Foreign Direct Investment and Productivity IN FOCUS A Literature Review on the Effects FINANCE, COMPETITIVENESS & of FDI on Local Firm Productivity INNOVATION Abhishek Saurav and Ryan Kuo INVESTMENT CLIMATE © 2020 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non- commercial purposes. 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Photo Credit: World Bank Photo Library and Shutterstock.com INTRODUCTION 4 PRODUCTIVITY OF MNC AFFILIATES 4 VERTICAL PRODUCTIVITY EFFECTS 5 HORIZONTAL PRODUCTIVITY EFFECTS 7 LIMITATIONS OF EXTANT LITERATURE AND FUTURE DIRECTIONS 9 CONCLUSION 9 REFERENCES 11 FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY | 1 2 | FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY T he impact of foreign direct investment (FDI) on the productivity of domestic firms is significant, but the economic gains from FDI are not guaranteed to be large or positive for individual firms. The impacts depend on the characteristics of foreign and domestic firms. This survey of literature explores the heterogeneous effect of FDI on three types of domestic firms: foreign-owned local firms that are affiliates of multinational corporations (MNCs), local firms that are suppliers to or customers of MNC affiliates, and local firms that compete with MNC affiliates (figure 1). We find consistent evidence that foreign ownership increases the productivity of MNC affiliates in developing countries. For firms in upstream sectors (that is, suppliers of MNCs), evidence suggests significant productivity benefits, whereas the evidence is mixed for downstream sectors (that is, buyers and distributors). Competitors of MNCs generally experience insignificant and sometimes negative spillovers. While researchers postulate that multiple potential transmission channels could be at work, future research should more robustly attribute impacts to specific productivity channels. Figure 1. Key Findings Regarding the Effect of FDI on Domestic Firm Productivity Domestic Suppliers (firms in supplying sectors) + FDI increases the productivity of target firms Vert. upstream Large positive vertical productivity effects + Technology/capability effects transfer + Scale and demand effects + Availability of + Direct assistance financial resources + Quality requirements Direct effects MNC Affliliate Horizontal Domestic Competitors MNC Parent + 0/- through FDI (subsidiary of foreign firm) effects (firms in the same sector) FDI increases Vert. downstream the productivity of target firms Limited literature finds mixed results - Competition (market stealing) effects + Direct assistance + Competition (incentive to improve) + Input quality and + Demonstration + Net positive productivity impact suitability + Labor movement 0 No net productivity impact - Supplier competition ? + Shared supplier strengthening - Net negative productivity impact + Positive spillover channel Domestic Buyers (firms in buying sectors) - Negative spillover channel Source: Authors’ representation based on review of literature. Note: FDI = foreign direct investment; vert. = vertical. FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY | 3 Introduction against affiliates. Relatedly, domestic firms’ characteristics such as size, industry, target markets, For developing countries, foreign direct and technological sophistication may influence investment (FDI) can be a key driver of economic the degree to which firms are impacted by FDI. growth and participation in global value chains. Understanding which companies stand to benefit or FDI is the largest source of external financing to not from FDI and the circumstances governing such developing countries, totaling US$700 billion relationships is thus critical to inform policy making in 2018, greater than the combined volume of to maximize gains from FDI. remittances and official development assistance (UNCTAD 2019). At the macroeconomic level, Despite a voluminous body of research, few studies empirical work points to a positive relationship provide policy makers in developing countries between FDI and gross output levels (Borensztein, with an integrated view of productivity impacts De Gregorio, and Lee 1998; Choe 2003; Chowdhury accruing to domestic firms. Existing literature and Mavrotas 2006; Hansen and Rand 2006; Li reviews and meta-analyses on developing countries and Liu 2005). FDI can also deepen trade linkages investigate either (a) direct impacts on investees (Freund and Pierola 2012; Moran 2014; Swenson or (b) horizontal or vertical spillovers, but not all 2008): Inter- and intrafirm trade conducted by at once. This note synthesizes empirical evidence MNCs accounts for about three-fourths of global with the aim of summarizing the observed effects exports (UNCTAD 2013). These benefits typically and postulated transmission channels that explain accrue from MNCs’ ability to bring improved those effects. It is thus a step toward identifying technology, management practices, firm linkages, policy levers to maximize productivity gains from and scale to host economies. Thus the presence of FDI.1 The rest of the paper examines direct effects, foreign firms and FDI presents an opportunity for upstream and downstream vertical spillovers, and developing countries to boost productivity growth horizontal spillovers accruing to domestic firms as through market mechanisms. a result of FDI in the