Do Local Firms Benefit from Foreign Direct Investment? An Analysis of Spillover Effects in Developing Countries

Abstract

Developing countries are increasingly recipients of foreign direct investment (FDI). In this regard, governments are attempting to attract FDI due to the expected spillover effects, which relate to benefits in terms of increased productivity of local firms and technology diffusion from multinational enterprises (MNEs) to the domestic economy. However, it is generally not clear whether there are positive or negative spillover effects from FDI to local firms in developing economies. The purpose of this paper is to provide a review of the literature on spillover effects and linkages that arise from FDI in developing countries. Our review suggests that there tends to be negative intra-industry productivity spillover effects (i.e., spillovers between MNEs and local firms in the same industry). This may be explained by the fact that MNEs crowd out local competitors that are not able to compete against MNEs, and by the concept of “absorptive capacity” which implies that local firms may not be able to assimilate and absorb knowledge of MNEs. However, we find evidence for positive inter-industry spillovers through linkages between MNE affiliates and suppliers in different industry sectors which may be attributed to the benefits for MNEs in transferring knowledge and technology to their local suppliers. The study offers suggestions for future research.