Positive effects arising from FDI are often explained by the spillover effects that emerges from the new technologies and knowledge brought in by MNCs, which is transferred to the broader domestic enterprise sector. Inward FDI would play a key role in making domestic firms produce at a higher productivity level and stimulating domestic innovation, which tends to raise productivity growth. Studies, however, have shown that FDI can have a significant positive factor in growth for middle-income countries, but not for low-income countries. FDI generally only plays a positive role in host countries that have already achieved a prior level of development, and have the required infrastructure and skills base to sustain growth.

Existence of new technology within a foreign affiliate does not guarantee that its benefits will be widely diffused through the host economy. Often the critical factor is the extent to which the technology is made available to potential users outside the firm either directly, through linkages with host country firms, or indirectly via the “demonstration” effect. There is however a tendency of MNCs to locate their technology creating activities, such as research and development (R&D), either in the home country or in more industrialised countries. Little R&D has been located in developing countries, and MNCs tend to transfer little capabilities to generate new technology to foreign affiliates in developing countries.

The host country investment climate is an important determinant for the degree and scale of spillover effects. There have been some studies arguing that a liberal investment climate generates stronger spillovers, as it is more likely to attract FDI with qualities such as best management practices, and advanced technology. A restrictive investment climate, on the other hand, with conditions such as mandatory joint ventures and licensing, tend to attract FDI that is likely to exhibit slower rates of technology transfer, and that lags in the utilization of advanced management systems. Recent research, however, also points out that the extent of spillover effects is closely interlinked to the technological level of the host country’s enterprise sector. If FDI is to reach a higher impact on productivity than domestic investment, the “technology gap” between domestic enterprises and foreign investors must be relatively limited. Thus, the capability of domestic enterprises and the absorptive capacity of a host economy affect the kind of FDI that is attracted to the country, as well as to what extent knowledge and technology is transferred by the foreign affiliate and used by the domestic firm.

One of the most important ways to tap the “technology gap” is through production linkages between foreign affiliates and domestic firms, as well as through clustering. When such production linkages and clustering activities take place, production and exports by foreign affiliates are likely to be more sustainable and beneficial for host countries by involving domestic inputs with a higher value added, and thus contributing to strengthening the competitiveness of the domestic enterprise sector. Placement of orders for inputs by the foreign affiliate with host country suppliers raises the technical expertise in the host country. The sourcing of inputs locally may lead to the emergence of new domestic firms, which enhances and stimulates domestic innovation. Spillover effects, however, will occur only if the foreign affiliate of the MNC do becomes linked to local firms. The most significant linkages are backward or supply linkages, and the crucial issue is whether and to what extent the MNC either imports inputs or procures them from local suppliers. Host countries can also promote technology transfer by providing assistance to strengthen the host country’s technological base and its capacity to act as a host to FDI from technology intensive industries.         

This section reviews some of the publications, which give a broad overview on possible spillover effects arising from FDI.

Linking FDI, Technology Development for Capacity Building and Strategic Competitiveness, Transnational Corporations Journal, Vol. 11, No.3, December 2002 

This paper views competitiveness in its contextual setting of globalisation, growing integration and rapid technological change. The paper discusses the role of FDI in technology transfer and learning, particularly by MNCs. It highlights the important role that MNCs can play in the transfer of technology, but emphasises that technology transfer should be maximised and complemented by appropriate country policies. Based on the South East Asian experience of success in domestic capacity building, the paper develops a rationale of technology policy, and reviews key strategies for industrial competitiveness. 

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Mode of Foreign Entry, Technology Transfer, and FDI Policy, Mattoo, A., Olarreaga, M., Saggi, K., Policy Research Working Paper WPS 2737, December 2001.

FDI can take place through the direct entry of foreign firms or the acquisition of existing domestic firms. The authors examine the preferences of a foreign firm and the host country government with respect to these two modes of FDI in the presence of costly technology transfers. The trade-off between technology transfer and market competition emerges as a key determinant of preferences.

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Parental Supervision: The new Paradigm for FDI and Development, Theodore H. Moran, August 2001.

The author examines two types of FDI in his book:

• Those that are tightly integrated into the parent firm’s strategy, and
• Those that are hindered by joint venture and domestic content requirements.

The study is a comparison between these two types of FDI; its backward linkages to local suppliers, operations and local affiliates, and the spillovers and externalities in the host economy differ from one type of foreign operation to the other. In tightly integrated networks, not only is the performance of local affiliates superior and upgraded more continuously, but also the backwards linkages from the affiliates to local suppliers tend to be larger and more robust. The author reviews contemporary efforts to measure the impact of simultaneous trade and investment liberalization on host country welfare.