economy. Nevertheless, maximizing positive impacts from FDI depends on understanding the firm-level Productivity of MNC Affiliates heterogeneity of FDI impacts because these The evidence consistently finds that foreign impacts are not guaranteed to be large or positive ownership increases the productivity of affiliate for individual firms. How FDI impacts local firms firms in developing countries.2 The level of depends on the firms’ relationships with MNCs. For ownership control exercised by the foreign parent example, recipients of FDI are partly managed by firm is an important factor for productivity gains as MNCs, while firms that sell to or buy from MNC it allows business practices, managerial know-how, affiliates may change their businesses to adapt to and technologies to flow from MNCs to affiliates MNCs’ needs and offerings, with implications for (Liu, Lu, and Qiu 2017; Perez-Gonzalez 2005). the firms’ productivity and global competitiveness. It would thus seem that the higher the MNC’s Similarly, firms operating in the same sector as MNC ownership share, the more the affiliate firm stands affiliates may change their business practices after to benefit from a foreign firm’s intangible assets. observing MNC affiliates’ operations. They may However, evidence suggests that the relationship also experience business impacts from competing is not necessarily linear and that there may be a 1 Such policy levers include enhancing the technology-absorption capacity of domestic firms, concentrating efforts on more efficiency-seeking FDI, and developing and deepening linkages with local suppliers. 2 For South Asia and East Asia and Pacific, see Aitken and Harrison (1999); Arnold and Javorcik (2009); Girma et al. (2015); and Liu, Lu, and Qiu (2017). For Europe and Central Asia, see Damijan et al. (2003); Djankov and Hoekman (2000); and Yudaeva et al. (2003). For Latin America and the Caribbean, see Perez-Gonzalez (2005). For the Middle East and North Africa, see Haddad and Harrison (1993). 4 | FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY trade-off between global best practices and local Vertical Productivity Effects contextualization. High levels of foreign ownership may limit local partners’ ability to exercise control FDI also affects the productivity of firms that and to adapt affiliate operations to local needs (Liu, are linked to MNCs through supplier and buyer Lu, and Qiu 2017).3 relationships (that is, vertically linked firms). Such productivity spillovers can impact upstream firms Emerging evidence shows that the level of foreign that supply to MNC affiliates as well as downstream ownership across the sector and the technology firms that procure from MNC affiliates. gap between MNCs and their affiliates may be important mediating factors. Girma et al. (2015) Upstream Sectors find that productivity gains in affiliates are larger when the level of foreign ownership is higher across FDI has large, positive vertical productivity effects the overall sector. The authors argue that MNC on domestic firms that supply inputs to MNC affiliates interact more effectively among themselves affiliates in developing countries. A large meta- than with local firms. Other authors find that higher analysis by Havranek and Irsova (2011) covering 47 productivity gains occur when the technology gap countries and 57 studies finds robust evidence that between MNCs and affiliates is wide, which allows upstream vertical effects are positive on average, for greater space for FDI-driven improvements (Liu, even after adjusting for publication bias toward Lu, and Qiu 2017). positive and significant results.4 The literature that finds evidence of positive effects covers developing Transmission Channels for FDI Investees countries across regions, including East Asia and Pacific and South Asia (Blalock and Gertler 2008; Transfer of Technologies and Business Liu, Wang, and Wei 2009; Nguyen et al. 2008; Capabilities: Parent MNCs possess sophisticated Thang, Pham, and Barnes 2016), Europe and production technologies and business practices. Central Asia (Gorodnichenko, Svejnar, and Terrell Researchers argue that after investments are made, 2007; Javorcik 2004, 2008), Latin America and the MNCs are likely to transfer specialized know-how Caribbean (Blyde, Kugler, and Stein 2005; Jordaan to affiliates (Arnold and Javorcik 2009; Djankov 2008), and Sub-Saharan Africa (Bwalya 2006). and Hoekman 2000). Although such transfers could theoretically be made through arm’s length Some evidence suggests that upstream effects arrangements, direct transfers are more efficient. are conditioned by characteristics of domestic For the parent firm, the ownership stake and implied suppliers (for example, the sectors in which control over the affiliate lower the risk of technology they operate), firms’ absorptive capacities, and leakage (Djankov and Hoekman 2000). geographical distance from foreign-owned firms. Though few studies cover spillovers in services, Availability of Financial Resources: In many some studies that cover both manufacturing and developing countries, financial markets are not fully services find that productivity gains are lower for developed, which prevents domestic firms from local services firms (Havranek and Irsova 2011; making investments in technology and capacity Reyes 2017) and sometimes even negative (Nguyen upgrades. FDI can help affiliate firms alleviate such et al. 2008). Some evidence also suggests that firms financial constraints, thereby leading to increased with better capabilities, such as those with larger production efficiency (Arnold and Javorcik 2009). scale or more qualified managers, are better able to 3 The authors do not explore whether this trade-off stems from only wholly foreign-owned firms (which lack local partners to help them adapt), nor do they explore the extent to which hiring local managers could address this issue. 