contributes no productivity or wage spillovers as expected.
Before Spain joined the EU, its trade'productivity and competitiveness are relatively low. Then look into manufacturing industry in Spain using the panel data during 8 years after joining EU, there is no evidence of inter-sectorial spillovers in the study conducted by Barrios and Strobl (2002).
Current researches often use macroeconomic investment data on FDI to measure, but this only measures investment flowing between countries. The efficiency of FDI as a channel of technology transfer is determined by its entry mode. If the firm enters the market by acquisition or merger, there will be smaller effect on technology. Braconier, Ekholm and Knarvik (2000) looks into whether the inward and outward FDI work as channel for R&D spillovers using both firm-level and industry-level data and summarize that, no evidence of FDI related R&D spillovers and the real factors that influence the productivity are their own R&D spending and capital-labour ratio.
Haddad and Harrison (1993) state that there is no evidence carried out for the positive effect of FDI on host country's spillovers as the technical gap between MNEs and domestic country is too large.
All the results carried out differently is due to the different data and methodologies that they use, and the research will also be affected by the targeting area's situation, way of selecting the data, validity of the data and so on. The positive standing about this topic always insists that domestic firm is able to learn the skills through demonstration effect competition, while others may consider that the effect of FDI on innovation is only the expansion of geographic scope of knowledge.

' Data
(from Chinese Year Book of Science and Technology)
Does the FDI in Jiangsu, Zhejiang and Shanghai Provinces affect the number of patent application in manufacturing industry? Will FDI be the only factor that could generate more innovation? The reason that I choose these three provinces here as sample is because Jiangsu, Shanghai and Zhejiang are the most typical provinces in coastal area. In addition, the economic infrastructures and regional properties of these three provinces are similar, which is to avoid the situation difference that may influence final consequence. There are various kinds of factors that will affect innovation ability in an industry, like R&D personnel, innovation environment, efficiency of capital usage and human resources, economic infrastructure and market environment. GDP is considered to be an intuitive indicator to measure a region's economic development level. Now we can know obviously that FDI is not the only element affecting innovation activities, and we assume that economy level is another factor to exert and influence, so regional GDP will be another study object here for explaining the increase of patent application.
The data I will use covers various kinds of manufacturing industry, like the pharmaceutical industry, electronic and telecommunication equipment industry, textile industry, food manufacturing industry, ordinary machinery manufacturing, aerospace vehicle manufacturing and so on. In this paper, due to the incomplete data problem, I will use the sum of these manufacturing industries' data as study object. As Zhejiang Technology Year Book shows, foreign direct investment on R&D and regional GDP will be treated as endogenous factor in the correlation.
To measure the innovation ability in coastal area, the number of invention application will be used as it is the most difficult one among three kinds of patent: invention, utility model and external design. Utility model is very similar to the patent, but usually has a shorter term (often 6 to 15 years) and less stringent patentability requirements. External design usually refers to the change of a product's appearance. Compared to the other two, invention acquires higher capacity of innovation and larger cost which measures firms' ability more accurately (Cheung and Lin, 2004). Of course, only taking patent application as measurement has limitations. Some firms choose not to file the invention to avoid tax, while the quality of some inventions is not examined well. Compared to other methods, this data is more direct and intuitive. Including external design and utility model could make the study more comprehensive but we ignore them here for reducing interference factors. It could generate more accurate result if we use number of patent application in different industries, but it is hard to find specific data of patent number in Chinese database so we use the macro data instead. Though there is limitation using these data, it could still prove the point of view in some way.
With the result of data analysis, I want to find out whether there is positive relationship between FDI and innovation in coastal area which indicates how local firms should react to the result. If they are correlated positively, it will be beneficial to invest more on R&D and attract more FDI to increase the domestic innovative capacity. On the contrary, firms should consider what cause this problem and decide either to keep on improving the condition or looking for another way to maximize their profits.
' Methodology

Now the model is set up to examine what are the factors that will affect innovation. Here I will use the number of patent application as the measurement of innovation output. Foreign direct investment on manufacturing industries is shortened as FDIrd, GDP represents gross value of production in manufacturing (Shanghai, Zhejiang and Jiangsu). 'ivta' means the number of patent for invention application and 'HRsnr' represents specialized technical personnel with senior professional titles in manufacturing industry of each province. Because there are other indicators that will affect the number of patent for invention, here we add an error term to represent these variables. The model is stated as follows:

ivta= ??0+ ??1FDIrd+ ??2GDP+ ??3 HRsnr +??

