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ISSN: 1439-2305 Number 345 April 2018 FOREIGN INVESTMENT REGULATION AND FIRM PRODUCTIVITY: GRANULAR EVIDENCE FROM INDONESIA Robert Genthner and Krisztina Kis-Katos

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ISSN: 1439-2305

Number 345 – April 2018

FOREIGN INVESTMENT REGULATION

AND FIRM PRODUCTIVITY:

GRANULAR EVIDENCE FROM

INDONESIA

Robert Genthner and Krisztina Kis-Katos

Foreign investment regulation and firm productivity:

Granular evidence from Indonesia∗

Robert Genthner† and Krisztina Kis-Katos‡

March 8, 2018

Abstract

Based on a yearly census of Indonesian manufacturing firms for 2000-2014, we

investigate the effects of a sector-specific investment policy reform on firm productiv-

ity. Hereby we exploit a protectionist foreign direct investment reform (the so-called

negative investment list) that designated certain sectors at the five-digit level to be-

come closed or only conditionally open to foreign investors. The list was first released

in 2000 and has been repeatedly revised by the Indonesian authorities since. Our

empirical analysis links the changes within this regulatory framework to variation in

firm-level productivity in a large firm panel. Controlling for an extensive set of fixed

effects as well as potential drivers of endogeneous regulation, we find robust evidence

of declining foreign capital shares in sectors subject to restrictions on foreign direct

investment, followed by a sizable decrease in firm productivity. From the different

types of conditions, sector-wide FDI bans were linked to the largest productivity de-

clines. We also document the presence of negative backward productivity spillovers

of regulation that propagate throughout the value chain.

JEL Classification: F23, L51, D24, F21, L6

Keywords: FDI, regulation, Indonesia, total factor productivity, spillovers

∗We would like to thank Rebecca Süss for excellent research assistance and Friederike Lenel, GüntherG. Schulze, Marcel Timmer and participants of seminars and workshops in Freiburg, Göttingen as well asconference participants at the ETSG in Florence, the IWB workshop in Göttingen and the FDI workshopin Mainz for helpful comments and suggestions. All remaining errors are our own.

†University of Göttingen, Germany‡University of Göttingen, Germany and IZA, Bonn

1

1 Introduction

In the course of the last two decades developing and emerging economies liberalized their

markets substantially. The process of globalization has not only lead to a successive

dismantling of trade barriers but has also facilitated the operation of multinational enter-

prises by liberalizing the inflows of foreign direct investment (FDI) world-wide. However,

this process of trade and market liberalization has not progressed uniformly and also

experienced numerous regulatory shifts and reversals, affecting FDI flows (Harding and

Javorcik 2011, Bourlès et al. 2013). While a substantial literature has documented links

between foreign participation and firm productivity (Aitken and Harrison 1999, Arnold

and Javorcik 2009),1 only few papers have studied the effects of FDI regulation on firm

productivity directly (Bourlès et al. 2013, Duggan et al. 2013, Eppinger and Ma 2017).

Foreign capital is expected to affect firm productivity through several channels. It can

substitute for domestic capital and relieve liquidity constraints if access to domestic cap-

ital is limited. Foreign investors have been shown to introduce nontangible productive

assets such as technological, managerial and marketing skills, trading contacts and rep-

utation (Aitken and Harrison 1999, Arnold and Javorcik 2009). As a result, firms with

foreign participation are typically more productive, more capital intensive and pay higher

wages (Harrison and Rodríguez-Clare 2010). Moreover, the effects of FDI can spill over

horizontally within industries or vertically along the value chain. Empirically, the evi-

dence is strongest in support of positive backward spillovers from foreign-invested firms

to their domestic suppliers, most likely taking place through targeted transfers of technol-

ogy (Javorcik 2004, Blalock and Gertler 2008, Barrios et al. 2011, Newman et al. 2015).

By contrast, studies documenting no or negative horizontal spillovers within the same

industry (Djankov and Hoekman 2000, Javorcik 2004, Blalock and Gertler 2008) and no

forward spillovers to domestic customers (Javorcik 2004, Newman et al. 2015) suggest

that foreign invested firms are successful at preventing technology leakages to their local

competitors as well as down the value chain.

Since precise data on FDI regulation is frequently unavailable, most studies rely on FDI

flows to proxy for reforms in FDI regulation. But as investment flows themselves are

influenced by a large number of different factors, this raises the fundamental problem

of unobserved heterogeneity (Harrison and Rodríguez-Clare 2010). Alternatively, newer

studies rely on aggregated indices of FDI openness (Topalova and Khandelwal 2011, Dug-

gan et al. 2013), which by construction cannot be used to capture differential effects of

regulation across more disaggregated sectors. The use of disaggregated regulation data

should help us to trace the effects of FDI regulation as well as regulatory spillovers at a

much finer grained sectoral scale.

1See Görg and Strobl (2001) and Görg and Greenaway (2004) for surveys of the earlier literature.

2

Indonesia offers a great case to study the effects of FDI on firms (e.g., Blalock and Gertler

2008) as well as the effects of FDI regulation itself. As one of the largest economies in

the world, with a wide variety of industries that rely on an abundance of both human

and natural resources, Indonesia has emerged as an attractive FDI recipient. At the same

time, the Indonesian government has been sending mixed signals to foreign investors,

among others by setting up a blacklist of sectors to be closed or only conditionally open

to FDI (Lindblad 2015). The first negative investment list (NIL) has been released in

2000 in order to protect selected domestic industries from international competition and

foreign acquisitions. It has been repeatedly revised since, with a substantial tightening

of FDI policies in 2007 that was followed by partial deregulation in later years. The

effects of this policy instrument have been hitherto unexplored and offer a particularly

interesting opportunity to investigate the effects of FDI regulation on firm performance at

a highly disaggregated level. The excellent quality of Indonesian firm data, especially as

compared to that from other developing countries (Blalock and Gertler 2008), enables us to

investigate the effects of FDI policies on a large sample of middle and large manufacturing

enterprises in an emerging economy at an unusually high granularity.

This paper exploits variation due to three revisions (in 2007, 2010 and 2014) of the NIL

that regulates sectors at the five-digit sector code level, listing each sector that will be

fully or partially closed to FDI in the future and also specifying whether all firms or only

certain types of firms are to be affected.2 The first revision of 2007 substantially tightened

the existing FDI regulation, increasing the restrictiveness towards FDI in a wide range

of sectors. While the revision of 2010 only introduced minor changes, the restrictions on

inward FDI were substantially relaxed in 2014.

We link the regulatory changes in the NIL at the fine-grained level of five digit sectors

to a firm panel of 15 years (2000 to 2014), derived from the Indonesian yearly census of

manufacturing plants. This census intends to include the full universe of manufacturing

firms with at least 20 employees and measures a wide range of plant-level outcomes.3

Our two main outcome variables are the share of foreign ownership of each firm and

an estimated measure of firm productivity. Our regulation indicators are firm-specific

and vary by year, linking information from the NIL to the firm’s main product (at five-

digit level) while also utilizing individual firm characteristics (firm size, legal status and

prior foreign investment) to identify direct exposure to regulation. In a further step, we

construct regulatory spillover variables that measure the indirect penetration of the NIL

to other potentially non-regulated sectors through the value chain (Bourlès et al. 2013).

2The KBLI (Klasifikasi Baku Lapangan Usaha) sector classification is published by BPS (IndonesianStatistical Office, Badan Pusat Statistik). It is equivalent to the United Nation’s International StandardIndustrial Classification of All Economic Activities (ISIC) at the four-digit level, but it is adjusted tofive-digit level in order to distinguish between additional Indonesian sectors of local importance.

3In what follows, we use the concepts of firm and plant interchangeably as we have no further informationon the structure of multiplant firms.

3

All our regressions are conditional on firm fixed effects and hence only consider within-

firm variation in the main economic outcomes over time. Additionally, our preferred

specifications include two-digit sector-year effects that capture all average time variation

due to global and national industry-specific shocks as well as variation in average input

prices. By that, we only focus on the differences between regulated and unregulated

firms within the same broad economic sector and year. The panel structure of 15 yearly

waves allows us to investigate the time profile of regulation in a more flexible way by also

including lags and leads of regulatory change.

The identification of causal linkages between FDI regulation and firm-level changes in

foreign capital shares and productivity requires two main conditions to be fulfilled: no

spuriously correlated further interventions and no endogenous regulation. As to the first

condition, by the mid-2000s the tariff liberalization of the Indonesian economy was already

mostly over, and although there were some further adjustments in non-tariff barriers to

trade over the decade, their sectoral range was much more limited than the sectoral

coverage of the NIL. By that, we are fairly confident that two-digit industry-year effects

can sufficiently deal with average effects of additional broad regulatory trends as well as

industry-level shocks to market prices.

The second requirement poses a larger challenge as firms operating in the least productive

sectors may be more successful at lobbying for protection against foreign entry. Thus,

a negative correlation between regulation and productivity may arise as a result of the

endogenous lobbying process (in the spirit of Grossman and Helpman 1994). The use

of firm and two-digit industry year-effects reduces these concerns to some extent as they

capture both time invariant differences in firm characteristics and general shifts in the

likelihood of regulation at the broad industry level. After the inclusion of these fixed

effects, we see no evidence of pre-reform trends in productivity differences across regu-

lated and non-regulated firms, which also supports a causal interpretation. Finally, our

preferred specifications control for the potential drivers of endogenous protection (sectoral

concentration of sales, share of blue-collar employment and share of public enterprises)

explicitly, interacting pre-reform sector characteristics at the five-digit level with a full set

of year effects. We also test for a more extensive set of sectoral characteristics as initial

conditions. These control for the residual correlation between industry characteristics that

may drive lobbying success and political decisions as well as changes in firm productivity

over time. Our results remain robust to the inclusion of these controls, which makes us

confident that our results are not driven by reverse causality.

The results document a robust negative relationship between regulation and foreign capital

shares: regulated firms shed more or acquire less foreign capital than their unregulated

counterparts. Firms seem to react already one year before the regulation comes into force,

reflecting the importance of anticipation effects. Furthermore, we find that following the

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regulatory changes, total factor productivity of regulated firms decreases relative to that

of non-regulated firms operating within the same broad economic sectors. The regulatory

effect on productivity persists if we control for changing foreign capital shares within the

firm. Hence, the productivity declines must be driven by general changes in the decision

environment that go beyond the effects of the measured changes in foreign capital shares.

We also find that these productivity declines are concentrated in the middle of the firm

productivity distribution and among firms with global trade linkages. When comparing

the effects of different types of regulation, we see that sector-wide investment bans lead

to the largest and most significant productivity declines, whereas bans that are linked

to firm-specific conditions or regulations that do not ban FDI but only establish upper

limits on FDI shares do not matter as much for firm productivity. As such regulations may

offer themselves to a more flexible interpretation, they may not constrain firm decisions as

much as a blank prohibition. We also find a weakly significant negative effect of additional

licensing requirements on productivity.

When analyzing productivity spillovers of the NIL along the value chain, we mainly find

backward productivity spillovers from regulated firms to their local suppliers. Thereby, the

use of more disaggregated national input-output tables allows us to distinguish between

spillover effects within and across two-digit sectors. The backward spillover effect across

two-digit sectors is negative and conforms with previous literature that relies on similar

sectoral detail (Javorcik 2004, Newman et al. 2015), showing productivity losses among

supplier industries, potentially due to reduced technology transfer. By contrast, backward

spillovers within the same two-digit sectors are weakly positively linked to productivity. If

industries within the same two-digit sector provide closer substitutes as targets of foreign

investment to each other, regulation may shift foreign investment to and exert competitive

pressure on more closely related unregulated sectors.

Our contribution to the literature is twofold. First, we are among the first to exploit fine

grained variation in the regulatory framework of FDI in an emerging economy.4 By also

taking firm characteristics into account, we identify direct firm exposure to regulation

more precisely and link it to declines in firm productivity. We also investigate effect

heterogeneity of regulation across firms and across different types of rules. Second, we

add to the literature on FDI spillovers by measuring the horizontal and vertical spillover

effects of FDI regulation. Since we use detailed national input-output tables including 87

manufacturing sectors, we are able to carefully disentangle vertical spillovers within and

across two-digit sectors. We thereby show that our results are mainly driven by regulatory

spillovers across but not within two-digit industries.5

4To our knowledge, there is only one other study (Eppinger and Ma 2017) that looks at FDI regulation atthe firm level. Eppinger and Ma (2017) investigate the effect of China’s WTO accession and the relatedmassive liberalization of the FDI regime on changes in the ownership structure of firms. Their resultsshow that changing ownership structures also lead to a boost in output and labor productivity.

5Bourlès et al. (2013) also construct measures of “regulatory burden”. In their cross-country study they

5

This paper proceeds as follows. Section 2 describes the regulatory framework of the

negative investment list in Indonesia and introduces the data sources. Section 3 presents

the estimation strategy and the identification approach. Section 4 presents our results on

the direct effects of the investment reform on foreign capital share and firm productivity

as well as the indirect effects through regulatory spillovers. Section 5 concludes.

2 Regulatory background and measurement

2.1 Foreign investment regulation in Indonesia

Indonesia started to remove the first barriers to foreign direct investment already un-

der the “New Order” regime of President Suharto. The investment coordination board

(BKPM, Badan Koordinasi Penanaman Modal) was installed in 1973 in order to deal with

foreign investment approvals (Gammeltoft and Tarmidi 2013). However, due to its strong

dependence on natural resources, the Indonesian manufacturing sector was only poorly

developed until the early 1980s (Lindblad 2015). Starting in 1983, successful efforts to-

wards industrialization increased the importance of the manufacturing sector and made it

the driving force behind Indonesia’s accelerating growth (Blalock and Gertler 2008). Dur-

ing the 1990s the Indonesian government has changed its previously investment-hostile

regime by opening up the economy to investments from abroad. It quickly became “one

of the most promising host countries [for investment], combining liberal legislation with a

massive endowment of natural resources and a huge and rapidly growing domestic market

for manufactured goods” (Lindblad 2015, p. 225).