4 Havranek and Irsova’s (2011) meta-analysis covers studies from all FDI recipient countries, including high-income countries, but the majority of the studies concern middle-income countries. FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY | 5 absorb positive spillovers (Blyde, Kugler, and Stein Transmission Channels for Upstream 2005; Liu, Wang, and Wei 2009; Reyes 2017).5 Sectors Finally, Thang, Pham, and Barnes (2016) assert that, because sourcing relationships are local, suppliers Direct Assistance: MNCs can affect the productivity located far from where FDI takes place are less of their domestic suppliers through direct transfer of likely to benefit, even after controlling for general technologies and production techniques (Javorcik economic agglomeration effects. 2004; Paus and Gallagher 2008). Direct assistance may include management and worker training, FDI’s source country, motivation, level of foreign improved production inputs, and additional ownership, and local sourcing intensity can financing (Crespo and Fontoura 2007; Javorcik be important factors affecting the magnitude 2004, 2008; Lall 1980). While MNCs are known to of upstream vertical productivity effects. maintain tight control over technological know-how Gorodnichenko, Svejnar, and Terrell (2007) argue that to prevent leakage to competitors, they are more FDI originating in countries outside the Organisation likely to share technology and knowledge with their for Economic Co-operation and Development domestic suppliers given the incentive to improve (OECD) results in greater upstream spillovers supplier performance and quality (Blalock and because firms from non-OECD countries—that is, Gertler 2008; Pack and Saggi 2001). less advanced economies—are better able to select the most appropriate technologies to be deployed in Quality Requirements: Some authors posit that developing countries. However, Lin, Liu, and Zhang MNCs indirectly induce productivity improvements (2009) come to the opposite conclusion. Reyes in suppliers by imposing higher product and service (2017) finds heterogeneity in upstream productivity quality requirements (Gorodnichenko, Svejnar, and effects depending on FDI motivation. Investments Terrell 2007; Javorcik 2004; Javorcik, Keller, and aimed at leveraging greater efficiency and lower Tybout 2006). Under these authors’ logic, suppliers costs lead to the greatest upstream effects, compared are incentivized to upgrade their production and with low to moderate effects from market-seeking management practices to meet such requirements. FDI and none from natural resource–seeking FDI. Over the long run, suppliers who are able to In addition, partial foreign ownership is consistently successfully adapt to serve MNCs’ demand may in shown to result in greater upstream vertical turn gain market share in the form of competitors productivity effects compared with fully foreign- who fail to improve allocative efficiency (Javorcik, owned firms (Gorodnichenko, Svejnar, and Terrell Keller, and Tybout 2006). 2007; Javorcik and Spatareanu 2008). Authors Scale Effects: If FDI increases demand for locally speculate that wholly owned MNC affiliates may produced intermediate goods, that may help require more advanced inputs that are beyond the domestic producers achieve economies of scale capabilities of domestic suppliers, thereby limiting by spreading out fixed costs and moving down the the potential for supplier linkages. Finally, Giroud, average cost curve (Javorcik 2004). Lin and Saggi Jindra, and Marek (2012) find that the intensity of (2005) developed a theoretical model outlining knowledge transfer between MNC affiliates and potential scale effects from MNC entry, arguing that suppliers follows a nonlinear pattern with respect to the net effect on supplier productivity can run in the proportion of inputs sourced locally, increasing both directions. The net effect depends on whether at first but eventually leveling off. This pattern the increased demand from MNCs outweighs suggests that the degree of integration in global decreased demand from domestic competitors who value chains affects upstream productivity. may experience drops in market share attributable to MNC entry. Liu, Wang, and Wei (2009) address potential concerns related to reverse causality by also using state and foreign ownership 5 among suppliers as instruments for firm absorptive capacity. 