16
Multinationals, Institutions and Economic Growth in China* Yi Che and Danny T. Wang Received 26 July 2010; Accepted 25 July 2012 This study examines the effects of multinationals and economic institutions on the economic growth of cities in China. Consistent with previous findings, the empiri- cal results suggest that property rights institutions are significantly more important than contracting institutions in promoting economic growth. The direct effect of multinationals on economic growth is generally insignificant statistically. However, a statistically significant and robust interaction effect exists between property rights institutions and multinationals on economic growth, whereas no such effect is observed between contracting institutions and multinationals. The results are attributable to the fact that multinationals can rely on reputation or personal connections to enforce contracts when contracting institutions are weak. However, it is difficult for multinationals to operate when the state expropriates their profits (i.e. property rights institutions are weak). Keywords: multinationals, property rights institutions, contracting institutions, economic growth. JEL classification codes: F21, O10. doi: 10.1111/asej.12001 I. Introduction Since the 1980s, multinational firms have played an increasingly prominent role in international business. Policy-makers in developing countries endeavour to attract multinationals through various incentives, such as low taxes. The under- lying belief that multinationals create spillovers and, therefore, can stimulate economic growth is an important reason for promoting them. The channels through which multinationals can affect economic growth are believed to include productivity gains, human capital turnover from foreign companies to domestic firms, the diffusion of technology, and the creation of a competitive environment to ‘push’ domestic firms to work harder (Wang and Wong, 2009; Sun, 2010). *Che (corresponding author): School of Business, University of Hong Kong, Pokfulam Road, Hong Kong. Email: [email protected]. Wang: Department of Marketing, School of Busi- ness, Hong Kong Baptist University, Kowloon Tong, Hong Kong. Email: [email protected]. We gratefully acknowledge the comments received from Zhigang Tao, Yi Lu, Managing Editor Julan Du, and anonymous reviewers of the Journal. The project was funded by a grant from the Research Grants Council of Hong Kong (GRF no. 752809) to the second author. Asian Economic Journal 2013, Vol. 27 No. 1, 1–16 1 © 2013 The Authors Asian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

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Page 1: Multinationals, Institutions and Economic Growth in China

Multinationals, Institutions and EconomicGrowth in China*

Yi Che and Danny T. Wang

Received 26 July 2010; Accepted 25 July 2012

This study examines the effects of multinationals and economic institutions on theeconomic growth of cities in China. Consistent with previous findings, the empiri-cal results suggest that property rights institutions are significantly more importantthan contracting institutions in promoting economic growth. The direct effect ofmultinationals on economic growth is generally insignificant statistically.However, a statistically significant and robust interaction effect exists betweenproperty rights institutions and multinationals on economic growth, whereas nosuch effect is observed between contracting institutions and multinationals. Theresults are attributable to the fact that multinationals can rely on reputation orpersonal connections to enforce contracts when contracting institutions are weak.However, it is difficult for multinationals to operate when the state expropriatestheir profits (i.e. property rights institutions are weak).

Keywords: multinationals, property rights institutions, contracting institutions,economic growth.

JEL classification codes: F21, O10.

doi: 10.1111/asej.12001

I. Introduction

Since the 1980s, multinational firms have played an increasingly prominent rolein international business. Policy-makers in developing countries endeavour toattract multinationals through various incentives, such as low taxes. The under-lying belief that multinationals create spillovers and, therefore, can stimulateeconomic growth is an important reason for promoting them. The channelsthrough which multinationals can affect economic growth are believed toinclude productivity gains, human capital turnover from foreign companies todomestic firms, the diffusion of technology, and the creation of a competitiveenvironment to ‘push’ domestic firms to work harder (Wang and Wong, 2009;Sun, 2010).

*Che (corresponding author): School of Business, University of Hong Kong, Pokfulam Road,Hong Kong. Email: [email protected]. Wang: Department of Marketing, School of Busi-ness, Hong Kong Baptist University, Kowloon Tong, Hong Kong. Email: [email protected]. Wegratefully acknowledge the comments received from Zhigang Tao, Yi Lu, Managing Editor Julan Du,and anonymous reviewers of the Journal. The project was funded by a grant from the Research GrantsCouncil of Hong Kong (GRF no. 752809) to the second author.

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Asian Economic Journal 2013, Vol. 27 No. 1, 1–16 1

© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

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However, whether and under what conditions multinationals can accelerateeconomic growth is still debated. Wang and Wong (2009) argue that multina-tionals can stimulate economic growth by improving the total factor productivityof domestic firms. Borensztein et al. (1998) hold that a minimum human capitallevel must exist in a host country before it can utilize the advanced technologythat multinationals make available. Much of this literature emphasizes how thecharacteristics of foreign firms affect their ability to contribute to growth. Otherstudies argue that host economy characteristics affect the ability of multinationalsto facilitate growth. For example, Alfaro et al. (2004) and Wang and Wong(2009) argue that growth effects of multinationals are stronger in countries withrelatively well-developed financial markets. Therefore, the capacity of a countryto take advantage of multinationals’ spillover appears to be contingent on its localconditions.