The Asian financial crisis of 1997 marks a break in Indonesia’s economic development.

Despite immediate intervention by the International Monetary Fund, the consequences of

the rapidly depreciating Rupiah spread to the real economy. This was accompanied by

social and political instability that destroyed much of the confidence in Indonesia as a

host for investment (WTO 1998). In order to regain the confidence of foreign investors,

steps towards democratization, administrative reform and further trade liberalization were

taken (Duggan et al. 2013). However, Indonesia did not immediately return to economic

growth and foreign investors remained cautious since the business and legal environment

remained rather precarious. Major reforms after 2004 introduced fiscal incentives to

foreign investors, streamlined bureaucratic procedures and prescribed non-discriminatory

treatment for foreign and domestic investors (WTO 2013). In the aftermath of these

reforms, FDI inflows have massively increased again and economic growth has recovered

strongly.

Despite the ongoing liberalization, trade and investment policy in Indonesia remains

especially focus on the impact of upstream sector regulation on productivity in downstream industries.

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“blurred by contradictory signals” (Lindblad 2015, p. 229). In the close aftermath of

the Asian financial crisis in 2000, the president released the Presidential Decree 96/2000,

at the core of which lies the so-called negative investment list (NIL 2000), naming sec-

tors that are closed or only conditionally open to FDI. Conditions included the need to

form joint ventures between domestic and foreign entities, authorization in certain regions

and licensing requirements. Before 2000, no explicitly formulated version of the NIL was

available. There was a blacklist of sectors closed to foreign investment, but approval pro-

cedures lacked transparency and were completely in the hands of the BKPM. The NIL

2000 was the first to publish regulatory information in a transparent way but still listed

sectors verbally, without recurring to detailed sector codes.

The NIL has been revised for the first time in 2007 and the new list was released with

the Presidential Decree 77/2007. The new version replaced the old vague register from

2000 (Article 7) and listed sectors by their detailed KBLI codes at five-digit level for the

first time. In its trade policy review, the World Trade Organization highlights that a

detailed NIL brings greater transparency with respect to investment and therefore may

be beneficial (WTO 2013). However, closing or conditionally opening certain sectors to

foreign investment is likely to be associated with wasted gains from FDI. In this sense,

the revised version can be considered as a protectionist measure as it adds substantially

more sectors and involves more conditions compared to the NIL 2000. The NIL 2007

comprises manufacturing as well as agriculture and services and introduces standardized

categories of conditions for the first time. According to these conditions, some sectors were

fully closed to foreign investment, in others, FDI was only allowed in small and medium

sized firms, in form of partnerships, up to a certain limit of foreign capital ownership, in

certain locations, or required licensing by the ministry in charge. The next revision of

the NIL came with the Presidential Decree 36/2010, leaving regulation in some sectors

unchanged but also removing some sectors from and adding other sectors to the NIL.

Finally, the latest revisions (with the Presidential Decrees 39/2014 and 44/2016) removed

many sectors from the list of closed sectors, converted bans into licensing requirements,

and clearly decreased the overall extent of regulation. A comprehensive overview of all

revisions of the NIL is provided in Table A1 in the Appendix, including its representation

in the sample and the shares of regulated firms in total manufacturing output.6

6An important characteristic of all versions of the NIL is that regulation is forward looking and doesnot apply to previously approved investments. Thus, the regulation refers to new investment plansand interferes with possible future FDI inflows. See Article 8, Presidential Decree 36/2010, article 5 ofPresidential Decree 77/2007 and article 9 of Presidential Decree 39/2014.

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2.2 Firm data

The source of firm data is the annual manufacturing census of Indonesia (Survei Industri,

SI) that surveys the universe of all registered Indonesian manufacturing firms with at least

20 employees. The census has been conducted by BPS yearly since 1975 and contains a

rich set of information at the level of manufacturing plants, including the values of inputs

and output, foreign ownership, the value of imports and exports as well as employment

and capital stocks. We follow the literature by using the share of foreign capital as a proxy

of FDI (see e.g., Amiti and Konings 2007, Blalock and Gertler 2008, Arnold and Javorcik

2009, all based on the same SI data). In the SI data, sector codes always refer to the main

product of a firm, which introduces some imprecision as multi-product firms may switch

between sectors every year. We assess the potential extent of this issue by recording all

switches in the main product from year to year. One concern is that regulation creates

incentives to switch the sector to avoid limitations to FDI. We test for the relevance of

this channel in section 4.4.

The data is cleaned for missing values and extreme outliers. As common in the literature,

data points are interpolated between the previous and the next year to avoid the loss of

too many observations, while further missing observations are dropped from the sample

(Amiti and Konings 2007).7 Our final dataset consists of an unbalanced panel of 30,508

firms with a total of 208,120 observations. The sample size decreases further in some

regressions because of missing values in some of the control variables as well as due to the

choice of lag structure: the main regressions estimating the effects of regulation on firm

productivity rely on 185,978 observations. We investigate the robustness of our results to

the choice of lag structure and to using other proxies of productivity for a larger sample

of firms in section 4.4.

We transform all input and output variables to their natural logarithms, using a Box-Cox-

transformation to deal with zeros. This not only allows for a more intuitive interpretation

of coefficients as percent changes but also makes estimations less vulnerable to remaining

outliers. We deflate all monetary values to the base year 2008 by using the yearly wholesale

price index from BPS and comment on the role of price deflators in section 4.4.

There are some concerns regarding data quality in the SI. First, doubts arise with respect

to its completeness since it claims to include all medium sized and large manufacturing

firms in Indonesia. Due to the large number of firms, it is at least possible that SI misses

firms in some years or cannot investigate cases of non-respondents, leading to non-random

selection and undercounting of smaller firms. The presence of financial incentives for the

field agents to register new firms and verify firms that do not reply immediately reduces

this problem as budgets are linked to the number of reported establishments (Blalock and

7Appendix A.1 provides more detailed information on data cleaning procedures.

8

Gertler 2008, Arnold and Javorcik 2009). However, this may also create wrong incentives

by tempting field agents to fill in values of non-reporting firms themselves. A second

issue arises because of potential misreporting by firms. Government law guarantees the

exclusive and anonymized use of information for statistical purposes. Firms may still be

concerned, however, that reported information is leaked to tax authorities or competitors

and may intentionally report wrong data (Blalock and Gertler 2008). Furthermore, if firms

do not put much effort into the correct completion of the questionnaires, numbers may

be falsely reported by accident. Hence, noise within the data is likely to be a considerable

issue. However, as long as firm selection and response behavior is not directly linked to FDI

regulation, firm and two-digit sector-year fixed effects are likely to lead to unbiased within-

estimates. We investigate one specific potential channel of misreporting more explicitly

in section 4.4 by assessing whether regulation makes firms to switch their reported main

product and whether switching firms show different productivity responses to regulation.

2.3 Combined dataset and descriptive trends

We combine the firm data with self-collected information from five revisions of the NIL

by five-digit KBLI sector. While total closure to any investment within a sector unam-

biguously affects all firms, other rules depend on firm characteristics such as firm size,

legal status or location. We thus use the survey information on sales, net assets, legal

status and location to determine firm-specific exposure to regulation. Moreover, since the

preambles of the Presidential Decrees exclude already existing foreign investments from

a new regulation, we offset regulation for those firms that exceed the later legal limits on

the share of foreign capital already before the revision of the NIL.8

Finally, although some of the NIL stipulations verbally narrow regulation to selected

subcategories (e.g., to product features) within a five-digit KBLI sector, we always assume

regulation for the whole five-digit sector. The resulting measurement error is most likely

to cause attenuation bias and thus our results will be underestimated. For a detailed

description of the coding and merging procedures, see Appendix A.2.

We combine the detailed conditions of the NIL with firm level information to generate a

single measure of exposure to regulation. The indicator variable Regulated takes one if

a firm is subject to any kind of regulation in a certain year, taking firm characteristics

relevant for the applicability of the regulation into account. For example, Regulated takes

zero if a medium sized firm operates in a sector that is open to small and medium sized

firms but requires licensing from large firms. For a large firm operating in the same sector,

8The effect of regulation on firm productivity does not crucially depend on this latter adjustment. However,the effect on FDI is much weaker without excluding firms with existing FDI from the regulation. As theforeign capital share in most of the adjusted cases is 100% or close, forward looking regulation does notlimit the direct scope of FDI in such firms, at least in the short run.

9

however, Regulated takes one since FDI is conditional on a successful licensing procedure.9

We further investigate which types of rules affect foreign share and productivity by ex-

plicitly differentiating between different types of regulation (sector-wide and firm-specific

bans and limitations and licensing requirements) in section 4.3.

Table 1 presents summary statistics for the main variables in the years 2000, 2007 and

2014.10 Despite increasing regulation, the overall share of foreign capital increases over

time, although most domestic firms receive zero FDI throughout the whole time period.

Figure 1 shows the more detailed time patterns of regulation and total factor productivity.

The black dashed line shows the average share of regulated firms over time and marks a

strong tightening of regulation in 2007 as the share of regulated firms increased from less

than 5% to more than 20%. In 2014, the scope of regulation declined somewhat, with

a marked shift from firm specific bans towards licensing requirements (cf. Table 1). The

solid lines plot the average development of total factor productivity in our sample of firms

over time. They distinguish between regulated and non-regulated firms in the respective

years and show that on average, firms that operated in sectors subject to FDI restrictions

were slightly more productive than other firms before 2007. In 2007, both regulated

and non-regulated firms faced a negative productivity shock on average, but the drop

in productivity was larger among the regulated firms. In the aftermath, productivity in

both groups recovered again. This evidence is clearly descriptive but already foreshadows

our identified results. The observed negative productivity shock precedes any potential

effects of the global financial crisis, the macro-economic effects of which did not reach

the emerging markets for other two years. It was only in 2009 that Indonesian GDP

experienced a short stagnating period with a subsequent quick recovery and hence the

2007 productivity drop is less likely to be driven by this common global market shock.

Moreover, common market shocks that affected whole industries will be factored out in

our empirical analysis by the use of two-digit sector-year effects.

Table 2 displays the share of regulated firms, the average foreign capital share and total

factor productivity by two-digit sector and year. Regulation across sectors shows a very

heterogeneous picture. Some industries are not affected by the NIL at all whereas other

sectors like wood and wood products were already strictly regulated in 2000. Our analysis

will utilize variation in regulation and productivity across the sub-sectors of the presented

two-digit sectors over time, while controlling for sector-year effects. Thus, we do not

explain changes in FDI penetration or sector-wide changes in productivity, but only focus

9We define firm size according to the Presidential Decree No. 36/2010 that refers to law 20/2008 on smalland medium sized enterprises. A firm is defined as large by this law if its annual sales are higher than50 billion IDR or its net assets (excluding land and buildings) surpass 10 billion IDR. The PresidentialDecree No. 77/2007 refers to an earlier law 9/1995 on small enterprises with very similar definitions oncethe thresholds are adjusted for inflation. We apply this rule yearly, adjusting for inflation.

10Summary statistics for the full sample can be found in Table A2 in the Appendix. Table A3 shows theyearly number of observations in the two largest estimation samples.

10

at the within-firm and within-sector-year differential relationship between FDI regulation

and firm outcomes.

3 Estimation strategy

3.1 Baseline model

We investigate the effect of the foreign investment regulation on firm outcomes by esti-

mating the equation

yijt = αREG ijτ +X′ijtβ + λi + γrt + ψst +Z

′j,2005 × φt + εijt τ = t− 1, t, (1)

where yijt measures the relevant outcomes of firm i operating in the five-digit sector j

in year t. Our two main outcomes measure the percentage of foreign equity in total

firm equity (FDI share) and the log of total factor productivity per firm. REG ijτ is the

investment restriction in sector j in year τ , conditional on the characteristics of firm i.

We test for contemporaneous as well as lagged effects of regulation, τ = t, t − 1, and in

further tests also include up to three lags and leads of regulation at the same time. All

regressions include a vector of controls X ijt to capture time-variant firm characteristics,

such as a set of indicators for firm age categories and a public enterprise indicator (if

more than half of a firm’s capital is owned by the state). We condition our results on firm

fixed effects λi, a set of year effects that vary by macro-region (island) γrt,11 and two-digit

sector-year fixed effects ψst. The residuals εijt are robustly estimated and clustered at the

firm level.

Our extensive fixed effects mitigate issues with unobserved heterogeneity and endogenous

regulation. Firm fixed effects absorb all time invariant unobservable firm characteristics,

including the firms’ average propensity to enjoy protection or be subject to regulation

(Goldberg and Pavcnik 2005). Island-year fixed effects control flexibly for all regional

influence factors that may correlate with both regional exposure to regulation and shifts

in foreign capital shares. The sector-year fixed effects control for time variant incentives

to lobby for protection at the two-digit sector level (Blalock and Gertler 2008). The time

effects also implicitly cancel out common time trends and common macroeconomic or

regulatory shocks to FDI and productivity. Adding further lags and leads of regulation

helps us to better understand the timing patterns of regulatory effects and to look for

anticipation effects or pre-trends.

