1. Introduction
Although domestic equity ownership requirements used to be extensively utilized by governments in developing countries,2 their incidence has sharply declined in recent years (UNCTAD, 2003). Increasingly competitive environment for foreign direct investment (FDI) and the need to comply with international commitments have put pressure on governments to relax restrictions on foreign entrants.
One of the original motivations for the existence of ownership sharing conditions was the belief that local participation in foreign investment projects reveals their proprietary technology and thus benefits domestic firms by facilitating technology diffusion (see Beamish, 1988 and Blomström and Sjöholm, 1999). As writing a contract specifying all aspects of the rights to use intangible assets is difficult, if not impossible, joint domestic and foreign ownership of an investment project is more likely to lead to knowledge dissipation. A local partner may use the knowledge acquired from the foreign investor in its other operations not involving the foreign shareholders or being in charge of hiring policies, as is often the case, the local partner may have less incentive to limit employee turnover.3 This problem is reduced when the multinational is the sole owner of its affiliate.4 As a consequence, multinationals may be more likely to transfer sophisticated technologies and management techniques to their wholly owned subsidiaries than to partially owned affiliates.5
This in turn has implications for knowledge spillovers to local producers in a host country. Less sophisticated technologies being transferred to jointly owned FDI projects may be easier to absorb by local competitors, which combined with a better access to knowledge through the actions of the local shareholder may lead to greater intra-industry (or horizontal) knowledge spillovers being associated with the shared ownership structure than with wholly owned foreign affiliates. Moreover, lower sophistication of inputs needed by jointly owned FDI projects and the familiarity of the local partner with local suppliers of intermediates may result in greater reliance on locally produced inputs and thus greater vertical spillovers accruing to local producers in upstream sectors. While a lot of research effort has been put into looking for the evidence of FDI spillovers (see the next section), little attention has been devoted to how the ownership structure affects this phenomenon.6
This paper is a step forward in understanding the implications of the ownership structure of FDI projects for the host country. Using firm-level panel data from Romania for the 1998–2003 period, we examine whether wholly owned foreign affiliates and investments with joint domestic and foreign ownership are associated with a different magnitude of spillovers within the industry of operation and to upstream sectors supplying intermediate inputs. The results suggest that the ownership structure in FDI projects does matter for productivity spillovers.
Consistent with our expectations, the analysis indicates that projects with joint domestic and foreign ownership are associated with positive productivity spillovers to upstream sectors but no such effect is detected for wholly owned foreign subsidiaries. The difference between the two coefficients is statistically significant. The magnitude of the former effect is economically meaningful. A one-standard-deviation increase in the presence of investment projects with shared domestic and foreign ownership is associated with a 4.4% increase in the total factor productivity of domestic firms in the supplying industries. This pattern can be found at the national as well as at the regional level. It holds for both best performers in each sector as well as for firm exhibiting lesser performance. The presence of joint ventures in downstream sectors benefits domestic firms but has no effect on foreign affiliates.
In contrast to the vertical effects, the presence of FDI appears to have a negative effect on the performance of local firms operating in the same sector. As argued by Aitken and Harrison (1999), this may be due to the fact that local producers lose part of their market share to foreign entrants and thus are forced to spread their fixed cost over a smaller volume of production. The empirical literature suggests that the negative competition effect outweighs the positive effect of knowledge spillovers in developing countries (Aitken and Harrison, 1999, Djankov and Hoekman, 2000 and Konings, 2001). If greater knowledge dissipation tends to be associated with jointly owned FDI projects, we would expect that FDI with shared ownership has a less negative effect on local producers than do wholly owned foreign projects. Our findings are consistent with this expectation, as in all specifications we find the anticipated pattern. The difference between the magnitudes of the two coefficients is statistically significant for sectors with domestic-market orientation, in the subsample of foreign firms and in the regressions focusing on regional spillovers.
While our findings are consistent with the existence of externalities associated with FDI, a word of caution is in order. We use the term ”spillovers” very broadly as our methodology does not allow us to distinguish between pure knowledge externalities, the benefits of scale economies that may be enjoyed by suppliers to multinationals or the effects of increased competition resulting from foreign entry into the product market. More work is certainly needed to fully understand the effects of FDI inflows on host countries.
Our findings should not be interpreted as suggesting that restrictions on the extent of foreign ownership are desirable, as such restrictions may lead to lower overall FDI inflows and have other implications not addressed in our analysis. There exist other policies that could potentially be used to facilitate local sourcing by multinationals, such as improvements to the business climate or supplier development programs that assist local producers in learning how to satisfy requirements of foreign buyers. In any case, more research is needed to enhance our understanding of host country conditions facilitating knowledge spillovers from foreign direct investment and the role government policies may play in this area.
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