The primary purpose of the current study is to revisit the relationship betweenmultinationals and economic growth. Following Alfaro et al. (2004), the interac-tion between the growth effects of multinationals and local economic institutionsis examined. In the present study, property rights institutions and contractinginstitutions are the focus of the analysis, as proposed by Acemoglu and Johnson(2005). Because variables such as culture and social infrastructure are omitted incross-country analysis, the present work focuses on only one country (i.e. China)to alleviate related omitted variable biases.

The results indicate that property rights institutions are more important directdeterminants of economic growth than contracting institutions, which is consis-tent with previous findings (e.g. Acemoglu and Johnson, 2005). Moreover, thepresence of multinationals has a significant and positive effect on growth inChinese cities only when these cities have good property rights protection. Thisconclusion suggests that ensuring private property rights not only promoteseconomic growth directly, but also enhances the effect of multinationals oneconomic growth. In contrast, if establishing efficient contracting institutions iscostly, policy-makers can postpone the plan because contracting institutions havelittle effect on economic growth.

The remainder of this paper is organized as follows. Section II reviews therelated literature. Section III introduces the data and the variables used in thecurrent research. Section IV presents the methodology of the empirical analysis.In Section V, the primary results are reported and interpreted, and a robustnesscheck is performed. Section 6 provides a conclusion and discusses the implica-tions of the study.

II. Economic Growth in China’s Provinces and Cities

There is a growing consensus among economists that institutions are an importantfactor in economic growth (North, 1981). A large number of cross-country studiesdocument the importance of institutions for economic performance in cross-country studies (Acemoglu et al., 2001, 2002; Knack and Keefer, 1995; Hall and

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Jones, 1999; Mauro, 1995) and micro empirical investigations (Besley, 1995;Johnson et al., 2002). Although China is a unitary state with uniform de jure lawsacross the country, a wide variation of de facto institutional quality exists acrossregions (Du et al., 2008). Numerous studies documented the effect of de factoinstitutions on economic performance via various channels in China (Deiningerand Jin, 2003; Du et al., 2010a, 2010b). For example, using firm-level survey datafrom 18 cities in China, Lu et al. (2012) find that firm managers’ perception ofproperty rights protection has a positive and significant effect on firm laborproductivity and total factor productivity. The two-step generalized method ofmoment is used to show that this relationship is causal. More recently, through theuse of a more comprehensive dataset from 1998 to 2005, Che et al. (2011) showthat institutional quality, including property rights protection and contractenforcement, have positive and significant effects on new firms’ survival rate. Atthe household level, Jacoby et al. (2002) find that in rural China, households witha high risk of land expropriation and high tenure insecurity are less likely to investin fertilizers for farm use.

However, although institutions may be necessary to attract investment, alonethey may be insufficient. Firms in China tend to be capital scarce (Song et al.,2011). Thus, even with secure property rights, such firms may have nothing toinvest. It is under such conditions that multinationals with foreign capital becomean important factor in economic growth.

Several previous studies have considered the importance of multinationals foreconomic growth in the host country (Borensztein et al., 1998; Alfaro et al.,2004; Wang and Wong, 2009). For China, Wen (2007) examines the effect ofinteraction between the development of regional markets and foreign directinvestment on economic growth, and finds that in Eastern China, which has awell-developed market, foreign direct investment is more conducive to economicgrowth compared with other regions. Using a large panel of Chinese manufac-turing firms, Liu (2008) finds that foreign direct investment negatively affectsdomestic firm productivity in the short run (due to competition), but yields apositive effect in the long run (due to technology spillover). Overall, both eco-nomic institutions and multinationals appear to have contributed to the spectacu-lar economic growth in China.

The present study applies the growth model at the city level in China. Thus,reviewing relevant literature on China is of utmost importance. Lin (1992) usesprovince-level panel data to examine the effect of the 1978 policy reforms onagricultural growth in China. He finds that decollectivization and price adjust-ment had positive and significant effects on agricultural growth in China between1978 and 1984. Also using province-level panel data, Yao (2006) finds that tradeliberalization and foreign direct investment have positive effects on economicgrowth in China. Madariaga and Poncet (2007) use city-level panel data todetermine that foreign direct investment has positive and significant effects oneconomic growth. The panel data model can control for time invariant attributesat either the city or provincial level; hence, this type of analysis can improve the

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© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

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efficiency of the estimates. To date, no city level analysis has been conducted onthe interactions among multinationals, institutions and economic growth.

