The Role of Foreign Direct Investment as an Instrument in Enhancing Manufacturing Productivity: Evidence from Chinese Provinces

Since productivity has been proposed as a prime determinant of the countrys prosperity, and with the increased research and development (R& D), and the knowledge flows from high-tech manufacturing firms, China has experienced a considerable period of development in manufacturing industrial structure, which had affected the country growth overall. However, because previous studies have not settled the relationship between foreign direct investment (FDI) and productivity in a robust and consistent manner. This study will try to resolve the dispute by analyze the indirect relation between FDI and the manufacturing industrial productivity through R& D, using two-stage least squares (2SLS) that helps to overcome the correlation problem of the independent variables with the error term by using the instrumental variable i. e. (FDI). By employing a provincial data from the National Bureau of Statistics of China on manufacturing industry from 2008 to 2016, we were able to find that FDI flows into China has increased the competitiveness in the Chinese market, prompting industrial firms to invest more in R& D particularly in the labor-intensive provinces. On the other hand, we have noted that the increased expenditure in R& D is no longer sufficient to spur productivity growth and confront strong competition, especially since the manufacturing market has reached an advanced level of development, it is necessary to promote creativity and innovation more effectively, in addition, to improve the production methods rather than only increasing the production quantity.