# On the Estimation of Cross-Firm Productivity Spillovers with an Application to FDI

## TL;DR

This paper introduces a new methodology for identifying firm productivity and spillover effects simultaneously, addressing limitations of previous approaches, and applies it to analyze FDI impacts in China's electric machinery sector.

## Contribution

It develops a unified proxy variable approach that accounts for cross-sectional dependence due to spillovers, improving the identification of productivity and spillover effects.

## Key findings

- Identifies significant productivity spillovers from FDI in China's electric machinery industry.
- Provides a consistent framework for analyzing productivity and spillovers without contradictory assumptions.
- Demonstrates the importance of accounting for cross-sectional dependence in spillover analysis.

## Abstract

We develop a novel methodology for the proxy variable identification of firm productivity in the presence of productivity-modifying learning and spillovers which facilitates a unified "internally consistent" analysis of the spillover effects between firms. Contrary to the popular two-step empirical approach, ours does not postulate contradictory assumptions about firm productivity across the estimation steps. Instead, we explicitly accommodate cross-sectional dependence in productivity induced by spillovers which facilitates identification of both the productivity and spillover effects therein simultaneously. We apply our model to study cross-firm spillovers in China's electric machinery manufacturing, with a particular focus on productivity effects of inbound FDI.