III. Data and Variables

The first dataset used in the current study is obtained from the China CityStatistical Yearbook. The dataset has been compiled every year since 1997 by theChinese Statistical Bureau City Survey Department. The yearbook recordseconomic and social activities at the city level, including those reflecting thepopulation, labor, geography, aggregate economic development, governmentexpenditure, industrial production, transportation status, environmental pollution,the education system and health infrastructure. Out of all 287 cities in China, 10small cities with notable missing data are omitted from the list, leaving 277 citiesfor analysis. The dependent variable used in the current study is the growth rateat the city level. According to Stock and Watson (2007), a log difference betweenthe GDP per capita of the current year and that of the previous year can be takenas a proxy for the GDP growth rate. For example, the growth rate of 2002 iscalculated as log (GDP2002) - log (GDP2001). In the current study, the growtheffect of multinational presence, measured as the share of foreign firms in the totaloutput of all firms in a city, is a key concern.1 This measure of foreign presenceincludes the shares of firms from Hong Kong, Macao and Taiwan and firms fromother foreign countries.

The second dataset is sourced from the annual China Regional MarketizationIndices (i.e. the Fan–Wang–Zhu index), developed by Fan et al. (2006). In themost recent version, from 2006, the standard of variable coding was changed;hence, for consistency, we draw data only from the 2001 to 2005 reports. The finaldataset, combining the China City Statistical Yearbooks and the China RegionalMarketization Indices, covers 277 cities from 2001 to 2005.

Before explaining the measures for property rights institutions and contractinginstitutions, definitions of the two concepts are provided. Following Acemogluand Johnson (2005), contracting institutions are defined as the rules and regula-tions governing contracts between ordinary citizens, who have no access topolitical power. The essence of contracting institutions is similar to the functionof a legal system, supporting private contracts in each city. When foreign firmsinvest in a city with weak contracting institutions, they may have difficultyenforcing a contract, and litigation may be very costly. In such cases, multina-tionals may not contribute significantly to the economic development of the city.Property rights institutions are defined as the rules and regulations that govern therelationship between the government or powerful elites and citizens in society. Incities with strong property rights institutions, rules and regulations provide acheck on government power, and protect private properties from expropriation byelites. If a city does not have strong protection for private property, and if elites

1 This formulation strictly follows the theoretical model of Borensztein et al. (1998).

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can easily expropriate the investments of foreign firms, such firms will have littlemotivation to invest. Thus, multinationals only play a minor role in promotingeconomic growth in these cities.

The Fan–Wang–Zhu index contains measures for contracting institutions andproperty rights institutions at the provincial level. Specifically, property rightsinstitutions are measured by the fraction of time that firm managers spend dealingwith government officials: for example, at social gatherings, dining out, or evenengaging in bribes (Li et al., 2006). A higher value for this variable is assumed toreflect weaker property rights institutions in the city, as the measure implicitlyconsiders the time firm managers need to build personal relationships with gov-ernment officials to gain protection and favors. As Fan et al. (2006) note, ifgovernment officials purposively delay procedures that are necessary for firmoperation (i.e. license registration), they, in fact, seek economic rent from thefirm. As a result, managers have to spend more time with government officials tosecure their property and maintain operations. For a robustness check, anothersub-index in the Fan–Wang–Zhu index is used: the ratio of extra-legal feesrequired by the government (tanpai in Chinese) to firm profit. Extra-legal non-taxfees do not reflect the will of the firm, but the government claims on firm profit;therefore, the ratio potentially captures the degree of expropriation by the gov-ernment. A higher ratio of average extra-legal non-tax fees to net profit results ina lower value of this sub-index, which, in turn, indicates a lower degree of privateproperty protection.

Contracting institutions are measured by the ratio of the number of lawyers tothe population in a given province. An increasing number of lawyers in a localitysuggests two things. First, this implies that a good contracting system exists, inthe sense that credit default or other inconsistent behavior violating the contractcan be effectively handled. Second, a large number of lawyers can only besustained when a good contracting system is in place. If no acceptable contractinginstitution exists in the local setting, economic agents would resort to third partiesor informal adjustments for inconsistent behaviors to the contract. Therefore, theratio of lawyers is considered an appropriate proxy for contracting institutions.For a robustness check, an alternative measure is constructed using the Survey ofChina’s Private Enterprises. The survey was jointly conducted by the UnitedFront Department of the Central Committee of the Communist Party of China andthe China Society of Private Economy at the Chinese Academy of Social Science.In the survey, a question on whether the owner of the firm would prefer to use thecourts to resolve business disputes is put forward, where 1 denotes an affirmativeanswer, and 0 denotes otherwise. Contracting institutions are constructed byaveraging the responses of firms at the provincial level, a measure that reflects thepercentage of firms with affirmative answers. Better contracting institutionsfacilitate the use of the courts as a way of resolving business disputes. Hence, ahigher value of this index indicates better contracting institutions in the province.This measure is consistent with previous research (Cull and Xu, 2005; Du et al.,2008). However, the survey data are only available for 2001, 2003 and 2005. No

