According to John Dunning’s OLI theory, flawed property laws that are ineffective to protect undiffused property rights encourage MNCs to internalize their production. The MNCs can also internalize the market though the establishment of foreign subsidiaries (e.g. R&D centres) that may exploit the use of firm-specific proprietary knowledge and invent new sources of knowledge. However, I argue that the weak intellectual property (IP) protection in China discourages MNCs from investing in China, despite its attractive low labour costs.
China has the most MNC R&D centres in the world than in any other locations. By 2012, more than 1,600 R&D centres were founded in China. There are many benefits that came along with this phenomenon. First of all, these centres result in knowledge spillover that strengthens the productivity of local Chinese manufacturers over time. Secondly, it expands the Chinese consumer market by developing new goods and services for local need. MNC R&D centres also provide relatively well-paying jobs for local citizens. Hence, these R&D centres are both important to the MNCs and China.
However, there are many shortcomings too. For example, institutional IP protection is significantly lacking in China. Thus, MNCs in China face the risk of competitors (local and foreign MNCs) expropriating their core technologies at mere or even no legal consequences. As a result, weak IP protection in China erodes the capability for MNCs to internalize their proprietary knowledge, hence discourages MNCs from investing in China. Also, MNCs will need to resort to other more expensive routines and systems to safeguard their core knowledge, leading to even higher factor costs.
The Chinese government did try to strengthen IP protection in the country. For example, it passed the Foreign Trade Law in 2004, which “empowers the investigation of IP violations and specifies penalties, including fines, confiscations, and suspension of trading privileges”. However, its legal institution is still not on par with the standards in developed economies, with enforcement and regulations being lax oftentimes.
With that being said, the low labour and land costs in China no longer attract MNCs that much when the costs of weak IP protection are so high. In fact, China’s weak IP protection represents a locational disadvantage for foreign direct investment.
Source: Holmes, R. M., et al. “The Effects of Location and MNC Attributes on MNCs’ Establishment of Foreign R&D Centers: Evidence from China.” Long Range Planning, vol. 49, no. 5, 2016, pp. 594-613.