An Analysis of Productivity Spillovers from Foreign Direct Investment in India’s Services Sector

Published date01 November 2016
Date01 November 2016
DOIhttp://doi.org/10.1177/0015732516650805
Subject MatterArticles
An Analysis of Productivity
Spillovers from Foreign
Direct Investment in
India’s Services Sector
Pooja Thakur1
L.G. Burange1
Abstract
The paper tries to study productivity spillovers from foreign direct investment in
the services sector of India. Using firm-level data for the period 2000–2010, hori-
zontal and vertical spillovers are tested with the help of panel data fixed effects
‘within’ model. Spillovers across different industries of the services sector are
also examined. It is inferred that horizontal spillovers positively affect total factor
productivity of domestic firms in the services sector. Spillovers through back-
ward vertical channels and forward vertical channels are, however, encountered
to be negative. At an industry level, it is deduced that productivity spillovers vary
across different industries with horizontal spillovers being more dominant than
vertical spillovers.
JEL: F21, F23, L60, O30, O47
Keywords
Productivity spillovers, foreign direct investment, services sector, panel data
models
Introduction
Most of the developing economies have opened their doors to foreign direct
investment (FDI) in the recent years1. The main reason behind this is to benefit
Foreign Trade Review
51(4) 271–286
©2016 Indian Institute of
Foreign Trade
SAGE Publications
sagepub.in/home.nav
DOI: 10.1177/0015732516650805
http://ftr.sagepub.com
Corresponding author:
Pooja Thakur, Department of Economics (Autonomous), M.G. Ranade Bhavan, Vidyanagari Campus,
Kalina-Santacruz (East), Mumbai 400 098, India.
E-mail: pooja.thakur04@gmail.com
1 Department of Economics (Autonomous), M.G. Ranade Bhavan, Vidyanagari Campus, Kalina-
Santacruz (East), Mumbai, India.
Article
272 Foreign Trade Review 51(4)
from advanced production techniques and processes that accompany FDI. It is
often argued that multinational enterprises (MNEs), through which majority of
FDI is channelized, own firm-specific proprietary advantages like technical know-
how, marketing and managerial skills, access to cheap raw materials, export mar-
kets etc., which enable them to operate in the host country markets. Though all
these advantages are non-tangible in nature, they possess the characteristics of a
public good. Domestic firms can benefit from them via productivity spillovers
(Caves, 1974; Hymer, 1976; Javorcik, 2004; Kugler, 2006).
Analysis of productivity spillovers has, therefore, gained significant impor-
tance in the empirical literature. However, most of the studies have taken
into account the manufacturing sector, ignoring the services sector completely
(Anwar & Nguyen, 2010; Javorcik, 2004; Joseph, 2007; Kohpaiboon, 2009;
Kugler, 2006; Sasidharan & Ramanathan, 2007; Smarzynska, 2002; Wang &
Gu, 2006). There exist very few studies focusing on spillovers from FDI in the
services sector (Lesher & Miroudot, 2008). Lesher and Miroudot (2008) point
out in this context that productivity spillovers from FDI are not solely confined
to the manufacturing sector. In reality, the services sector also provides inputs to
other sectors of the economy and is in turn recipient to inputs from them.
Services sector, thus, has great potential to exploit the concomitant spillovers
from FDI.
In their study, Lesher and Miroudot (2008) assessed productivity spillovers
across various industries belonging to the services sector for the OECD coun-
tries. Using panel data fixed effects model for the period 1993–2006, they found
positive horizontal spillovers in industries like hotels and restaurants, land
transport, other transport services, finance and insurance, health and social work
and other social and personal services. On the other hand, backward vertical
spillovers were encountered to be positive for construction, hotels and restau-
rants, water transport, computer-related activities, other business activities and
education. Industries like wholesale and retail trade, real estate, other business
activities, education and health services gained from forward vertical spillovers.
Their study suggested that the services sector experienced significant spillovers
from FDI. Assessment of productivity spillovers for the services sector is, there-
fore, crucial.
The objectives of the paper are twofold. First, the paper tries to analyze pro-
ductivity spillovers from FDI in the services sector of India. Second, a scrutiny of
spillovers across all industries belonging to the services sector is also aimed at in
order to determine the industries that benefit from spillovers. Taking into account
the growing importance of services sector in the Indian economy, such type of an
analysis would help in understanding whether FDI has aided the growth of serv-
ices sector or not.
The rest of the paper is organized as follows. The second section reviews the
channels through which productivity spillovers take place. The data and method-
ology applied for the purpose of analysis are explained in the third and fourth
sections. The fifth section presents the empirical results, while the last section
concludes the paper.

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