Externalities from FDI in the Portuguese Manufacturing Sector

Abstract

Until the end of the 1990s, Portugal benefited from backwardness advantages and converged vis-a-vis with the EU average via the effects of Foreign Direct Investment that operated a structural shift towards technology-intensive exports. However, being a small open economy located on the European periphery, Portugal is vulnerable to external factors. Thus, since 2000, those factors, largely triggered by the global financial crisis, led to a drop in industrial production accompanied by a reduction in Foreign Direct Investment attraction. Technology transfer resulting from the foreign presence in a host country may increase the Total Factor Productivity. In this context, the manufacturing sector, being a major producer of tradable goods, is a driver of technological change since it potentially generates high rates of innovation and drags capabilities to other sectors of the economy. Nevertheless, previous studies for Portugal show mixed results. Based on a new database containing 5,045 firms, this paper investigates the existence of externalities from Foreign Direct Investment, from 1995 to 2007. Applying the Wooldridge- Levinshon and Petrin (2009) technique to estimate the Total Factor Productivity, we find that firms in scale-intensive and supplier-dominated industries benefit from positive externalities from Foreign Direct Investment. The uneven distribution of such externalities confirms the heterogeneous nature of manufacturing firms and, therefore, the need of a disaggregated analysis by industries, in order to understand how externalities, affect each industry.