Volume 19, Number 2 Article by T J Joseph June, 2007
Spillovers from FDI and Absorptive Capacity of Firms: Evidence from Indian Manufacturing Industry after Liberalisation :
Foreign direct investment (FDI) through multinational enterprises (MNEs) is expected to generate a set of externalities on domestic producers, referred to as ‘spillovers’. Economic liberalisation, which attracts foreign investment, accelerates such productivity spillovers. Domestic firms are supposed to increase their productivity by adopting the brand new technologies of MNEs, known as horizontal (intra-industry) spillovers from FDI. Domestic firms may also benefit when they are employed as suppliers or subcontractors to MNEs as that helps them to expand output and achieve economies of scale. Such externalities are referred to as vertical (inter-industry) spillovers. However, these spillovers do not occur naturally and depend on the ability of the domestic firms to absorb such knowledge spillovers.
T J Joseph’s study analyses both horizontal and backward spillover effects of FDI on the productivity of domestic firms and the role of domestic firms’ absorptive capacity to benefit from these spillovers. Using panel data for 469 Indian manufacturing firms for the period 1993-2004, the study finds that both horizontal and backward spillovers from foreign firms’ sales have a significant positive impact on the productivity of domestic firms. The results indicate that there is both a positive competition effect from the presence of foreign firms (horizontal effect) and a positive complementary effect due to backward linkages between domestic firms and foreign firms, where local firms act as suppliers of raw materials to the foreign firms. The R&D effort of domestic firms is found to be a critical factor in absorbing the positive spillovers from foreign firms both as competitors and as suppliers. The author recommends strong policy emphasis in facilitating the creation of supply networks around leading foreign firms and also policy incentives to encourage the R&D activities of domestic firms to absorb FDI spillovers.
Reprint No 07204
