A new study published in the Global Strategy Journal helps in better understanding how local firms in emerging markets build and deploy political connections when they face inward foreign direct investment (FDI). Such investment refers to when a company purchases a business or sets up new operations in a country different from the one of its origin. According to the new research, the local firms cannot rely solely on the government to confront the competition. Instead, they should consider market strategies (i.e., being competitive within the marketplace) and nonmarket strategies (i.e., working to shape regulation and public opinion) when facing inward FDI competition. The study also suggests that firms should try to understand the similarities between the resources provided by inward FDI and the government when implementing and balancing market and nonmarket strategies.
Meitong Dong of the University of Hong Kong, Pengcheng Ma of Renmin University of China, and Lin Cui of Australian National University wanted to clarify the relationship between foreign firms, local firms, and the local government. The researchers drew from resource dependence theory to argue that, when there is a low to moderate level of inward FDI, its overall spillover benefits can alleviate local firms’ dependence on the government for some resources, which reduces the need for political connections. However, when inward FDI grows to a moderate to high level, the competitive threats it poses to local firms begin to outweigh the spillover benefits, which in turn motivates local firms to foster stronger connections with the government in an effort to neutralize foreign firms’ competitive advantages.
The team used China as its research setting, drawing from a sample of 1,463 Chinese listed firms from 2009 to 2017, along with data that measured FDI and the local firms’ political connections. They also used governmental R&D funding, institutional development, and market diversification to reflect the resource similarity offered by foreign firms and the local government.
They identified a U-shaped relationship between inward FDI and local firms’ political connections: When the resources from foreign firms and the government are similar in type, local firms’ nonmarket strategies — their political connections — are more responsive to inward FDI. This occurs because the spillover benefits of inward FDI are more likely to be substitutable for government resources; at the same time, the competitive threats can be neutralized if local firms can secure matching resources from the government. Therefore, the U-shaped relationship is more pronounced when the resource similarity is high.
While FDI remains below pre-pandemic levels, the findings may be particularly useful for local firms involved in certain industries. An April report from UN Trade and Development found that FDI is increasingly favoring services over manufacturing: The share of cross-border greenfield projects in the services sector jumped from 66% in 2004 to 81% in 2023. During this same period, investment in services within manufacturing industries almost doubled to about 70%, spurred on by technological advances.