6 | FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY Downstream Sectors area for further research in light of mixed findings in the empirical literature. The limited literature on downstream productivity effects points to mixed results. Compared to the literature that explores upstream Transmission Channels for Downstream vertical productivity effects, relatively few studies Sectors examine the impact on downstream firms. Some Direct Assistance: MNC affiliates may provide researchers find positive and typically small effects their domestic buyers with training and technical on average (Arnold et al. 2016; Fernandes and support to improve local sales and distribution Paunov 2012; Havranek and Irsova 2011; Liu, networks (Blomstrom and Kokko, 1998; Nguyen Wang, and Wei 2009). In contrast, other widely cited et al. 2008; Wei, Liu, and Wang 2008). This is not studies (Gorodnichenko, Svejnar, and Terrell 2007; a commonly observed phenomenon, but rather is Javorcik 2004; Thang, Pham, and Barnes 2016) practiced in rare instances. find negative or no effects. Finally, Newman et al. (2015) find mixed effects depending on downstream Input Availability and Quality: MNC affiliates firms’ relationships with MNC affiliates: Those with have greater technological capabilities and thus direct linkages benefit from technology transfer, but produce higher-quality products that are more all downstream firms experience negative impacts widely available. Domestic firms that can access from dominance of MNC affiliates among their such intermediate goods and services from MNC supplier base. affiliates can in turn benefit by incorporating improved inputs (Blomstrom 1991; Javorcik 2004). Some researchers examine how different factors However, higher quality can have the opposite may condition downstream vertical effects, but it effect on other domestic firms. Some researchers is not possible to draw definitive conclusions. From argue that products of MNC affiliates may be too a sectoral perspective, Gorodnichenko, Svejnar, and technologically advanced or more expensive. Such Terrell (2007) find that downstream productivity intermediate inputs may not be suitable for domestic effects are more likely to be positive for local services producers, which can result in declines in firm firms relative to manufacturing firms, but Nguyen et productivity (Schoors and van der Tol 2002; Thang, al. (2008) come to the opposite conclusion. Within Pham, and Barnes 2016). services, a relatively large amount of research has been conducted on so-called backbone services (that Supplier Competition: MNC affiliates compete is, telecommunications, finance, and transportation): with domestic firms in the same sector and may Scholars such as Arnold et al. (2016) consistently gain significant market share to the point of find that reforms that open up such services to FDI pushing local competitors out of the market. With positively impact downstream manufacturing firms’ fewer local competitors, MNCs may charge higher productivity, although researchers are typically markups for their products. Increased input prices unable to disentangle the effects of FDI per se from may in turn adversely affect the productivity of local those of increased competition in general.6 From a downstream firms (Thang, Pham, and Barnes 2016). geographic perspective, Thang, Pham, and Barnes (2016) find that negative productivity effects are Horizontal Productivity Effects likely to be more pronounced for firms closer to the location of FDI. This may be because sourcing Evidence suggests that horizontal productivity relationships are local in nature, meaning that MNC effects accruing to domestic firms in the same entry primarily affects those downstream firms sector as MNC affiliates (i.e., competitors of MNC located near the area of FDI. Nevertheless, sources affiliates) are generally insignificant and can even of heterogeneity in productivity effects remain a key be negative. A large meta-analysis of effects across Also see Eschenbach and Hoekman (2005) and Fernandes and Paunov (2012). 6 FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY | 7 all country income groups by Irsova and Havranek and Spatareanu (2008) find that partially (2013) finds that the effects are not statistically foreign-owned affiliates create fewer negative significant on average. An earlier meta-analysis by spillovers. They reason that, if affiliates are only Meyer and Sinani (2009)—also across all country partially foreign-owned, MNCs transfer less income groups—finds mixed results depending sophisticated technologies that are more easily on the host country’s level of development. The imitated by competitors. Affiliates with partial authors find more positive (or insignificant) impacts foreign ownership are also likely to have deeper at the highest and lowest income levels and negative pre-existing in-country networks through which (or insignificant) impacts at intervening levels. technology may diffuse to competitiors. Estimates Similarly, Wooster and Diebel’s (2010) meta- from Irsova and Havranek’s (2013) meta-analysis analysis, which focuses on developing countries, further corroborate this assertion. In addition, fails to find significant net horizontal spillovers. efficiency-seeking FDI from export-oriented MNCs Null and even negative results have been observed results in positive horizontal spillovers because across world regions.7 it is less likely to compete with domestic firms. In contrast, market-seeking FDI is more likely to Domestic firms with greater absorptive capacity compete with domestic firms, translating to greater and more sophisticated technologies benefit from incentives for MNCs to prevent positive spillovers positive horizontal effects. Local competitors (Blyde, Kugler, and