MULTINATIONALS, INSTITUTIONS AND GROWTH IN CHINA 5

© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

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data are available for 2002 and 2004. To ensure that the alternative measure ofcontracting institutions is complete for the 2001–2005 period, the value for 2002is computed as the average of the 2001 and 2003 values, and the value for 2004as the average of the 2003 and 2005 values.2

Table 1 provides key descriptive statistics of the 15 lowest/fastest growingcities. Rows 1 to 15 correspond to cities with the lowest average growth rate over

2 The central government controls all 31 provinces and four municipal cities (i.e. Beijing, Shanghai,Tianjin and Chongqing). Every province comprises prefectures, and every prefecture or municipalitycan be divided into urban districts and rural counties. The present sample includes the urban directdistrict.

Table 1 Descriptive statistics of 30 cities

Growthrate

Property rightsinstitutions

Contractinginstitutions

Multinational outputover total output

Shantou -0.069 1.976 2.954 0.402Haikou -0.026 3.948 1.684 0.209Jiangmen -0.021 1.976 2.954 0.487Putian -0.015 4.618 1.722 0.618Yuxi -0.002 8.182 0.994 0.054Huaian 0.004 3.860 1.776 0.096Dongguan 0.007 1.976 2.954 0.823Zhuhai 0.017 1.976 2.954 0.752Jingmen 0.022 7.046 0.982 0.034Suqian 0.025 3.860 1.776 0.044Huizhou 0.029 1.976 2.954 0.923Quzhou 0.033 5.322 2.482 0.021Quanzhou 0.037 4.618 1.722 0.442Daqing 0.039 9.350 1.506 0.009Zhumadian 0.041 8.560 0.766 0.062Simao 0.230 8.182 0.994 0.124Guyuan 0.232 7.596 2.110 0Meizhou 0.234 1.976 2.954 0.102Zhangjiajie 0.237 8.662 1.044 0.028Zhongwei 0.238 7.596 2.110 0Heyuan 0.266 1.976 2.954 0.694Baotou 0.269 8.740 1.432 0.048Erdos 0.270 8.740 1.432 0.613Jinchang 0.280 9.594 0.656 0Hohhot 0.284 8.740 1.432 0.170Jiayuguan 0.287 9.594 0.656 0.001Luliang 0.291 8.496 1.528 0Yan’an 0.329 4.916 1.320 0Longnan 0.363 9.594 0.656 0Qingyang 0.387 9.594 0.656 0.002

Notes: Rows 1 to 15 correspond to cities with the lowest average growth rates over the sample period,whereas rows 16 to 30 correspond to cities with the fastest growth rates.

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© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

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the sample period, whereas rows 16 to 30 correspond to cities with the fastestgrowth rate. The table shows that the fastest growing city, Qingyang, has thehighest score for property rights institutions (9.594). However, the scores forcontracting institutions and multinational output (MO) are quite low (0.656 and0.002, respectively). In contrast, in the lowest growing city, Shantou, the propertyrights institutions’ score is quite low (1.976). In contrast, the scores for contract-ing institutions and MO are rather high (2.954 and 0.402, respectively). A positiverelationship apparently exists between property rights institutions and economicgrowth, but not between contracting institutions or MO and economic growth. Toverify whether this pattern persists after controlling for other factors affectingeconomic growth, a regression analysis is employed in the next section.

IV. Methodology

The economic relationship under investigation can be written as

log( ) logy y y P C P F C F Fit it it it it it it it it− −= + + + + +1 1 1 2 3 4 5 6β β β β β β iit it

i t it

X+ ′+ + +

αλ γ ε , (1)

where yit is the GDP per capita in city i in year t. The log difference between yit andyit-1 represents the growth rate in year t. To eliminate concerns regarding theomitted variable bias, which could result in spurious correlation, the usualcovariates are included in the growth model. Specifically, the initial level of percapita GDP in the city log yit-1 is first incorporated because regions with low levelsof development are known to catch up more quickly. This condition implies anegative effect of the initial GDP level on the economic growth rate (Barro, 1991).In addition, ′Xit denotes other conventional covariates in the model, including thephysical investment ratio (Solow, 1956), government expenditure (Mankiw et al.,1992) and human capital (Barro, 1997), whereas a is a vector of coefficient ofall covariates.

