The Role of FDI in Eastern Europe and New Independent States: New Channels for the Spillover Effect. Irina Tytell Ksenia Yudaeva

What can we expect from FDI in a transition country? Existing literature: Foreign firms are more efficient (Survey by Lipsey (2004) and Lipsey and Sjoholm (2005) Unclear, whether there are positive spillovers (Konings (2001), Damijan et al (2003), Javorcik and Spatareanu (2004) Backward linkages

Other possibilities: Education and institutions may have an effect both on the type of FDI, and on spillovers On production function – domestic firms become more similar or more different from foreign Different FDI (exporting vs. competing with imports) may have different effects. Exporting FDI (Moran, 2005)

Four countries Poland: the richest of the 4 countries, with relatively good quality of government and the rule of law, but high costs of starting a business and enforcing contracts. Romania: 3rd in terms of GDP per capital, relatively good institutions (smallest costs of starting business) Russia: 2 nd rich, relatively bad institutions (but lower costs of starting business and enforcing contracts than in Poland) Ukraine: twice as poor as Poland, bad institutions.

Data Poland: Amadeus Romania: Amadeus Russia: Rosstat Ukraine: Statistical office. No capital, and no costs data Foreign ownership data are cleaned for off-shores, NIS, and other suspected cases. For Poland and Romania only the latest ownership info. In Russia there is information about natural resource extracting sectors. We do not use it in regressions: list of industries is the same for all countries. Russia: OKONH => NACE

FDI statistics In Poland and Romania the share of foreign firms in production is above 20%. In Russia and Ukraine it is less that 5% Shares of FDI by industry in Poland and Romania is correlated with the coefficient 0.3. Shares of FDI by industry in Russia and Ukraine is correlated at 0.86% These shares aren’t so tightly correlated between the two country groups.

Static specification

Methodology Cobb-Douglas production function: Keane (2005) Industry: NACE (1.1) 2 digit. Proxy for spillovers:

Direct effect of foreign ownership Foreign companies have higher TFP, and higher capital intensity. Difference in TFP is much smaller in Poland than in other countries. Difference in capital intensity is much smaller in Poland and Romania than in Russia.

No Productivity Spillovers

Exception: Exporting FDI in Russia

Production Function Spillovers? In Russia domestic firms, competing with foreigners are less capital intensive, in Poland, where there are more FDI, domestic firms, competing with foreign, are more capital intensive.

Role of Education: direct effect is stronger in low education regions

Role of Education: spillovers concentrated in high education regions

Corruption in Russia: Productivity differences are larger if corruption low

Corruption: Spillovers are concentrated in low corruption regions

Foreign companies are more productive than domestic, but difference is not large, with the exception of the regions with low education level Domestic companies in the sectors with high FDI Density are more capital intensive than other domestic companies. This effect is observed only in the regions with high education level No productivity spillovers Countries with good institutions and high FDI inflows (Poland):

Countries with bad institutions and low FDI inflows (Russia): Foreign companies are more productive than the domestic ones, and difference in productivity is almost 70%. Domestic companies in the sectors with high FDI Density are less capital intensive and more labor intensive than other domestic companies. This effect is mainly observed in the regions with high education level and/or low corruption level. No productivity spillovers with the exception of exporting FDI.

Dynamic Specifications

Methodology: Specification: autoregressive panel data with fixed effect: Blundell and Bond (1998) GMM: a system of equations in levels and first differences, which uses lagged first differences and lagged levels of endogenous variables as instruments

Specification Dependent variable: TFP is the residual from Cobb-Douglas production functions estimator Additional controls: FDI TFP. –Peri and Urban (2004))

Dynamic effect of FDI density on productivity

More productive foreign firms produce larger productivity spillovers The effect of density of foreign firms is negative in 3 out of 4 countries –In Romania it is less negative in the sectors with more than 50% foreign share In Russia the effect of FDI Density is positive, but insignificant, and gets negative and insignificant if foreign share is larger than 50%

Dynamic effects of FDI Density on K/L Ratio

In Poland and Romania the effect of FDI TFP is positive and significant, but FDI share is negative and significant, unless foreign share is really high. Previous finding that Polish firms, competing with foreign companies, are more capital intensive can be due to the effect of FDI quality. In Russia: no or negative effect of both FDI TFP and FDI DENCITY.

Role of Education: productivity of Romanian firms Effect on productivity: In high educated regions positive effect of FDI productivity, and insignificant spillovers. In Low education regions the first effect is insignificant, and the second effect is negative.

Role of education: K/L ratio of Romanian firms. In highly educated regions foreign firms productivity has positive effect, and density is insignificant. In low educated regions foreign firms productivity is insignificant, and density is negative

Summary of findings from dynamic specifications More productive FDI lead to both productivity and production function spillovers, which we observed earlier. Both effects are stronger if education level is high. After controlling for FDI productivity, FDI density has no or negative effect on domestic firms productivity and K/L ratio. But negative effect is subject to a threshold.

Conclusions Differences in production function spillovers between 2 groups of countries, which may result from differences in the type of FDI, which go to these countries –Vertical in Poland and Romania –Horizontal in Russia No productivity spillovers in the static specification with the exception of exporting FDI. In dynamic specification increased density of FDI produced negative effect on host country firms productivity. High education and low corruption enhance production function spillovers and positive dynamic effect from very productive foreign companies.