Comment on "Multinational Firms and Backward Linkages" by Ping Lin and Kamal Saggi

I highlight some of the key econometric problems facing the literature on FDI spillovers. For the most part, the existing literature takes the approach of estimating production functions in which the total factor productivity (TFP) of the domestic firms in a particular industry/country is allowed to be a function of some measure of the FDI directed by multinational corporations (MNCs) into that industry. One major problem with this general approach is the failure to deal seriously with heterogeneity in firms' production processes. It seems unlikely that we can make sense of FDI spillovers in a modeling framework where all they do is shift TFP. If knowledge spillovers occur, it seems likely that FDI will alter the production functions of domestic firms in much more subtle and extensive ways. For example, perhaps a knowledge spillover will lead to a more capital-intensive production process or enable a reorganization of the domestic firm so that it can take advantage of economies of scale. These complex aspects of spillovers will need to be modeled explicitly if we are to make progress.