Foreign Investment and Markups of Local Firms: Evidence From China

ABSTRACT Based on the micro data set of Chinese manufacturing firms, this paper examines the influence of foreign investment on markups of local Chinese firms and its mechanism. The results show that foreign investment significantly increases the markups of local Chinese firms, whereas the influence of foreign investment on markups of different types of local firms isn't the same, and significant heterogeneity exists. Further analysis of the influence mechanism suggests that foreign investment increases markups of local firms through the production efficiency channel rather than the market pricing channel. Based on the dynamic decomposition of the change in the aggregate markup at the industry level, this paper also finds that foreign investment significantly increases the aggregate industry markup by influencing the across‐firm effects. This paper enriches the research literature on foreign investment and markups and provides a new perspective for understanding foreign investment's influence on local firms' micro performance.