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Trade, FDI, and international technology transfer: a survey, Kamal Saggi, Policy Research Working Paper, WPS 2349, May 2000.

This paper is focused on trade and FDI as channels for technology transfer. The findings suggest that the extent to which trade encourages growth, depends on whether knowledge spillover is national or international. According to the authors, foreign firms choose licensing or joint ventures if local policy makes pure FDI infeasible. It remains unclear whether licensing or joint ventures lead to more learning by local firms. The author points out that the absorptive capacity in the host country is essential for getting significant benefits from FDI.  A country's policy on protection of intellectual property rights affects the type of industry it attracts, and policy on intellectual property rights also influences whether technology transfer comes through licensing, joint ventures, or the establishment of wholly owned subsidiaries.

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The Determinants of Host Country Spillovers from FDI, Magnus Blomström , Steve Globerman , Ari Kokko, Centre for Economic Policy Research, Discussion Paper 2350,  January 2000 

This paper reviews and synthesizes the available literature focusing on the determinants of efficiency spillovers from inward FDI. The theoretical framework is based on the scope and magnitude of FDI spillovers to host economies. The findings suggest that the competitiveness of host country markets and the technical capability of local firms are among the most important determinants of spillover benefits.

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The World Investment Report 1999: FDI and the Challenge of Development, Division on Investment, Technology, and Enterprise Development, 1999

Part II of the World Investment Report 1999 is entitled ‘FDI and the Challenge of Development’ looks at the impact of FDI on key objectives of economic development: increasing financial resources for investment, enhancing technological capabilities, boosting export competitiveness, generating and upgrading employment, and protecting the environment. The Report concludes that although FDI can yield major economic spillovers for the host country, such benefits can be enhanced through appropriate policies. Governments therefore have an important role to play in creating the conditions that attract FDI and in maximizing the positive contribution that FDI can make to growth and development. Policies can either aim at the determinants of technological investors, the diffusion of technology, or the generation of technology. For each strategic approach, several possibilities are given to stimulate FDI, and to generate maximum benefits from these investments.

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Spillovers from multinationals in developing countries: Mechanisms at work, Richard E. Caves, School of Business Administration, University of Michigan, Working Paper 247, June 1999.

The paper analyses that while productivity spillovers from foreign subsidiaries to local firms are widespread, they are depending upon the nature of the production process and the local market structure. The focus should therefore be on where and how they occur. At the same time, more focus should be put on the question of what factors retard or advance the capabilities of local firms to achieve productivity. The authors point out that the government’s justification to encourage inflows of FDI is likely conditional on the country’s state of development and the structures of particular industries in which foreign subsidiaries operate. FDI might be beneficial to some industries, but not to others. Evidence on the effectiveness of certain policies is not yet in hand.

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Do Domestic Firms Benefit from Direct Foreign Investment? Evidence from Venezuela, Brian J. Aitken and Ann E. Harrison, American Economic Review, Vol. 89, No. 3, June 1999

The authors research whether inward foreign investment encourages technology 'spillovers' from foreign to domestic firms, by using data on Venezuelan plants. The authors find that foreign equity participation is positively correlated with plant productivity (the 'own-plant' effect), but this relationship is only robust for small enterprises. They then test for spillovers from joint ventures to plants with no foreign investment. Foreign investment negatively affects the productivity of domestically owned plants. The net impact of foreign investment, taking into account these two offsetting effects, is quite small. The results of this research seem to indicate that the gains from foreign investment in Venezuela are entirely captured by joint ventures.

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Technology spillovers through FDI, Yuko Kinoshita, William Davidson Institute, University of Michigan, Working Paper 221, January 1999.

This paper addresses both the quantitative importance of technology spillovers to economic growth of developing countries, as well as the question how to maximize these spillover effects. The author uses data on 468 manufacturing firms in China between 1990 and 1992, whereby both the importance of technology spillovers and a firm’s effort to build up productivity skills are taken into account. Spillover effects are decomposed into four components: the demonstration-imitation effect, the competition effect, the foreign linkage effect, and the training effect. The results of this study seem to indicate that both the demonstration-imitation effect and the training effect were important sources of productivity growth for domestically owned manufacturing firms in China between 1990 and 1992.

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FDI and Development: The New Policy Agenda for Developing Countries and Economies in Transition, Theodore H. Moran, November 1998.