In our preferred specifications, we capture a further set of determinants of the propensity

to be subject to regulation at the detailed five-digit sectoral level by interacting average

11We distinguish between Sumatra, Java, Kalimantan, Sulawesi and the rest of smaller islands.

11

characteristics of sector j from two years before the major regulatory reform with a full set

of year effects: Z′j,2005 × φt. By doing so, we explicitly control for sectoral characteristics

at the five-digit level that may explain the later success of lobbying behavior. In our

main specifications we interact the sectoral concentration of sales, the share of blue-collar

(production) workers and the share of public enterprises within the sector in 2005 with a

full set of year effects. A higher sector concentration provides firms with better incentives

to pursue co-ordinated action and more power to lobby for protection (Grossman and

Helpman 1994). Sectors with a larger share of low-skilled workers are potentially more

vulnerable and policymakers tend to protect those sectors more (Topalova and Khandelwal

2011). Finally, sectors with a high share of government-owned enterprises may be more

successful at hindering foreign entry (Chari and Gupta 2008).

In further specifications, we also test for a more extended set of initial sector traits in

2005, again interacted with a full set of year effects. These additional characteristics

include employment growth between 2000 and 2005, average capital intensity, average

foreign capital share and import penetration. Employment growth controls for declining

industries which may be treated with special care by policymakers (Grossman and Help-

man 1994). Moreover, high capital intensity, existing FDI presence or strong competitive

pressure from foreign imports have also been argued to influence the political decision for

regulation (Gawande and Krishna 2003).

3.2 Estimating total factor productivity

We estimate total factor productivity (TFP) for each firm, while simultaneously account-

ing for the correlation of the firm’s input choices with the error term (cf. Javorcik 2004,

Amiti and Konings 2007, Newman et al. 2015). If a firm adjusts its choice of inputs to

unobserved productivity shocks, disregarding this adjustment will induce a severe simul-

taneity problem and, thus, lead to biased coefficients.12

The estimation is based on a Cobb-Douglas production function in value added terms on

plant level:

VAit = Yit −Mit = AitLαL

it KαK

it , (2)

where the value added of firm i in year t, VAit, is calculated by subtracting the value

of the intermediate inputs Mit from total firm output Yit. Value added is a function of

productivity Ait, the variable input factor labor Lit and quasi-fixed capital Kit. Taking

natural logs results in:

vait = α0 + αLlit + αKkit + ωit + eit, (3)

12See van Beveren (2012) for a detailed discussion of total factor productivity estimation in the literature.

12

where small letters denote logs. The error term can be decomposed into two components,

an unobserved productivity component ωit and the independently identically distributed

error term eit. Simultaneity bias is introduced because a part of the productivity shocks

is also correlated with the choice of the variable inputs, namely labor and intermediate

goods.

In order to consistently estimate total factor productivity, we apply the approach sug-

gested by Wooldridge (2009). We estimate the log of total factor productivity for each

two-digit sector s separately, taking into account the varying importance of input factors

across industries:

ln(TFP)ist = vaist − α̂0s − α̂l

s list − α̂ks kist, (4)

where αsl and αs

k are the sector-specific input coefficients (see also Table A4).13

A more disaggregated estimation, yielding separate input coefficients on three-digit sector

level, is also feasible. However, as this results in somewhat less stable input coefficients,

we prefer to rely on two-digit input coefficient estimates for the baseline results. We

comment on the role of aggregation in section 4.4. Moreover, estimating TFP over time

may also be sensitive to the choice of price deflators. As detailed sector specific price

deflators are not available for the whole time period, our main results rely on a common

wholesale price deflator. Section 4.4 reports further results that use more detailed sectoral

input and output deflators measured at the five-digit level.

3.3 The effects of regulatory spillovers

As a further step, we investigate the effects of horizontal and vertical regulatory spillovers

that are propagated along the value chain:

yijt = αREG ijt + δ1 Horizontalkt + δ2 Backwardkt + δ3 Forwardkt+

X′ijtβ + λi + γrt + ψst +Z

′j,2005 × φt + εijt τ = t− 1, t.

(5)

Horizontalkt captures the extent of overall regulation within the three-digit sector k in

year t and is measured by the share of protected firms within a sector weighted by each

firm’s median sales Salesi (Javorcik 2004):14

Horizontalkt =

(∑

∀i∈k

REG it × Sales i

)/∑

∀i∈k

Sales i. (6)

13See Appendix A.3 for a more detailed description of the approach and Newman et al. (2015) for usingthe same approach on the two-digit sector level.

14We determine the median level of sales for each firm to make sure that results are not driven by time-varying output. Results are robust to the use of time-varying sales.

13

Horizontal spillovers arise when regulation affects foreign investment or productivity

within a whole sector beyond its direct effects on each regulated firm. Horizontal spillovers

may capture regulatory avoidance behavior that shifts foreign capital to the non-regulated

parts of the three-digit sector, or overall shifts in competitive pressure. Their productivity

effects are ex-ante ambiguous: shifting FDI may increase the productivity of non-regulated

firms, but at the same time, reductions in the overall competitive pressure within the sec-

tor or increasing perceptions of regulatory insecurity may also reduce productivity.

Backwardkt proxies for regulatory penetration in the customer industries v of the three-

digit industry k:

Backwardkt =∑

v 6=k

αkv × Horizontalvt, (7)

where αkv is the proportion of sector k’s output supplied to sector v, taken from the nation-

wide input-output (IO) table of 2005 (BPS 2005). Unlike international IO databases,15

the BPS provides highly disaggregated information that distinguishes 175 sectors in total

(out of which 87 belong to manufacturing), which is broadly comparable to the three-digit

sector level.

Due to this high level of disaggregation, we are able to differentiate between two different

types of backward spillovers separately. We define the variable Intra-sectoral Backwardkt

to capture spillovers to suppliers that occur within the same two-digit industries, and

Inter-sectoral Backwardkt to capture those that affect suppliers that are active in other

two-digit sectors. Due to the relatively low level of disaggregation, other studies usually

refer to inter-sectoral spillovers whenever they identify backward linkages (Javorcik 2004,

Blalock and Gertler 2008, Newman et al. 2015). We expect a negative impact of regulation

on firm productivity in downstream industries if both industries are sufficiently distinct

from each other (inter-sectoral backward linkages). Protection of important customer

sectors may reduce transfers of technology and other non-tangible assets to domestic

upstream firms. This can arise either because of a decrease in foreign presence or because

existing foreign-invested firms abstain from knowledge transfers to local suppliers in the

face of higher uncertainty. However, the mechanisms are not necessarily the same if the

customer and upstream industry operate within the same two-digit sector as in this case

the intra-sectoral backward effect could also pick up spillovers that are usually labeled

as horizontal and reflect avoidance behavior by foreign investors towards non-regulated

sub-sectors or types of firms. The net effect in this case is not clear ex-ante.

Finally, we construct Forwardkt that proxies for regulatory penetration in the supplying

15OECD (2005) or the world input-output database (Timmer et al. 2015).

14

industries w of three-digit industry k (Bourlès et al. 2013):

Forwardkt =∑

w 6=k

σwk × Horizontalwt, (8)

where σwk is the proportion of sector k’s intermediate inputs that it purchases from sec-

tor w. Like before, we disentangle Intra-sectoral Forwardkt and Inter-sectoral Forwardkt

spillovers to account for potentially different linkages across sectors within the same broad

industry and across industries. In all cases, variation within the horizontal and vertical

spillover measures stems from changes in regulation over time. Both the input-output

coefficients and the firm sales are fixed to make sure that we only measure effects that

originate from revisions of the NIL and not from general structural change.

4 Results

4.1 Pre-trends and anticipation effects

A preliminary investigation of time patterns in FDI and productivity around the regula-

tory change indicates some anticipation effects for FDI but no pre-trends in productivity.

This latter finding supports a causal interpretation of the effects of regulation on pro-

ductivity. Figure 2 plots estimated coefficients from fully specified firm level regressions

that include time variant controls, initial sector traits in 2005 interacted with a full set of

year effects, firm fixed effects as well as island-year and two digit sector-year fixed effects.

Moreover, they include the main regulation indicator together with its three lags and

three leads:

yijt =∑t+3

τ=t−3 ατREG ijτ +X′itβ + λi + γrt + ψst +Z

′j,2005 × φt + εijt, (9)

the estimated coefficients α̂τ from which then are plotted in Figure 2 (see also Table A5

for all coefficients and alternative dependent variables).16

Figure 2 shows that foreign capital shares and productivity follow substantially different

time patterns around the regulatory intervention. FDI shares within the regulated firms

as compared to their non-regulated counterparts decline already before the regulation

has taken effect, with a significant reduction in the year before the regulatory tightening,

followed by a further decrease in the year of regulation (see Panel A of Figure 2). FDI

stabilizes in the aftermath of regulation and we even see a short-term rebound effect in

16The inclusion of several lags and leads of regulation reduces the sample size substantially, especially aswe omit the years 2000 and 2001 from the regression. We include leading observations of regulation byrelying on information from the NIL 2016 revision. Table A3 of the Appendix provides an overview ofthe total number of observations by year in our full sample.

15

the year t + 1. This result holds not only for the intensive but also for the extensive

margin of FDI (see column 2 of Table A5).

By contrast, the time effects on total factor productivity show no pre-trends in the three

years before regulation (see Panel B of Figure 2). Regulated and non-regulated firms

are comparable in the run-up to regulatory change in terms of their productivity once

sector-year, island-year and firm fixed effects are factored out. Starting with the year

of regulation, productivity shows a marked drop in the group of regulated firms and

the negative effects persist for two further periods. While the coefficient on regulation

becomes statistically significantly different from zero only two periods after regulation has

been introduced, the Figure shows that the structural break occurs already in t.

Given these time patterns, we decided to follow the literature by linking TFP to regulatory

intervention within the past year, setting τ = t − 1 (see equation 1), but at the same

time to consider a shorter term response of FDI to contemporary regulation with τ = t.

The missing pre-trends in productivity suggest that policy-makers were not implementing

protectionist measures in sectors with declining productivity and thus reverse causality is

unlikely to drive our results. Nonetheless, the significant FDI reaction in the year before

regulation highlights the potential importance of anticipation effects.

Anecdotal evidence indeed suggests that firms already may have anticipated changes in

the regulatory framework before the introduction of the new presidential decrees. For

instance, the largest Indonesian newspaper, Kompas, has already started to cover the

topic in 2005 (June 30), two years before the actual NIL 2007 revision, reporting that

the wheat industry will not enter the new list. Coverage got more pronounced at the

beginning of 2007. On February 8, Kompas announced that the Ministry of Industry

wants sugar refineries to enter the list. When the revision finally took place, Kompas

reported some concerns from business actors who criticized the list because “existing

investment is difficult to develop even though the NIL is not retroactive” (July 16, 2007,

p. 18). Similarly, Kompas already started to report on plans to revise the NIL at the

beginning of 2013 while the Presidential Decree was only released in April 2014. In

February 2013, Kompas quoted the head of the Investment coordination board, M. Chatib

Basri, saying that “the main goal is to improve national competitiveness and to be more

investor friendly” while “there are still sectors that must be protected” (February 18, 2013,

p. 20). Another article reported on plans for relaxation of investment in the alcoholic

beverage industry on July 12, 2013. By the end of 2013, news coverage of the topic

increased substantially. For example, Reuters reported on the “ease of regulation to allow

foreign companies [...] to manage and operate airports” (November 20, 2013). Around the

same time, Kompas published a letter to the editor in which a concerned reader named

further sectors where access to foreigners is planned, among others also pharmaceuticals

(November 28, 2013).

16

Even though this evidence is only anecdotal, the fact that newspapers openly discussed

the revisions of the NIL more than one year ahead shows its relevance for the Indone-

sian economy. We further believe that industries and firms have been aware of more

detailed plans of the revisions even before they entered public media, which can explain

the observed anticipation effects and sinking foreign investment shares in selected sectors.

4.2 Baseline results

Results in Table 3 show a significant decline in FDI within regulated firms. The first five

columns report the baseline effects of regulation on FDI shares within the firms, using

equation (1) and linking FDI shares to contemporary regulation. As FDI has responded

immediately to regulation (and has even shown anticipation effects, see above), we focus

here on the immediate response that started in the year of regulation. The first column

in Table 3 includes only firm fixed effects and island-year effects whereas further columns

consecutively extend this specification, without changing the magnitude or statistical

significance of the estimated effect. Column 2 adds categories of firm age and an indicator

for state enterprises as time variant controls. Column 3 extends the model by two-digit

sector-year interactions whereas column 4 and 5 interact five-digit sector characteristics

in the pre-reform year 2005 with a full set of year effects. While column 4 uses a more

limited set of sector characteristics, including sector concentration, the share of blue-collar

workers and the share of public enterprises, column 5 extends this list even further by

adding prior employment growth, capital intensity, the share of foreign capital and import

penetration at the five-digit level.

Throughout all specifications, the estimated impact of the regulation indicator on foreign

capital share is highly significant and implies that becoming protected is associated with

a 0.8 percentage points lower foreign equity ownership share on average. This effect may

not seem very substantial but it still amounts to about 10% of the mean ownership within

the sample (which is about 7%). Column 6 shows that our result is not driven by the

intensive margin of firm ownership only. When we substitute the dependent variable by

an indicator for a multinational enterprise (MNE, defined as a firm with at least 10%

foreign ownership), the results show that regulation also reduces the likelihood of a firm

having considerable foreign capital (at the extensive margin). Overall, the coefficients

stay remarkably stable when further fixed effects and initial industry characteristic times

year fixed effects are additionally controlled for, indicating that endogenous regulation is

unlikely to drive these results.