The variables of interest, Pit and Cit, represent the level of property rightsinstitutions and contracting institutions, respectively, of city i in year t. Fit is theratio of MO to total output of city i in year t. The effect of multinationals oneconomic growth is still under debate; thus, the primary interest of the currentwork is on the interaction term between multinationals and local economicinstitutions. More specifically, PitFit denotes the interaction term between prop-erty rights institutions and the MO of city i in year t, whereas CitFit denotes theinteraction term between contracting institutions and the MO of city i in year t.

Possibly, the city fixed effect, li, may correlate with multinationals, economicinstitutions and city economic growth. Therefore, the difference of Equation 1 isfirst taken to eliminate li. yit-3 is then used as an instrument for (yit-1 - yit-2) tocontrol for dynamic bias. This formula is known as the Anderson and Hsiao(A–H) model (Nichell, 1981; Anderson and Hsiao, 1982).

MULTINATIONALS, INSTITUTIONS AND GROWTH IN CHINA 7

© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

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Potential problems may emerge out of this application.3 The present resultsindicate that in the short run (e.g. 2001 to 2005) MO has a positive effect oneconomic growth only in cities with good property rights institutions. However,in the long run, both property rights institutions and contracting institutions arelikely to play important roles in the multinational production process. This con-dition is especially true when multinationals require long-term and multi-agentcontracts. Therefore, caution needs to be exercised when extending the currentresults to the long run.

V. Empirical Results

V.1 Main results

Table 2 reports the main results for the relationships among institutions, multi-nationals and economic growth. Columns 1–3 present the results of the two-wayfixed effect models which control for both city and year fixed effects. Fixed effectmodels may suffer from dynamic panel bias, resulting in biased coefficients ofinterest. Thus, the A–H models are used (Anderson and Hsiao, 1982). The resultsare presented in columns 4 to 6. Variables are included step by step for eachmodel: economic institutions first, followed by multinationals and, finally, theinteractions between economic institutions and multinationals. In all model speci-fications, all control variables, human capital, physical investment and govern-ment expenditure are included. All standard errors in Table 2 are robust toarbitrary heteroskedasticity, and they are clustered at the city level, which is alsorobust against serial correlation within cities.

The baseline results in Table 2 confirm that property rights institutions aresignificantly more important than contracting institutions in promoting economicgrowth. The results show that property rights institutions have positive andstatistically significant (at 0.01 levels) effects on economic performance, whereascontracting institutions do not register any significant effect. Interestingly, whencontrolling for the dynamic panel bias, the coefficient of property rights institu-tions further increases by approximately 50 percent (from 0.008 in column 3 to0.014 in column 6), suggesting that the dynamic panel bias may, indeed, be aconcern in ordinary two-way fixed effect models.

Although statistically significant, the effect of property rights institutions oneconomic performance is quantitatively small. For example, if the value of theproperty rights of Bengbu (a small and underdeveloped city in Anhui Province) isenhanced to the level of Beijing in 2001, the coefficient in column 6 of Table 2suggests that only 12.5 percent of the variation can be explained by the change inper capita GDP (standard error is 0.005). Considering that a dynamic model is

3 The most important limitation of this study is in the application of a model that is often used todescribe long-term economic growth patterns (e.g. growth over 10-year periods) to annual data. Whenapplying a standard Barro-type model for the period 2001 to 2005, the primary results becameunstable. These results are available upon request.

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Tab

le2

Mai

nem

piri

cal

resu

lts

(per

iod:

2001

to20

05)

(1)

(2)

(3)

(4)

(5)

(6)

Fix

edF

ixed

Fix

edA

–HA

–HA

–H

Log

GD

Ppe

rca

pita

t-1

-0.6

13**

*-0

.587

***

-0.5

85**

*-0

.832

***

-0.7

26**

*-0

.716

***

(0.0

38)

(0.0

40)

(0.0

40)

(0.1

73)

(0.1

68)

(0.1

68)

Pro

pert

yri

ghts

inst

itut

ions

t0.

005

0.00

6*0.

007*

*0.

007

0.00

9*0.

010*

*(0

.003

)(0

.003

)(0

.003

)(0

.005

)(0

.005

)(0

.005

)C

ontr

acti

ngin

stit

utio

nst

0.01

70.

019

0.01

40.

050

0.05

00.

040

(0.0

19)

(0.0

20)

(0.0

23)

(0.0

32)

(0.0

34)

(0.0

42)

Phy

sica

lin

vest

men

t t-0

.086

**-0

.037

-0.0

37-0

.179

***

-0.1

38**

*-0

.140

***

(0.0

33)

(0.0

36)

(0.0

36)

(0.0

43)

(0.0

45)

(0.0

45)

Gov

ernm

ent

expe

ndit

ure t

-1.6

01**

*-2

.126

***

-2.1

38**

*-2

.059

***

-1.9

03**

*-1

.899

***

(0.1

99)

(0.2

55)

(0.2

55)

(0.2

84)

(0.3

26)

(0.3

26)

Hum

anca

pita

l t0.

