11 FDI’s Imact on Domestic Firms: spillover through backward linkage Javorcik (AER, 2004) Paul Deng March 22,

Big Picture 2

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4 The Impact of FDI on Host Countries MNEs are the most productive firms in their home countries MNEs, most of the time, are more productive than firms in host countries, especially compared to those in developing countries Most MNEs are skill intensive, knowledge intensive, and heavy in R&D investment Host countries want to attract FDI because they may benefit from MNE’s presence, through spillover effect 4

5 The Impact of FDI on Host Countries The spillover effect could be positive, because  personnel (both workers and executives) trained at MNEs are more skilled, and later they may open their firms, or work in other domestic firms  Technology may leak to domestic firms, through domestic firms’ interactions with MNEs  Above two are the most obvious and easiest spillover channels  There are other channels, the mechanism of which economists are still trying to untangle, and we will discuss them later 5

6 The Impact of FDI on Host Countries The spillover effect could also be neutral or even negative  MNEs’ incentives to protect technology from leaking so to maintain their lead in innovation put a brake on technology transfer  MNE’s entry into domestic industry may out-compete domestic firms, sometimes forcing them to shut down or switch to other industries  Again, there are more complicated channels, which we will discuss later 6

7 Spillover and Its Relation to Type of FDIs Horizontal spillovers – related to horizontal FDI  Spillover from MNEs to domestic firms within the same industry Vertical spillovers – related to vertical FDI  Backward linkage spillover from downstream firms to upstream firms e.g., spillover from foreign firms to their domestic suppliers  The focus of this paper  Forward linkage spillover from upstream firms to downstream firms e.g., foreign circuitboard producer and domestic PC maker 7

Javorcik (2004), FDI and Its Spillover Effect Research question:  Does FDI increase doemstic firms’ productivity?  Through what channel? Javorcik investigated spillover effect through the following channels or linkages:  Horizontal, i.e., within the same industry  Backward, i.e., downstream industry to upstream industry  Forward, i.e., upstream to downward industry The author argues spillovers from FDI are more likely to be vertical than horizontal. Why? Pay special attention to how he defines and measures the vertical linkages 8

Javorcik (2004), Data Description Lithuanian firm-level data, with the whole sample covering 85% of total output This paper only focuses on manufacturing firms, in over 20 industries Unbalanced panel data from 1996 to 2000, each year around 2000 to 2700 firms, after data cleaning process 9

A Snapshot of FDI in Lithuania 10

Javorcik (2004), Estimation Strategy 11 i: firm j: industry r: region t: year Note that the first 4 variables are indexed at firm i level, while the rest 3 variables are indexed at industry level Also note firm-level fixed effect is not controlled in this regression equation time effect regional effect Industry effect (1)

How might the linkages work through? Horizontal linkages  Knowledge spillover thru personnel turnover  Competition effect – negative and positive? Vertical linkages  Backward linkage Selection effect Scale of economy effect  Forward linkage Competition effect – more efficient production or cheaper inputs 12

Javorcik (2004), Linkage Measures 13

Javorcik (2004), Linkage Measures 14 backward linkage Firms in industry j MNEs in downstream industry forward linkage MNEs in upstream industry Firms in industry j

Spillover Linkages 15

Javorcik (2004), Estimation Results 16

Fixed Effect with Difference Estimator 17 Reminder:

Estimation Results with Fixed Effects 18

Foreign Ownership and Vertical Spillover 19

Summary of Empirical Findings Backward linkage is quite robust in various different estimations Forward and horizontal linkages are much less robust Backward linkage seems to work best when a foreign firm has a local partner, i.e., joint ventures --- important policy implications for host countries 20

Some Further Thoughts The specific mechanisms through which backward linkage operates are still not very clear Does backward linkage operate through a selection effect by MNEs?  Higher quaility control?  Picking more productive suppliers?  Competition among suppliers (in winning MNE’s contract) lead to more efficient production? Economists are still trying to figure out… 21

Next Time… Our last class; Afterwards, Niels will take over Read Harrison (1999), AER, ”Do Domestic Firms Benefit from FDI.” Really start to think hard on your term paper, don’t wait until too late. 22