In his knowledge-capital model (Multinational Firms, Location & Trade, Markusen, 1998), Markusen defines knowledge capital to include human capital, industry-specific knowledge, proprietary knowledge (e.g. blueprints, patents) and marketing assets such as trademarks and brand names. Evidence suggests that multinationals predominantly specialise in R&D, marketing, scientific and technological sectors, and product differentiation and complexity. This in turn implies that these firms will be knowledge-capital intensive ones.
In the majority of circumstances, local firms will naturally have a far better knowledge as to the skill level of potential employees, factor market conditions and political and economic climates than their foreign counter-parts. In order to capture this knowledge, many foreign firms will invest in a joint-venture between them and a domestic firm. This will increase the rate of transfer of knowledge-capital and also the likelihood of it being diffused into the local economy. Indeed, many governments have restricted foreign ownership, forcing multinationals into joint venture agreements (Blomstrom & Sjoholm, 1999) for precisely this reasoning. In the case of joint-venture schemes, however, there are a couple of objections which are raised against the effectiveness of joint venture schemes in facilitating knowledge-capital transfers: As there is a greater risk of asset loss to the foreign firm working with a local partner, it might be inclined to use less advanced technology or invest less; Similarly, the greater the foreign ownership of the affiliate, the greater the incentive for the firm to transfer technology and human capital to it – joint ownership will naturally compromise this incentive.
Maybe the most influential “spill-over” as a result of a multinational presence in a developing economy are the efficiency gains to the specific sector that arise due to the increased competition. The more protected a sector is, the less competitive the incumbent firms will be and so therefore the greater the potential efficiency gains to be made. However, the greater the technological advantage of the foreign firm, the greater the possibility any possible economies of scope can be exploited, and this may well lead to a market stealing effect where the multinational increase its market share at the expense of domestic firms in the short run as it will take some time for the domestic firms to adjust their working practices in order to become efficient enough to compete with the multinational firm. Aiken & Harrison, (1999) show that the initial reduction in the quantity produced by domestic firms will force many onto a higher average cost curve, due to the presence of fixed costs. This will prolong the “catch-up” period that it takes domestic firms to increase efficiency in order to remain competitive in the sector.
The question to be asked now is which effect will dominate, and therefore what will be the net effect of the spill-overs from the multinational firm be?
Empirical Evidence:
Before looking at the empirical evidence given, it is important to note the following identification problem that econometricians have when attempting to capture the effects of a multinational on labour productivity in the domestic sector. The problem lies in the fact that foreign investors will naturally gravitate towards the more productive industries. Therefore, any attempts to model a relationship between foreign presence in a developing economy and labour productivity will overstate the effect that it has. Similarly, multinationals may simply be more competitive due to their larger firm size. In Morocco, Haddad & Harrison (1993), found that firms with a foreign influence tended to be larger, more export orientated firms. These are likely to be more productive firms, due to the economies of scale that can be exploited, and the presence of external competition in the export market. Again, without taking this into account, the positive spill-over effect on labour productivity from multinationals will be overestimated.
When Haddad & Harrison controlled for these effects, estimating the levels of labour productivity for small foreign owned firms and small domestic owned firm, no significant difference was found, implying that the overall effect of the spill-overs in this case was not significant. However, when estimating the effects with-in sectors, they found that, on average, foreign firms had achieved a significantly higher level of productivity. Productivity growth was found to be lower amongst foreign firms, which seems to confirm the “catch-up” hypothesis that domestic firms have more efficiency gains to be made. Indeed, no evidence of foreign investment on productivity growth was found in Morocco either at a firm or sector level, contradicting the technological transfer model discussed earlier. The differing levels of productivity can therefore be attributed to the effect of increased competition on the productivity of domestic firms rather than any positive technological spill-over. Joint ventures were found to benefit from foreign investment suggesting that any positive spill-overs that were apparent were internalised by the affiliates.
In their research conducted in Indonesia, Blomstron & Sjoholm (1999) found that industry level benefits were apparent due to the presence of foreign firms. However, they also found that the degree of FDI in an industry did not affect the level of productivity within that sector, and that any intra-industry spill-overs were not technological. This could well be due to the technology gap being too large and again supports the theory that any gains in productivity experienced by domestic firms was due to the threat of increased competition.
Highlighting the negative spill-overs from increased competition, Aitken & Harrison (1999) found significant domestic contraction in sectors as a result of FDI. Further to this, upon testing the persistence of these effects they found them to have a continuing significant negative effect for over 4 yrs. Again, upon testing, joint-ventures were shown to be more productive than domestic firms in the same industry. Productivity gains associated with FDI were solely shown to be positive and significant for small firms. It would be expected that the domestic firms operating in the same locale as the multinational firm would capture any knowledge-capital spill-overs. If the knowledge-capital theory holds then positive local spill-overs would be expected. However, Aitken & Harrison did not find any to be present. The overall net effect of FDI in Venezuela was found to be marginal and positive using WLS but negative when OLS estimates were used. They concluded that any positive spill-overs were again internalised by the joint-ventures.
Conclusion:
To conclude, results linking FDI to productivity growth have been variable, although do show that the surge in popularity in attracting FDI amongst governments of developing countries may be partly due to the identification problem overestimating the effects of spill-overs on productivity. Part of the problem in ascertaining the effect of spill-overs on developing countries is the difficulty in modelling the relationship accurately. As has been seen, different estimating techniques will yield differing results, there is the identification problem to be controlled for, and always the possibility of omitted variable bias within the regressions. Even at best, the variables used in the regressions are proxies for the actual unobservable variables that we wish to model. Due to the relative infancy of the fad of widespread FDI there is, unfortunately, no great volume of past research that present models can be judged against. We know neither which models give us the most “realistic” results, nor the appropriate time-length to base our judgements on. What has been shown is that, in the three studies looked at, the overall net effect of spill-overs is minimal, and that it many instances spill-overs are completely internalised by joint-ventures. In addition, it seems that any increase in domestic productivity caused by FDI seems to not be a result of technological or knowledge based spill-overs but rather of increased competition.
Of course, there is no general rule – spill-overs may tend to be more prominent in export-orientated economies (firms competing on the world market will naturally be assumed to be more competitive than those competing solely domestically. The technology gap between multinationals and domestic firms is therefore more likely to be breechable), but the effects will vary country to country and firm to firm. Unfortunately, I have found no compelling evidence for or against the net impact of spill-overs on developing economies, but enough evidence to show that the perception of only positive spill-overs arising from multinational companies is indeed a misconception.
Scott Crawford
