Foreign Direct Investment in the MED Region: Equity Relationship, Spillovers and Policy Implications S. Alessandrini, FEMISE, University of Modena and Reggio Emilia International Conference “Bridging the Gap: the Role of Trade and FDI in the Mediterranean” June , Naples, Italy

General Overview of the paper Introduction The questions The three surveys The results Policy implications

The questions to examine whether the productivity of domestic firms (foreign or domestically owned) is correlated with the presence of multinationals in their sectors and to what extent the presence of the MNC is affecting the characteristics of the domestic firms. whether potential benefits stemming from vertical linkages are related to the extent of foreign ownership in affiliates and to the export-orientation of the MNC

Spillovers Within the literature, spillovers are represented by contacts between MNC and domestic suppliers (vertical spillovers or backward/forward linkages), and increased competition in the domestic market which would raise the average productivity in the industry (horizontal spillovers or competition linkages) Kind of spillovers (technological sp, competition sp, demonstration effects) Evidence of positive externalities resulting from FDI is contradictory

The three surveys The three surveys were conducted in 2004 and 2005 by the research team in Jordan and Tunisia Unbalanced panel of 110 firms spanning over the period Selection criteria Asking perceptions and facts Questionnaire and interviews to owners and managers

The three surveys Number of surveyed firms JordanTunisia Primary2 Manufacturing3334 Textile & Clothing274 Chemicals53 Machinery110 Others17 Trade2 Services (ICT)327 Missing4 TOTAL3669

Theoretical background Internalisation theory (Caves, Dunning, Helpman) and firm-specific or assets advantages Property right theory (Grossmann, Sandford and Hart, Williamson..) and failure of contractual relations of markets

Foreign ownership and gains in productivity Foreign owned firms increased productivity over time Also domestic foreign owned firms increased productivity over time In average, productivity is similar to international standards for foreign owned firms In average, domestic owned firms’ productivity is lower than international standards

Foreign ownership and gains in productivity Change of productivityDomesticMinorityMajority Full OwnershipTotal Decreased2 1 3 Same Increased Total Level of productivity compared to international standardsDomesticMinorityMajority Full OwnershipTotal Lower Same Higher Total Results not supporting the direct correlation between ownership and productivity. It is true that the larger productivity gains are within firms with full ownership (level 3), however foreign- participated firms did not significantly show a better performance relative to locally-owned firms.

Foreign ownership and human capital Domes tic firmsForeign firmsTotal Index of human capitalTotalMinorityMajority Full Owners hipTotal Primary school (0-40)33369 Secondary school (40-60) Relevant Technical education (60-80) Higher education (80-100) Total

Foreign ownership and innovation Contrary to expectation our survey shows that the domestic firms have great technological capabilities. The level of innovation embedded in their equipment are quite substantial since fifty percent of the sample renewed their equipment in the last 2 years, while foreign owned firms had made their investment in the last 3-5 years

Foreign ownership and R&D Activities Domestic firmsForeign firmsTotal R&D activities Foreign market Domesti c marketTotal Foreign market Domesti c marketTotal Decreased Same Increased Total

Foreign ownership and Global governance Table 14 - Share of export on total sales and ownership Domestic firmsForeign firmsTotal Less 20% % % %112 More 80%72936 Total Table 15 - Share of imported inputs on total costs and ownership Domestic firmsForeign firmsTotal Less 20% % % %7411 More 80%82533 Total303360

Dependent variable: Change of productivity All Jordania n firms Tunisian firms All Part of a MNC network1,6292,2372,1250,9792,214 (0,066) c (0,026) b (0,071) c (0,175) d (0,054) d Foreign ownership-1,473-1,914-0,647-2,996-3,108 (0,085) c (0,062) b (0,637)(0,195) d (0,073) b Presence of MNC (branch)0,2603,896 (0,705)(0,050) b Presence of MNC (site)-0,449-2,908 (0,474)(0,055) b Age of equipment-0,053 (0,952) Frequency of contacts-0,820-2,265-0,732 (0,068) c (0,103) c (0,053) b Location in SEZs0,0771,241-0,8650,300 (0,916)(0,372)(0,403)(0,724) Inputs bought from MNC0,4421,1430,0290,633 (0,330)(0,190)(0,965)(0,198) d Sales to MNC-1,0710,226-0,793-0,833 (0,028) b (0,833)(0,209)(0,159) d Size of firms1,4521,1030,455 (0,177) d (0,028) b (0,566) Share of export on total sales-2,881-1,211 (0,039) b (0,017) b Share of foreign inputs on total costs3,2231,740 (0,020) b (0,005) a n. obs LR chi23,816,388,206,7011,022,9927,7912,4023,00 Prob > chi20,14890,17250,08440,15250,02630,39350,00020,02970,0001 Pseudo R20,04420,08470,13490,08510,25680,08950,54150,17020,4067 P|z| in parenthesis a,b,c and d denote significance at the 1%, 5%, 10% and 20% levels, respectively

