FDI Spillovers and Industrial Policy: The Role of Tariffs and Tax Holidays

Abstract

This paper examines how industrial policy – specifically tariff liberalization and tax subsidies – affects the magnitude and direction of FDI spillovers. We examine these spillover effects across the diverse ownership structure of China’s manufacturing sector. Using this approach, we control for policies that are likely to be correlated with both firm-level productivity and industry FDI, thereby limiting the problem of omitted variables and bias associated with estimating the impacts of FDI spillovers. During 1998-2007, the span of our Chinese firm-level data set, both tariffs and FDI tax holidays changed dramatically. Our results highlight the efficacy of vertical FDI spillovers. We find that tariff reforms, particularly tariff reductions associated with China’s WTO ascension, increased the productivity impacts of FDI’s backward spillovers. Tax policy – both corporate income and VAT subsidies – has seemingly drawn FDI into strategic industries that spawn significant vertical spillovers. We conclude that liberalization measures during the critical 1998-2007 period on balance served to enhance productivity growth in Chinese industry.