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KNOWLEDGE SPILLOVERS FROM FOREIGN SUBSIDIARIES TO DOMESTIC FIRMS Advances in the theory of foreign direct investment

What are FDI (knowledge) spillovers? (1). FDI spillovers is a channel of knowledge (technology) transfer from foreign subsidiaries to host country firms. This is probably the most extensively analysed channel of technology transfer. Knowledge spillovers from FDI take place when the presence of fore

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KNOWLEDGE SPILLOVERS FROM FOREIGN SUBSIDIARIES TO DOMESTIC FIRMS Advances in the theory of foreign direct investment

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    1. KNOWLEDGE SPILLOVERS FROM FOREIGN SUBSIDIARIES TO DOMESTIC FIRMS “Advances in the theory of foreign direct investment” Matija Rojec University of Ljubljana, Institute for Economic Research matija.rojec@gov.si Bucharest, March 16, 2007

    2. What are FDI (knowledge) spillovers? (1) FDI spillovers is a channel of knowledge (technology) transfer from foreign subsidiaries to host country firms. This is probably the most extensively analysed channel of technology transfer. Knowledge spillovers from FDI take place when the presence of foreign subsidiaries increases knowledge of domestic firms, and MNEs are not able to fully approppriate (internalize) the value of these benefits => Some of this knowledge spills over (free of charge) to host country firms (Kokko 1992, Blomstrom and Kokko 1998, Smarzynska, 2003).

    3. What are FDI (knowledge) spillovers? (2) FDI spillovers have increasingly been treated as (the most) important FDI related development effect for host countries, in the literature as well as by policy makers The economics of investment incentives is largely based on the possibility of (positive) spillovers (knowledge and technology in the first place) from foreign subsidiaries to domestic firm ARE SPILLOVERS QUANTITATIVELY LARGE ENOUGH TO JUSTIFY LARGE SUBSIDIES THAT GOVERNMENTS PROVIDE TO ATTRACT FDI?

    4. Issues to be tackled Economics of knowledge spillovers Types and channels of FDI spillovers The extent of FDI spillovers in practice; how important they really are for host countries => Main findings and messages of the literature

    5. Economics of knowledge spillovers Knowledge spillovers are fundamental to theories of endogenous growth (Romer 1986, 1990, Aghion and Howitt 1992, 1998, Grossman and Helpman 1991etc.); they appear as engines of growth in endogenous growth models (Keller 2004, Griliches 1979, 1992) Knowledge spillovers arise from two aspects of technology: Return to technological investments is partly private and partly public => technological investments often create benefits to others than the investor; another firm may also use an innovation produced by one firm, without incurring additional cost Non-rival character of technology & innovation => meaning that marginal costs of using technology for an additional agent are negligible

    6. FDI spillovers – definitions and channels (1) Channels of FDI spillovers (Kokko 1992, Blomstrom and Kokko 1998): Demonstration-imitation effect => domestic firms learn supperior technologies (managerial & organizational innovation, technology) from foreign subsidiaries Competition effect => foreign subsidiaries competition force domestic rivals to update their technologies and techniques, to cope with the increased competitive pressures Foreign linkage effect => domestic firms learn to export from foreign subsidiaries Training effect => movements of staff from foreign subsidiaries to domestic firms Negative spillover effects: crowding-out effect or business-stealing effect (Aitken and Harrison 1999, Haddad and Harrison 1993, Djankov and Hoekman 2000 etc.).

    7. FDI spillovers – definitions and channels (2) Vertical inter-industry (co-operation) vs horizontal intra-industry (competition) spillovers (Blalock 2001, Schoors and van der Tol 2001, Smarzynska 2001, 2003, Smarzynska and Spatareanu 2002, Damijan et al 2003b) Lall (1980) identifies the following MNE-supplier interactions that contribute to vertical spillovers: Help prospective suppliers set up production facilities; Demand from suppliers reliable, high quality products that are delivered on time, while also providing the suppliers with technical assistance or information to help improve the products or facilitate innovations; Provide training and help in management and organization; and Assist suppliers to find an additional costumer including their sister affiliates in other countries.

    8. FDI spillovers – definitions and channels (3) Smarzynska (2003) identifies additional channels of vertical spillovers through backward linkages: Increased demand for intermediate products due to MNE entry, which allows local suppliers to reap the benefits of scale economies; and Competition effect - MNEs acquiring domestic firms may choose to source intermediates abroad instead of at home thus increasing competition in the intermediate products market. Lack of knowledge on the exact mechanisms through which FDI spillovers occur, on how spillovers actually take place, on the process of spilling-over (Gorg and Strobl 2001, Griffith, Redding and Simpson 2004, Hoppe 2005 etc.)

