Does administrative decentralization promote outward foreign direct investment and productivity? Evidence from China

The causal relationship between decentralization and economic consequences remains an open question. Geographical and institutional proximity can make subnational governments more responsive to local demands, but can also lead to problems of elite capture and corruption. This paper evaluates the effects of administrative decentralization on firm performance by employing a quasi-natural experiment of the delegation of overseas investment approval authority to subnational governments in China. We find that firms in the pilot provinces are engaged in more outward foreign direct investment (OFDI) and experience higher productivity. Decentralization leads to a significant increase in OFDI for technology-seeking and overseas-production motives, thus improving the innovation of the parent firm and reducing costs. Consistent with decentralization theory, information advantages and jurisdictional competition mediate the economic effects of administrative decentralization. The productivity effect is pronounced for local state-owned enterprises and private firms with political connections, and increases with the inter-jurisdictional competition.