Despite the fact that many governments give incentives and tax benefits to attract foreign direct investments (FDI), empirical studies on Venezuela, Czech Republic and Central and Eastern Europe have consistently shown that FDI crowd out and take away market opportunities from domestic enterprises and make the domestic firms less efficient. However, it could be that not all FDI firms are alike, particularly when only some FDI use local intermediate inputs and have strong backward linkages.
In a recent Bank study, under the request of the Bangladeshi government, I showed that there could be a positive spillover of FDI to consider: the shared supplier spillover effect, when FDI and domestic firms share common local input suppliers. Typically, foreign and domestic firms share suppliers of intermediate inputs, locally. But since foreign firms are known to be “pickier,” their presence can create incentives for local suppliers to deliver higher quality goods (Javorcik, 2004). Thus, domestic firms who share suppliers with foreign firms gain access to newer, better local inputs, allowing them to expand their product scope and productivity.
In an interview conducted as part of the study, a supplier of zippers used by both foreign and domestic garment firms explained how positive spillovers arise:
"Serving FDI garment firms was an important reason for us to set up our plant in Dhaka, EPZ. At the beginning, the share of FDI garment firms in our total sales was about 20%. Now it is 35-40%.... To comply [with] the standard of FDI garment firms [we were required] to upgrade and expand product range, capacity, efficiency, and to reduce our costs and lead time. Moreover, [we share] market intelligence...from our FDI garment clients regarding the latest product requirements and fashion trend with our other clients. Thus, the domestic garment firms that buy from us can further improve themselves based on the information."
—Managing Director of LSI Industries Ltd., Bangladesh, November 2010.
Overall, the study shows that the spillover effects of a shared supplier can explain 1/4 of the product scope expansion and 1/3 of the productivity gains within domestic firms during the period 1999-2003.
For policymakers interested in promoting domestic firms through FDI, the shared supplier effect is a new avenue to consider. Furthermore, the study provides empirical support for the idea that designing policies to attract FDI with significant backward linkages may help promote intermediate input industries while also benefitting domestic final goods firms.
For a more complete column, please refer to my post on voxeu.org. Go here for the working paper.
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