The impact of FDI on R&D investment of small and medium-sized enterprises in Vietnam: The role of institutions

Abstract

This paper investigates how the quality of the local institutional environment affects the impact of foreign direct investment (FDI) on R&D investment of domestic small and medium-sized enterprises (SMEs) in Vietnam. By analysing data of 2690 manufacturing SMEs in 2011, 2013 and 2015, we find that FDI presence hinders R&D activities of domestic SMEs, probably due to SMEs' low absorptive capacity, large technological gap, lack of economies of scale and low market power. However, institutions positively moderate the relationship, that is better institutions mitigate the negative impacts of FDI on R&D investment of domestic SMEs. When the quality of local institutions improves beyond a certain minimum level, FDI exerts positive spillovers that encourage R&D activities of domestic SMEs. Our hypothesis suggests that institutions can moderate FDI spillovers to SMEs' R&D by promoting the foreign investors' incentive and ability to create technological spillovers, mitigating FDI crowding-out effects, enhancing domestic SMEs' absorptive capacity, and facilitating interaction and knowledge sharing in the local business environment. We also find that the institutional moderating effect is less pronounced for FDI originating from countries with lower institutional quality compared to that from countries with higher institutional quality. This suggests that multinational enterprises (MNEs) in the former group may be more susceptible to institutional impacts due to their unfamiliarity with institutional obstacles in the host economy. Our study highlights the importance of institutions to researchers who explore the relationship between FDI and domestic firms’ R&D investment and to policymakers in emerging economies where FDI inflows and domestic SMEs play a pivotal role.