Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers through Backward Linkages

Many countries aim to attract foreign direct investment (FDI) by offering ever more generous incentive packages and justifying their actions with the expected knowledge externalities to be generated by foreign affiliates. Despite being hugely important to public policy, there is little conclusive evidence to support this claim. This study examines firm-level data from Lithuania in an effort to further our understanding of this issue. The empirical results are consistent with positive productivity spillovers from FDI taking place through contacts between foreign affiliates and their local suppliers in upstream sectors, but there is no indication of spillovers occurring within the same industry. The data indicate that local firms benefit from the operation of foreign affiliates both in their own region and in other parts of the country, albeit the evidence of the latter outcome is weaker. A larger effect is associated with domestic-market- rather than export-oriented foreign companies. There is no difference, however, between the impact of fully-owned foreign firms and those with joint domestic and foreign ownership.spillovers, foreign direct investment, technology transfer

Does foreign direct investment increase the productivity of domestic firms : in search of spillovers through backward linkages

Many countries compete against one another in attracting foreign investors by offering ever more generous incentive packages and justifying their actions with the productivity gains that are expected to accrue to domestic producers from knowledge externalities generated by foreign affiliates. Despite this being hugely important to public policy choices, there is little conclusive evidence indicating that domestic firms benefit from foreign presence in their sector. It is possible, though, that researchers have been looking for foreign direct investment (FDI) spillovers in the wrong place. Multinationals have an incentive to prevent information leakage that would enhance the performance of their local competitors in the same industry but at the same time may want to transfer knowledge to their local suppliers in other sectors. Spillovers from FDI may be, therefore, more likely to take place through backward linkages-that is, contacts between domestic suppliers of intermediate inputs and their multinational clients-and thus would not have been captured by the earlier literature. This paper focuses on the understudied issue of FDI spillovers through backward linkages and goes beyond existing studies by shedding some light on factors driving this phenomenon. It also improves over existing literature by addressing several econometric problems that may have biased the results of earlier research. Based on a firm-level panel data set from Lithuania, the estimation results are consistent with the existence of productivity spillovers. They suggest that a 10 percent increase in the foreign presence in downstream sectors is associated with 0.38 percent rise in output of each domestic firm in the supplying industry. The data indicate that these spillovers are not restricted geographically, since local firms seem to benefit from the operation of downstream foreign affiliates on their own, as well as in other regions. The results further show that greater productivity benefits are associated with domestic-market, rather than export-oriented, foreign affiliates. But no difference is detected between the effects of fully-owned foreign firms and those with joint domestic and foreign ownership. The findings of a positive correlation between productivity growth of domestic firms and the increase in multinational presence in downstream sectors should not, however, be interpreted as a call for subsidizing FDI. These results are consistent with the existence of knowledge spillovers from foreign affiliates to their local suppliers, but they may also be a result of increased competition in upstream sectors. While the former case would call for offering FDI incentive packages, it would not be the optimal policy in the latter. Certainly more research is needed to disentangle these two effects.Banks&Banking Reform,Economic Theory&Research,Decentralization,Environmental Economics&Policies,Health Economics&Finance,Environmental Economics&Policies,Banks&Banking Reform,Trade and Regional Integration,Foreign Direct Investment,Health Economics&Finance

Pollution havens and foreign direct investment : dirty secret or popular myth?

The"pollution haven"hypothesis refers to the possibility that multinational firms, particularly those engaged in highly polluting activities, relocate to countries with weaker environmental standards. Despite the plausibility and popularity of this hypothesis, there is little evidence to support it. The authors identify four obstacles that may have impeded researchers'ability to find evidence in favor of the"pollution haven"hypothesis: 1) The possibility that some features of host countries, such as bureaucratic corruption, may deter inward foreign direct investment and also be positively correlated with lax environmental standards. Omitting this information in statistical analyses may produce misleading results. 2) The possibility that country- or industry-level data, typically used in the literature, may have masked the effect at the firm level. 3) Difficulties associated with measuring environmental standards of the host countries. 4) Difficulties associated with the measuring the pollution intensity of the multinational firms. The authors attempt to surmount these obstacles by explicitly taking into account corruption in host countries and using a firm-level data set on investment projects in 24 transition economies. With these improvements, the authors find some support for the"pollution haven"hypothesis, but evidence is still weak and does not survive numerous robustness checks.Sanitation and Sewerage,Environmental Economics&Policies,Water and Industry,Pollution Management&Control,Decentralization,Environmental Economics&Policies,Water and Industry,TF030632-DANISH CTF - FY05 (DAC PART COUNTRIES GNP PER CAPITA BELOW USD 2,500/AL,Sanitation and Sewerage,Pollution Management&Control

