chapter  12
44 Pages

Foreign investment and firm selection in Italy: competition, linkages and firms’ absorptive capacity


Section 12.4 presents the econometric model adopted and the estimation results. Finally, Section 12.5 summarizes and concludes.

12.2.1 FDI effects: a theoretical overview of the key hypothesis

As discussed by Görg and Strobl (2003) the theoretical a priori behind the issue of how foreign presence affects the host country firms’ survival are ambiguous. On the one hand, foreign establishments are likely to intensify competition and may force domestic establishments go out of the market, as described in some prominent works (Aitken and Harrison, 19994; Haddad and Harrison, 1993; Djankov and Hoekman, 2000). Multinationals may also have negative effects on firm survival via their higher wages, which may attract the most productive workers away from indigenous firms (Barry et al., 2005). On the other hand, domestic firms may benefit from knowledge or pecuniary spillovers from foreign establishments. The common assumption made in the literature on technology diffusion is that there is a potential technology gap between domestic firms and MNEs as they have firm-specific assets or efficiency advantages that enables them to operate abroad successfully (Markusen, 2002; Helpman et al., 2004). This creates the opportunity for knowledge externalities and transfer of more efficient technology and managerial practices and superior knowledge embedded in FDI from foreign to domestic firms, as emphasized in early case studies and industry-level findings (Caves, 1974; Blomström, 1986). The empirical literature has identified two main channels through which FDI impacts on domestic-owned plants: the horizontal intra-industry economic linkages between domestic-and foreign-controlled affiliates, mainly through competition for market shares but also through imitation, demonstration and labour mobility (Blomström and Kokko, 1998); the vertical inter-industry linkage, which can be upstream or downstream, i.e. the economic linkages of a local firm with foreign firms through respectively purchasing intermediate inputs from them or through selling products to them. The channels of impact on firm survival in sectors that supply inputs to multinationals is described by Markusen and Venables (1999). According to this model, the presence of multinationals has three effects on the host economy: (1) a negative competition effect: the increase in total output due to multinationals’ production decreases the market price, which leads to the exit of some domestic firms; (2) a demand effect: multinationals create additional demand for domestically produced intermediate goods through linkages with indigenous suppliers which induce the entrance of new intermediate producers; (3) a derived entry effect: a fall in the price of intermediates which induces the entry of domestic final-good producing firms. The latter two positive effects may outweigh or not the potential negative competition effect.