Stein 2005). with higher levels of foreign ownership (Girma et al. 2015; Liu, Wang, and Wei 2009), older firms Finally, the direction and magnitude of horizontal (Gorodnichenko, Svejnar, and Terrell 2007), and spillovers may depend on characteristics of the high-growth firms (Reyes 2017) often experience host market. Irsova and Havranek (2013) find positive horizontal spillovers. Similarly, domestic that horizontal spillovers are more positive (or less firms with lower technology gaps relative to foreign negative) when intellectual property protections are firms are also more likely to experience positive weaker, making diffusion easier. Paradoxically, they spillovers (Irsova and Havranek 2013; Meyer and also find larger positive spillovers in countries with Sinani 2009). lower trade openness; they speculate that countries with higher trade openness may have already Some researchers argue that domestic firms absorbed technological advances through trading in the services sector are better positioned relationships, thereby decreasing the marginal to benefit from positive horizontal spillovers benefit of FDI (Irsova and Havranek 2013). (Gorodnichenko, Svejnar, and Terrell 2007; Nguyen et al. 2008; Reyes 2017). Such authors argue that Transmission Channels for Domestic business practices and technologies in services Competitors are more readily observable and are less likely to be subject to intellectual property protections than Competition: The entry of MNCs through is the case in manufacturing, making it easier for investments in affiliates increases competitive competitors of MNC affiliates to emulate affiliates’ pressures on domestic firms in the same sector advanced practices. (Alfaro 2017). With higher capital stocks and more sophisticated technologies, MNC affiliates are often The level of ownership of MNCs and the type well-positioned to gain market share at the expense of FDI affect horizontal spillovers. Javorcik of domestic competitors. Competition can affect Studies that find null or negative results cover Europe and Central Asia (Gorodnichenko, Svejnar, and Terrell 2007; Javorcik 2004; 7 Javorcik and Spatareanu 2008), South Asia and East Asia and Pacific (Blalock and Gertler 2008; Girma et al. 2015; Kathuria 2000; Thang, Pham, and Barnes 2016), Latin America and the Caribbean (Aitken and Harrison 1999; Blyde, Kugler, and Stein 2005; Jordaan 2008), the Middle East and North Africa (Haddad and Harrison 1993), and Sub-Saharan Africa (Bwalya 2006). Older studies are more likely to find positive effects, but such studies often use cross-sectional data rather than panel data (Görg and Greenaway 2004). 8 | FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY domestic firms both positively and negatively. On entry of new suppliers. MNC investments in suppliers the one hand, domestic firms are likely to invest in enhance the quality of products and services, and the improved production techniques to compete and entry of new suppliers lowers prices for all buyers— maintain market share (Blyde, Kugler, and Stein not just MNCs—so domestic competitors of MNC 2005; Glass and Saggi 2002; Görg and Greenaway affiliates may stand to benefit (Gorodnichenko, 2004; Wang and Blomstrom 1992). On the other Svejnar, and Terrell 2007; Kee 2014). hand, MNC affiliates can deplete the market share of domestic firms and diminish their production scale. Limitations of Extant Literature and This causes domestic competitors’ average costs to increase as they spread their fixed costs over a Future Directions smaller production base (Aitken and Harrison 1999). The primary limitation of the literature is that little is known about specific transmission Demonstration: MNCs from developed countries channels and their relative importance in possess a differentiated set of management practices improving domestic firms’ productivity. Existing and production technologies. Several authors posit empirical studies of vertical spillovers largely follow that domestic firms are likely to engage in imitation Javorcik’s (2004) design, regressing supplier firms’ by observing MNC affiliates (Das 1987; Wang and total factor productivity on measures of exposure to Blomstrom 1992; Wei, Liu, and Wang 2008). By downstream FDI while applying various controls. reverse engineering technologies and emulating Similarly, recent studies on horizontal spillovers management and other business practices, domestic regress productivity estimates on measures of firms may become more efficient over time. FDI presence in the sector. The research designs Movement of Labor: Even if new technologies deployed by such investigations are thus unable to and know-how are not immediately observable attribute effects to specific transmission channels, by domestic competitors, they may eventually instead uncovering net effects across all channels. diffuse to domestic firms when employees of MNC Some studies have tried to disaggregate horizontal affiliates leave to join competitors. Such spillovers spillover effects for specific channels by deploying may occur from the migration of both managers different measures of FDI exposure. For example, with in-depth knowledge of best practices (Glass some use employment share of FDI to capture labor and Saggi 2002; Görg and Strobl 2005) and workers movement effects (Liu, Wang, and Wei 2009). who have undergone