??1 is the magnitude of foreign direct investment on manufacturing industries. ??2 represents the magnitude of gross value of production in manufacturing (Shanghai, Zhejiang and Jiangsu) and ??3 means the magnitude of specialized technical personnel with senior professional titles in manufacturing industry of each province. The number of personnel for R&D in manufacturing industry is one of inputs for R&D activity (Here we use one-year lagged data). We are going to use correlation analysis to find out the effect of FDI on patent application.
Figure 1
Correlations For Zhejiang Province
FDIrd GDP ivta HRsnr
FDIrd Pearson Correlation 1 .952** .940** .875**
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
GDP Pearson Correlation .952** 1 .996** .967**
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
ivta Pearson Correlation .940** .996** 1 .964**
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
HRsnr Pearson Correlation .875** .967** .964** 1
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
**. Correlation is significant at the 0.01 level (2-tailed).

The sign '**' proves that the correlation is significant at the 0.01 level. We can see from the Figure 1 that Pearson correlation coefficients of gross value of production in manufacturing, specialized technical personnel with senior professional titles in manufacturing industry, the number of patent for invention application and foreign direct investment on manufacturing industries these four indicators are all over 0.8, and most of them approximate to one. P value for them is near zero (smaller than 0.01). All these results reveal that all these four indicators have strong positive correlations with each other. That is to say, foreign investment on R&D, regional economic level and human capital investment have influences on the innovation activities in manufacturing industry and will bring about positive effectiveness.

Figure 2
Correlations For Shanghai Province
FDIrd GDP ivta HRsnr
FDIrd Pearson Correlation 1 .862** .874** .805**
Sig. (2-tailed) .001 .000 .003
N 11 11 11 11
GDP Pearson Correlation .862** 1 .963** .945**
Sig. (2-tailed) .001 .000 .000
N 11 11 11 11
ivta Pearson Correlation .874** .963** 1 .970**
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
HRsnr Pearson Correlation .805** .945** .970** 1
Sig. (2-tailed) .003 .000 .000
N 11 11 11 11
**. Correlation is significant at the 0.01 level (2-tailed).

Figure 3
Correlations For Jiangsu Province
FDIrd GDP ivta HRsnr
FDIrd Pearson Correlation 1 .968** .939** .949**
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
GDP Pearson Correlation .968** 1 .981** .925**
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
ivta Pearson Correlation .939** .981** 1 .874**
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
HRsnr Pearson Correlation .949** .925** .874** 1
Sig. (2-tailed) .000 .000 .000
N 11 11 11 11
**. Correlation is significant at the 0.01 level (2-tailed).

Data for Shanghai province is collected from 'Shanghai Statistical Yearbook of Science and Technology 2000-2010' and 'Shanghai Statistical Year Book 2000-2010'. Similarly, Jiangsu province's data is collected from 'Jiangsu Statistical Yearbook of Science and Technology 2000-2010' and 'Jiangsu Statistical Year Book 2000-2010'. The significance of these data are all smaller than 0.01 and Person correlation are larger than 0.8, which means these four indicators have strong positive correlations with each other. Compared to the results getting from Zhejiang province's data, Shanghai almost owns the same condition that FDI and other two factors will affect innovation activities in a positive way. Referring to Figure 3, which is the analytical result of Jiangsu province. It delivers almost the same result with Shanghai and Jiangsu provinces. But can we just infer from these three perfect positive correlations that FDI will definitely facilitate innovation activity? The answer is 'no'. We can say that under specific situation FDI will adds some benefit for innovation, while other factors like cooperation' learning ability, foundation level of the domestic firm, type of technical skills transferred and so on.

