Geographical proximity, foreign presence and domestic firm innovation: the micro-level evidence

The question as to whether foreign presence benefits or harms domestic firm innovation is yet to reach a definitive answer. This paper provides micro-level evidence to shed light on this topic. By incorporating insights from economic geography into the literature on foreign presence, we developed a geography-based foreign presence, defined as foreign presence weighted by geographical proximity between a focal domestic firm and each foreign firm in the same region. Based on theoretical reasoning and informed by the literature on geographical proximity and foreign presence, we proposed an inverted 'U'-shaped relationship between a domestic firm's geography-based foreign presence and its innovation performance in the context of the world's largest emerging economy, China. We argue that such a relationship is steepened for domestic state-owned firms and when the foreign firms within the region present a high level of innovation performance. By analysing a sample of Chinese firms in manufacturing industries between 1998 and 2014, we found support for our propositions.