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Jan Svejnar, Yuriy Gorodnichenko and Katherine Terrell
  Jan Svejnar, Yuriy Gorodnichenko, PhD '07, and Katherine Terrell

The "Spillover" Effects of Foreign Investing

12/21/2006 --

Benefits may not be as broad-based for local firms in emerging-market economies.

ANN ARBOR, Mich.—The impact of foreign direct investment (FDI) in emerging-market economies may not be as broad-based and beneficial to local firms as many observers believe.

In a recent study, researchers from the Ross School of Business investigate when, where and under what conditions foreign investments by multinational enterprises (MNEs) in developing countries produce knowledge "spillover" effects that increase the efficiency and productivity of those countries' own firms, thus improving the welfare of those nations. Since the late 1990s, governments in transition economies have attempted to attract FDI in order to spur economic development. The commonly held belief is that FDI increases productivity directly through "greenfield" investments and acquisitions of domestic firms, as well as indirectly through positive productivity spillovers on other local companies.

MNEs can have spillover effects on local competitors within the industry (horizontal spillovers) as well as on upstream and downstream domestic firms that serve as suppliers or purchasers of their products (vertical spillovers). Although local companies may benefit by learning to imitate a new process or to improve the quality of their products through observation or coaching, multinational corporations also may have a negative effect on domestic firms' output and productivity by "stealing" their markets or draining away their best human capital. Hence, the question is whether the net effect is positive or negative.

In their study, Katherine Terrell, professor of business economics and public policy, and Jan Svejnar, the Everett E. Berg Professor of Business Administration, both of the Ross School, and graduate student research assistant Yuriy Gorodnichenko, PhD '07, analyze 2002-05 Business Environment and Enterprise Performance Survey (BEEPS) data on small, medium and large manufacturing and service firms in 26 transition economies. Theirs is the first study to use data that cover this many countries and such a broad range of firm sizes, in addition to including the service sector. Most studies examine only large manufacturing firms in one country.

Their findings suggest that there is an increase in the efficiency of those domestic firms that either supply local industries dominated by foreign-owned companies or export a majority of their output, i.e., sell more goods or services to foreign firms than to those with operations inside their own country.

In contrast, domestic firms that buy from foreign-owned firms either domestically or through imports do not gain from knowledge spillover effects of MNEs. Furthermore, the researchers found that only large domestic firms benefit via horizontal spillovers from the presence of foreign firms in their industries. There is no similar improvement in the productivity of small local firms.

In other results, Gorodnichenko, Svejnar and Terrell find no difference in the productivity spillovers of MNEs from wholly owned versus partially owned foreign firms. Nor do they find evidence of any advantage in having foreign investments made by more-developed Organisation for Economic Co-operation and Development (OECD) countries compared to those of less-advanced non-OECD nations.

The researchers also conclude that the strength of spillovers does not vary with the degree of corruption, bureaucratic red tape or openness to trade in the host country. In addition, they find that domestic companies in industries where the technology gap with foreign firms is greater are less efficient and less likely to benefit from horizontal spillovers. Similarly, they report that large domestic firms with more highly educated workers (who presumably can more easily apply new technology) do indeed tend to realize positive horizontal spillovers.

Written by Claudia Capos

For more information, contact:
Bernie DeGroat
Phone: (734) 936-1015 or 647-1847