' Conclusion

In conclusion, determinants of innovation output exist in several aspects, both for foreign and domestic firm. Firstly, if the skill gap between two firms is too large, it will be hard for a low-skilled firm to study advanced skills with weak foundation; secondly, learning capability is vital when there is knowledge spillovers, otherwise only the transfer of advanced machines and equipment is not equal to technology capability (Chen, 2007); thirdly, the domestic firm itself has to expose the potential to absorb the knowledge, that is because with lower openness the firm get no access to innovate itself. Local financial government should help to run external financing as it is difficult to utilize large amounts of foreign investment by company itself; fourthly, similar to the previous one, some foreign firms tend not to leak their core skills to competitors in order to own the advantage in the intense market (output value of technology skill is much higher than other kinds of industries). The aim of multinational cooperates setting up subsidiaries in other countries is to achieve higher economic profits. Then if there is any possibilities that by the way of transferring technology skills into other countries the parent cooperate may loose competitive power, they will behave more prudently to protect their core skill from imitation; fifthly, technology skills stands in different positions in all industries, i.e. technology is the crucial factor in chemical, pharmaceutical and aircraft industries so that MNEs in these areas may not want to expose their skills and it requires higher ability for local firms to learn from it. In conclusion, there exists 'threshold effect' for foreign investment utilization in every region. China as a developing country has weaker performance in human resource, economic environment and infrastructure compared to developed countries. Only if these three conditions are all over a certain level, foreign investment will be absorbed and utilized sufficiently.
Opening up strategy and attracting foreign investment are not the only ways to increase technological innovation ability. Marketization level and the speed of reformation also determine the regional innovation ability. The key point for innovation is the company's own driving force and capability to take full advantage of local resources and various technical resources. A mature market environment and a perfect management structure for innovation could lead innovation activity to an easier way. An area with high level of innovation ability will bring about prosperous economic development, and high level of regional GDP will add more opportunity for innovation industry.
Although the correlation of FDI and innovation activity is ambiguous, it is still meaningful to conduct some researches in specific areas to carry out implications for policy makers and government to amend plans. Innovation activity is essential for the regional economic development, government should notice the negative effects FDI fosters and take proper measures to manage foreign investment, considering like what kind of ratio is proper for FDI to account for in domestic usage. The importance of human capital is proved to be one of the key factors in innovation activity. In order to use human capital more reasonably and efficiently, there are some essential points to take care of, '1. Management system of human capital development has to be improved by government, and local companies should pay attention on guaranteeing workers' security system. The reason for noticing these is that foreign advanced technicians are not willing to stay in a company with low welfare guarantee. This group of high level labor cares not only economic output getting from working abroad, but also the perception of affiliation for the receiving company. With high utility of working abroad, more and more talented workers will choose to enter that company and create larger amount of economic benefits. 2. Domestic government should add more investment on education as education is the foundation for training advanced technical personnel. It is the essential solution for shortage of high standard level of human capital. 3. Enhance the communication between foreign and domestic funded enterprises and emphasize the horizontal cooperation between two kinds of enterprises. The government is bound to lead foreign and domestic enterprises to conduct direct project cooperation. Local company could ask foreign parent company for training labors in subsidiaries. Since financial crisis in 2008, investment environment all around the world is getting worse. Foreign investors tend to lose confidence in investing abroad as the increasing instability of economic situation. Under such condition, it is essential to investigate in FDI spillover by the view of financial development in order to know the effects on FDI skill spillover brought by financial development, which contributes to the analysis of technical innovation. With data collected, government should seize the chance to adjust financial policies for the purpose of raising effective utilization of FDI spillovers. Such measures benefit China from coping with financial crisis and keeping steady fast development of economy.

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