Does FDI spur innovation, productivity and knowledge sourcing by incumbent firms? Evidence from manufacturing industry in Estonia

Abstract

Does FDI affect productivity growth, innovation, and knowledge sourcing activities of domestic firms? This study employs detailed firm-level panel-data from Estonia’s manufacturing sector to investigate different channels through which FDI can affect domestic firms. I use instrumental variables approach to identify the effects. I find no evidence of an effect of FDI entry on local incumbents’ TFP and labour productivityg rowth in the short term. The effect on productivity does not depend on the local firms’ distance to the productivity frontier. However, there are positive spillovers on process innovation. The results show significant positive correlation between the entry of FDI in a sector and the more direct measures of spillovers in subsequent periods. This is consistent with the view that FDI inflow to a sector intensifies knowledge flows to domestic firms.