The composition of foreign direct investment and protection of intellectual property rights : evidence from transition economies

While existing literature has examined the impact of intellectual property protection on the volume of foreign direct investment (FDI), little is known about its effect on the composition of FDI inflows. The author addresses this question empirically, using a unique firm-level data set from Eastern Europe and the former Soviet Union. She finds that weak protection deters foreign investors in technology-intensive sectors that rely heavily on intellectual property rights. The results also indicate that a weak intellectual property regime encourages investors to undertake projects focusing on distribution rather than local production. The latter effect is present in all sectors, not justthose relying heavily on intellectual property protection.International Terrorism&Counterterrorism,Economic Theory&Research,Labor Policies,Environmental Economics&Policies,Legal Products,Trade and Regional Integration,International Terrorism&Counterterrorism,Legal Products,Environmental Economics&Policies,Economic Theory&Research

Technological leadership and foreign investors'choice of entry mode

Developing country governments tend to favor joint ventures over other forms of foreign direct investment, believing that local participation facilitates the transfer of technology, and marketing skills. The author assesses joint ventures'potential for such transfers by comparing the characteristics of foreign investors engaged in joint ventures with those of foreign investors engaged in wholly owned projects in transition economies in the early 1990s. Unlike the existing literature, the author focuses on intra-industry differences rather than inter-industry differences in research and development, and advertising intensity. Empirical analysis shows that foreign investors who are technological, or marketing leaders in their industries, are more likely to invest in wholly owned projects than to share ownership. This is true in high- and medium-technology sectors, but not in industries with low research and development spending. The author concludes that it is inappropriate to treat industries as homogeneous in investigating modes of investment. She also suggests that in sectors with high research and development spending, joint ventures may present less potential for transfer of technology, and marketing techniques than wholly owned subsidiaries.Public Health Promotion,International Terrorism&Counterterrorism,Health Monitoring&Evaluation,Water and Industry,Banks&Banking Reform,International Terrorism&Counterterrorism,Health Monitoring&Evaluation,Water and Industry,Banks&Banking Reform,Agricultural Knowledge&Information Systems

Foreign direct investment and integration into global production and distribution networks : the case of Poland

Not until the end of the twentieth century, the"second globalization,"has the ratio of trade to Gross Domestic Product been comparable to that during the first globalization, which took place at the end of the nineteenth century and was interrupted by World War I. Technological progress has increased the importance of the international division of labor and of global production and distribution networks. Multinational corporatios have been a driving force behind these developments. As a transition economy, Poland provides an interesting case for study, as its sudden opening to foreign investment after a long period of isolation allows the process of integratio into global networks to be studies more clearly. Using Poland as a case study, the authors study multinational corporatios'role in integrating a host country into the increasingly international division of labor. They provide evidence that inflows of foreign direct investment are increasing Poland's participation in global production and distribution networks. They conclude that because of the large volume of foreign direct investment inflows expected in Poland in the near future, Poland's exports--driven by fragmented production production--will continue to expand at even faster rates than observed there recently.Agribusiness&Markets,Economic Theory&Research,Environmental Economics&Policies,Trade Policy,Payment Systems&Infrastructure,Economic Theory&Research,Environmental Economics&Policies,TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT,Trade Policy,Consumption

Roll out the red carpet and they will come : investment promotion and FDI inflows

