“Does Ethnicity Pay?,” Y. Huang, L. Jin & Y. Qian (2010)

Ethnic networks in trade and foreign investment are widespread. Avner Greif, in his medieval trade papers, has pointed out the role of ethnic trade groups in facilitating group punishment of deviations from implicitly contracted behavior in cases where contracts cannot be legally enforced. Ethnic investors may also have an advantage when investing in their home country, due to better knowledge of local profit opportunities.

Huang, Jin and Qian investigate the ethnic advantage using an amazing database of the universe of Chinese industrial firms. The database tags firms formed using FDI (perhaps as a joint venture) from Hong Kong, Macao and Taiwan; in the latter two cases, nearly 100 percent of Chinese FDI is from ethnic Chinese. Amazingly, firms funded with FDI from these regions performs worse, as measured by ROI, ROA or margins, than Chinese firms funded with FDI from other countries. In the first years after the firms are founded, there is only a small difference between Chinese-funded firms and others, but over time, the disadvantage grows; it is not just that ethnic Chinese investors invest in companies with low profitability at the beginning, but that they actually get worse over time. Restricting the sample just to Taiwanese electronics firms’ FDI compared to Korean electronics firms’ FDI, the Koreans make more profitable investments, both at the beginning and as measured by relative performance over time.

What’s going on here? It’s not just that ethnic Chinese are making low profit investments in their ancestral hometown; omitting Fujian and Guangdong, ancestral source of most HK, Macao and Taiwan Chinese, does not change the results in any qualitative way. Instead, it appears that ethnic Chinese-funded firms do substantially less work building up intangible assets and human capital in the firms they invest in. Stratifying the firms, if Chinese-funded firms would have grown their human capital (as proxied by employee wage) or intangible assets (as measured in accounting data) at the same rate as non Chinese-funded firms, there would have been no difference in ROI over time.

This leads to a bigger question, of course. Why would ethnic investors fail to build up intangible capital? Certainly there are anecdotal stories along these lines, particularly when it comes to wealthy minority investors; think Lebanese in West Africa, Fujianese in Indonesia, or Jewish firms in 19th century Europe. I don’t have a model that can explain such behavior, however. Any thoughts?

2010 NBER working paper (IDEAS version)

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