FDI and Business Internationalization of the Unorganized Sector: Evidence from Indian Manufacturing

Abstract

Available evidence, though limited to the organized sector only, suggests that FDI flowing in with MNE activities or direct FIIs generate technological and market access spillovers for firms outside the core group in destination countries. We investigate the organizational link between formal and informal sectors in India and argue that the spread of internationalization is more when production outsourcing prevails between such units. Higher wage in the organized sector is a factor that breaks standard institutional barriers leading to outsourcing of production to informal units. The evidence is puzzling to the extent that foreign capital and better know-how as drivers of international business to developing countries usually relax the credit constraint facing formal sector units at the destination and cause expansion of formal units. Using a measure of technology and a panel data for a large number of industrial units in India, we show that FDI transmitted through technology spillover leads to significant increase in the gross value added for several industries located in the informal sector. The paper points out that production re-organization associated with international capital movements should provide additional insights for standard measures of internationalization of production and services.