Foreign Direct Investment and Technology Spillovers: An Analysis of Indian Manufacturing
| Published date | 01 February 2025 |
| DOI | http://doi.org/10.1177/00157325231190509 |
| Author | Chandrakanti Behera |
| Date | 01 February 2025 |
Foreign Direct
Investment and
Technology Spillovers:
An Analysis of Indian
Manufacturing
Chandrakanti Behera1
Abstract
Using a rich firm-level panel dataset of Indian manufacturing over 2010–2018,
this study aims to identify the spillover effects associated with foreign direct
investment (FDI). To this end, we distinguish spillover effects into horizontal
(Intra-industry linkage) and vertical (backward or downstream and forward
or upstream Inter-industry linkages) FDI channels. We employ various semi-
parametric methods to tackle the endogeneity issues in productivity estimation.
We find that backward spillover from the downstream multinational enterprises
is the only source of total factor productivity gains. However, the magnitude of
negative forward–vertical linkage is larger than the positive backward–vertical
effect. The analysis also broadly compares technology spillovers for domestic
and all firms in the sector. Finally, we investigate productivity spillover across
industries based on their technology intensity. Our findings suggest that industry
heterogeneity is a key driver of FDI spillover.
JEL Codes: F23, D24, O33, L1
Keywords
Foreign direct investment, TFP, technology transfer; industry heterogeneity
Original Article
Foreign Trade Review
60(1) 83–108, 2025
© 2023 Indian Institute of
Foreign Trade
Article reuse guidelines:
in.sagepub.com/journals-permissions-india
DOI: 10.1177/00157325231190509
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1
Humanities & Social Sciences Department, Indian Institute of Technology Madras, Chennai, Tamil
Nadu, India
Corresponding author:
Chandrakanti Behera, Humanities & Social Sciences Department, Indian Institute of Technology
Madras, Chennai, Tamil Nadu 600036, India.
E-mail: chandrakantibehera95@gmail.com
84 Foreign Trade Review 60(1)
Introduction
Foreign direct investment (FDI)1 is regarded as a prominent means for narrowing
the productivity gap between developed and least developed countries (LDCs).
This is because multinationals are often superior to domestic rms in terms of
large-scale operation, investment in research and development activities, training,
and hiring of skilled workers (Havranek & Irsova, 2011). In fact, many develop-
ing countries resort to various strategies to attract FDI through either scal or
other incentive programmes.2 Moreover, the handbook of statistics (UNCTAD,
2022) conrms that FDI continues to be an important source of external nance
for LDCs—crucial for their sustainable development and eventual graduation.
The report also highlights that global FDI inows increased by 64% to US$1.6
trillion in 2021, 39% of which was contributed by developing economies in Asia.
Several previous studies have shown that multinational enterprises (MNEs)
can help upgrade production facilities through technology spillover (Blomstrom
& Kokko, 2001; Caves, 1974; Javorcik, 2004).3 Generally, technology spillovers
refer to positive externalities that trickle down from foreign to domestic firms
resulting in productivity improvements through technology transfer (Bournakis,
2021; Bournakis et al., 2022). However, although sufficient research has tried to
investigate the effects of FDI spillover on the productivity of domestic firms,
many have been unable to provide definitive evidence. As a result, the outcome of
these studies on FDI spillover is mainly inconclusive—varying from neutral
effects to negative and positive ones (Aitken & Harrison, 1999; Caves, 1971;
Javorcik, 2004). A similar case is encountered regarding findings pertaining to
emerging economies, such as India (Kathuria, 2010; Lall, 1980; Mondal & Pant,
2018). Given the significance of MNEs, especially among developing nations,
technology spillover continues to be a considerably ambiguous subject.
To address these mixed and contradictory results, the current study aims to re-
examine the impact of FDI spillovers on the productivity of domestic firms.
Considering this context, India is an interesting case to study since it has emerged
as one of the most favourable destinations for foreign investments. Following the
economic liberalisation of 1991, India has actively undertaken FDI and bilateral
trade agreements to boost domestic production. In recent years, the government
has opened up various entry routes and increased sectoral caps for foreign invest-
ments. The Indian government currently allows 100% FDI through automatic
routes in the coal and mining, telecom, greenfield pharmaceuticals, and civil avia-
tion sectors. Similarly, via the government route, 100% FDI is permitted for
railway infrastructure, retail trading, e-commerce, and teleports, while 74% of
foreign investment is allowed for private agencies and brownfield pharmaceuti-
cals.4 Additionally, India has been actively participating in global consolidation,
predominantly through the purchase of imported technologies and technology
transfer agreements (Confederation of Indian Industries report, 2017).5 Despite
these measures, a few limited studies provide a detailed analysis of the relation-
ship between foreign presence and the productivity of domestic firms in the con-
text of India (Table 1).
This study empirically tests the presence or absence of FDI spillover through
horizontal and vertical channels. Following the standard practice in the literature
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