Quid Pro Quo, Knowledge Spillover, and Industrial Quality Upgrades: Evidence from the Chinese Auto Industry

This paper studies the impact of FDI via quid pro quo (technology for market access) in facilitating knowledge spillover and quality upgrades. Our context is the Chinese auto- mobile industry, where foreign automakers are required to set up joint ventures (the quid) with domestic automakers in return for market access (the quo). The identification strategy exploits a unique dataset of detailed vehicle quality measures along multiple dimensions and relies on within-product quality variation across dimensions. We show that affiliated do- mestic automakers, compared to their nonaffiliated counterparts, adopt more similar quality strengths of their joint venture partners. Quid pro quo generates knowledge spillover to affiliated domestic automakers in addition to any industry-wide spillover. We rule out al- ternative explanations involving endogenous joint venture network formation, overlapping customer bases, or direct technology transfer via market transactions. Analyses leveraging additional micro datasets on worker flows and upstream suppliers demonstrate that labor mobility and supplier networks are important channels mediating knowledge spillover. Fi- nally, we estimate an equilibrium model for the auto industry and quantify the impact of quid-pro-quo-induced quality upgrading on domestic sales and profits. Quid pro quo im- proved the quality of affiliated domestic models by 3.8-12.7% and raised their sales (profit) by 0.9-3.9% (1.02-3.49%) between 2007 and 2014 relative to unrestricted FDI.