Foreign firms and productivity in developing countries

In recent years, many countries, particularly in the developing world, have sought to attract foreign investment, especially in the form of foreign direct investment (FDI). The touted benefits of increased foreign participation in the economy include the capital brought in, employment opportunities and spillovers, technological and otherwise, which contribute to enhanced economic growth. For the lowest income developing countries, the manufacturing sector in particular is considered a driving force for modernization and job creation. This paper assesses the performance of domestically and foreign-owned firms in a large sample of developing and transition countries. Detailed data collected by the World Bank in its Enterprise Surveys over the last decade allow a characterization of productivity and foreign firm presence across 119 countries, thus moving significantly beyond single country studies, which have dominated this literature. We compare the productivity of foreign and domestic firms and analyze the impact of foreign firm presence in a sector on domestic firms in that same sector. A robust result is that foreign firms are more productive than domestic private firms, regardless of specification and accounting for unobservable heterogeneity across several dimensions, time, location and industry. Accounting for observable firm level determinants of productivity, such as skilled labor, export orientation, age, capacity utilization and the usage of imported inputs, reduces the size of, but does not eliminate the statistically significant productivity advantage. However, it proves crucial to eliminate outlying observations through a careful econometric procedure since this removes a positive correlation between foreign firm presence in a sector and productivity. There are even some indications of a negative correlation in some regions of the world.