Chapter 5. The Microfoundation of State Intervention and Policy Effectiveness

This chapter explains the effectiveness of policy implementation and the varied capabilities of local governments, using policy tools to generate firm-level upgrading incentives. Using China’s largest manufacturing industry—the electronics industry—as an example, the chapter compares the development of China’s two largest manufacturing cities, Suzhou and Shenzhen. It demonstrates how earlier patterns of FDI attraction and the prioritization of large or small FIEs gave rise to distinctive foreign–domestic firm relations. Through both in-depth case studies and hierarchical models, the chapter shows that a segregated relationship started by the group-offshoring strategy of large FIEs makes upgrading policies, such as government funding and tax cuts, less effective and dampens the innovation incentives for domestic private firms. By contrast, a more equal, broadly connected relationship started by the subcontracting strategy of small FIEs makes upgrading policies more likely to generate firm-level innovation behavior.