In 2001, the Chinese auto industry sold fewer than a million cars. By 2017, it was responsible for more than a third of all the cars produced or sold on earth. Quality improved, too: between 2001 and 2014, malfunction rates in domestic Chinese passenger vehicles fell by 75 percent. How did this growth happen so quickly?
Part of the answer has to do with “knowledge spillovers” from foreign auto firms doing business with domestic partners in China. Shengmao Cao, an assistant professor of strategy at Kellogg, defines these spillovers as “the production know-how, sometimes held secret by a firm, that a partner can observe and assimilate into their own independent operations.”
Cao and his collaborators Jie Bai of Harvard University, Panle Jia Barwick of the University of Wisconsin–Madison, and Shanjun Li of Cornell University wanted to know if the rise in Chinese auto-manufacturing quality could be partly explained by knowledge spillovers from these joint ventures.
Quality on the rise
Historically, researchers have measured the effects of knowledge spillover in terms of “total factor productivity,” a ratio that compresses all of a domestic company’s various economic inputs and outputs together.
To construct more-concrete measures of how knowledge spillovers affected Chinese car-manufacturing quality, the researchers consulted annual customer surveys conducted by J.D. Power and Associates. They analyzed ratings across 19 different performance and quality dimensions (such as fuel economy, braking responsiveness, and interior materials) gathered from nearly 19,000 Chinese car buyers between 2001 and 2014. The surveys covered cars made by Chinese companies like FAW and Brilliance, as well as cars made by joint ventures like FAW-Toyota and BMW-Brilliance (which produce Toyota and BMW vehicles, respectively, for Chinese markets).
Strengthening the case for spillovers
Still, the researchers wanted to rule out other explanations beyond knowledge spillover, such as domestic car companies partnering either with companies that are already very similar to them or with companies that target the same kinds of customers.
But while a domestic Chinese auto manufacturer like SAIC may have similarities to Volkswagen in the year 2025, it’s highly unlikely that those overlaps existed when the joint venture was originally formed decades earlier. “Many of these Chinese companies did not have an existing business in the passenger-car industry; they used to produce agricultural machines like tractors and only started making their own cars after accumulating some experience in a joint venture,” Cao says.
A recipe for success?
A near-10 percent bump in manufacturing quality due to knowledge spillover may not sound like much. But this isn’t the only kind of spillover that’s happening in the Chinese auto industry, Cao says. Instead, he thinks of it as a kind of “bonus” that joint ventures add to the baseline amount of industry-wide spillover that normally results from foreign investment.
“Take a hypothetical scenario where BMW is making its own cars in China without a joint venture—spillover would still be happening in other ways, just by [BMW] being there,” Cao says. “What this work shows is that there’s an additional benefit from this direct affiliation in a joint venture.”
For foreign companies, the upside of this quid pro quo is murkier. “Multinational firms sometimes accuse joint-venture policies of just being forced technology transfers,” Cao adds. “It’s actually one of the reasons why Trump initiated the first wave of the trade war between the U.S. and China in 2018.”
Joint ventures aren’t necessarily a foolproof way for industries in developing countries to climb the quality ladder, either. Foreign automakers only enter into Chinese joint ventures because global demand for cars is so huge that “the cost of giving up the Chinese market would be too high,” says Cao. In other markets or industries, the same quid-pro-quo calculus may not make sense. “There’s also the trade disputes that this arrangement might generate,” Cao adds.
Still, Cao’s findings show that under the right circumstances, joint ventures—and the knowledge spillovers they encourage—can be a clear win for host countries. “China’s passenger-vehicle industry went from almost nonexistent 25 years ago to having the highest car sales in the world in 2010,” Cao says. “It looks like a success story.”
Read the full article by Panle Jia Barwick, Shengmao Cao, Shanjun Li / Kellogg Insight
