A review of the literature indicates that Foreign Direct Investment has the potential to increase the intensity of competition and to act as a channel for technology transfers. Using a Spanish firm level data set, we disentangle these effects by estimating a dynamic model of firm level performance, which we proxy by mark-ups. We find that FDI has a positive long-run effect on the mark-ups of targets, but this is limited to firms in R&D intensive sectors. In addition, we find weak evidence that foreign presence dampens margins. However, this effect appears to be more than compensated by positive spillovers in the case of knowledge intensive industries.
In an early pioneering contribution, Caves (1974) put forward the idea that Foreign Direct Investment (FDI) influenced host country conditions through two main channels. On the one hand, FDI ought to result in technology transfers to host country firms. This effect was conjectured to be both direct—Multinational Corporations (MNCs) providing subsidiaries an efficiency advantage—and indirect—MNCs generating positive spillovers. On the other hand, an important foreign presence could also increase the intensity of competition in the recipient country.1 While the latter conjecture is intuitively appealing, direct empirical evidence of the pro-competitive effect of FDI is limited, if not non-existent.2 By and large, the empirical literature has focused on the technological effect, possibly because unearthing the pro-competitive effect of FDI is not trivial.3
The purpose of this paper is to attempt to disentangle empirically the efficiency, spillovers, and competition effects of FDI on firms' mark-ups. We chose mark-ups as a proxy for firm performance for three reasons. First, mark-ups are a natural choice when attempting to gauge changes in competitive pressure. Second, this measure captures the evolution of price as well as costs, both of which will be affected by the FDI induced effects identified above. Third, this variable is less prone to measurement problems stemming from the use of industry-wide deflators, as it directly reflects firms' pricing behaviour.
The empirical analysis is carried out with Spanish firm level data over the period 1983–1996. Potentially, Spain's experience represents an interesting case to test the conjectures presented above as a number of factors contributed to a large increase in competitive pressure and a surge in FDI.4 The increase in competitive pressure is documented in Siotis (2003), where a drop in (econometrically estimated) industry mark-ups is identified as a result of Spain's entry into the EU.
The main innovations contained in this paper are as follows. First, we use price-cost margins rather than productivity (in the remainder of the paper, we use mark-ups and price-cost margins interchangeably). Second, we focus on the dynamic responses of the dependent variable. In turn, these responses form our main identification argument. Concretely, we conjecture that the effects identified above will work their way through at a different pace. Third, we split our sample using R&D intensity, which provides an additional identifying hypothesis. Fourth, we use the identity of firms as a further check on the robustness of our results. Since Spanish owned firms typically lag foreign subsidiaries along the technological dimension, domestic firms (as opposed to foreign subsidiaries) are likely to be the main beneficiaries of spillovers. Fifth, we apply the Generalised Method of Moments (GMM) in order to deal with endogeneity biases. This also allows us to properly account for industry and firm level fixed effects.
We find that after controlling for potential endogeneity biases and economy-wide effects, FDI has a positive long-run effect on the mark-ups of target firms, but this is limited to R&D intensive sectors. In addition, domestically owned firms are the main recipient of spillovers in knowledge intensive industries. Last, the results weakly indicate that an important foreign presence dampens margins, at least in the short-run. However, in the case of R&D intensive industries, this appears to be more than compensated by positive spillovers.
The rest of the paper is organised as follows. The next section indicates why, under fairly general conditions, FDI could be expected to act as a channel for technology transfers as well as influence the intensity of competition. Section 3 presents the data and describes how we constructed the variables. Section 4 contains the econometric specification as well the main results. Section 5 concludes.
In this paper, we have attempted to disentangle some of the effects usually attributed to FDI in the spirit of the conjectures first put forward by Caves (1974). On the one hand, the fact that MNCs possess firm-specific advantages that can be transferred back and forth across locations suggest that subsidiaries ought to enjoy greater levels of efficiency, and therefore mark-ups. Overall, we find support for this conjecture, but this is limited to R&D intensive sectors. For the rest of manufacturing, the long-run effect of a change from domestic to foreign ownership is nil. Furthermore, and in line with the existing literature, we find evidence of transient costs associated with a change in ownership.
With regard to the impact of foreign presence on mark-ups, the dichotomy between R&D and non-R&D sectors is also present. For non-R&D sectors, our results indicate that increased multinational presence dampens margins in the short-run. However, this effect vanishes over time, a finding that is consistent with MNCs also generating positive externalities for host country firms. This conclusion is further supported by the results pertaining to the impact of foreign presence in R&D intensive sectors. In the latter case, the positive spillover effect dominates. Finally, we find evidence consistent with the idea that domestic firms belonging to R&D intensive sectors are the main beneficiaries of spillovers. This should come as no surprise, given that Spanish entities are likely to lag their foreign-owned counterparts.