025

0.02

30.

025

0.05

6**

0.04

60.

051*

(0.0

23)

(0.0

23)

(0.0

23)

(0.0

28)

(0.0

30)

(0.0

30)

Mul

tina

tion

alou

tput

t(M

O)

0.04

10.

053

0.12

90.

171*

(0.0

70)

(0.0

71)

(0.0

91)

(0.0

97)

MO

*Pro

pert

yin

stit

utio

nst

0.01

50.

033*

(0.0

14)

(0.0

19)

MO

*con

trac

tIn

stit

utio

nst

0.01

60.

066

(0.0

44)

(0.0

95)

Obs

erva

tion

s10

4693

993

978

371

771

7N

umbe

rof

citi

es27

727

727

727

727

727

7R

20.

370.

370.

38

Not

es:

Rob

usts

tand

ard

erro

rsar

een

clos

edin

pare

nthe

ses.

The

depe

nden

tvar

iabl

eis

the

econ

omic

grow

thra

te.C

olum

ns1

to3

repo

rtth

efi

xed

effe

ctm

odel

resu

lts.

Col

umns

4to

6pr

esen

tre

sult

sof

the

And

erso

nan

dH

siao

(198

2)(A

–H)

mod

el.Y

ear

fixe

def

fect

sar

ein

clud

edin

all

regr

essi

ons.

Ato

tal

of27

7ci

ties

and

a5-

year

obse

rvat

ion

peri

odw

ere

used

.Obs

erva

tion

sin

the

sam

ple

are

277

*5

=13

85.A

lag

ofth

eon

e-pe

riod

log

ofG

DP

per

capi

tais

incl

uded

inth

efi

xed

effe

ctm

odel

,so

obse

rvat

ions

inye

ar20

01ar

eex

clud

ed(i

.e.

nola

glo

gof

GD

Ppe

rca

pita

can

beus

edfo

rob

serv

atio

nin

2001

).M

oreo

ver,

this

pane

lis

unba

lanc

edin

the

sens

eth

ata

num

ber

ofva

riab

les

have

mis

sing

valu

esin

the

orig

inal

city

stat

isti

caly

earb

ook.

Thu

s,ob

serv

atio

nsw

ith

mis

sing

valu

esar

eex

clud

edin

the

regr

essi

on.T

heov

eral

lsa

mpl

esi

zein

colu

mns

4to

6is

smal

ler

than

that

inco

lum

ns1

to3

beca

use

inth

eA

–Hm

odel

,ado

uble

lag

log

ofG

DP

per

capi

tais

used

asan

inst

rum

entt

oob

tain

the

firs

tdif

fere

nce

ofth

ela

glo

gof

GD

Ppe

rca

pita

inth

eci

ty.T

hus,

obse

rvat

ions

inye

ar20

01an

d20

02ar

eex

clud

edin

colu

mns

4to

6.In

colu

mns

2an

d3

and

5an

d6,

MO

isad

ded

inth

ere

gres

sion

.M

Oha

sm

issi

ngva

lues

.H

ence

,ob

serv

atio

nsar

efu

rthe

rex

clud

edin

colu

mns

2an

d3

and

colu

mns

5an

d6,

resp

ecti

vely

.**

*,**

and

*re

pres

ent

sign

ifica

nce

atth

e1,

5an

d10

%le

vel,

resp

ecti

vely

.

MULTINATIONALS, INSTITUTIONS AND GROWTH IN CHINA 9

© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

Page 10: Multinationals, Institutions and Economic Growth in China

employed, this effect can be estimated in the long run in the sense that per capitaGDP in the current period is affected by that in the previous period.4

More importantly, the interaction term of multinationals and property rightsinstitutions is found to exert a positive and significant effect (b = 0.037, with arobust standard error of 0.02), and the interaction between multinationals andcontracting institutions has an insignificant effect (b = 0.117, with a robuststandard error of 0.099). Moreover, the coefficient of interaction between prop-erty rights institutions and multinationals is almost three times the coefficient ofproperty rights institutions alone. In the cases of Bengbu and Beijing, the varia-tion in the interaction with property rights institutions explains approximately50 percent of the variation in per capita GDP in the long run. At the same time,no significant effect of multinationals on economic growth is observed. Thisfinding suggests that the effect of multinationals on city economic growth isprimarily contingent on the level of property right institutions.