At the same time, regulation is also linked to a statistically significant decline in total

factor productivity (see Table 4). Unlike before, we use the first lag of the regulatory

indicator in our main specifications as productivity is usually expected to adjust more

17

slowly upon regulation (and Figure 2 has shown no anticipation effects).17 The first five

columns of Table 4 report the baseline effects of regulation on TFP (based on equation

1). As before, the table starts with firm and island-year effects only and adds further

controls step-by-step. Unlike in the case of FDI shares, controls do make a difference for

our TFP estimates. Although the productivity effects of regulation have a negative sign

even without any controls, they only gain significance once two-digit sector-year effects are

included in the regressions. This makes sense as sector-year effects are often considered

as crucial controls for productivity estimates (Goldberg and Pavcnik 2005), especially as

they also pick up industry-specific variation in the price of intermediates, which will affect

TFP estimates substantially.18

Adding time effects interacted with initial five-digit sector characteristics to the regressions

in columns 4 and 5 does not change the point estimates, which shows that the changes in

productivity are not driven by characteristics of the finely grained sectors that may make

regulation more likely. The point estimate on the regulation coefficient implies that a firm

that has become regulated in the previous year experiences a 3.4 to 3.6 percent reduction

of its TFP ceteris paribus. Column 6 checks the sensitivity of our results to the specific

TFP estimation. It takes the log of value added per worker as an alternative dependent

variable which is often used as proxy for labor productivity in the literature (cf. Amiti

and Konings 2007). The coefficient of regulation barely changes and remains significant

at the five percent level.19

Our baseline TFP regressions measure the full regulatory effect, without controlling for

changes in FDI shares directly. However, alternative specifications that include the foreign

capital share as additional control result in virtually the same regulatory coefficient (see

Table A9 in the Appendix). While we also find that TFP is positively related to foreign

ownership shares (though without reaching conventional levels of statistical significance),

the regulatory effects do not seem to be driven by immediate drops in the firms’ FDI

shares and may rather reflect changing patterns of technological upgrading or changing

expectations with respect to competitive pressure that lead to adjustments in factor use.

17Table A6 shows that our results are robust to substituting contemporaneous for lagged regulation. Seealso section 4.4.

18Columns 7 to 9 of Table A7 in the Appendix show that when using five-digit sector-specific input andwholesale price deflators and estimating TFP at the three-digit level, regulation significantly reducesTFP even without the inclusion of sector-year effects. As more detailed price deflators are not availablefor the full time period and have to be partially imputed, while the three-digit TFP estimates turn outgenerally less robust, we prefer to rely on the aggregated wholesale price index, two-digit sector basedTFP estimates and two-digit sector-year effects in our main specifications. See also section 4.4.

19Alternative measures of productivity, such as total value added, value added per worker and value addedper capital yield overall comparable results (see Table A8 in the Appendix).

18

4.3 Heterogeneities in regulation and across firms

Our general regulation indicator combines a range of different provisions, not all of them

equally restrictive. In order to better understand which types of regulatory interven-

tions are more likely to affect FDI and productivity, Table 5 differentiates between major

types of regulation by contrasting licensing requirements with the more direct bans and

limitations on FDI. Licensing requirements leave the affected sectors open to FDI but

potentially increase the compliance burden by introducing costly and time-consuming

procedures. However, as licensing requirements have been more extensively used in the

later years (as part of the easing of regulation in 2010 and later), their introduction may

have also been seen as guaranteeing openness and signaling that FDI will still be possible

in these sectors. By contrast, the diverse bans and limitations on FDI are less ambiguous

in their effect as they are more likely to restrict FDI flows. We further disentangle these

latter rules into three groups: 1. limitations that introduce upper limits on FDI shares,

2. sector-wide bans that prohibit FDI in the given sectors irrespectively of firm character-

istics, and 3. firm-specific bans that restrict FDI conditional on firm characteristics like

firm size or legal status.20 Table 5 shows that licensing requirements do not curb for-

eign investment whereas bans and limitations generally tend to reduce FDI (column 1).

However, both types of regulation are similarly costly in productivity terms (column 4).

Further disentangling the restrictions by their type is somewhat limited by power issues,

but the results show that while all bans and limitations tend to reduce FDI (columns 2

and 3), in terms of productivity losses, the closing of full sectors to FDI seems to be the

most detrimental (column 6), suggesting the importance of general reductions in perceived

competitive pressure.

In Table 6, we investigate which types of firms were the most affected by regulation and

distinguish between firms based on their foreign market linkages, their place in the rela-

tive productivity distribution, and their size. Firms with linkages to international markets

may be more directly (and hence also more strongly) affected by protectionist measures.

We thus check for differential effects of regulation among those firms that have engaged

in either exports or imports, or had an above ten percent foreign capital participation

at least in one year of our sample period.21 The results show that FDI decreased upon

regulation not only in firms with international linkages but also on average (column 1).

The regulatory effects on FDI did not differ in firms that engage in foreign trade, but

were naturally concentrated among MNEs (defined as firms with above 10% of foreign

ownership at any point over the whole time period). The interaction coefficient on foreign

ownership is highly significant and shows a total decline of about 4.1 percentage points

20See Appendix A.2 for a detailed overview of the types of regulation and how categories are aggregated.21There are 12,691 firms with some import or export activity and 3,379 firms with foreign participation.

2,907 firms show both trade and FDI linkages.

19

in FDI shares in MNEs. This reflects a nearly-mechanical scale effect as the scope of

adjustment is highest among such firms by definition. By contrast, the decomposition of

productivity effects by foreign market exposure does not yield significant coefficients (col-

umn 4), although the total effect for domestic trading firms is substantial (−5.6 percent)

and tests significant at the 1 percent level. These two sets of results show that regula-

tion did not act directly by reducing productivity in the MNEs only, rather, it especially

affected domestic firms with global trade linkages.

As a second test of across-firm heterogeneities, we split firms into three groups according

to their position within the productivity distribution. The low (high) productivity group

includes those firms that have been in the lowest (highest) decile of the two-digit sectoral

TFP distribution in at least one year. The group of medium productivity comprises

firms that have never been in the lowest or highest decile of the sectoral productivity

distributions, or, in some cases, appeared in both the upper and lower decile, mostly

due to sector switches across two-digit industries.22 The results show that regulation

reduced FDI shares in firms of all three productivity categories significantly (column 2),

but high productivity firms suffered substantially larger declines in FDI (of 1.5 instead of

0.3 percentage points on average). The subsequent productivity losses have been especially

concentrated in medium productivity firms. Finally, we distinguish between medium-sized

and large enterprises following Indonesian legal definitions.23 We find no statistically

significant differences in FDI or productivity effects of regulation by firm size.

4.4 Further robustness issues

The baseline models fixed the time structure of the regulatory response by considering

contemporaneous regulation for FDI and lagged regulation for TFP. Figure 2 and Table A5

depict a more complex timing structure of regulatory effects, but the lag structure comes

at the cost of using a substantially shorter time frame and showing reduced significance

of the yearly effects of regulation on TFP. As an alternative test of time patterns around

the regulatory intervention, Table A6 repeats the baseline regressions for FDI and TFP

by shifting the time lag of the regulatory treatment by a year in each direction. Unlike

the results based on three lags and leads (see Figure 2 and Table A5), these shifts in the

lag-structure reduce the sample by one year only. We report the results pairwise using

regulation in t and t − 1 (or t and t + 1), relying on the same sample for each pair. For

FDI, there is hardly any difference between the coefficient of regulation in t and t+1, with

22According to this definition, there are 7,960 firms in the lowest category (with an average foreign capitalshare of 1.3%), 15,774 firms in the mid category (with an average foreign capital share of 4.6%) and 7,291firms are identified as highly productive (with an average foreign participation of 15.8%).

23We distinguish between medium-sized and large enterprises according to the definition in law law 20/2008on micro, small and medium enterprises (see also Appendix A.2). There are 29,236 (1,789) medium-sized(large) firms in our sample with an average foreign capital share of 4.9% (29.3%).

20

both of them being significant, whereas regulation in t − 1 does not reach conventional

levels of significance. By contrast, while there is no evidence in favor of any anticipation

effects on TFP, the lagged coefficient comes out somewhat larger in magnitude and more

significant than the contemporaneous effect.

Although our results are identified within the same firms and hence are less likely to be

driven by shifts of firm composition, it is still useful to understand whether the compo-

sition of firms endogenously adjusts in response to the revision of the NIL. Protection

of a sector may increase the incentives for new firms to enter the market or reduce the

exit rate of firms by allowing non-competitive firms to stay in the market. Conversely,

regulation may also impact firms negatively, forcing them to leave the market or keeping

new entrants out of the market. It is not clear in which direction the effect will go ex

ante, but the resulting shifts in firm composition may affect average firm productivity.

Column 1 of Table 7 documents that regulation within a particular sector indeed reduces

the probability of market entry by new firms in the same period. Furthermore, regulation

also increases the likelihood of market exit in the next period. However, the nature of the

data does not allow for a closer analysis of market entry and exit dynamics as the exact

year of entry or exit may be mismeasured due to firm (non-)response behavior. We thus

concentrate instead on whether there is a differential response to regulation among those

firms that either enter or exit the market over the sample period. Columns 3 and 5 show

that new entrants do not differentially respond to regulation in terms of their FDI or TFP:

while interaction coefficients are positive, they are not significant. For firms exiting over

the sample period, the interaction coefficients with both FDI and TFP become positive

and significant in column 4 and 6. Taken together, these results show that entering and

exiting firms do not react more negatively (and potentially react somewhat more weakly)

to regulation. This makes it unlikely that even the average results would be driven by

sample selection issues.

A different, and potentially more serious, concern is that firms will endogenously decide on

whether they want to operate in a regulated sector or switch to a non-regulated product.

Such sector switching may bias our estimates, but the direction of the bias is not clear ex-

ante. It is both possible that firms select into newly protected sectors or choose to operate

in non-regulated sectors. Moreover, as SI firms (more accurately, plants) may produce

multiple products but only report their main product, regulation may also simply lead to

firms reporting to belong to a non-regulated sector as a form of avoidance behavior. This

second channel is unlikely to play a central role though as the firm census is not used by

the authorities to explicitly monitor firms (Blalock and Gertler 2008).

Table 8 addresses the product switching behavior by firms. Our dependent variable in

the first two columns is an indicator for a sector switch that takes one if a firm changes

its reported five-digit sector code in year t as compared to its previously observed sector.

21

Column 1 shows no evidence for a sector switch occurring in year t as a response to

contemporaneous regulation (in year t), hence firms do not switch into protected sectors.

Column 2 looks at the response to regulation in year t − 1 instead, testing for whether

firms actively select out of regulated sectors, yielding again an insignificant coefficient.

As a next step, we test the differential effects of regulation on FDI and TFP among

switching firms. We therefore distinguish between four different transition types: firms

switching from non-regulated to regulated, from regulated to non-regulated and within

the regulated or non-regulated sectors. Columns 3 and 4 of Table 8 find that, beyond the

robust negative effect of regulation on FDI, no form of sector switching is significantly

associated with a decline in FDI. Column 5 shows more pronounced differences for TFP:

firms that have recently switched sectors experience a drop in TFP by 1.9 percent in the

next period. This is intuitively plausible as switches may require changes in the production

process that come at the cost of initial productivity losses. As before, the direction of

the switch matters (see column 6). While the average regulatory effect remains robust,

firms switching into or out of regulated sectors do not experience changes in productivity,

only for firms switching within non-regulated sectors turns the coefficient to significantly

negative. This makes it clear that it is very unlikely that switching behavior across sectors

would drive our findings.

Due to a large number of missing observations on capital, our sample size shrinks sub-

stantially during the data cleaning process (see Appendix A.1 for more detail). Table A10

performs an important robustness check showing that our findings also hold when using

the full sample size, also including firms with missing capital observations. Naturally, we

cannot use TFP as a measure for productivity in this fuller sample as capital is a key

ingredient into the productivity estimates. But value added per worker (see also Table

4) can be used as an alternative productivity measure for the larger sample without any

further limitations. The effect of regulation on FDI is robust across specifications and

even larger in magnitude as compared to Table 3. Becoming subject to the NIL decreases

the share of foreign capital by about 1 percentage point in this larger sample. Just like

for the TFP results in Table 4, the effect of regulation on valued added per worker only

becomes significant when controlling for sector-year interactions in column 5. The esti-

mated coefficient turns out slightly smaller in magnitude as compared to the results in

column 6 of Table 4, but overall the baseline results can be fully confirmed.

As a last robustness check, Table A7 assesses the sensitivity of baseline results to our

TFP-estimation procedures. The first three columns of the table repeat the baseline

TFP-estimates, calculated at the two-digit level with and without sector-year fixed effects

and pre-reform sector traits and year interactions. As a comparison, the further columns

report results that are based on a more disaggregated TFP estimation. Here the TFP

regressions are separately estimated for each three-digit sector, even though some sectors

22

have to be combined because of insufficient observations. This is especially the case in

high technology sectors such as railways, aircraft and ships or optical medical instruments.

Columns 4 to 6 of Table A7 fully replicate our main results. Columns 7 to 9 of Table A7

add further detail to the three-digit TFP estimates by exchanging the common wholesale

price deflators used for the baseline results with five-digit sector specific price deflators.

These include a five-digit wholesale price index used to deflate firm sales, a five-digit

input price index used to deflate intermediate inputs, and a machinery price index, used

to deflate the capital stock and net assets (for identifying large firms).