skills training to improve Such approaches suffer from two weaknesses: (a) their productivity (Fosfuri, Motta, and Ronde 2001; they deploy imperfect measures of the mechanisms Glass and Saggi 2002). However, to preserve their at work, and (b) their measures are potentially competitive advantage, MNCs may try to prevent subject to collinearity issues (for example, between labor movement by offering higher wages, offering employment and capital investment). superior working conditions, and withholding Another limitation of the literature is the technologies from deployment in affiliate firms relatively light coverage of heterogeneities in (Blalock and Gertler 2008). FDI’s effect on productivity. Few studies that Supplier Improvements: MNC affiliates and their estimate FDI’s effects on the productivity of domestic local competitors in the same sector may rely on a firms account for heterogeneity across types of FDI, shared set of suppliers for intermediate inputs. As ownership modalities (joint ventures versus foreign covered earlier in this paper, FDI generates positive control), source country or region, industry, and productivity spillovers to upstream industries as characteristics of domestic firms.8 More research MNC affiliates invest in local suppliers or induce the to test for heterogeneities would thus be valuable Many studies analyze heterogeneity along at least one dimension, but few individual dimensions are covered by multiple papers 8 across the literature. FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY | 9 to enhance policy makers’ understanding of when FDI and domestic firm characteristics affect FDI does or does not lead to positive productivity productivity gains. Larger productivity gains outcomes. Furthermore, the bulk of existing studies accrue to domestic suppliers of MNCs that operate examine spillovers in manufacturing in middle- in the manufacturing sector, have larger production income countries. Thus services and low-income scale and superior management capacity, and are countries, particularly in Africa, are key areas for located closest to MNCs. Greater productivity closer future research. Finally, downstream spillover gains to local suppliers are also observed from effects have received relatively limited attention. efficiency-seeking FDI, partially owned MNC affiliates (such as in joint ventures), and MNCs that The lack of suitable data limits the ability deploy technologies that are not too advanced for to attribute effects (or at least intermediate developing countries. Among domestic competitors outcomes) to specific transmission channels of MNCs, productivity gains are more positive if using regression-based studies. More work should local firms already possess somewhat sophisticated thus focus on collecting and analyzing detailed technologies and have higher absorptive capacity. microdata that allow modeling of mechanisms The easier transmission of know-how in services (see Winkler 2013).9 Concurrently, the use of in- industries may also benefit domestic competitors depth case studies (see Larrain, Lopez-Calva, of MNC affiliates in services. Finally, economies and Rodriguez-Clare 2000) to validate postulated that are only just starting to liberalize and offer channels and to develop a fuller understanding of lower barriers to knowledge diffusion (for example, sectoral heterogeneities can be insightful. weaker intellectual property protections) exhibit greater potential for positive horizontal spillovers. Conclusion Future research should address gaps in the This note synthesizes evidence on productivity existing literature. The literature’s coverage spillovers accruing to domestic firms from the of the channels through which productivity presence of FDI in developing countries. For impacts occur and the mediating factors that firms in upstream sectors, evidence suggests the influence impacts is modest. Future research presence of large, positive productivity effects, could focus on illustrative case studies to assess whereas evidence in downstream sectors is mixed. the presence and relative significance of channels Domestic firms that compete with MNC affiliates in through which MNC affiliates affect domestic the same sector generally experience insignificant firms’ productivity. These insights could then be or negative horizontal productivity effects. While leveraged to guide the generation of microdata to various transmission channels are postulated to be support empirical estimation. at work, their presence has not been sufficiently validated qualitatively or quantitatively. 9 Relatedly, some debate exists in the literature as to the best way to measure productivity using available data (for ex- ample, revenue versus volume as a dependent variable, or appropriate control functions) in light of endogeneity issues in estimating production functions. Appendix A of Cusolito and Maloney (2018) contains a detailed discussion of such issues. Nevertheless, the most widely cited meta-analyses account for different studies’ estimation methods, and the vast ma- jority of studies reviewed here apply the widely used Levinsohn-Petrin or Olley-Pakes methods to account for commonly cited simultaneity and selection issues. 10 | FOREIGN DIRECT INVESTMENT AND PRODUCTIVITY References Aitken, Brian J., and Ann E. 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