Productivity Spillovers from Foreign Direct Investment in the Cambodian Manufacturing Sector: Evidence from Establishment-Level Data
AbstractForeign Direct Investment (FDI) is generally regarded as an important source of finance, especially for the developing countries. Aitken and Harrison (1999) indicated that the largest source of external finance during the 1990s made available to the developing economies consisted of FDI. However, the role played by FDI in host countries through the transfer of technology, which in turn leads to an increase in labor productivity in the domestic firms via mainly indirect effects, is even more important. Since FDI is believed to be an important channel through which the international transfer of technology takes place, it has been identified as a major growth-enhancing factor in host countries. With a view to attracting inward FDI, governments in many countries (developed and developing) have liberalized their FDI regulations and adopted an investment-friendly policy. Additionally, handsome incentives such as tax holidays, the absence of import duties on intermediate inputs, low corporate tax rates, etc. are granted to investment projects by foreigners. Cambodia is no exception to such favorable policy for foreign investors. That host countries subsidize FDI activities is based on the expectation that, in addition to the employment generated by these activities, FDI makes available to the host country a package of capital, modern technology, know-how, and managerial and marketing skills, and consequently fosters productivity growth in the FDI-receiving country. When domestic firms in the host country also have access to the modern technologies and skills introduced by inward FDI, this in turn may lead both to improvements in the host country’s labor productivity and to increasing efficiency of domestic firms. However, some local firms may also suffer from the competitive presence of the more efficient foreign counterparts, as they may be forced to reduce their output or stop their activities. When their average cost curve is driven up, productivity is reduced. Certain home country conditions, such as institutions and the degree of competition, and the skill levels of the labor force might also affect the relative magnitudes of the costs and benefits. Given the benefits and costs, associated with the presence of FDI, the question is whether or not it is justified for the host country to take such generous measures in favor of foreign investors. Yet, Aitken and Harrison (1999) argue that if the benefits generated by FDI in the host country are not completely internalized by those firms, some types of subsidy may be justified. A large number of studies have been carried out to provide both the theoretical foundations and empirical results about the impact of FDI on the host country economy. The theoretical developments have stirred numerous empirical investigations into the role that FDI has played in the transfer of technology both in developed and developing countries. Data at the levels of the industry, firm, or plant have been used in those studies. The results of these analyses are ambiguous, with the slope parameter estimates of the “spillover” variables ranging from positive to negative. These mixed findings may be due to differences in research design, methodology, and the quality of data, and even the construction of the spillover variable. However, on balance, it is widely accepted that the entry of multinational enterprises (MNEs) generates a net positive effect on the local firms’ productivity in the host countries. The main objective of this paper is to analyze the net benefits generated by the presence of FDI in the manufacturing sector of the small, open economy of Cambodia. FDI has flowed into Cambodia since the outset of the country’s economy opening-up to the outside world after the first general election in 1993. Manufacturing FDI amounted to 43 percent of total FDI in Cambodia (see further below). From 1994 to 2004, the manufacturing sector contributed, on average, more than 70 percent to the total industrial output (Ministry of Planning, 2006). The importance of FDI in the Cambodian manufacturing sector will be studied to find an answer to the question whether FDI has played a role in improving local manufacturing productivity in Cambodia? Cross-sectional data from the latest and more informative ‘Survey of Industrial Establishments 2000’ will be used for this purpose. The remainder of this paper is organized as follows. Section 2 discusses the theoretical developments. The evidence on the FDI impact on productivity spillovers is discussed in section 3, while section 4 describes FDI in Cambodia’s manufacturing sector. Section 5 presents a testable econometric model. Data and methodology are discussed in section 6. Estimation results are presented in section 7. Section 8 concludes and provides some policy implications.
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