The results show that our preferred specification yields almost the same regulatory effects

on TFP irrespective of the sectoral aggregation for TFP estimation and sectoral detail in

price deflators. Moreover, Table A7 also yields a further insight. In our baseline model, the

inclusion of sector-year effects is needed in order to detect a significant effect of regulation

on TFP. By contrast, using more detailed sectoral price deflators together with more

detailed TFP estimates renders the regulation coefficient significant even before state-

year effects are included (see column 7 of Table A7). This suggests that sector specific

variation in input and output prices over time makes the inclusion of sector-year effects

necessary when using two-digit TFP estimates. At the same time, two-digit sector-year

effects also seem sufficient for dealing with the issue of sectoral price and productivity

variation at a finer scale.

All in all, we prefer to use the two-digit TFP estimates (together with the aggregated

wholesale price deflator) as our baseline as the higher level of detail in TFP sectors and

price deflators comes at the cost of a loss in precision. Due to the relatively lower number

of firms operating in some three-digit sectors, input coefficients estimated at the three-

digit level tend to be more unstable and some of them even turn negative, which does not

happen at the two-digit level (cf. Table A4). Moreover, five-digit sector-specific output

and input price indices as well as the machinery price index are only available to us until

2012 and have to be imputed for the following years by assuming proportionate sectoral

price variation. As our fully specified results do not change when using more detailed

TFP estimates or more detailed price deflators, we interpret this as a support of our more

aggregated TFP estimation approach.

4.5 Regulatory spillover effects

The effects of regulation are very likely to be transmitted along the value chain, leading

not only to a significant productivity decline in regulated firms, but also affecting other

non-regulated firms. Regulatory spillovers could potentially help to explain at least a

part of the substantial productivity drop observed among non-regulated firms (cf. Figure

1). Classical FDI spillovers are expected to mainly act through the channel of technology

23

diffusion and hence be less frequent horizontally among competing firms (Blalock and

Gertler 2008, Newman et al. 2015) but rather take place vertically and especially be

directed from buyers to their suppliers as backward spillovers (Javorcik 2004, Barrios

et al. 2011). By contrast, we expect FDI regulation to generate not only vertical but also

horizontal spillovers. When regulated firms face harder constraints with respect to foreign

investment (up to a complete ban), FDI may shift to similar non-regulated firms or sub-

sectors within the same sector, reducing the productivity of regulated and increasing the

productivity of non-regulated competing firms. At the same time, a second, countervailing

force may also be at play as with a larger penetration of regulation within any sector, a

decrease in average productivity may reduce the overall competitive pressure, dampening

the productivity even of the non-regulated firms (Caves 1974, Kokko et al. 1996). Which

of the horizontal forces outweighs is a priori unclear. When considering vertical spillovers,

the use of detailed input-output tables allows the distinction between vertical spillovers

that take place across and within two-digit sectors. While we expect vertical regulatory

spillovers across two-digit sectors to conform with the usual findings on FDI spillovers,

the vertical spillovers within two-digit sectors may still be closer to horizontal spillovers

in their nature.

Table 9 shows the results of regulation and its spillovers on foreign capital share and pro-

ductivity, measuring the underlying input-output linkages on three-digit level. Columns

1 and 4 introduce the general measures of horizontal, backward and forward regulatory

spillovers. Columns 2 and 5 split each type of vertical spillovers into those working within

the same two-digit sector and those working across two-digit sectors. Finally, columns

3 and 6 test alternative dependent variables. Over all specifications, the direct effects

of regulation remain robust and significantly negative: regulation directly reduces the

foreign capital share by 1 percentage point and productivity by up to 3.8 percent. Hori-

zontal spillovers within the same three-digit sector turn out to significantly increase FDI

but not to affect productivity. A one standard deviation larger increase of horizontal

penetration of regulation increases FDI shares by about a quarter of a percentage point

(0.23×−0.011 = −0.0025), potentially reflecting FDI shifting out of regulated firms into

other firms within the same three-digit sector. Nonetheless, the horizontal productivity

spillovers do not turn out significant. This is not surprising as we expect productivity to

increase due to FDI shifts and to decline due to reducing competition, and hence these

two effects may well cancel out.

Vertical regulatory spillovers do not have a strong effect on FDI shares or productivity on

average (see columns 1 and 4). Backward spillovers from regulated buyers do not seem

to affect foreign capital shares, neither productivity. Forward spillovers from regulated

suppliers seem to slightly decrease foreign capital shares but the effect is of negligible

size: a one standard deviation larger penetration in forward spillovers reduces FDI by 0.1

24

percentage points (0.08×−0.017 = −0.001).

However, splitting up vertical spillovers into those that act within and across two-digit sec-

tor reveals a somewhat more nuanced picture, especially in terms of TFP. For FDI shares,

only one of the four vertical spillover measures is significant (increasing FDI shares due

to backward spillovers across two-digit sectoral borders) but it does not turn out con-

sistently significant across the intensive and extensive margin (columns 2 and 3) and

lies below 0.1 percentage points per standard deviation (0.01 × 0.089 = 0.0009). For

spillovers in TFP, the coefficient of regulatory intra-sectoral backward spillovers remains

insignificantly positive in column 5. However, inter-sectoral backward spillovers turn out

marginally significant and of a substantial and economically relevant size: a one stan-

dard deviation larger regulatory penetration in customer industries reduces productivity

across two-digit sectoral lines by 1 percent (0.02 × −0.513 = −0.01). Compared with

the direct productivity effect of regulation of about 3.5%, a 1% productivity decrease is

still sizable. Using an alternative proxy of labor productivity in column 6 shows practi-

cally the same negative backward productivity spillovers across two-digit industries and

marginally significant positive productivity spillovers within two-digit industries. The

positive within-two-digit sector spillovers show a more modest effect of about 0.4% per

standard deviation (0.03 × 0.140 = 0.04). Regulatory forward linkages are smaller in

magnitude and do not reach conventional levels of significance.

Our results demonstrate that the level of aggregation matters when looking at linkages

along the value chain. Our highly disaggregated input-output table allows us to identify

vertical linkages that would have been coded as horizontal spillovers on less granular level.

We show that intra-sectoral spillovers behave differently from inter-sectoral spillovers and

that the TFP spillovers in column 4 mask a composition effect of two opposing mecha-

nisms. For example, take two vertically linked firms operating in the food and beverages

industry (two-digit) where one of them is protected by the NIL while the other not. A

foreign investor who initially was interested in investing into the protected firm may easily

adjust her investment plans towards the non-regulated firm. In that sense, regulation may

put competitive pressure on other sectors within the same two-digit industry due to the

easier substitution of investment, leading to increased productivity in the non-regulated

firms. The same mechanism may not be relevant for across industry linkages as an in-

vestor cannot easily switch its investment target from a firm in the food and beverages

sector to an IT enterprise because of missing know-how and expertise. Thus, the competi-

tion channel is muted. The dominating vertical spillovers of regulation work through less

technology and managerial skill transfers, lower quality of intermediate inputs, or lower

demand for and supply of domestic products.

25

5 Conclusion

This paper contributes to the literature on the effects of sector specific regulation of

foreign investment. Despite an increasingly open FDI regime, the Indonesian government

uses the instrument of negative investment lists that restrict future foreign investment in

particular industries. For our analysis, we especially exploit the revisions of the NIL in

2007, 2010 and 2014. Our identification strategy is based on an extensive set of fixed effects

at the firm, region-year and two-digit sector-year level. Moreover, we allow for yearly

productivity changes being proportionate to a set of five-digit industry characteristics

in order to control for classical political economy factors that could drive industry-level

variation in regulatory action. An examination of the time pattern of productivity changes

helps to exclude that the effects of regulation merely reflect differences in pre-trends.

We find robust evidence that shows a substantial effect of FDI restrictions on foreign

ownership shares within the affected firms, once time variant controls and an extensive

set of fixed effects are controlled for. Analyzing the relationship between regulation by the

NIL and firm level productivity, we find evidence in favor of a causal negative influence

of investment regulation on TFP and value added per worker. FDI restrictions are asso-

ciated with an average decrease of total factor productivity of about 3.5 percent in the

year following the regulatory change. The productivity declines cannot be mechanically

explained by a drop in foreign capital shares. Instead, we see productivity declines to

be concentrated among firms in the middle of the productivity distribution and among

firms with global trade linkages. From the different types of regulation, blanket sector

level bans turn out to reduce productivity the most but licensing requirements are also

negatively linked to productivity. We also see some evidence that regulation indirectly

affects non-protected firms through the value chain. Using a disaggregated input-output

table, we show that regulatory backward spillovers across the two-digit sectors have a

sizable productivity reducing effect. By contrast, backward spillovers across firms op-

erating within the same two digit sector turn out weakly positive, potentially reflecting

countervailing effects of competitive pressure.

Our empirical results raise substantial doubts about the economic benefits of a protec-

tionist policy by showing that regulatory tightening of the FDI regime in Indonesia had

on average detrimental effects on firm productivity. Naturally, policy makers do follow

multidimensional objectives when deciding on such regulatory interventions. The NIL

may have brought short-run political benefits domestically but also may have affected

other economic outcomes beyond productivity more favorably. Investigating its effects

from a broader perspective would complement our study and offer an interesting avenue

for further research.

26

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29

Figures

Figure 1: Average regulation and total factor productivity

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Note: The graph plots the share of protected firms over the sample period (right scale), as well as the average log oftotal factor productivity among regulated and non-regulated firms in the respective year (left scale).

30

Figure 2: Timing effect on FDI and ln(TFP)

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Note: Plotted coefficients are estimated controlling for categories of firm age, a public enterprise indicator and inter-actions of five-digit sector traits with year dummies, as well as firm, island-year and industry-year FEs. Bars aroundthe point estimates denote ninety percent confidence intervals.

31

Tables

Table 1: Summary statistics in 2000, 2007 and 2014

2000 2007 2014

Mean SD Mean SD Mean SD

Regulated 0.03 0.18 0.22 0.42 0.15 0.36Licensing requirements 0.01 0.10 0.03 0.16 0.07 0.25FDI limitations + bans 0.02 0.15 0.22 0.41 0.12 0.33Sector-wide limits 0.00 0.00 0.01 0.11 0.03 0.18FDI bans 0.02 0.15 0.21 0.41 0.10 0.30Sector-wide bans 0.02 0.14 0.01 0.10 0.01 0.11Firm-specific bans 0.00 0.05 0.20 0.40 0.09 0.28

Reg. horizontal 0.04 0.15 0.19 0.29 0.19 0.25Reg. backward 0.01 0.02 0.06 0.17 0.07 0.14

Reg. backward (within 2 digit) 0.01 0.02 0.05 0.17 0.06 0.14Reg. backward (across 2 digit) 0.00 0.01 0.01 0.02 0.01 0.03

Reg. forward 0.04 0.08 0.04 0.06 0.06 0.07Reg. forward (within 2 digit) 0.01 0.05 0.03 0.06 0.04 0.07Reg. forward (across 2 digit) 0.03 0.07 0.02 0.02 0.02 0.03

FDI share 0.05 0.21 0.06 0.22 0.08 0.26MNE 0.07 0.25 0.06 0.25 0.09 0.29ln(TFP) 10.13 1.57 10.05 1.53 10.97 1.60ln(VAD/L) 9.91 1.24 9.88 1.23 10.74 1.28ln(K) 14.29 2.07 13.79 2.07 14.25 2.12ln(L) 4.21 1.16 4.03 1.06 4.18 1.16Firm age below 5 years 0.15 0.36 0.16 0.37 0.21 0.41Firm age between 5-15 years 0.45 0.50 0.39 0.49 0.20 0.40Firm age between 15-25 years 0.24 0.43 0.27 0.44 0.30 0.46Firm age above 25 years 0.15 0.36 0.19 0.39 0.29 0.45Switch in t 0.16 0.37 0.19 0.40 0.12 0.33

Switch into regulated 0.00 0.07 0.03 0.16 0.01 0.11Switch into nonregulated 0.00 0.00 0.01 0.09 0.01 0.11Switch within regulated 0.00 0.00 0.00 0.05 0.01 0.08Switch within nonregulated 0.16 0.36 0.16 0.36 0.09 0.29

Exit in t 0.00 0.00 0.02 0.15 0.00 0.00Entry in t 0.06 0.23 0.04 0.19 0.00 0.00

Note: Number of observations in 2000: 12,762; 2007: 14,126; 2014: 13,227.

32

Table 2: Summary statistics by sectors in 2000, 2007 and 2014

Regulated FDI ln(TFP)

2000 2007 2014 2000 2007 2014 2000 2007 2014

Food products and beverages 0.01 0.28 0.16 0.02 0.03 0.04 9.42 9.48 10.13Tobacco products 0.00 0.27 0.78 0.00 0.00 0.00 8.44 8.42 10.35Textiles 0.00 0.11 0.10 0.05 0.04 0.05 10.68 10.47 11.22Wearing apparel 0.00 0.00 0.03 0.05 0.05 0.09 9.25 9.17 10.10Leather and leather products 0.00 0.00 0.00 0.06 0.07 0.09 11.05 10.85 11.67Wood and wood products, except furniture 0.33 0.31 0.30 0.04 0.04 0.06 10.13 9.85 10.67Pulp, paper and paper products 0.01 0.03 0.01 0.05 0.07 0.10 10.64 10.60 11.36Publishing, printing and recorded media 0.00 0.18 0.00 0.01 0.01 0.02 10.83 11.20 11.56Coke, refined petroleum products and nuclear fuel 0.00 0.00 0.00 0.29 0.00 0.11 10.75 10.94 11.06Chemicals and chemical products 0.09 0.36 0.32 0.14 0.16 0.19 12.49 12.59 13.34Rubber and plastics products 0.00 0.00 0.10 0.06 0.10 0.11 11.63 11.78 12.45Other non-metallic mineral products 0.00 0.71 0.11 0.02 0.01 0.03 9.58 9.51 10.35Basic metals 0.00 0.15 0.27 0.22 0.18 0.21 11.55 11.59 12.05Fabricated metal products 0.00 0.06 0.05 0.09 0.13 0.12 10.45 10.69 11.50Machinery and equipment 0.02 0.20 0.16 0.13 0.20 0.24 10.71 11.06 11.77Electrical equipment, office machinery, computers 0.00 0.00 0.00 0.26 0.32 0.24 12.32 12.30 13.43Radio, television and communication equipment 0.00 0.00 0.00 0.54 0.61 0.53 12.84 12.39 12.78Medical, precision and optical instruments 0.00 0.00 0.00 0.19 0.25 0.19 11.54 11.10 11.58Motor vehicles 0.00 0.00 0.00 0.13 0.20 0.22 11.94 12.05 13.13Other transport equipment 0.00 0.64 0.48 0.08 0.12 0.18 10.63 11.35 12.06Furniture and n.e.c. 0.00 0.14 0.09 0.05 0.06 0.10 10.03 10.04 10.95

Total 0.03 0.22 0.15 0.05 0.06 0.08 10.13 10.05 10.97

Note: Average share of regulated firms, average foreign capital share and average log productivity within sectors. Number ofobservations in 2000: 12,762; 2007: 14,126; 2014: 13,227.

