Outward FDI and domestic input distortions: evidence from Chinese Firms

Abstract

This paper studies how discriminations against private enterprises (i.e., non-state-owned enterprises or non-SOEs) in the domestic market affect .rms. investment and production strategies abroad. We first document three puzzling empirical findings using data on Chinese multinational companies (MNCs). First, private MNCs are less productive than state-owned MNCs. Second, SOEs are less likely to undertake FDI. Third, relative size of state-owned MNCs (compared with non-exporting or non-FDI firms) is larger than that of private MNCs. A theoretical model is built to rationalize these facts. The economic force is that distortions in the domestic input market incentivize private firms to invest and produce abroad, which results in less tougher self-selection into FDI for those .rms. Compared with state-owned MNCs, private MNCs allocate output disproportionately more in the foreign market, and their size increases disproportionately when they become MNCs. All such theoretical pre- dictions are strongly supported by the firm-level data of China.