Friday, October 19, 2012

19/10/2012: FDI: It ain't all it is claimed to be...



Quite an interesting little study out of the US worth reading (link here to an earlier version).

Christian Fons-Rosen, Sebnem Kalemli-Ozcan, Bent E. Sørensen, Carolina Villegas-Sanchez, and Vadym Volosovych just published a working paper titled "Where are the Productivity Gains from Foreign Investment? Evidence on Spillovers and Reallocation from Firms, Industries and Countries".

The paper identifies "the effect of foreign direct investment (FDI) on host economies by separating positive productivity (TFP) effects of knowledge spillovers from negative effects of competition."

"Policymakers around the world have welcomed this development and encouraged it given the perceived benefits of FDI such as technology transfer, knowledge spillovers, and better management practices. Several macro-level studies confirm these predictions by documenting a positive correlation between aggregate growth and aggregate FDI flows (see Kose, Prasad, Rogoff, and Wei (2009)). Researchers argue that this positive correlation between FDI and growth is a result of knowledge spillovers from multinationals and their foreign-owned affiliates to domestic firms in the host country."

Unfortunately, as the authors point out, "there is no direct causal evidence at the firm-level supporting this view for a large set of countries. Available evidence lacks external validity and the existing findings vary to a great extent between developed countries and emerging markets depending on the focus of the particular study".

The point raised is that "Any finding of a positive relation between foreign owner- ship and domestic productivity can be an artifact of (a) foreigners investing in productive firms in productive sectors and (b) exit of low productivity domestic firms following foreign investment. Establishing a causal effect of FDI on productivity (directly on foreign owned firms and indirectly via spillovers on domestic firms) is challenging: to identify such an effect, firm and sector specific selection effects must be accounted for, as well as the possibility of dynamic effects through the exit of weak domestic firms."

"The second difficulty in the quest for identification arises from the simultaneity problem. Foreign investment may be correlated over time with higher productivity of affiliates, or higher productivity of domestic firms with whom they interact; however, dynamic patterns might be driven simultaneously by time varying factors other than foreign ownership."

To control for the above, the study uses "a unique new firm/establishment-level data set covering the last decade for a large set of countries (60 countries) with information on economic activity, ownership stake, type, sector, and country of origin of foreign investors."

Top of the line conclusion is that:
"Controlling for foreigners potentially selecting themselves into productive firms and sectors, we show that the positive effect of FDI on the host economy’s aggregate productivity is a myth.
-- Foreigners invest in high productivity firms and sectors, but do not increase productivity of the acquired firms nor enhance the productivity of the average domestic firm.
-- In emerging markets, we find that the productivity of acquired firms increases but the effect is too small to significantly affect the aggregate economy.
-- For domestic firms, a higher level of foreign investment in the same sector of operation leads to strong negative competition effects in both developed and emerging countries.
-- In developed countries, we find evidence of positive spillovers through knowledge transfers only for domestic firms with high initial productivity levels operating within the same broad sector as the multinational investor but in a different sub-sector.
-- Our results confirm the predictions of the new new trade and FDI literature, in that more productive firms select themselves into exporting and FDI activities."

Oops!

More damning:
"Our preliminary results show that foreign owned firms/multinational affiliates are more productive … in developed countries; however, …this effect in developed countries is solely driven by future fundamentals (growth potential); i.e., growing firms becoming foreign-owned."

Double Oops!

Next:
"We find evidence of positive spillovers from foreign activity only when we look at a finer sectoral classification where the domestic firms are not direct competitors of the foreign firms and where domestic firms are at the top of the productivity distribution." Now, let's face it, folks, in MNCs-dominated sectors, Irish firms are not exactly a shining example of being at the top of the productivity distribution (except perhaps in ICT services, but most certainly not in pharma or medical devices or financial services). Which means that by and large we should not expect significant spillovers from the MNCs to Irish firms.


PS: Sadly, the study was not able to incorporate data from Ireland, because - to use polite authors' expression - Ireland belongs to a group of countries with 'Problematic Data Coverage' (aka dodgy data) for Manufacturing firms 2002-2007.

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