Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers through Backward Linkages

Abstract

Many countries aim to attract foreign direct investment (FDI) by offering ever more generous incentive packages and justifying their actions with the expected knowledge externalities to be generated by foreign affiliates. Despite being hugely important to public policy, there is little conclusive evidence to support this claim. This study examines firm-level data from Lithuania in an effort to further our understanding of this issue. The empirical results are consistent with positive productivity spillovers from FDI taking place through contacts between foreign affiliates and their local suppliers in upstream sectors, but there is no indication of spillovers occurring within the same industry. The data indicate that local firms benefit from the operation of foreign affiliates both in their own region and in other parts of the country, albeit the evidence of the latter outcome is weaker. A larger effect is associated with domestic-market- rather than export-oriented foreign companies. There is no difference, however, between the impact of fully-owned foreign firms and those with joint domestic and foreign ownership.