This book addresses the questions of benefits and opportunities that foreign firms have to offer; the risks and dangers they pose; and whether authorities in host countries need a proactive (rather than passive) policy toward FDI. The book uses many sources to assess policies towards FDI in developing countries and economies in transition. Emphasis is put on investment promotion, domestic content mandates, export-performance requirements, joint-venture requirements, and technology-licensing mandates. According to the author, host authorities can play an important role in maximizing the benefits they can obtain from FDI while minimizing the dangers. Some suggestions are made on how they might best pursue this agenda.

The book can be obtained here

Technology Transfer and Spillovers? Does Local Participation with Multinationals Matter?, Magnus Blomstrom, Fredrik Sjoholm, NBER Working Paper No.w6816, November 1998. The paper was also published in: European Economic Review, Vol 43, nos.4-6 (April 1999): 915-923.

This paper examines the effects on technology transfer and spillovers deriving from ownership sharing of foreign multinational affiliates. The study uses unpublished Indonesian micro data to answer two questions:

• Do establishments with minority and majority ownership differ in terms of productivity levels?
• Does the degree of spillover differ with the degree of ownership in the FDI?

The study concludes that foreign establishments have comparable high levels of labour productivity and that domestic establishments benefit from spillovers. However, the degree of foreign ownership does neither affect the level of labour productivity in foreign establishments, nor the degree of spillovers.

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A note on FDI and Industrial Competitiveness in Brazil, Regis Bonelli, IPEA — Institute for Applied Economic Research, Rio de Janeiro, Brazil, June 1998.

This paper addresses a key issue of the link between increased capital inflows through FDI and industrial competitiveness in Brazil. It provides an analysis of the two-way relationship, which can exist in theory between FDI and competitiveness, as well as some empirical evidence from Brazil in the 1990s. The author finds evidence of FDI both as a source of finance for the Current Account deficit and as a source of technology transfer. In particular, FDI is seen as a source for competitiveness-enhancing tangible and intangible resources of FDI, such as capital, R&D capacity, technology, skills, organizational, and managerial practices.

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How does FDI affect economic growth?, E. Borenszteina, J. De Gregoriob and J-W. Leec, Journal of International Economics, June 1998

The authors tested the effects of FDI on economic growth, using data on FDI flows from industrial countries to sixty-nine developing countries over the last two decades. The authors conclude that FDI is an important vehicle for the transfer of technology, and contributes relatively more to growth than domestic investment. However, they also point out that this higher productivity of FDI only holds when there is sufficient absorptive capability of the advanced technologies available in the host economy. This requires the availability of a minimum level of human capital in the host country. Additionally, the authors find that FDI has the effect of increasing total investment in the economy more than one for one, which indicates that FDI have complementary effects on domestic firms.

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FDI as a Catalyst for Industrial Development, James R. Markusen, Anthony J. Venables, NBER Working Paper No.w6241, October 1997. This paper was also published in: European Economic Review, Vol. 43 (1999): 335-356.

This paper addresses the question of how a FDI project affects local firms in the same industry. Although competition in the product and factor markets tends to reduce the profits of local firms, linkage effects to supplier industries may reduce the input costs and raise the profits. The paper develops an analytical framework to assess these effects. The analytical framework establishes circumstances in which FDI is complementary to the local industry, and it is shown how FDI may lead to the establishment of local industrial sectors.

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FDI in Developing Countries: A Selective Survey, L.R. de Mello Jr., Department of Economics University of Kent, Discussion Paper 97/1, March 1997 (Published in Journal of Development Studies, 1997, 34, pp. 1-34)

This paper surveys developments in the literature on the impact of inward FDI (FDI) on growth in developing countries. In general, FDI is thought of as a composite bundle of capital stocks, know-how, and technology, and hence its impact on growth is expected to be manifold and vary a great deal between technologically advanced and developing countries. The ultimate impact of FDI on output growth in the recipient economy depends on the scope for efficiency spillover to domestic firms, by which FDI leads to increasing returns in domestic production, and increases in the value-added content of FDI-related production.

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FDI, International Knowledge Transfers, and Endogenous Growth: Time Series Evidence, L.R. de Mello Jr., Department of Economics University of Kent, Discussion Paper 96/10, June 1996

This paper evaluates the impact of FDI and international knowledge transfers and spillovers on the long-run growth rate of the recipient economy. The hypothesis of increasing returns due to FDI is tested for the five Latin American economies (Brazil, Mexico, Venezuela, Chile, and Columbia) that absorbed most of the FDI in the region between 1970 and 1991 period. The findings suggest that both open-economy performance variables and domestic policy variables affect FDI and growth in the long run, which reinforces the conclusions of other growth models that policy parameters affect growth rates endogenously.

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