Geographical proximity, foreign presence and domestic firm innovation: the micro-level evidence

ABSTRACTThe question as to whether foreign presence benefits or harms domestic firm innovation is yet to reach a definitive answer. This paper provides micro-level evidence to shed light on this topic. By incorporating insights from economic geography into the literature on foreign presence, we developed a geography-based foreign presence, defined as foreign presence weighted by geographical proximity between a focal domestic firm and each foreign firm in the same region. Based on theoretical reasoning and informed by the literature on geographical proximity and foreign presence, we proposed an inverted 'U'-shaped relationship between a domestic firm's geography-based foreign presence and its innovation performance in the context of the world's largest emerging economy, China. We argue that such a relationship is steepened for domestic state-owned firms and when the foreign firms within the region present a high level of innovation performance. By analysing a sample of Chinese firms in manufacturing industries between 1998 and 2014, we found support for our propositions.KEYWORDS: foreign presenceemerging marketgeographical proximityforeign direct investment spilloverinnovation performanceJEL: F23O30R12 DISCLOSURE STATEMENTNo potential conflict of interest was reported by the authors.Notes1. Notably, research has shown that strong foreign firms tend to avoid agglomeration with domestic firms, resulting in weak domestic firms having limited opportunities to locate closely to and learn from them (Alcacer & Chung, Citation2007; Mariotti et al., Citation2019; Shaver & Flyer, Citation2000). However, this explanation may not fully apply in our context, as domestic firms have greater freedom to choose their locations compared with foreign firms, which often face more regulatory constraints in their location decisions (Hu et al., Citation2021). Also, substantial evidence indicates that foreign firms in China generally possess more advanced technologies than the majority of domestic firms (e.g., Li et al., Citation2018). Additional informationFundingThis study was supported by the Shandong Provincial Natural Science Foundation for Excellent Young Scholars [grant number 2023HWYQ-090]; and the National Natural Science Foundation of China (NSFC) [grants numbers 71902117 and 72072160].