    9. FDI spillovers – main findings and messages of the literature (1) Overall conclusion: The largest and the most influential literature on FDI spillovers has been focused on estimates of the magnitude of intra-industry FDI spillovers in terms of domestic productivity The literature offers mixed results => econometric analyses find positive, neutral and negative FDI spillover effects There can be FDI spillovers, but there is no strong consensus on the magnitudes of FDI spillovers (Blomström, Globerman and Kokko, 2000), nor on the causality (possibly reverse causality) (Lim, 2001). But recent firm level studies speak in favor of positive, in some cases economically large, FDI spillovers (Keller and Yeapl 2003, Smarzynska 2003, Girma, Greenaway and Wakelin 2001, Haskel, Pereira and Slaughter 2001, Damijan et al 2003b, Saggi 2006)

    10. FDI spillovers – main findings and messages of the literature (2) Three types of empirical FDI spillover analysis: Case studies Sectoral studies Lately primarily micro, firm-level data based studies Case studies (Rhee and Belot 1989, Larrain et al 2000, Hanson 2001, Moran 2001): mixed results, their conclusions are not easily generalized Sectoral studies (Caves 1974, Globerman 1979, Blomstrom 1986, Blomstrom and Persson 1983, Blomstrom and Wolff 1994, Kokko 1994, 1996, Blomstrom, Kokko and Zejan 1994, Sjoholm 1999, Xu 2000, Blomstroem 1996, Cantwell 1989) : For a long time FDI spillover research dominated by industry level studies Mostly show positive correlation between foreign presence and sectoral productivity The problem of sectoral studies: difficulty in establishing the direction of causality => FDI may tend to locate in high productivity industries; exit of less productive domestic firms

    11. FDI spillovers – main findings and messages of the literature (3) Firm level panel data studies: Most firm level studies cast doubt on the existence of FDI spillovers in developing countries; if positive limited to certain industries (Haddad and Harrison 1993, Aitken and Harrison 1999, Harrison 1996, Blomström and Sjöholm 1999, Blomström, 1994 etc.) The picture is slightly more optimistic for industrialized countries (Girma, Greenaway and Wakelin 2001, Haskel, Pereira and Slaughter 2001, Berry et al 2001, Alverez et al 2002 etc.) For transition countries, the firm-level panel data suggest that there are few intra-industry spillovers from FDI (Konings 2001, Djankov and Hoekman 2000, Kinoshita 2000, Damijan et al 2003 etc.); some more recent studies show better results (Nicolini and Resmini 2006, Tytell and Yudaeva 2005)

    12. FDI spillovers – main findings and messages of the literature (4) Sectoral and case level studies show more positive FDI spillovers than firm level studies Reasons for the lack of evidence on FDI spillovers in firm level analysis Substantive nature (non-existence or negative spillovers) Methodological nature (data related and methodological problems)

    13. FDI spillovers – main findings and messages of the literature (5) Issues of substantive nature: MNEs might be effective in protecting their technology advantages, in preventing potential spillovers (Görg and Greenaway 2001) Domestic firms may be confronted with a shift of demand to foreign subsidiaries – negative spillovers through competition effect (Gorg and Strobl 2001, Sgard 2001, Aitken and Harrison 1999, Caves 1996). Positive spillovers only affect some categories of firms (heterogeneity): with sufficient absorptive capacity, geographically not to distant (Kokko et al 1996 Keller and Yeapl 2003, Aitken and Harrison 1995, Gorg and Strobl 2001). Spillovers may not occur horizontally (intra-industry) but through vertical (inter-industry) relationships Positive spillovers only occur in the context of adequate host country environment (well-functioning markets, undistorted trade and FDI regime, etc.) (Keller 2004)

    14. FDI spillovers – main findings and messages of the literature (6) New determinants have been brought in the analysis which eliminate some of the above problems: Vertical (inter-industry) FDI spillovers are more likely to happen than horizontal (intra-industry) ones => foreign investors tend to prevent leaking of information to competitors (horizontal) but often provide information to their suppliers (vertical) (Kugler 2006, Smarzynska 2003, Blalock 2001, Damijan et al 2003 etc.) Domestic vs export market orientation of foreign affiliates => different conclusions (Smarzynska vs Moran) Acquisition/joint ventures tend to result in higher spillovers than greenfield (wholly foreign-owned) FDI => established networks, local partners Geographical distance: domestic firms that are locate near to foreign affiliates are more likely to receive spillovers

