This paper contributes to the debate on the effect of foreign direct investment (FDI) on indigenous firms in host economies. Using a Melitz-type theoretical model involving firm heterogeneity, we first show that FDI affects the revenue of indigenous firms, in both domestic and export markets, through a direct as well as indirect channel. In the presence of positive FDI-related productivity spillovers, the direct effect is positive but the indirect effect is negative. As the overall effect cannot be unambiguously determined, in stage two, we further investigate this issue by using firm level data from China’s textile industry over the period 2005-07. We find that FDI in China’s textile industry decreases (increases) the revenue of indigenous firms in the domestic (export) market. The empirical results are also robust across (i) alternative measures and (ii) sources of FDI.
Quarterly Review of Economics and Finance / Vol. Article in Press