Is Inward FDI Enhancing or Crowding-out Domestic Innovation Capability in Emerging Markets? Evidence from BRICT Countries

Abstract

Foreign Direct Investment (FDI) has been considered by many development economists as an important channel for the transfer of technology to emerging markets. However, whether it can promote technological progress for the host country depends on the sector specific and country specific characteristics, especially technological infrastructure and human capital. This study investigates the impact of inward FDI on absorptive capacity and domestic innovation capability in BRICT countries. Two competing hypotheses of the effect of inward FDI are tested by employing panel data approach for BRICT countries for the period of 2000-2007. Empirical results reveal that Random Effects Model outperforms Ordinary Least Square and Fixed Effects Models. The hypothesis that domestic innovation capability stems from knowledge generation process with well equipped human resources like scientists, engineers, technicians, research equipment and cumulative R&D expenditure is supported for the given sample. Therefore, inward FDI promote domestic firms’ innovation capability and the spillover effects may arise through channels such as reverse engineering, skilled labor turnovers, demonstration effects, and backward linkages. In addition, the impact of the effect of local R&D expenditure on innovation capability is very significant determinant of innovation capability. On the contrary, the hypotheses of crowding-out effect of inward FDI on domestic innovation capability and high welfare and development level in a country stimulates innovation capability is rejected for the BRICT countries.