chapter  7
20 Pages

Foreign Direct Investment and Effi ciency: A Stochastic Frontier Analysis

BySuman Sharma

Foreign direct investment (FDI) is considered to play an impor-tant role in recipient economies, especially in the developing economies. Foreign fi rms bring with them technical knowhow, equipment, management, marketing, and other skills. They may give rise to different types of externalities in the host country, which in turn generate spillovers. Productivity spillovers from FDI occur through three channels: (a) when skilled workers who once worked for the FDI fi rms move to local fi rms, it results in local productivity growth (Blomström and Persson, 1983; UNCTAD, 1999); (b) due to demonstration effect the mere presence of foreign products in domestic markets can stimulate domestic fi rms’ creative thinking and thus help generate blueprints for new products and processes. The technologies that FDI fi rms bring in have already been tested by consumers in the foreign markets; similar products and technologies will likely work well for the host country as well; and (c) due to the competitive effect, Caves (1974) argues that the entry of a foreign fi rm into local markets can force more active rivalry and an improvement in performance than would a domestic fi rm at the same scale. This is because FDI is thought of as a vehicle for disseminating the transfer of technology, including a higher level of technical effi ciency.