    15. FDI spillovers – main findings and messages of the literature (7) New determinants have been brought in the analysis which eliminate some of the above problems: Firm heterogeneity: spillovers do not affect all firms equally. FDI spillovers depend on foreign parent companies – foreign subsidiaries – domestic firms specific characteristics => studies that disaggregate data into more homogenous groups of firms find more encouraging results Time/dynamic dimension. Crowding-out is static (short-term) effect while positive spillovers need some time to develop (Kosova 2006, Cantwell 1989) Spillovers may depend on foreign investors home country: Japanese firms tend to bring their traditional suppliers

    16. FDI spillovers – main findings and messages of the literature (8) Issues of methodological nature: MEASURING: How the presence of MNEs is defined (Gorg and Strobl 2001): different measures may yield different evidence => preferable to use alternative measures MEASURING: Problems of measuring technological spillovers with productivity (Alvarez and Robertson 2004, Chen 1997, Smarzynska 2003, Ornaghi 2004) : To the extent that productivity spillovers are also a result of other factors apart from technological externalities, they are not a good indicator of technological externalities. MEASURING: The data employed must be closely related to technology diffusion (Keller and Yeapl 2003, Keller 2004): FDI spillovers estimated from subsidiary/parent firm R&D is better than foreign share in employment

    17. FDI spillovers – main findings and messages of the literature (9) MEASURING: Data quality/accuracy, limited samples, short panels; problems with capturing spillovers which need time lags to happen (Keller and Yeapl 2003, Keller 2004, Damijan et al 2003b) LEVEL OF AGGREGATION: Appropriate level of aggregation (Keller 2004): It is not the issue which data - micro or more aggregate - is preferred, but that the level of aggregation influence the results: the higher is the level of aggregation, the stronger the evidence for externalities and learning effects, micro data can capture heterogeneity accross firms, while aggregate level studies cannot control for this

    18. FDI spillovers – main findings and messages of the literature (10) CROSS-SECTION vs PANEL ANALYSIS: Simultaneity and endogeneity problem (Keller 2004, Gorg and Strobl 2001) => Cross-sectional studies may overstate the spillover effects because they do not allow for the time-invariant firm or sector specific effects ESTIMATION METHOD: hypothesizing a linear relationship between spillovers and local firms' productivity growth is not adequate (Damijan et al 2003b) using inappropriate econometric techniques such as simple pooled OLS or static panel data techniques (Damijan et al 2003b) Employing of Olley-Pakes' estimation method instead of time-differencing method (Keller and Yeapl 2003) leads to a greater role for FDI spillovers, because Olley-Pakes results in a better estimate of in-sample productivity growth

    19. Absorption capacity (1) Recipient’s absorption capacity is crucial for external knowledge transfers: Knowledge/FDI spillovers tend to be higher in more developed countries (Blomstrom et al 1994, Xu 2000 etc.) FDI can contribute to domestic productivity growth only if technology gap between domestic and foreign firms is not too large and when a sufficient absorptive capacity is available in domestic firms (Kokko 1994, Kokko, Tansini and Zejan 1996, Borensztein, De Gregorio and Lee 1998, Kinoshita 2000, Keller and Yeapl 2003, Damijan et al 2003a). Firms with more advanced technology or R&D sprending are likely to benefit more from the presence of foreign firms (Halpern and Murakozy 2006, Abraham et al 2006, Girma et al 2006)

    20. Absorption capacity (2) Bigger technological gap offers more room for technological spillovers (Findlay 1978, Haskel et al 2001, Castellani and Zanfei 2003) Human capital is the most important for the absorption capacity (Borensztein, De Gregorio and Lee 1998, Hoppe (2005). Other determinants of absorption capacity identified in the literature includes: company size (Ornaghi 2004), trade, investment and business climate, infrastructure in a host country (Keller 2004, Balasubramanyam, Salisu and Sapsford 1996, Moran 1998, Kinoshita and Lu 2006)), extent of agglomeration of foreign subsidiaries in a host country (Sgard 2001), exports vs local market orientation od firms (Smarzynska 2003, Sgard 2001), host economy size etc.

    21. Directions for future research To distinguish between productivity and technology spillovers from FDI To enter new determinants in the analysis of FDI spillovers To introduce data and methodological improvements in the measuring of FDI spillovers To study channels and processes of FDI spillovers To refine the aspect of domestic firms’ absorption capacity for FDI spillovers

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