DO DOMESTIC FIRMS REALLY BENEFIT FROM FOREIGN DIRECT INVESTMENT? THE ROLE OF HORIZONTAL AND VERTICAL SPILLOVERS AND ABSORPTIVE CAPACITY

Abstract

This paper examines whether the existence of externalities associated with foreign direct investment (FDI) benefits the domestic firms of Indian manufacturing industries. Empirical findings reveal that local firms benefit from vertical foreign presence, whereas the horizontal foreign presence at the industry level could not substantially raise the value addition of labor across Indian industries. The absorptive capacity of domestic firms is highly relevant to reap the benefit from foreign presence, and could act as a precondition for incorporating the benefit of FDI externalities. Higher concentration and a greater size of the domestic market facilitate to raise the productivity spillovers from foreign presence. Furthermore, the FDI-technology spillovers seem to be higher for RD Wang and Blomstrom, 1992). The introduction of a new technology into a given market may be too expensive and risky for a domestic firm to follow, because of the cost inherent in acquiring its knowledge and uncertainty of the results that may be obtained (Crespo and Fontoura, 2007). If a technology is successfully used by a MNE, then domestic firms will be encouraged to adopt such technology. Barrios and Strobl (2002) suggest that the relevance of this effect increases with the similarity of the goods produced by the two types of firms in case of spillover related to product and process technology.FDI spillovers could be occurred, when the possibility of domestic firms hiring of MNEs workers, who have knowledge and experience of the technology and are able to apply this technology in domestic firms (Fosfuri et al., 2001; Glass and Saggi, 2002). However, the possibility of negative impact arising through this channel could not be avoided, as MNEs may attract best workers from domestic firms by offering higher wages and salaries (Sinani and Meyer, 2004). In addition, the influence of labor mobility on the efficiency of local firms is difficult to evaluate, as it involves tracking the workers in order to investigate their impact on the productivity of other workers (Saggi, 2002).2 The remaining important channels of FDI spillovers are exports, competition, and forward-backward linkages with domestic firms, etc.3FDI and technology imports could be recognized as alternative channels for technology spillover (Kanturia, 2001, 2002; Behera et al. …