Following the work of Barro (1991) and to provide a clearer illustration, theeffects of property rights institutions and their interaction with multinationals areshown in Figures 1 and 2. Figure 1 shows the partial association between GDP

4 This result indicates that the increase of GDP per capita attributable to property rights institutionswill also affect future economic performance in the city. If the period reaches infinity, the dynamiclong-run effect of property rights institutions on economic performance can be obtained.

Figure 1 Economic growth and the interaction between property rights institutions andmultinational output

–2–1

01

2E

cono

mic

gro

wth

0 2 4 6Interaction of property rights institutions and foreign direct investment

ASIAN ECONOMIC JOURNAL 10

© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

Page 11: Multinationals, Institutions and Economic Growth in China

growth and the interaction between property rights institutions and multination-als. The y-axis is the predicted residual of economic growth less the interactionterm, and the x-axis is the interaction between property rights institutions andmultinationals. Figure 1 clearly shows the explanatory power of the interactionbetween property rights institutions and multinationals on economic growth. InFigure 2, the y-axis is a predicted residual of economic growth without consid-ering property rights institutions, whereas the x-axis represents the level ofproperty rights institutions alone. Comparing Figures 1 and 2, the explanatorypower of the interaction between multinationals and property rights institutions isobserved to be significantly greater than the primary effect of the institutionsalone.

The empirical results suggest that property rights institutions have a first-ordereffect on economic growth, which is consistent with previous findings (Acemogluand Johnson, 2005). More importantly, an interaction effect is observed betweenproperty rights institutions and multinationals, whereas no such effect can be seenbetween contracting institutions and multinationals. A plausible reason may bethat foreign firms find it easy to change contract terms and rely on reputation todeal with contract disputes when contracting institutions are weak. However, theyhave no incentive to invest when they know that their profits cannot be effectivelyprotected.

Figure 2 Economic growth and property rights institutions

–2–1

01

2E

cono

mic

gro

wth

0 5 10 15Property rights institutions

MULTINATIONALS, INSTITUTIONS AND GROWTH IN CHINA 11

© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

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V.2 Robustness check

In this subsection, the robustness of the current results to alternative measures forproperty rights institutions and contracting institutions, and to subsamples isvalidated.

Table 3 provides the results generated using alternative measures of propertyrights institutions and contracting institutions. A significant and positive interac-tion is observed between property rights institutions and multinationals; however,no such effect exists between contracting institutions and multinationals. Theresults based on alternative measures of economic institutions confirm the robust-ness of the primary results.

Table 4 provides the fixed effect results after removing regions (e.g. Jiangsuand Zhejiang), where industries are characterized by large intermediate consump-tion. As the output measure of foreign direct investment is used, industries withlarge intermediate consumption may confound the results. However, the primaryresults still hold in Table 4. A significant and positive effect of interactionbetween MO and property rights institutions is found, whereas no such interactioneffect between MO and contracting institutions exists.

The main effect of MO on economic growth is noticeably unstable, but sig-nificant in Tables 2 and 4. However, the result becomes insignificant in Table 3.These results suggest that the main effect of multinationals is inconsistent andtrivial, whereas its interaction with property rights institutions is a more importantfactor in determining economic growth.

VI. Summary and Concluding Remarks

This study has revisited the relationship between multinationals and economicgrowth in Chinese cities. Specifically, it has explored the effects of economicinstitutions (i.e. property rights institutions and contracting institutions) onthe interaction between multinationals and economic growth (Acemoglu andJohnson, 2005). The following issues have been empirically examined: (i) thetype of institution that is more important for economic growth; and (ii) the meansby which to channel multinationals for efficient use.

We find that property rights institutions, which shape the incentives for invest-ment by economic actors, have a first-order effect, whereas contracting institu-tions have a minimal effect on economic performance across Chinese cities.This finding is consistent with empirical evidence from cross-country studies(Acemoglu and Johnson, 2005). Multinationals also promote economic growth.However, the main effect is unstable and varies across different model specifi-cations. The most interesting finding in the study is that property rights institu-tions efficiently channel multinationals to promote local economic growth. Interms of contracting institutions, because economic actors are able to find otheravenues (e.g. relying on reputation and personal connections to compensate forthe weak contracting environment), both its main effects and its interaction withmultinationals are insignificant.

ASIAN ECONOMIC JOURNAL 12

© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

Page 13: Multinationals, Institutions and Economic Growth in China

Tab

le3

Em

piri

cal

resu

lts

wit

hal

tern

ativ

em

easu

res

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onom

icin

stit

utio

ns(p

erio

d:20

01to

2005

)

(1)

(2)

(3)

(4)

(5)

(6)

Fix

edF

ixed

Fix

edA

–HA

–HA

–H

Log

GD

Ppe

rca

pita

t-1

-0.6

22**

*-0

.602

***

-0.6

02**

*-0

.881

***

-0.7

66**

*-0

.774

***

(0.0

38)

(0.0

40)

(0.0

40)

(0.1

73)

(0.1

69)

(0.1

61)

Pro

pert

yri

ghts

inst

itut

ions

t0.

