Perspectives on ChinaTHE PAST SEVERAL DECADES have witnessed significant liberalization among developing economies to foreign trade and investment, as advocated by international organizations. Nevertheless, for strategic reasons, emerging economies such as China, India, and Brazil continue to impose considerable restrictions on foreign direct investment (FDI) in certain sectors. One such policy is quid pro quo (technology for market access), which requires multinational firms to form joint ventures (JVs) with domestic firms, often with a significant cap on foreign equity, in return for access to the host country’s domestic market. While the joint venture requirement more directly exposes firms in developing countries to foreign technology, multinational firms consider it a form of coerced technology transfer and a significant barrier to investing in developing countries. Quid pro quo lies at the forefront of the U.S.-China trade debate, and concern over this policy was a key stated justification for the Trump administration’s decision to impose tariffs on $50 billion worth of Chinese imports in 2018.

Despite the historical and contemporary relevance of quid pro quo and these recent controversies, little is known about its benefits to the host country over a policy of unrestricted FDI. In a recent paper, I and coauthors study the importance of the joint venture requirement under quid pro quo in facilitating knowledge spillover from foreign to domestic firms. Our context is the Chinese automobile industry, where quid pro quo was first introduced in the country, eventually becoming a major industrial policy. Foreign automakers are required to set up joint ventures (the quid) with domestic automakers to produce and sell cars in China (the quo). A fixed cap of 50% is imposed on the foreign ownership share, and it is binding in all cases. China has had the largest automobile market in the world since 2009. All major multinational automakers compete in this large market, including 23 joint ventures (e.g., BMW–Brilliance), 12 domestic automakers that are affiliated with the joint ventures but have independent production (e.g., Brilliance Auto), and seven domestic automakers with no joint venture affiliation (e.g., BYD).

Jie Bai

“Has the ownership affiliation stipulated under the quid pro quo policy been effective in inducing knowledge spillover from foreign automakers to domestic automakers?”

Jie Bai

The automobile industry is the paradigmatic industry for studying knowledge spillover given the multitude of technologies embodied in the final products, including propulsion, electronics, safety, fuel efficiency, emission control, materials, and most recently AI technologies. In recent years, Chinese domestic automakers have developed high-quality indigenous brands, potentially benefiting from knowledge spillover from foreign automakers via JVs. The rich dynamics of this industry allow us to study the following questions: Has the ownership affiliation stipulated under the quid pro quo policy been effective in inducing knowledge spillover from foreign automakers to domestic automakers? If so, to what extent, and what are the underlying mechanisms? What will happen if quid pro quo is lifted? This latter question speaks directly to the current trade debate between the United States and China. 

Conceptually speaking, the joint venture requirement creates a set of domestic automakers that are affiliated with foreign automakers through JVs. These domestic automakers are the primary beneficiaries of the policy, receiving direct access to foreign technology. Leveraging rich multidimensional vehicle performance quality data, we find that affiliated domestic automakers (“followers”) indeed learn more from their affiliated foreign automakers (“leaders”) than do nonaffiliated domestic automakers. This reflects in the fact that the domestic followers tend to adopt similar quality strength as their affiliated leaders. Worker flows and shared supplier networks are important channels mediating the knowledge spillover. 

Finally, turning to the policy question of what would happen to domestic automakers’ quality if quid pro quo were lifted. Evidence suggests that ownership affiliation as required by quid pro quo is not a necessary condition for knowledge spillover and that the presence of affiliated domestic partners is not a necessary “conduit” for knowledge to flow from foreign to domestic automakers. Evidence from the upstream parts and components industry further shows that ownership affiliation does not confer a significant advantage in terms of knowledge spillover compared with full foreign ownership. These findings speak directly to the current U.S.–China trade debate. Amid recent tensions with the United States regarding forced technology transfers via the quid pro quo policy, the Chinese government has pledged to remove the foreign ownership requirement in several strategic sectors, including the auto industry. Our findings suggest that doing so would not significantly hinder quality upgrades in the domestic industry. 

The discussion focuses on the benefits of quid pro quo for Chinese domestic firms but does not speak about the costs to foreign firms in terms of either the profit split or potential IP infringement risks. With a majority stake or even sole ownership, foreign automakers may have stronger incentives to bring the most advanced technology into the Chinese market, as they can better guard their know-how. How such incentives are shaped by global knowledge diffusion is an important open area for future research. 

Assistant Professor of Public Policy Jie Bai’s research focuses on microeconomic issues in developing countries and emerging markets.

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