Do foreign firms crowd out domestic firms? Evidence from the Czech Republic.

Abstract

I analyze the effect of foreign presence on the growth and survival of domestic firms. I separate the two opposing effects that foreign firms may have on domestic firms: a negative crowding out effect and a positive technology spillover effect. Unlike previous studies, which analyze spillovers by estimating firm production functions, I use a model that combines a dominant firm/competitive fringe framework with a model of firm and industry dynamics (Jovanovic, 1982 and Sun, 2002). In my model, foreign firms as a group are represented by the dominant firm and domestic firms form a competitive fringe. As in Jovanovic (1982), domestic firms face uncertainty about their production efficiency and learn about it while operating in the industry. Following Sun (2002), I also assume that domestic firms' production is affected by cumulative technology shocks (technology spillovers). I test the model predictions for the growth and survival of domestic firms using firm-level panel data, from the Czech Republic during 1994--2001. My results show evidence of both technology spillover and crowding out effects. However, crowding out appears to be a short-term or static phenomenon: initial foreign entry increases the exit rate of domestic firms. Subsequently, however, the growth of the foreign industry segment is accompanied by increases in both the growth rate and survival of domestic firms. Moreover, domestic firms that do not face foreign competition have systematically higher exit rates. Further analyses on various sub-samples show that domestic firms in the technologically advanced industries are the primary beneficiaries of technology spillovers. Moreover, dividing industries among low-export and high-export oriented, suggests that the positive impact of foreign industry growth on domestic firm growth rates and survival represents domestic demand creation rather than export market spillovers. In addition, the sub-sample analysis according to firm ownership indicates that domestic firms without foreign partners, not the joint ventures, benefit from both the stimulating effects of foreign industry growth and technology spillovers. Finally, separating foreign firms by nationality shows that firms from Anglo-Saxon countries generate the largest technology spillovers, but the investors from Western Europe have the largest demand creation impact.