33

Table 3: Baseline results: Impact on FDI

Dependent variable: FDI share MNE

(1) (2) (3) (4) (5) (6)

Regulated −0.007*** −0.007*** −0.007*** −0.008*** −0.008*** −0.008***(0.002) (0.002) (0.002) (0.002) (0.002) (0.002)

Controls Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes YesSector traits in 2005 × Year Yes YesExtended traits in 2005 × Year YesTreatment in year t t t t t t

Observations 208,120 208,120 208,120 208,120 207,105 208,120Firms 30,508 30,508 30,508 30,508 30,444 30,508R-squared 0.875 0.875 0.876 0.876 0.876 0.873

Note: The dependent variables measure the share of foreign capital within each firm and a multinationalenterprise indicator turning 1 if the foreign capital share is above 10%. Time-variant controls includecategories of firm age and a public enterprise indicator. Five-digit sector traits in 2005 include sectorconcentration of sales, the share of blue collar workers and the share of public enterprises. The extended setof sector traits in 2005 adds employment growth, capital intensity, the share of foreign capital and importpenetration at the sectoral level, all interacted with a full set of year effects. All regression include firm andisland-year FE. Robust standard errors are clustered on firm level and reported in parentheses. Significanceat or below 1 percent (***), 5 percent (**) and 10 percent (*).

34

Table 4: Baseline results: Impact on productivity

Dependent variable: ln(TFP) ln(VAD/L)

(1) (2) (3) (4) (5) (6)

Regulated −0.009 −0.009 −0.036*** −0.036*** −0.034*** −0.034***(0.012) (0.012) (0.013) (0.013) (0.013) (0.013)

Controls Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes YesSector traits in 2005 × Year Yes YesExtended traits in 2005 × Year YesTreatment in year t− 1 t− 1 t− 1 t− 1 t− 1 t− 1

Observations 185,978 185,978 185,978 185,978 184,999 185,978Firms 28,307 28,307 28,307 28,307 28,232 28,307R-squared 0.822 0.822 0.835 0.835 0.835 0.746

Note: The dependent variable is log of total factor productivity or log of value added per worker. Time-variant controls include categories of firm age and a public enterprise indicator. Five-digit sector traits in 2005include sector concentration of sales, the share of blue collar workers and the share of public enterprises. Theextended set adds employment growth, capital intensity, share of foreign capital and import penetration. Allregression include firm and island-year FE. Robust standard errors are clustered on firm level and reportedin parentheses. Significance at or below 1 percent (***), 5 percent (**) and 10 percent (*).

35

Table 5: Distinguishing between types of regulation

Dependent variable: FDI share ln(TFP)

(1) (2) (3) (4) (5) (6)

Licensing requirements 0.006* 0.006 0.006 −0.046* −0.046 −0.048(0.003) (0.004) (0.004) (0.026) (0.032) (0.032)

FDI limitations + bans −0.010*** −0.028**(0.002) (0.014)

FDI limitations −0.007 −0.008 −0.018 −0.020(0.006) (0.006) (0.052) (0.052)

FDI bans −0.010*** −0.013(0.002) (0.013)

Sector-wide bans −0.013*** −0.066**(0.004) (0.031)

Firm-specific bans −0.009*** −0.003(0.002) (0.015)

Controls Yes Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes Yes Yes YesSector traits in 2005 × Year Yes Yes Yes Yes Yes YesTreatment in year t t t t− 1 t− 1 t− 1

Observations 208,120 208,120 208,120 185,978 185,978 185,978Firms 30,508 30,508 30,508 28,307 28,307 28,307R-squared 0.876 0.876 0.876 0.835 0.835 0.835

Note: The dependent variable is the foreign capital share within each firm or log total factor productivity.Time-variant controls include categories of firm age and a public enterprise indicator. Five-digit sectortraits in 2005 include sector concentration of sales, the share of blue collar workers and the share ofpublic enterprises. All regressions include firm and island-year FE. Robust standard errors are clusteredon firm level and reported in parentheses. Significance at or below 1 percent (***), 5 percent (**) and10 percent (*).

36

Table 6: Analysis of effect heterogeneity on FDI and TFP across firms

Dependent variable: FDI share ln(TFP)

(1) (2) (3) (4) (5) (6)

Regulated −0.004*** −0.003** −0.006*** −0.019 −0.009 −0.039***(0.001) (0.001) (0.002) (0.017) (0.021) (0.013)

Trading firm × regulated 0.000 −0.037(0.002) (0.025)

Foreign firm × regulated −0.037** 0.012(0.018) (0.048)

Mid productivity × regulated −0.002 −0.081***(0.002) (0.025)

High productivity × regulated −0.012** 0.027(0.005) (0.036)

Large firm × regulated −0.014 0.026(0.010) (0.048)

Controls Yes Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes Yes Yes YesSector traits in 2005 × Year Yes Yes Yes Yes Yes YesTreatment in year t t t t− 1 t− 1 t− 1

Observations 208,120 208,120 208,120 185,978 185,978 185,978Firms 30,508 30,508 30,508 28,307 28,307 28,307R-squared 0.876 0.876 0.876 0.835 0.835 0.835

Note: The dependent variable is the share of foreign capital within each firm or log of total factor produc-tivity. Time-variant controls include categories of firm age and a public enterprise indicator. Five-digitsector traits in 2005 include sector concentration of sales, the share of blue collar workers and the shareof public enterprises. All regression include firm and island-year FE. Robust standard errors are clusteredon firm level and reported in parentheses. Significance at or below 1 percent (***), 5 percent (**) and 10percent (*).

37

Table 7: Robustness: Exit and entry of firms

Dependent variable: Entry Exit FDI share ln(TFP)

(1) (2) (3) (4) (5) (6)

Regulated −0.009*** 0.006** −0.009*** −0.009*** −0.047*** −0.047***(0.002) (0.003) (0.002) (0.002) (0.017) (0.014)

Entry firm × regulated 0.004 0.027(0.003) (0.023)

Exit firm × regulated 0.006** 0.053**(0.003) (0.025)

Controls Yes Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes Yes Yes YesSector traits in 2005 × Year Yes Yes Yes Yes Yes YesTreatment in year t t− 1 t t t− 1 t− 1

Observations 194,515 185,978 194,515 194,515 185,978 185,978Firms 29,665 28,307 29,665 29,665 28,307 28,307R-squared 0.283 0.325 0.878 0.878 0.835 0.835

Note: The dependent variable is an entry (exit) indicator turning 1 if a firm enters (leaves) the sample int, the foreign capital share within each firm or log total factor productivity. Time-variant controls includecategories of firm age and a public enterprise indicator. Five-digit sector traits in 2005 include sectorconcentration of sales, the share of blue collar workers and the share of public enterprises. All regressioninclude firm and island-year FE. Robust standard errors are clustered on firm level and reported inparentheses. Significance at or below 1 percent (***), 5 percent (**) and 10 percent (*).

38

Table 8: Robustness: Sector switching behavior

Dependent variable: Switch FDI share ln(TFP)

(1) (2) (3) (4) (5) (6)

Regulated −0.005 0.001 −0.007*** −0.008*** −0.037*** −0.041***(0.005) (0.005) (0.002) (0.002) (0.013) (0.015)

Sector switch −0.001 −0.019***(0.001) (0.006)

Switch into regulated sector 0.000 0.001(0.002) (0.020)

Switch into nonregulated sector −0.003 −0.006(0.003) (0.021)

Switch within regulated sectors −0.003 0.011(0.006) (0.043)

Switch within nonregulated sectors −0.001 −0.023***(0.001) (0.007)

Controls Yes Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes Yes Yes YesSector traits in 2005 × Year Yes Yes Yes Yes Yes YesTreatment in year t t− 1 t t t− 1 t− 1

Observations 194,515 185,978 194,515 194,515 185,978 185,978Firms 29,665 28,307 29,665 29,665 28,307 28,307R-squared 0.373 0.382 0.878 0.878 0.835 0.835

Note: The dependent variable is a sector switch indicator turning 1 if a firm switches its operating sector in t, theforeign capital share within each firm or log total factor productivity. Time-variant controls include categoriesof firm age and a public enterprise indicator. Five-digit sector traits in 2005 include sector concentration ofsales, the share of blue collar workers and the share of public enterprises. All regression include firm andisland-year FE. Robust standard errors are clustered on firm level and reported in parentheses. Significance ator below 1 percent (***), 5 percent (**) and 10 percent (*).

39

Table 9: Spillover effects on FDI and TFP

Dependent variable: FDI share MNE ln(TFP) ln(VAD/L)

(1) (2) (3) (4) (5) (6)

Regulated −0.011*** −0.011*** −0.014*** −0.038*** −0.036** −0.025*(0.002) (0.002) (0.003) (0.015) (0.015) (0.015)

Reg. horizontal 0.011*** 0.012*** 0.018*** 0.009 0.007 −0.018(0.003) (0.003) (0.004) (0.025) (0.025) (0.025)

Reg. backward 0.005 0.096(0.005) (0.078)

Reg. backward (within 2 digit) 0.002 0.003 0.117 0.140*(0.005) (0.006) (0.081) (0.078)

Reg. backward (across 2 digit) 0.089* 0.093 −0.513* −0.543*(0.053) (0.071) (0.307) (0.303)

Reg. forward −0.017* 0.021(0.009) (0.065)

Reg. forward (within 2 digit) −0.011 −0.013 −0.037 −0.059(0.009) (0.011) (0.073) (0.072)

Reg. forward (across 2 digit) −0.033 −0.032 0.179 0.130(0.026) (0.029) (0.110) (0.109)

Controls Yes Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes Yes Yes YesSector traits in 2005 × Year Yes Yes Yes Yes Yes YesTreatment in year t t t t− 1 t− 1 t− 1

Observations 208,120 208,120 208,120 185,975 185,975 185,975Firms 30.508 30.508 30.508 28.307 28.307 28.307R-squared 0.876 0.876 0.873 0.835 0.835 0.746

Note: The dependent variable is the share of foreign capital within each firm, a multinational enterpriseindicator turning 1 if the foreign capital share is above 10%, log of total factor productivity or log of valueadded per worker. Time-variant controls include categories of firm age and a public enterprise indicator. Five-digit sector traits in 2005 include sector concentration of sales, the share of blue collar workers and the shareof public enterprises. All regression include firm and island-year FE. Robust standard errors are clustered onfirm level and reported in parentheses. Significance at or below 1 percent (***), 5 percent (**) and 10 percent(*).

40

A Appendix

A.1 Cleaning the firm data

Matching the yearly firm panel and the NIL regulatory data requires that five digit sector

codes are unambiguously available for all observations of each firm. We first deal with

missing or incomplete sector codes, which is especially relevant in the years 2001 and

2003. We consider sector codes as incomplete if they have less than five-digits, e.g., ‘151’

instead of ‘15111’. Whenever plausible and unambiguously possible, we impute the same

code as in the year before or in the next year.

We exclude all observations for which sector codes are still missing or incomplete after this

adjustment. Additionally, sector codes are converted to the common standard of KBLI

2000 coding based on conversion tables provided by BPS. We drop all observations with

ambiguous conversion results.

We start with 351,366 observations over the 15 years, of which 1,229 have to be removed

due to missing or incomplete coding. 472 additional observations are lost because of

ambiguous conversion results between the years. These may occur because of a split or

unification of sector codes between different versions.

In order to estimate total factor productivity, TFP, we rely on information on the capital

stock, employment, the value of intermediate inputs, and value added. Out of these

four core variables, capital stock is the one missing most frequently. As common in the

literature (Amiti and Konings 2007), we interpolate the capital stock if values are missing

in a unique year. This is especially relevant in the year 2006, where information on the

capital stock is missing for a large part of the firm sample. We are able to interpolate

21,304 observations within 17,010 firms. Even after interpolation, we have to drop 120,561

observations within 30,361 firms due to missing information on the capital stock. Thereby

we lose 10,307 firms completely. We investigate the sensitivity of our results to these

missing observations by also repeating our estimates for a larger sample using value added

per worker as a proxy for productivity, the results on which are comparable.

