FDI, Trade, and Product Innovation: Theory and Evidence

[Acknowledgment]

We thank John Pepper (Co-Editor) and three anonymous referees for their valuable comments on earlier drafts of this article. We are also grateful for the financial support from the National Science Council of Taiwan in the form of grants NSC 95-2415-H-002-011 (Hui-lin Lin) and NSC 96-2415-H-007-009-MY2 (Eric S. Lin).

1. Introduction

The current trend toward globalization has greatly increased the frequency of cross-border investments and international trade. For example, the amount of inward foreign direct investment (inward FDI) approved by the Investment Commission of the Ministry of Economic Affairs in Taiwan from 1991 to 2000 has had an average annual growth rate of 24.12%, which indicates that the local market actively uses the inward FDI. The amount of the approved outward FDI has shown an even higher average annual growth rate of 46.24% over the same period of time, which indicates that local firms are actively investing in foreign markets. According to the Taiwan Statistical Data Book 2008, the average growth rates of exports and imports from 1991 to 2000 were 8.28% and 9.79%, respectively, representing the prevalence of international trade. The competition generated by these cross-border investments and trade has been highly influential in shaping the innovative activities of firms (Jacquemin 1982; Cave 1985; Kumar and Siddharthan 1994; Bertschek 1995; Coe and Helpman 1995; Wagner 1995). Typically, there are two kinds of competition: One is generated by the entry of domestic firms into foreign markets and the other by the entry of foreign firms into domestic markets. The former takes the form of outward FDI and exports, while the latter takes the form of inward FDI and imports. Many studies have examined the effect of inward FDI and imports on firm innovation, such as those of Zimmermann (1987), Veugelers and Houte (1990), Scherer and Huh (1992), Bertschek (1995), Co (2000), and Lofts and Loundes (2000). The authors of these studies find that inward FDI and imports can enhance competition and accelerate the process of innovation in the local manufacturing industry. However, only a few studies discuss the influences of outward FDI and exports on innovative activities. Lin and Yeh (2004) find that outward FDI and exports have a complementary...