Foreignization and Innovation: Insights from Heterogenous Supply Chains

China has been shifting from foreignization to domestication, especially since recent years, resulting in a decrease in foreignization dividend. This paper diverges from the majority of existing literature on the innovation impact of foreign direct investment or foreign ownership by focusing on supply chains. We employ unique input-output tables to discern the nuanced effects of foreignization across heterogenous supply chains, and find that: (1) Foreignization both within the target firms and of the upstream firms associates with an enhancement in innovation, as measured by quality-adjusted patent counts. (2) while OF (Other foreign) shareholdings do possess advantages over HMT (Hong Kong, Macau, and Taiwan) shareholdings in terms of providing high-quality intermediate goods, HMT shareholdings are more friendly in engaging in innovation activities in China, compared to the OF shareholdings. (3) While foreignization in DOEs (domestically-owned enterprises) have negative impact on innovation, that in FOEs (foreign-owned enterprises) have positive impact on innovation. (4) Intellectual property institutions perform better than patent subsidy policies in foster innovation, especially through supply chains. These findings shed new light on the specific role of foreignization in promoting innovation and provide valuable policy implications to address the challenges of domestication.