In a next step, we exclude extreme outliers by dropping all observations for which inputs

or output are not within the threefold of the inter-quartile range above and below the

25 and 75 percentiles. We deal with extraordinary spikes in the data by also dropping

all observations with plant-level input growth (labor, intermediate inputs and capital) as

well as output growth that is outside the first and ninety-ninth percentile range of each

variable’s distribution. These steps reduce our sample size by further 12,642 observations

within 8,026 different firms.

Finally, we drop all firms with only one observation within the sample period. We end

up with a final dataset of 209,048 observations pertaining to 31,025 firms.

41

A.2 Merging the NIL conditions to product codes

Both the Negative Investment List (NIL) and the main products of the firm (KBLI) are

encoded at the same five-digit level that we use to determine a sectoral match between

firms and regulated sectors.

Unlike in later years, NIL 2000 does not yet provide KBLI codes, but only states the

names of the included sectors. Thus, in this one year we match the verbally stated sector

names to the corresponding KBLI sector codes. Furthermore, as the NIL 2007 slightly

changes in 2008 by an amendment to the existing regulation, we use the content of the

first draft of NIL for 2007 and the amendment for the years starting with 2008. We

convert the changing KBLI sector codes between the years and adjust the coding of the

NIL 2010, NIL 2014 and NIL 2016 to the KBLI 2000 standard. The regulatory and firm

data are merged according to the five-digit KBLI 2000 sector codes and the relevant year.

As several of the regulatory instruments are conditional on firm characteristics (see Table

A1 for a more detailed representation), we encode them conditional on firm attributes:

• Closed [closed to new investment in general] applies to all kinds of investment, both

domestic and foreign. We set this regulatory measure to zero for firms that have

already existing foreign involvement as the regulation is forward looking and cannot

restrict foreign participation anymore.24 The average FDI share among these firms

is 85% with the majority of firms reporting full foreign ownership of 100%. Thus,

these firms are not limited by forward looking regulation since a further increase is

not feasible for them anyway.

• Condition a [opened to small and medium sized firms] is conditional on firm size as

regulated in law 20/2008 on micro, small and medium enterprises (see Presidential

Decree 36/2010). According to Law 20/2008, firms should be considered as large if

they have annual revenues from sales above 50 billion Rupiah and assets (excluding

land and buildings) equal or above 10 billion Rupiah. The earlier Presidential

Decree 77/2007 refers to the law 9/1995 on small enterprises, which establishes

similar thresholds in real terms. When applying the firm size thresholds over time,

we adjust for inflation. Accordingly, we generate an indicator variable that encodes

large firms based on their annual sales and assets, thereby deviating from the most

commonly used definition in literature which relies on the number of workers. Due

to high volatility in the data, we use the median sales and median net assets of each

firm in order to circumvent wrong coding in cases of outliers. Hence, we consider

the classification into large and small enterprises to be time invariant.

24We use offsets in this and other categories for a total of 799 firms: 755 firms in closed sectors (defined byconditions closed, a, b, d, f, i) and further 44 firms that fall under FDI limitations (c, h).

42

• Condition b [opened to partnerships] depends on the legal status of a firm. We ex-

ploit information on the firm’s legal status given by the SI as regulation in condition

b only applies to firms that do not have the legal status of a partnership. Unfor-

tunately, the SI does not give any useful extra information on neither the exact

structure of the partnership nor the partner’s identity. Additionally, the variable on

legal status suffers from plenty of missing values. In these cases, we assume no reg-

ulation as the default. Therefore, we suspect that we may undercount firms subject

to condition b. We checked the robustness of our results to setting condition b to

apply sector-wide instead: TFP results stay practically the same also if we consider

this condition to apply to all firms within a five-digit sector, while the results for

FDI reduce in size and significance.

• Condition c [upper limit to foreign capital] sets a maximum share of capital that

can be owned by foreign investors. In nine out of ten cases the upper limit to foreign

capital is set to be 95 percent of total capital. We set this regulatory measure to

zero for firms that have already reached a foreign capital share above the threshold

as the regulation is forward looking and cannot restrict their foreign capital shares

anymore.

• Condition d [limited to certain locations] and condition g [upper limits of foreign

capital ownership in a certain location] are easily implemented by matching the

regulation with plant location. Regulation is applied if a firm is located outside the

authorized province.

• Condition e [licensing requirement] and condition h [upper limit to foreign capital

ownership and license] allow for (limited) FDI under the prerequisite of a valid

license issued by the appropriate authorities.

• Condition f [investment open to domestic capital] and condition i [investment open

to domestic capital and license] ban FDI in the affected sectors entirely.

To investigate the impact of these conditions on our outcome variables, we introduce two

major categories of regulation. First, we collect all conditions that are related to Licensing

requirements since they should impose costs to investment but are different from full FDI

bans. This includes conditions e, h and i.

Second, we generate the category FDI limitations and bans. We collect all remaining con-

ditions as well as conditions h and i, since they also impose hard limitations on FDI. To

account for heterogeneity within the different types of limits and bans, we subdivide the

category into four further groups. We first split the former category into FDI limitations

(including conditions c and h) and FDI bans (including conditions closed, d, f and i).

Furthermore, we distinguish between two last subcategories Sector-wide bans (including

43

conditions closed, d, f and i) and Firm-specific bans (including conditions a and b). Both

FDI limitations and Sector-wide bans apply to whole sectors irrespectively of firm char-

acteristics, whereas Firm-specific bans heavily rely on individual firm characteristics such

as size, legal status or location.

A.3 The Wooldridge approach for productivity estimation

Wooldridge (2009) suggests an alternative and more efficient way of estimating total

factor productivity compared to the well-known procedures by Olley and Pakes (1996)

or Levinsohn and Petrin (2003). Hereby, estimation of total factor productivity needs to

account for potential simultaneity bias due to correlation of input choices with the error

term.25

By using small letters to denote logs, total output can be decomposed as:

vat = yt −mt = α0 + αllt + αkkt + ωt + et, (A1)

where vat denotes value added, yt stands for total output, lt for labor, kt for capital, and

mt for other intermediate inputs. The error term combines an unobserved productivity

shock component, ωt, which is correlated with the input choices, and the independently

identically distributed error term component, et. For the i.i.d. component it must hold

that

E(et|lt, kt,mt, lt−1, kt−1,mt−1, ..., l1, k1,m1) = 0. (A2)

At the same time, assume that the dynamics of productivity shocks are restricted to

E(ωt|kt, lt−1, kt−1,mt−1, ..., l1, k1,m1) = E(ωt|ωt−1)

= j(ωt−1),(A3)

where ωt−1 = g(kt−1,mt−1).

By introducing productivity innovations at, the error components turns to

ωt = j(ωt−1 + at), (A4)

under the assumption that

E(at|kt, lt−1, kt−1,mt−1, ..., l1, k1,m1) = 0. (A5)

Consequently, only the contemporaneous choice variables lt and mt are correlated with

innovations at, while kt and all past values of inputs are uncorrelated with at. The

25See CompNet Task Force (2014) for a more detailed description of the approach. Our notation followsthat of CompNet Task Force (2014).

44

production function becomes:

vat = α0 + αllt + αkkt + j(g(kt−1,mt−1)) + ut, (A6)

where ut = at + et and E(ut|kt, lt−1, kt−1,mt−1, ..., l1, k1,m1) = 0.

Assuming that the productivity process is a random walk with drift ωt = τ + ωt−1 + at

(cf. CompNet Task Force 2014) and the function g(.) takes the polynomial form of order

three, we can identify the coefficients of input factors αK and αL. Then, equation (A6)

becomes:

vat = (α0 + τ) + αllt + αkkt + g(kt−1,mt−1) + ut. (A7)

We estimate equation (A7) using a pooled instrumental variable approach, instrumenting

labor by the one period lag of labor input. The estimation relies on a two-step efficient

generalized method of moments (GMM) approach.

45

A.4 Additional tables

46

Table A1: Conditions of the NIL over time: affected sectors and regulated firms in the sample

Industry division closed a b c d e f h iRegulatedfirms insample

% share ofregulated

firmswithin

industry

% share ofregulatedfirms intotal

output

Panel A: NIL 2000

Food and beverages 3 0 0 0 0 1 0 0 0 26 0.79 0.85

Wood products 0 0 0 0 2 3 0 0 0 406 34.73 2.93

Pulp and paper 0 0 0 0 0 1 0 0 0 2 0.78 0.57

Publishing and printing media 0 0 0 0 0 1 0 0 0 0 0 0

Chemicals 2 0 2 0 0 1 0 0 0 55 9.34 0.65

Machinery and equipment 1 0 0 0 0 0 0 0 0 3 1.66 0.00

Regulated firms in sample 41 0 28 0 261 162 0 0 0 492 3.44 5.00

Panel B: NIL 2007

Food and beverages 3 14 7 7 0 0 0 1 0 1118 28.90 8.44

Tobacco products 0 1 3 0 0 3 0 0 0 280 30.34 9.20

Textiles 0 3 1 0 0 0 0 0 0 182 10.98 0.05

Wood products 0 7 5 0 0 4 0 0 0 288 30.80 1.24

Pulp and paper 0 0 0 0 0 2 0 0 0 7 2.56 1.57

Publishing and printing media 0 0 0 0 0 1 2 0 0 69 18.75 0.47

Chemicals 3 1 1 3 0 2 1 2 0 179 34.76 2.50

Rubber and plastic 0 1 0 0 0 0 0 0 0 0 0 0

Other non-metallic mineral prod. 0 1 11 0 0 0 0 0 0 923 70.46 4.75

Basic metals 1 0 0 0 0 1 0 0 0 18 17.14 0.82

Fabricated metal products 0 4 1 0 0 0 0 0 0 29 6.94 0.19

Machinery and equipment 0 0 3 0 0 0 0 0 1 32 18.10 0.06

Other transport equipment 0 0 4 0 0 0 0 0 0 83 63.85 1.37

Furniture 0 1 6 0 0 0 0 0 0 245 14.69 0.64

Regulated firms in sample 67 130 3150 87 0 333 103 123 1 3453 22.26 31.30

Panel C: NIL 2010

Food and beverages 3 16 9 0 0 0 0 11 0 1254 31.75 12.20

Tobacco products 0 1 1 0 0 3 0 1 0 685 88.73 4.52

Textiles 0 5 1 0 0 0 0 0 0 271 13.53 0.68

Wearing apparel 0 1 0 0 0 0 0 0 0 26 2.17 0.39

Wood products 0 7 5 0 0 5 0 0 0 313 35.45 1.23

Pulp and paper 0 0 0 0 0 2 0 0 0 3 1.01 1.77

Publishing and printing media 0 0 0 0 0 1 2 0 0 7 2.58 0.00

Chemicals 3 1 1 2 0 3 1 3 0 201 31.96 1.50

Rubber and plastic 0 3 0 0 0 1 0 3 0 39 3.95 2.22

Other non-metallic mineral prod. 0 1 6 0 0 0 0 0 0 143 11.33 0.03

Basic metals 0 0 0 0 0 1 0 0 0 31 19.75 0.85

Fabricated metal products 0 4 2 0 0 0 0 0 0 68 12.76 0.27

Machinery and equipment 0 0 3 0 0 0 0 0 1 35 18.32 0.34

Other transport equipment 0 0 4 0 0 0 0 0 0 98 51.90 0.79

Furniture 0 1 5 0 0 1 0 0 0 194 13.23 0.27

Regulated firms in sample 54 297 2712 84 0 515 53 469 2 3368 21.45 27.06

Panel D: NIL 2014

Food and beverages 3 16 7 4 0 0 0 11 0 702 17.31 16.08

Tobacco products 0 1 1 0 0 3 0 1 0 486 79.41 3.97

Textiles 0 5 1 0 0 0 0 0 0 167 9.77 0.97

Wearing apparel 0 1 0 0 0 0 0 0 0 44 3.91 0.78

Wood products 0 7 3 0 0 5 0 0 0 216 29.92 1.48

Pulp and paper 0 0 0 0 0 2 0 0 0 4 1.43 1.56

Publishing and printing media 0 0 0 0 0 1 2 0 0 7 2.34 0.22

Chemicals 3 1 1 2 0 3 1 3 0 197 30.26 1.46

Rubber and plastic 0 2 0 0 0 0 0 2 1 109 11.19 2.27

Other non-metallic mineral prod. 0 1 6 0 0 0 0 0 0 127 10.84 0.05

Basic metals 0 0 0 0 0 1 0 0 0 44 25.29 0.92

Fabricated metal products 0 4 1 0 0 0 0 0 1 28 5.34 0.18

Machinery and equipment 0 0 3 0 0 0 0 0 1 33 14.47 0.46

Other transport equipment 0 0 4 0 0 0 0 0 1 98 47.57 0.68

Furniture 0 1 5 0 0 1 0 0 0 121 9.70 0.33

Regulated firms in sample 42 297 1672 98 0 513 48 465 113 2383 16.00 31.41

Note: Panels A to D outline the sectoral incidence of various forms of regulation in the NIL 2000, 2007, 2010 and 2014. In eachpanel, two-digit sectors are displayed in rows and the various conditions of the NIL in columns (closed and a to i). The figuresdisplay the number of five-digit sectors that are subject to the specific form of regulation in the respective year whereas the lastcolumns display sectoral penetration of regulation. The specific conditions include: a - Reserved for micro, small and mediumenterprises and cooperatives. b - Reserved for partnerships. c - Upper limit to foreign capital ownership. d - Limited to certainlocations. e - Special license required. f - 100% local capital. g - Upper limit to foreign capital ownership and limited location. h- Special license and upper limit to foreign capital ownership. i - 100% local capital and special license.