As red tape in host countries and information asymmetries constitute a significant obstacle to investment flows across international borders, an important policy question is: what can aspiring FDI destinations do to reduce such barriers? This study uses newly collected data on 124 countries to examine the effects of investment promotion on inflows of US FDI. We test whether sectors explicitly targeted by investment promotion agencies in their efforts to attract FDI receive more investment in the post-targeting period, relative to the pre-targeting period and non-targeted sectors. The results of our analysis are consistent with investment promotion leading to higher FDI flows to countries in which red tape and information asymmetries are likely to be severe. The data suggest that investment promotion works in developing countries but not in industrialized economies

Corruption and Cross-Border Investment: Firm-Level Evidence

This paper studies the impact of corruption on inward foreign direct investment using a unique firm-level data set. It examines two effects of corruption simultaneously: a reduction in the volume of foreign investment and a shift in the ownership structure. Corruption makes local bureaucracy less transparent and hence acts as a tax on foreign investors. Moreover, corruption affects the decision to take on a local partner. On the one hand, corruption increases the value of using a local partner to cut through the bureaucratic maze. On the other hand, corruption decreases the effective protection of investor’s intangible assets and lowers the probability that disputes between foreign and domestic partners will be adjudicated fairly, which reduces the value of having a local partner. The importance of protecting intangible assets increases with investor’s technological sophistication, which tilts the preference away from joint ventures in a corrupt country. Empirical evidence shows that corruption reduces inward FDI and shifts the ownership structure towards joint ventures. Technologically more advanced firms are found to be less likely to engage in joint ventures.http://deepblue.lib.umich.edu/bitstream/2027.42/39879/3/wp494.pd

Corruption and Cross-Border Investment: Firm-Level Evidence

This paper studies the impact of corruption on inward foreign direct investment using a unique firm-level data set. It examines two effects of corruption simultaneously: a reduction in the volume of foreign investment and a shift in the ownership structure. Corruption makes local bureaucracy less transparent and hence acts as a tax on foreign investors. Moreover, corruption affects the decision to take on a local partner. On the one hand, corruption increases the value of using a local partner to cut through the bureaucratic maze. On the other hand, corruption decreases the effective protection of investor’s intangible assets and lowers the probability that disputes between foreign and domestic partners will be adjudicated fairly, which reduces the value of having a local partner. The importance of protecting intangible assets increases with investor’s technological sophistication, which tilts the preference away from joint ventures in a corrupt country. Empirical evidence shows that corruption reduces inward FDI and shifts the ownership structure towards joint ventures. Technologically more advanced firms are found to be less likely to engage in joint ventures.Corruption, Foreign direct investment, Multinational firms

Corruption and the composition of foreign direct investment - firm-level evidence

The authors study the impact of corruption in a host country on foreign investors'preference for a joint venture, or a wholly owned subsidiary. Their simple model highlights a basic tradeoff in using local partners. On the one hand, corruption makes the local bureaucracy less transparent, and increases the value of using a local partner to cut through the bureaucratic maze. On the other hand, corruption decreases the effective protection of an investors'intangible assets, and reduces the probability that disputes between foreign and domestic partners, will be adjudicated fairly, which reduces the value of having a local partner. As the investor's technological sophistication increases, so does the importance of protecting intangible assets, which tilts the preference away from joint ventures in a corrupt country. Empirical tests of this hypothesis on firm-level data show that corruption reduces inward foreign direct investment, and shifts the ownership structure toward joint ventures. Conditional on foreign direct investment taking place, an increase in corruption from the level found in Hungary to that found in Azerbaijan, decreases the probability of a wholly owned subsidiary by 10 to 20 percent. Technologically more advanced firms are less likely to engage in joint ventures, however. The authors find support for the view that U.S. firms are more averse to joint ventures in corrupt countries than other foreign investors - possibly because the U.S. Foreign corrupt Practices Act, which stipulates penalties for executives of U.S. companies whose employees, or local partners engage in paying bribes. But although U.S. companies are more likely than investors from other countries to retain full ownership of firms in corrupt countries, they are not less likely than firms from other countries to undertake foreign direct investment in thosecountries.International Terrorism&Counterterrorism,Fiscal&Monetary Policy,Decentralization,Economic Theory&Research,Legal Products,International Terrorism&Counterterrorism,Governance Indicators,National Governance,Foreign Direct Investment,Legal Products