013*

**0.

013*

**0.

010*

*0.

018*

**0.

014*

*0.

006

(0.0

04)

(0.0

05)

(0.0

05)

(0.0

07)

(0.0

07)

(0.0

07)

Con

trac

ting

inst

itut

ions

t-0

.030

-0.0

36-0

.036

-0.0

47*

-0.0

37-0

.017

(0.0

22)

(0.0

22)

(0.0

26)

(0.0

26)

(0.0

28)

(0.0

28)

Phy

sica

lin

vest

men

t t-0

.111

***

-0.0

61*

-0.0

58-0

.206

***

-0.1

67**

*-0

.029

(0.0

33)

(0.0

36)

(0.0

36)

(0.0

42)

(0.0

45)

(0.0

46)

Gov

ernm

ent

expe

ndit

ure t

-1.5

94**

*-2

.129

***

-2.1

71**

*-2

.093

***

-1.9

15**

*-2

.023

***

(0.1

98)

(0.2

54)

(0.2

55)

(0.2

84)

(0.3

27)

(0.3

43)

Hum

anca

pita

l t0.

024

0.02

40.

025

0.05

6**

0.05

0*0.

049*

(0.0

22)

(0.0

23)

(0.0

23)

(0.0

28)

(0.0

29)

(0.0

28)

Mul

tina

tion

alou

tput

t(M

O)

0.02

7-0

.015

0.10

30.

059

(0.0

70)

(0.0

77)

(0.0

93)

(0.0

95)

MO

*pro

pert

yin

stit

utio

nst

0.01

10.

017*

(0.0

10)

(0.0

09)

MO

*con

trac

tin

stit

utio

nst

-0.0

20-0

.248

(0.0

96)

(0.2

13)

Obs

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s10

4693

993

978

371

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ofth

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colu

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and

colu

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sion

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has

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es.H

ence

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sar

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rex

clud

edin

colu

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and

colu

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and

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nce

atth

e1,

5an

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%le

vel,

resp

ecti

vely

.

MULTINATIONALS, INSTITUTIONS AND GROWTH IN CHINA 13

© 2013 The AuthorsAsian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

Page 14: Multinationals, Institutions and Economic Growth in China

The results once again point to the importance of developing strong propertyrights institutions across China. Specifically, securing private property rights canbe an effective strategy to better utilize multinationals and to promote the localeconomy.5 In terms of contracting institutions, because establishing a sound legalsystem takes a long time, substitutes of contracting institutions exist in Chinesesociety (e.g. guanxi) and the role of such institutions in promoting economicdevelopment is relatively minor, policy-makers should prioritize the develop-ment of property rights institutions. The present study also provides a plausibleexplanation for why China can be prosperous without democracy. Although theChinese Communist Party dictates policies, its emphasis on protecting privateproperty rights can provide incentives for domestic and foreign investors, thusresulting in economic growth (Glaeser et al., 2004).

Although this study used several robustness checks, problems due to omittedvariables still exist (Acemoglu et al., 2009, 2011). For example, foreign direct

5 Previous studies have often focused on the important role of human capital and financial marketsin absorbing multinationals and enhancing economic development where property rights institutionsare largely overlooked.

Table 4 Empirical results without industries with heavy intermediate consumption

Period: 2001 to 2005

Log GDP per capitat-1 -0.716***(0.168)

Property rights institutionst 0.010**(0.005)

Contracting institutionst 0.040(0.042)

Physical investmentt -0.140(0.045)

Government expendituret -1.899***(0.326)

Human capitalt 0.051*(0.030)

Multinational firm outputt (MO) 0.171*(0.097)

MO*property institutionst 0.033*(0.019)

MO*contract institutionst 0.066(0.095)

Observations 717Number of cities 287R2 0.39

Notes: Fixed effect model results are reported without industries with heavy intermediate consump-tion. Robust standard errors are enclosed in parentheses. The dependent variable is theeconomic growth rate. ***, ** and * represent significance at the 1, 5 and 10% level,respectively.

ASIAN ECONOMIC JOURNAL 14

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investment might introduce an aspect of a foreign culture (e.g. hard work) to thehost city. If this ‘culture of hard work’ variable, which is time varying, is omitted,the empirical results would be biased upward. This is acknowledged to be apotential weakness of the current study. Future studies can explore suitableinstrumental variables and use better identification strategies to extend research inthis area. Moreover, given the methodological drawback in the current study, thestandard Barro-type growth model should be applied in future work when long-term data at the city level are available.

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