47

Table A2: Summary statistics of the main variables

Mean SD Minimum Maximum Observations

Regulated 0.12 0.32 0.00 1.00 208,120Licensing requirements 0.03 0.17 0.00 1.00 208,120FDI limitations + bans 0.10 0.31 0.00 1.00 208,120Sector-wide limits 0.01 0.12 0.00 1.00 208,120FDI bans 0.10 0.29 0.00 1.00 208,120Sector-wide bans 0.02 0.12 0.00 1.00 208,120Firm-specific bans 0.08 0.27 0.00 1.00 208,120

Reg. horizontal 0.12 0.23 0.00 1.00 208,120Reg. backward 0.04 0.12 0.00 0.88 208,120

Reg. backward (within 2 digit) 0.03 0.12 0.00 0.88 208,120Reg. backward (across 2 digit) 0.01 0.02 0.00 0.19 208,120

Reg. forward 0.05 0.07 0.00 0.38 208,120Reg. forward (within 2 digit) 0.02 0.06 0.00 0.35 208,120Reg. forward (across 2 digit) 0.02 0.05 0.00 0.35 208,120

FDI share 0.07 0.24 0.00 1.00 208,120MNE 0.08 0.27 0.00 1.00 208,120ln(TFP) 10.40 1.63 0.51 20.39 208,120ln(VAD/L) 10.18 1.31 1.06 19.99 208,120ln(K) 14.12 2.11 4.58 23.56 208,120ln(L) 4.15 1.14 3.04 9.26 208,120Firm age below 5 years 0.15 0.35 0.00 1.00 208,120Firm age between 5-15 years 0.37 0.48 0.00 1.00 208,120Firm age between 15-25 years 0.28 0.45 0.00 1.00 208,120Firm age above 25 years 0.21 0.41 0.00 1.00 208,120Switch in t 0.15 0.35 0.00 1.00 208,120

Switch into regulated 0.01 0.11 0.00 1.00 208,120Switch into nonregulated 0.01 0.10 0.00 1.00 208,120Switch within regulated 0.00 0.06 0.00 1.00 208,120Switch within nonregulated 0.12 0.33 0.00 1.00 208,120

Exit in t 0.04 0.21 0.00 1.00 208,120Entry in t 0.03 0.18 0.00 1.00 208,120

48

Table A3: Number of observations in the full sample by year

Year FDI regressions TFP regressions

2000 12,7622001 13,619 12,0762002 13,744 13,0922003 13,737 13,0732004 13,897 12,9302005 13,799 12,9142006 11,487 11,4152007 14,126 13,4502008 15,079 14,4632009 15,077 14,6592010 14,576 14,0282011 14,556 13,8962012 14,288 13,6852013 14,146 13,5732014 13,227 12,724

Total 208,120 185,978

49

Table A4: Production function coefficients by two-digit sector

ln(TFP)

Sector Labor Capital Observations

Food products and beverages 15 0.567*** 0.149*** 43,607Tobacco products 16 0.643*** 0.114*** 7,885Textiles 17 0.546*** 0.081*** 18,300Wearing apparel 18 0.795*** 0.093*** 14,886Leather and leather products 19 0.690*** 0.027 4,269Wood and wood products, except furniture 20 0.597*** 0.115*** 10,527Pulp, paper and paper products 21 0.574*** 0.112*** 3,088Publishing, printing and recorded media 22 0.679*** 0.036 4,165Coke, refined petroleum products and nuclear fuel 23 0.514*** 0.146* 361Chemicals and chemical products 24 0.443*** 0.059*** 7,185Rubber and plastics products 25 0.510*** 0.061*** 10,752Other non-metallic mineral products 26 0.440*** 0.142*** 15,444Basic metals 27 0.535*** 0.132** 1,633Fabricated metal products 28 0.659*** 0.084*** 6,304Machinery and equipment 29 0.617*** 0.089*** 2,624Electrical equipment, office machinery, computers 31 0.669*** 0.021 1,544Radio, television and communication equipment 32 0.598*** 0.044 1,102Medical, precision and optical instruments 33 0.543*** 0.096 413Motor vehicles 34 0.595*** 0.049 1,897Other transport equipment 35 0.513*** 0.121*** 2,030Furniture and n.e.c. 36 0.718*** 0.066*** 16,980

Note: The production function is estimated by GMM according to Wooldridge (2009).

50

Table A5: The time pattern of regulation

Dependent variable: FDI share MNE ln(TFP) ln(VAD/L)

(1) (2) (3) (4)

Regulated in t+ 3 0.002 0.005** 0.016 0.018(0.002) (0.002) (0.014) (0.014)

Regulated in t+ 2 −0.001 −0.002 0.009 0.007(0.002) (0.002) (0.013) (0.013)

Regulated in t+ 1 −0.006*** −0.007*** 0.013 0.018(0.002) (0.002) (0.013) (0.013)

Regulated in t −0.008*** −0.010*** −0.021 −0.016(0.002) (0.003) (0.014) (0.014)

Regulated in t− 1 0.004** 0.005** −0.020 −0.022(0.002) (0.002) (0.014) (0.014)

Regulated in t− 2 −0.001 −0.000 −0.035*** −0.033**(0.002) (0.002) (0.013) (0.013)

Regulated in t− 3 0.002 0.003 −0.009 −0.012(0.002) (0.002) (0.014) (0.014)

Controls Yes Yes Yes YesSector-year interactions Yes Yes Yes YesSector traits in 2005 × Year Yes Yes Yes Yes

Observations 116,555 116,555 116,555 116,555Firms 18,207 18,207 18,207 18,207R-squared 0.886 0.882 0.840 0.748

Note: The dependent variable is the share of foreign capital within each firm, amultinational enterprise indicator turning 1 if the foreign capital share is above10%, log of total factor productivity or log value added per worker. Time-variantcontrols include categories of firm age and a public enterprise indicator. Five-digit sector traits in 2005 include sector concentration of sales, the share of bluecollar workers and the share of public enterprises. All regression include firm andisland-year FE. Robust standard errors are clustered on firm level and reportedin parentheses. Significance at or below 1 percent (***), 5 percent (**) and 10percent (*).

51

Table A6: Shifting the time window of regulation

Dependent variable: FDI share ln(TFP)

(1) (2) (3) (4) (5) (6) (7) (8)

Regulated −0.008*** −0.007*** −0.008*** −0.002 −0.025* −0.001 −0.030** −0.036***(0.002) (0.002) (0.002) (0.002) (0.013) (0.012) (0.013) (0.013)

Controls Yes Yes Yes Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes Yes Yes Yes Yes YesSector traits in 2005 × Year Yes Yes Yes Yes Yes Yes Yes YesTreatment in year t t+ 1 t t− 1 t t+ 1 t t− 1

Observations 196,049 196,049 185,978 185,978 196,049 196,049 185,978 185,978Firms 28,674 28,674 28,307 28,307 28,674 28,674 28,307 28,307R-squared 0.875 0.875 0.877 0.877 0.829 0.829 0.835 0.835

Note: The dependent variable is the foreign capital share within each firm or log total factor productivity. Time-variant controlsinclude categories of firm age and a public enterprise indicator. Five-digit sector traits in 2005 include sector concentration ofsales, the share of blue collar workers and the share of public enterprises. All regression include firm and island-year FE. Robuststandard errors are clustered on firm level and reported in parentheses. Significance at or below 1 percent (***), 5 percent (**)and 10 percent (*).

52

Table

A7:

Impact

on

pro

duct

ivity

-Lev

els

ofT

FP

esti

mati

on

and

sect

or-

spec

ific

defl

ato

rs

Dep

enden

tvari

able

:ln

(TFP

)ln

(TFP

),3-d

igit

ln(T

FP

),3-d

igit

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

Reg

ula

ted

−0.0

09

−0.0

36***

−0.0

36***

−0.0

14

−0.0

31**

−0.0

31**

−0.0

27**

−0.0

32**

−0.0

32**

(0.0

12)

(0.0

13)

(0.0

13)

(0.0

12)

(0.0

13)

(0.0

13)

(0.0

12)

(0.0

13)

(0.0

13)

Contr

ols

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Sec

tor-

yea

rin

tera

ctio

ns

Yes

Yes

Yes

Yes

Yes

Yes

Sec

tor

traits

in2005×

Yea

rY

esY

esY

esTre

atm

ent

inyea

rt−

1t−

1t−

1t−

1t−

1t−

1t−

1t−

1t−

1

5-d

igit

sect

or

spec

ific

defl

ato

rsYes

Yes

Yes

Obse

rvations

185,9

78

185,9

78

185,9

78

185,9

78

185,9

78

185,9

78

185,6

44

185,6

44

185,6

44

Fir

ms

28,3

07

28,3

07

28,3

07

28,3

07

28,3

07

28,3

07

28,2

69

28,2

69

28,2

69

R-s

quare

d0.8

22

0.8

35

0.8

35

0.8

24

0.8

35

0.8

35

0.8

36

0.8

44

0.8

44

Note

:T

he

dep

enden

tvariable

islo

gto

talfa

ctor

pro

duct

ivity

as

estim

ate

don

the

two

dig

it(c

olu

mn

1to

3)

and

thre

edig

itse

ctor

level

(colu

mn

4to

9).

Colu

mn

7to

9additio

nally

use

five-

dig

itse

ctor-

spec

ific

input

and

whole

sale

pri

cedefl

ato

rs.

Tim

e-vari

ant

contr

ols

incl

ude

cate

gori

esof

firm

age

and

apublic

ente

rpri

sein

dic

ato

r.Fiv

e-dig

itse

ctor

traits

in2005

incl

ude

sect

or

conce

ntr

ation

ofsa

les,

the

share

ofblu

eco

llar

work

ers

and

the

share

of

public

ente

rpri

ses.

All

regre

ssio

nin

clude

firm

and

isla

nd-y

ear

FE

.R

obust

standard

erro

rsare

clust

ered

on

firm

level

and

report

edin

pare

nth

eses

.Sig

nifi

cance

at

or

bel

ow

1per

cent

(***),

5per

cent

(**)

and

10

per

cent

(*).

53

Table A8: Alternative TFP measures

Dependent variable: ln(TFP) ln(VAD) ln(VAD/L) ln(VAD/K)

(1) (2) (3) (4) (5) (6)

Regulated in t− 1 −0.036*** −0.026* −0.034*** −0.039*** −0.045*** −0.051***(0.013) (0.014) (0.013) (0.013) (0.012) (0.013)

Control for ln(K/L) Yes Yes

Regulated in t −0.029** −0.015 −0.023* −0.025* −0.046*** −0.027***(0.013) (0.014) (0.013) (0.013) (0.013) (0.009)

Control for ln(K/L) Yes Yes

Note: All entries report separate estimation results of regulation in t − 1 or t. The dependentvariable is log total factor productivity, log value added or log value added per worker (or percapital). All regressions include time-variant controls (categories of firm age, a public enterpriseindicator) and interactions of five-digit sector traits in 2005 (sector concentration of sales, shareof blue collar workers, share of public enterprises) with year dummies, as well as firm, island-year and sector-year FE. The number of observations is 208,120 when using regulation in t and185,978 for regulation in t− 1. Robust standard errors are clustered on firm level and reportedin parentheses. Significance at or below 1 percent (***), 5 percent (**) and 10 percent (*).

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Table A9: Impact on productivity while controlling for FDI

Dependent variable: ln(TFP) ln(VAD/L)

(1) (2) (3) (4) (5) (6)

Regulated −0.009 −0.008 −0.036*** −0.036*** −0.034*** −0.034***(0.012) (0.012) (0.013) (0.013) (0.013) (0.013)

FDI share 0.012 0.028 0.027 0.029 0.024(0.028) (0.026) (0.026) (0.026) (0.026)

Controls Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes YesSector traits in 2005 × Year Yes YesExtended traits in 2005 × Year YesTreatment in year t− 1 t− 1 t− 1 t− 1 t− 1 t− 1

Observations 185,978 185,978 185,978 185,978 184,999 185,978Firms 28,307 28,307 28,307 28,307 28,232 28,307R-squared 0.822 0.822 0.835 0.835 0.835 0.746

Note: The dependent variable is log total factor productivity or log value added per worker. Time-variantcontrols include categories of firm age and a public enterprise indicator. Five-digit sector traits in 2005include sector concentration of sales, the share of blue collar workers and the share of public enterprises. Allregression include firm and island-year FE. Robust standard errors are clustered on firm level and reportedin parentheses. Significance at or below 1 percent (***), 5 percent (**) and 10 percent (*).

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Table A10: Full sample including observations with missing capital

Dependent variable: FDI share ln(VAD/L)

(1) (2) (3) (4) (5) (6)

Regulated −0.010*** −0.010*** −0.011*** 0.001 −0.024** −0.024**(0.001) (0.002) (0.002) (0.010) (0.010) (0.010)

Controls Yes Yes Yes Yes Yes YesSector-year interactions Yes Yes Yes YesSector traits in 2005 × Year Yes YesFull sample (incl. missing capital) Yes Yes Yes Yes Yes YesTreatment in year t t t t− 1 t− 1 t− 1

Observations 298,487 298,487 298,487 267,582 267,582 267,582Firms 37,641 37,641 37,641 35,126 35,126 35,126R-squared 0.864 0.865 0.865 0.728 0.732 0.732

Note: The dependent variable is the foreign capital share within each firm or log value added per worker.Time-variant controls include categories of firm age and a public enterprise indicator. Five-digit sector traits in2005 include sector concentration of sales, the share of blue collar workers and the share of public enterprises.All regression include firm and island-year FE. The sample is larger compared to the baseline sample sizedue to non-omission of missing or zero capital values. Robust standard errors are clustered on firm level andreported in parentheses. Significance at or below 1 percent (***), 5 percent (**) and 10 percent (*).

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