Foreign Direct Investment, Local Small and Medium Enterprises and Technology Transfer in Developing Countries: A Story from Indonesia

Abstract

Official reports, academic papers and many case studies on small and medium enterprises (SMEs) in developing countries show that large enterprises (LEs) produce better products than those by SMEs, partly because the first enterprises have better technology, which make them more innovated compared to the second ones. Thus, as general rule, to be able to do innovation, SMEs need to improve, among other things, their technology. Improvement of technology can take place internally (inside the firm) or can be fostered through access to external sources, including from foreign direct investment (FDI). This study aims to examine how important is the presence of FDI for local SMEs with respect to transfer of technology in Indonesia. This study is based on a literature survey and a case study on SMEs in metalworking industry in Tegal, Central Java. It appears that in some cases foreign companies are the only source of technology for local SMEs through subcontracting arrangements. However, not all local SMEs, especially small enterprises (SEs) can become local subcontractors, due to their lack of skilled workers and basic technology. This study therefore suggests that government has an important role to play to support capacity building of especially SE so they can be accepted by foreign companies as their local suppliers.