China – Access to Finance Crucial for Innovation Activities of Chinese Enterprises

China has become an important location for R&D and innovative activity by domestic enterprises at least since the mid-1990s. At the same time, China has become an important host country for inward foreign direct investment (FDI). Foreign investments, however, do not per se lead to higher innovation activities in the Chinese economy. It is access to finance which turns out to be an important issue for Chinese firms’ innovation activity, and their ability to benefit from inward FDI. Access to domestic financial resources, however, is a crucial issue mainly for private and collectively owned firms, less so for state-owned firms which are the beneficiaries from the current domestic state-dominated financial system. This discrimination points to an adverse effect of domestic credit constraints on firms’ ability to benefit from inward FDI. This is the main finding of a study conducted by Holger Görg of the Kiel Institute for the World Economy and his co-authors Sourafel Girma and Yundan Gong of the University of Nottingham. The study, which has been published as Kiel Working Paper No. 1400, “Foreign Direct Investment, Access to Finance, and Innovation Activity in Chinese Enterprises,” will be forthcoming soon in the World Bank Economic Review.

Using a comprehensive database of Chinese enterprises for the period 1999-2005, they conduct an empirical analysis that shows that Chinese credit and financial constraints limit the ability of Chinese private and collectively owned enterprises to benefit from inward FDI. State-owned enterprises, by contrast, apparently still enjoy preferential treatment by the domestic financial system; hence, access to finance does not provide a bottleneck to them.

Two of the usual benefits that accrue to enterprises from inward FDI are technology transfer and easier access to finance. There exists no big difference between state-owned and private or collectively owned Chinese enterprises with regard to increased innovation output if they invest in own R&D activities. But access to finance turns out to be irrelevant for state-owned firms both in utilizing new technologies and, particularly, in improving their credit opportunities. By contrast, this is an important channel through which FDI affects innovative activities of Chinese private and collectively owned firms. Thus, the differential access to finance between the state-owned enterprises and the private and collectively owned enterprises, i.e. the finance access privileges enjoyed by the state-owned enterprises, constitutes an impediment to innovation in China.

Kiel Working Papers

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