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Linking FDI motivation and host economy productivity effects: conceptual and empirical analysis

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Abstract

We develop a taxonomy that relates foreign direct investment (FDI) motivation (technology- and cost-based) to its anticipated effects on host countries’ domestic productivity. We then empirically examine the effects of FDI into the United Kingdom on domestic productivity, and find that different types of FDI have markedly different productivity spillover effects, which are consistent with the conceptual analysis. The UK gains substantially only from inward FDI motivated by a strong technology-based ownership advantage. As theory predicts, inward FDI motivated by technology-sourcing considerations leads to no productivity spillovers.

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Notes

  1. See, for example, the growing empirical literature linking FDI flows to international labour market conditions (e.g., Sethi et al., 2003), informed by the conceptual work of Buckley and Casson (1998, 1999).

  2. However, in a detailed analysis of US direct investment flows, Love (2003) finds little evidence of technology sourcing as a motivation for FDI.

  3. There are numerous measures of R&D intensity, such as the share of total national R&D, or the share of worldwide industry level R&D. However, as we wish to compare international R&D intensities at the sectoral level, we use R&D as a proportion of value added, in order to remove size effects.

  4. The taxonomy outlined in Figure 1 is not incompatible with other classifications of FDI. For example, ‘market seeking’ FDI will typically be included in quadrants 3 or 4, since this form of investment requires some form of ownership advantage to compete with indigenous firms. The quadrant location of ‘resource seeking’ FDI would depend on which aspect of host-country resource endowment was being sought (e.g., cheap labour, better technology, natural resources etc.).

  5. Our taxonomy therefore goes beyond that of Patel and Vega (1999), which deals exclusively with technology as a motivator for FDI and contains no predictions or analysis of the effects of different FDI types. Le Bas and Sierra (2002) perform a re-analysis of Patel and Vega's classification using European patent data, but again there is no prediction or analysis of likely effects of different FDI types. See Love (2003) for an analysis of the determinants of US FDI using Patel and Vega's more limited taxonomy.

  6. However, while market stealing can be expected to have a negative effect on productivity in the short run, increased competition may have a positive effect on (domestic or foreign) productivity in the long run, either by encouraging other firms to become more efficient or by forcing the least efficient out of business.

  7. The omitted FDI is from countries such as Liechtenstein, or various UK dependencies such as Gibraltar, the Isle of Man or the Channel Islands, where comparing the UK with a ‘home’ country manufacturing base would be erroneous.

  8. The breadth of the sectors is due to the need to find suitable deflators and PPP currency data at the sectoral level, in order to compare R&D intensity and unit labour costs consistently across countries.

  9. It seems likely, in addition, that at least some of the US FDI into the UK will be motivated by the desire of MNEs either to diversify their knowledge portfolio, or simply to achieve greater scale in their R&D activities (Chung and Yeaple, 2004). Neither of these interpretations is inconsistent with the analysis above.

  10. This is the standard ‘fixed effects’ model, which is well understood, and is explained, for example, in Baltagi (2002). This allows for an industry-specific component and a time-specific component. The econometric treatment of this is discussed in the text.

  11. Qit−1 includes all other lagged values of Q, K and L by construction, as Qit−1 can be written as a function of Qit−2, Qit−3, …, Qit− n , thus picking up experience effects. This also effectively allows the effect of past investment to decline over time, whereas accumulated output does not.

  12. Or by MNEs seeking either to diversify their knowledge portfolios or to access economies of scale in R&D (Chung and Yeaple, 2004).

  13. The batting average effect arises from the tendency for inward-investing companies to be more productive than their indigenous UK counterparts (Oulton, 2001), thus raising the average level of productivity in the UK merely by the fact of entry.

  14. Görg and Greenaway (2004) provide a table summarising the results from many of the major studies.

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Acknowledgements

We are grateful for the constructive comments received when this paper was presented at the Third Annual JIBS/AIB/CIBER Conference on Emerging Research Frontiers in International Business, Erasmus University, Rotterdam, and at CIBAM, Judge Business School, Cambridge University. The helpful comments of Bruce Blonigen and three anonymous referees are also acknowledged.

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  1. Economics and Strategy Group, Aston Business School, Aston University, Birmingham, UK

    Nigel Driffield & James H Love

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  1. Nigel Driffield
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Correspondence to James H Love.

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Accepted by Bruce Blonigen, Departmental Editor, 14 August 2006. This paper has been with the authors for two revisions.

Appendix

Appendix

See Table A1 and Figure A1

Table a1 Variable definitions data sources and descriptive statistics
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Figure A1
figure 8

Number of sectors by FDI type.

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Data and sources

Countries in panel of inward investors AustraliaAustriaBelgiumBrunei BulgariaCyprusDenmarkFinlandFranceGermanyGreeceHong KongIcelandIrish RepublicItalyJapanMalaysiaThe NetherlandsNorwayPortugalRomaniaRussiaSingaporeSouth KoreaSpainSwedenSwitzerlandTaiwanTurkeyUSA

Sectors in panel (ISIC 3 codes)Food, Drink and Tobacco (15+16)Chemicals (24)Metal Manufacturing (27)Mechanical & Instrument Manufacturing (29+33)Transport Equipment exc. Vehicles (35)

Vehicles (34)Textiles, Leather and Clothing (17+18+19)Paper, Printing and Publishing (21+22)Rubber & Plastics (25)Electrical Engineering (30+31+32)Other Manufacturing (20+26+28+36+37)

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Driffield, N., Love, J. Linking FDI motivation and host economy productivity effects: conceptual and empirical analysis. J Int Bus Stud 38, 460–473 (2007). https://doi.org/10.1057/palgrave.jibs.8400268

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