Foreign Investment, Corporate Ownership, and Development: Are Firms in Emerging Markets Catching Up to the World Standard?

Abstract

Economic development implies that the efficiency of firms in developing countries is approaching that of firms in advanced economies. We examine the extent of this convergence among all firms as well as a subset of firms near the efficiency frontier in two economies that represent alternative models of implementing market-oriented development policies: the Czech Republic and Russia. Using 1992-2000 panel data on virtually all medium and large industrial firms in each country, we find that privatization to foreign owners markedly improved the efficiency of firms, whereas privatization to domestic owners did not; domestic firms are not catching up to the (world) efficiency standard given by foreign-owned firms. This is due in part to the lower efficiency of domestic startups relative to foreign startups and slower “learning” by domestic firms over time as they converge to a lower level of efficiency. However, foreigners’ acquisitions of more efficient domestic firms are also contributing to the gap. Domestic firms closer to the frontier are not more likely to catch up than firms further from the frontier although foreign firms do exhibit this behavior. The distance of the Russian firms to the efficiency frontier is much larger than that of the Czech firms. Nevertheless, after nearly a decade of reforms, neither model of development has resulted in convergence of domestic firms to the world standard.