Foreign Direct Investment Spillovers and their Inter-relationships with Trade

Foreign direct investment (FDI) represents an increasingly important dimension of international economic integration with global FDI flows growing faster than output over the past two decades. FDI is a particular form of investment, as it transfers knowledge as well as finance that may otherwise be unavailable in the domestic economy. This paper uses firm-level data to identify FDI spillovers across countries, sectors and time. The analysis suggests that knowledge-related spillovers from FDI vary considerably across sectors. It is in services industries that the productivityenhancing effects of FDI are the strongest, in particular through backward linkages. There is no strong evidence of horizontal productivity spillovers at the aggregate level. The results also indicate a significant and positive correlation between the degree of trade openness and output when measuring the impact of foreign presence in the domestic economy. One of the reasons why spillovers might be higher in more competitive markets is that stronger competition may induce greater knowledge transfer from MNE parent companies to their affiliates in order for the affiliate to compete effectively against its domestic rivals. Moreover, an open trade regime implies that domestic companies tend to export more and that more domestic companies are in sectors in which the host economy has a comparative advantage. Thus, trade liberalisation can be seen as an important component of any reform package designed to help countries maximise the benefits of FDI.