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FDI’s Imact on Domestic Firms: spillover

through backward linkage

Javorcik (AER, 2004)

Paul DengMarch 22, 2011

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Big Picture

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Big Picture

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The Impact of FDI on Host Countries

MNEs are the most productive firms in their home countries

MNEs, most of the time, are more productive than firms in host countries, especially compared to those in developing countries

Most MNEs are skill intensive, knowledge intensive, and heavy in R&D investment

Host countries want to attract FDI because they may benefit from MNE’s presence, through spillover effect

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The Impact of FDI on Host Countries

The spillover effect could be positive, because personnel (both workers and executives) trained at MNEs are

more skilled, and later they may open their firms, or work in other domestic firms

Technology may leak to domestic firms, through domestic firms’ interactions with MNEs

Above two are the most obvious and easiest spillover channels

There are other channels, the mechanism of which economists are still trying to untangle, and we will discuss them later

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The Impact of FDI on Host Countries

The spillover effect could also be neutral or even negative MNEs’ incentives to protect technology from leaking so to

maintain their lead in innovation put a brake on technology transfer

MNE’s entry into domestic industry may out-compete domestic firms, sometimes forcing them to shut down or switch to other industries

Again, there are more complicated channels, which we will discuss later

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Spillover and Its Relation to Type of FDIs

Horizontal spillovers – related to horizontal FDI Spillover from MNEs to domestic firms within the same industry

Vertical spillovers – related to vertical FDI Backward linkage

spillover from downstream firms to upstream firms e.g., spillover from foreign firms to their domestic suppliers The focus of this paper

Forward linkage spillover from upstream firms to downstream firms e.g., foreign circuitboard producer and domestic PC maker

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Javorcik (2004), FDI and Its Spillover Effect

Research question: Does FDI increase doemstic firms’ productivity? Through what channel?

Javorcik investigated spillover effect through the following channels or linkages: Horizontal, i.e., within the same industry Backward, i.e., downstream industry to upstream industry Forward, i.e., upstream to downward industry

The author argues spillovers from FDI are more likely to be vertical than horizontal. Why?

Pay special attention to how he defines and measures the vertical linkages

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Javorcik (2004), Data Description

Lithuanian firm-level data, with the whole sample covering 85% of total output

This paper only focuses on manufacturing firms, in over 20 industries

Unbalanced panel data from 1996 to 2000, each year around 2000 to 2700 firms, after data cleaning process

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A Snapshot of FDI in Lithuania

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Javorcik (2004), Estimation Strategy

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i: firm j: industry r: region t: year

Note that the first 4 variables are indexed at firm i level, while the rest 3 variables are indexed at industry level

Also note firm-level fixed effect is not controlled in this regression equation

time effect

regional effect Industry effect

(1)

How might the linkages work through?

Horizontal linkages Knowledge spillover thru personnel turnover Competition effect – negative and positive?

Vertical linkages Backward linkage

Selection effect Scale of economy effect

Forward linkage Competition effect – more efficient production or cheaper

inputs

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Javorcik (2004), Linkage Measures

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Javorcik (2004), Linkage Measures

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backward linkage

Firms in industry j

MNEs in downstream industry

MNEs in downstream industry

MNEs in downstream industry

forward linkage

MNEs in upstream industry

MNEs in upstream industry

MNEs in upstream industry

Firms in industry j

Spillover Linkages

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Javorcik (2004), Estimation Results

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Fixed Effect with Difference Estimator

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Reminder:

Estimation Results with Fixed Effects

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Foreign Ownership and Vertical Spillover

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Summary of Empirical Findings

Backward linkage is quite robust in various different estimations

Forward and horizontal linkages are much less robust

Backward linkage seems to work best when a foreign firm has a local partner, i.e., joint ventures --- important policy implications for host countries

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Some Further Thoughts

The specific mechanisms through which backward linkage operates are still not very clear

Does backward linkage operate through a selection effect by MNEs? Higher quaility control? Picking more productive suppliers? Competition among suppliers (in winning MNE’s contract)

lead to more efficient production?

Economists are still trying to figure out…

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Next Time…

Our last class; Afterwards, Niels will take over

Read Harrison (1999), AER, ”Do Domestic Firms Benefit from FDI.”

Really start to think hard on your term paper, don’t wait until too late.

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