Urban innovation, regional externalities of foreign direct investment and industrial agglomeration: Evidence from Chinese cities

This paper examines how urban industrial agglomeration interacts with the intra- and inter-regional externalities resulting from foreign direct investment (FDI) in city innovation in an emerging economy. It adds to the existing literature by highlighting the importance of considering both spatial proximity and urban industrial structures in understanding FDI knowledge spillovers in urban areas. Using a unique and manually collected city-level dataset for the period from 2005 to 2011 in China, our empirical results confirm the role of FDI as an important external knowledge source in the context of a developing country. The spatial externalities of FDI, however, are limited to the city of investment. We further show that FDI spatial spillovers are contingent upon the intensity of industrial agglomeration within and across cities. Specialized industrial structures absorb FDI knowledge spillovers within the cities and also facilitate their dissemination to nearby cities, while diversified ones provide a vibrant environment for local innovation. Our empirical evidence has important implications for both theories and policy making.