Change in productivity is positively affected by the MNC network, while the ownership status is working in the opposite way (eq 1 and 2) Competition affects are statistically not significant (eq 2) Foreign knowledge inflows will increase the chance that the firm increases its productivity in the future (eq 3 and 4) Contrary to expectations the frequency of formal or informal contacts with foreign firms may have an adverse effect on reducing productivity. The age of investment have surprisingly a negative but not significant coefficient In other words there is no evidence in the MENA region supporting the existence of positive productivity effects through foreign ownership and FDI Being member of a MNC network is a source of another type of spillovers since it will increase the efficiency of forward and backward transactions, because of the superior knowledge of MNC. The inputs bought from the MNC are positively correlated with the probability that a firm will increase its productivity (eq. 4 and 8). The impact of exports in instead statistically negative and significant (eq 7 and 9) Results

Eq 2 and 4 show that the knowledge flows of being part of a MNC network and the location into a SEZ are positively correlated with the probability that a firm will keep its productivity up to international standards. Contrary to expectation, the foreign ownership per se is not significant. Eq 7 show that knowledge inflows from other foreign sources, like the quality of equipment and machinery, usually imported as embedded knowledge, and the share of foreign ownership are negatively correlated with the probability that a firms has a productivity higher than the international average. Determinants of the level of productivity

The empirical results indicate that the share of export in total output is significantly higher for firms that have experiences of foreign ownership. Large firms also export more than small firms, and the coefficient is highly significant. On the contrary the participation to a MNC network as well as the quality of human capital have a negative but not significant coefficient, meaning that foreign ownership benefits local firms through other means such as access to the world markets and not only through technology spillovers. The degree of innovation in technology, measured by the age of the equipment, is positively correlated, but the coefficient is hardly significant. Foreign ownership is positively correlated with outsourcing, which concurs with the hypothesis that foreign owned-firms are more prone to buy their inputs abroad. Large firms also outsource more than small firms. This may reflect a pure size effect – large firms produce higher levels of output and therefore have more activities, in absolute terms, to outsource than smaller firms. The innovation efforts in technology, measured by the age of equipment, are also positive correlated with the share of imported inputs, but the parameter is not significant. Foreign ownership and export/import orientation

The empirical results indicate that exports are negatively related with the change of productivity. The negative coefficient are significant at 10 or 20% for both domestic and foreign-owned firms. Furthermore, this productivity effect of export is more pronounced in the sample of foreign-owned firms. There are strong backward spillovers trough the imported inputs, a specific form among the outsourcing activities of the firms. Foreign owned firms, but also domestic firms, would probably like to buy some parts and components on the foreign market in order to contain costs or increase their productivity. This creates a demand for higher quality inputs which generate new imports in the host economy. Change of productivity and export/import orientation

The foreign knowledge inflow don’t always conveys positive effects to local affiliated and other related firms in general. Foreign ownership, but not R&D intensity, are closely associated with sales in foreign markets. Competition intensity in the output and labour markets perceived by the firm seems to be positively related with the probability that a larger share of output will be sold in foreign market, while the cost of labour and the cost of better quality controls have negative effects. One of the factors that induce firms to undertake technological effort is competition, trough the demonstration effect. Technological effort provides a competitive edge and better growth prospects for the firms that undertake it. The performance of Tunisian firms in our sample is very illustrative. The presence of a competitive environment has been observed to lead to more rigorous cost- reducing technological research and segmentation of markets. In this context, competition is seen as a dynamic process whereby firms invest in new technologies and expand in new ITC sectors to gain a technological advantage, which, in turn, increases profitability and leads to further invention and innovation. Technological innovation is likely also in small firms, which are less bureaucratic and efficient, but they have the advantage of knowing the local market and the dynamism to innovate. Technological activities among smaller firms is increasing as technology became more easily available and cheaper. For those firms domestic orientation prevails on the export activities. Conclusions and recommendations