Does FDI promote productivity? A deep dive.

AuthorSingh, Awadhesh Pratap
PositionForeign direct investment - Report - Abstract


After the change in regime in 2014 general elections, India's new prime minister has been wooing foreign investors to invest in the country. He made his intention clear by stating that "FDI is a responsibility for Indian and an opportunity for the world. My definition of FDI for the people of India is: first develop India". This shows the intention and importance of FDI which is seen as an enabler for the Indian economy.

Indian manufacturing sector continues to be a subject of debate among policy makers and economists. The reasons for this interest are many, however the major one is that the sector's contribution to the national GDP has remained almost stagnant over the years, with a share of about 15% in 1990-91 to about 16% in 2014-15. In 2015, while India replaces China as the top FDI destination by securing $63 billion worth of FDI projects, manufacturing sector's share in it was less than 10%. However, it remains to be one of the biggest employers and a potential source to alleviate poverty in the country. It then becomes utmost important to carry out a deep analysis of manufacturing sector in the light of FDI which is largely considered to promote productivity and see its impact.

The trend of inwards FDI across countries increased in recent years due to globalization and trade reforms. Economic growth, open trade and emerging economies are the drivers behind this change. While in late 1960s and early 1970s, inward foreign direct investment (FDI) was frequently alleged to be disadvantageous for host countries, opinion in recent years have changed drastically (Sahu & Solarin, 2013). Most of the countries now offer generous tax and financial incentives to entice FDI. The prime motivation of a host country to attract FDI lies upon the belief that FDI would benefit it. Interestingly World Bank stated in 1993 that "FDI brings with it considerable benefits: technology transfer, management know-how, and export marketing accesses."

In many cases, host countries expressed concern that FDI entry through the takeover of domestic firms is less beneficial, if not completely harmful, for the economic development than the entry by setting up new facilities. The rationale behind such concerns is that overseas acquisitions do not promote the productive capacity but rather transfer ownership and shift the control from domestic to foreign hands. This transfer is usually accompanied by layoffs or optimized by closing some production or functional operations. Most importantly, the primary reasons to make these changes in the structure of firm are usually an important factor to achieve benefits; however they are frequently opposed by labor unions. Due to these challenges, the FDI route that promotes to takeover of the firms, is largely less researched and the literature is still evolving, especially in the case of cross-border acquisitions. This issue has been handled by the literature on multinational enterprise (MNE), and scholars in the field of industrial economics. On the other end, the FDI route where foreign firms invest in the enterprises in host countries are well researched and good amount of evidences are available. Besides, a new topic which is being researched in last few years viz. the FDI impact on family vs. non-family firms, is also gaining momentum. This paper reviews the literature associated with inward FDI and its impact on productivity first internationally and then in Indian context.

Inward FDI Accelerates Performance

Inward FDI has always attracted firms as it is one way to get access to funds. Besides, this also opens up the gates to access foreign technology and resources. Most of the earlier empirical papers pertaining to the developed and developing countries showcased evidences of positive impact by using cross-sectional data. Caves (1974) was the first to demonstrate the positive correlation between inward FDI and productivity using the time series data. Globerman (1979) also supported the findings that if foreign firms bring new products or innovation in the domestic market then domestic firms may benefit through the accelerated dissemination of technology. Blomstrom and Wolff (1989) observed that the inflow of FDI can reduce the technological gap among foreign and domestic firms of developing country and facilitate the latter to reach technology of the developed countries.

This process of transmission and transformation of technology in the local manufacturing sector may take place through spillover through several inward FDI channels. Domestic firms may get benefited from the presence of FDI in the same industry, leading to horizontal spillovers or intra-industry spillovers, through labor movement and competition impacts. On other side, there may be spillovers from foreign invested firms operating in other industries, promoting inter-industry or vertical spillovers as demonstrated by MacDuffe and Helper (1997) on US firms, Driffield et al. (2002) on UK firms and Blalock (2002) on Indonesian firms. Helpman (1999) demonstrated that economic relations with MNCs provide learning opportunities for the local firms. This reduces their innovation costs, which leads to improvement in total factor productivity. Kokko (1996) found that in due course of time, the changing local demand and the intense rivalry would eventually lead the local firms to improve productivity and adopt new technologies. Cantwell (1995) and Li et al. (2001) proved that the degree of technology spillovers depends on the technology gap between foreign and domestic firms and the technological competences of local firms. Meyer (2004) stated that while facing these kinds of empirical difficulties to measure the technology spillover, it can be evaluated by proxying the improvement in productivity among the firms that came in contact with FDI. Sahu and Solarin (2013) demonstrated the spillover by incorporating FDI in measuring productivity of the manufacturing sector at the firm level. Taking the clue of many other regions, Barrel and Pain (1999) for four European countries, Haskel et al. (2002)for UK, Rasiah (2002) for Malaysia, Sjohalm (1999)for Indonesia, and Hale and Long (2006)for Chinese firms, shared ample evidence of confirmatory positive impact of FDI on manufacturing performance.

Kokko and Blomstrom (1998) opened a new dimension when they found that FDI can also lead to acquisition where productivity needs to be compared before and after the acquisition. They demonstrated that FDI that leads to acquisition raises questions about their benefits. Besides the impact on productivity due to this change, it also led to a wide-ranging debate on the causes and consequences of acquisition and ownership change. Two categories of literature emerged here: first one includes Aitken and Harrison (1999) and McGuckin and Nguyen (2001) who demonstrated the impact of FDI and foreign ownership on the host economy and local firms in terms of efficiency and productivity. The second category rather investigated the impact of ownership changes on target and bidder firms' performance (Lichtenberg & Siegel, 1992), but it has only rarely distinguished between the nature and the nationality of the acquiring and the target companies. An interesting approach was adopted by Hughes (1984) who analyzed the benefits of the FDI, using stock markets approach and measured technical efficiency and productivity. The result suggested that the impact of FDI on the target firm is positive. Aitken and Harrison (1999) focused on relative advantages and disadvantages of FDI in the firms'...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT