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Foreign direct investment (FDI): friend or foe of non-innovating firms?

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Abstract

This paper examines the incentives of firms to bypass the innovation process by not pursuing innovation, focusing specifically on whether FDI enables innovation participation or retards it. This consideration of innovation participation is broader than the impact of FDI on innovation because it captures whether FDI leads to greater concentration in research markets. Using data on more than 50 countries and accounting for possible two-way causality between FDI and non-innovation, our results consistently show that FDI increases the ranks of non-innovators. These spillovers or crowding-out effects of FDI do not seem to have been widely recognized. Another interesting finding is that the main result is sensitive to the size of firms—large firms are less impacted by FDI relative to small and medium firms. Implications for technology policy are discussed.

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Notes

  1. In the discussion we use the terms non-innovative and non-innovating interchangeably to denote firms that do not pursue innovations. The rest of the firms are taken to be innovators or engaged in the pursuit of innovation – see Table 1.

  2. See Kamien and Schwartz (1982) for theoretical models linking market structure and innovation.

  3. Somewhat related to the FDI-innovation link, a section of the literature has studied whether FDI crowds-out or facilitates entrepreneurship (De Backer and Sleuwaegen (2003), Goel (2018)). A good review of the broader empirical research on FDI is by Kechagia and Metaxas (2018).

  4. Since the focus of this simple theoretical exercise is to clarify how non-innovators are different from innovation output, we are simplifying the analysis to have the innovation uncertainty be not firm-specific.

  5. For example, in the special case with no uncertainty (i.e., α = 1), with each innovating firm producing one innovation (e.g., patent), M = X.

  6. It seems useful to point out a limitation of our dependent variable, given the level of aggregation in the underlying data. In the absence of firm-level responses regarding nonparticipation in innovation, we are unable to ascertain whether the non-participation decision was voluntary (e.g., firms finding innovation to be unattractive) or whether it was involuntary (e.g., an insurmountable barrier to innovation). Yet, the overall question addressed in this work about whether FDI crowds out innovators is novel and has potential policy value.

  7. Lagging economic prosperity addresses the possible issue of reverse feedbacks (endogeneity) from non-innovating firms to economic prosperity.

  8. A larger market, per se, does not necessarily imply a need for demand-pull innovation (see Mowery and Rosenberg (1979) on demand-pull innovation). A lack of demand might be a barrier to innovation (Pellegrino and Savona (2017)).

  9. See Goel (2009) for demand complementarities and Galia and Legros (2004) note that there may be complementarities in obstacles to innovation. Furthermore, brand loyalties might present some firms with captive markets, reducing incentives to innovate (Montresor and Vezzani (2021), Wong and Merrilees (2008)).

  10. Fragility or political risk might also impact FDI flows (Méon and Sekkat (2012)).

  11. A broader discussion of why firms differ can be found in Nelson (1991), dimensions of which might extend beyond size to other aspects like age or vintage (see Pellegrino (2018)).

  12. Firm-level surveys might enable one to account for more specific aspects of non-innovating firms (e.g., age of the firm, age of the owner, ownership structure of the firm, etc.).

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Acknowledgements

Comments by Al Link and a referee are appreciated.

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Authors and Affiliations

  1. Department of Economics, Illinois State University, Normal, IL, 61790-4200, USA

    Rajeev K. Goel

  2. Kiel Institute for the World Economy, Kiel, Germany

    Rajeev K. Goel

  3. Department of Economics, Eastern Michigan University, Ypsilanti, MI, USA

    James W. Saunoris

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Goel, R.K., Saunoris, J.W. Foreign direct investment (FDI): friend or foe of non-innovating firms?. J Technol Transf 47, 1162–1178 (2022). https://doi.org/10.1007/s10961-021-09872-3

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