Where are the Productivity Gains from Foreign Investment? Evidence on Spillovers and Reallocation from Firms, Industries and Countries

We identify the net effect of foreign direct investment (FDI) on the host economy by separating positive productivity (TFP) effects of knowledge spillovers from negative effects of competition. We allow for foreigners selecting into productive firms and sectors. Using a new and unique firm/establishment-level data set for a large set of countries during last decade with information on economic activity, ownership stake, type, sector, and country of origin of foreign investors, we show that the positive effect of FDI on the host economy's aggregate productivity is a myth. Foreigners invest in high productivity firms and sectors but do not increase productivity of the acquired firms and enhance productivity of the average domestic rm. For emerging markets, we find that the acquired firms increase their productivity but the effect is too small to generalize to the aggregate economy. A higher level of foreign investment in the same sector of operation leads to strong negative competition effects both in developed and in emerging markets. In developed countries, we find evidence of positive spillovers through knowledge transfers only for domestic firms with very high initial productivity levels operating within the same broad sector as the multinational investor but in a different sub-sector. Our results not only con firm the predictions of the new trade and FDI literature but also show the importance of double heterogeneity in productivity and foreign investment for the effect of FDI on economic growth.