New research shows that on average privately owned Chinese manufacturing multinational companies are less productive than those that are in the hands of the state. This is despite private non-multinational manufacturing companies being on average more productive than state owned ones.

This is the findings of research by Cheng Chen, Wei Tian and Miaojie Yu published in the November 2019 issue of The Economic Journal, which investigates the production and investment strategies of China’s manufacturing multinational companies.

They also show that compared to private firms, the number of firms that undertake outward financial direct investment is smaller among state owned enterprises. What’s surprising about this is that state owned enterprises are much larger than private firms in China, and larger firms are more likely to become multinational companies. They also receive substantial support from the Chinese government to invest abroad.

To understand these findings, the researchers build a model to highlight two economic forces determining outward foreign direct investment: institutional arbitrage and selection reversal. They assume that private firms pay a higher rental price on land when producing domestically, compared with state owned companies. Similarly, all firms pay the same prices on inputs when they produce abroad.

The model shows that Chinese private firms pay higher costs when borrowing money and renting land in the domestic market, as a result of government intervention in financial markets and the national ownership of land in China. However, when private firms produce abroad, at least a part of the gap in input price ceases to exist as the financial and land markets in foreign economies are not controlled by the Chinese government.

As a result of this, there is an extra incentive for private firms to go and produce abroad, since they can circumvent the input market distortion that exists only domestically by becoming multinational companies (institutional arbitrage). Since they receive an extra benefit by producing abroad, the incentive of becoming a multinational company is higher to them. This leads to less selection into the outward foreign direct investment market for private firms (selection reversal). This explains why there are disproportionately fewer multinational companies among state owned enterprises than among private firms and why private multinationals are less productive than state owned ones.

Outward FDI and Domestic Input Distortions: Evidence from Chinese firms’ by Cheng Chen, Wei Tian and Miaojie Yu is published in the November 2019 issue of The Economic Journal

Cheng Chen

Associate Professor at Department of Economics at Clemson University

Miaojie Yu

Professor at China Center for Economic Research (CCER), National School of Development, Peking University