Testing for FDI externalities in Thailand: A firm level analysis of horizontal and vertical spillovers

Transcription

1 Testing for FDI externalities in Thailand: A firm level analysis of horizontal and vertical spillovers Chayanon Phucharoen * Chulalongkorn University, Bangkok, 10330, Thailand Abstract Many empirical researches have been dedicated to study the impacts of MNC on host nations economies however; the consensus among them is still a far reaching destination. Another form of impact of MNCs, the externalities toward the local firms generated by their presence, has lately gained researchers attention. This paper is designed to empirically investigate whether the presence of foreign-controlled plant in identical industry (horizontal FDI spillovers) or in the related industries (Vertical FDI spillovers) could enhance the productivity of Thai indigenous firms by using Translog based estimation model and latest NSO industrial census. First we generally found that the presences of foreign plants could increase productivity of local plants in the same industries. In addition; the positive productivity spillovers from the presence of foreigncontrol plants in the downstream industries are statistically reported and their magnitudes are relatively stronger than the horizontal spillover effects in capital intensive and natural resource base industries. In labor intensive industries, the positive spillovers from the existing of foreign plants in upstream industries were significantly reported; however, their presence in the downstream industries could deplete the performance of local plants in the supplying industries. JEL codes: F23, M11, D24 Keywords; Multinational corporations, FDI spillovers; and Technology transfer 1. Introduction Beside the external source of financial capital to the host nations and ob creation, the ustification for subsidizing FDI has been attributed to the positive externalities in which foreign firms could potentially generate to local firms. Theoretically, the presence of foreign firms not only could benefit local firms in the industry which they operate (Horizontal spillovers), but their presence could also enhance the performance of local firms who interact with them in the supply chain (Vertical spillovers). Some researchers had confirmed the validity of horizontal spillovers; some empirically disclaim the availability of all spillover effects while some researchers support only the existence of spillover impact to local plants in the upstream industries. * Chayanon Phucharoen, Ph.D. candidate, Faculty of Economics, Chulalongkorn University, Bangkok, Thailand. Tel.: ; fax: address:please_send-it@hotmail.com.

2 2 With the latest firm level data from 2006 National statistic organization industrial census, integrated with the latest NESDB s input-output table. We aim to investigate whether the productivity of local plants could be statistically influenced by the presence of foreign plants in the identical industry (horizontal spillovers) and the presence of foreign invested plants in the related industries (vertical spillovers). 2. Literature reviews If local plants can maintain their market share, Aitken and Harrison (1999) generally pointed out that the presence of the foreign-controlled plants in the same industry could lower the unit cost of output produced by local plants through spillover effects. This is the positive externalities from their presences. However their existence could potentially harm the current market share of local operators and this market share deterioration could eventually lead to less or to the point of insufficient production scale of local plants. This force is considered as negative externality of their presence. Since those two forces have opposite direction, the empirical consensus on this issue is not supportive as FDI promoting agents in many host nations have frequently claimed. From the review of the theoretical literatures, we found that externalities from MNC could be passed to the local firms through following channels. Through Imitation; Wang and Blomstrom(1992) illustrated that Domestic firms can learn from foreign competitors product and service, process, and technology through imitation; for example, reverse engineering process of proprietary knowledge used in the product, and technology which are introduced to the local counterparts by foreign-invested firms. Through competition; beside the market share stealing threat of foreign firms, Glass and Saggi, (2002) had shown that the presence of foreign invested firms would pressurize the domestic firms to improve their existing offers, process, and technology. With other factors constant, this pressurizing force would motivate local operators to increase their performance. Through export spillover; Domestic firms can learn the related export information (for instance; foreign markets, exporting procedures, and choice of transportation) from multinationals firms, who already have the established exporting network; this learning could potentially benefit the indigenous firms (Aitken, Hanson, and Harrison, 1997) as the penetrators to the foreign markets. Through the worker mobility; Domestic firms could be benefited from the knowledge-invested employees who have moved from foreign-invested firms. Not only local plants can learn the new technology (Fosfuri, Motta and Ronde [2001]), process and proprietary knowledge from those set of workers, but also the existing workers could formally and informally learn these knowledge body from the group of transferred workers. Empirically, the FDI spillovers are less visible than their suggested frameworks. As readers can observe in the Table 1, various proxies are employed to provisionally to check the robustness of the result (rather than to check whether particular channel exists). For the spillovers from the presence of foreign plants in downstream industries, Javorcik (2004) stated that foreign controlled plants would be benefited from improved intermediate goods manufactured by local suppliers. Therefore multinational plants are more willing to transfer the knowledge to their suppliers rather than transferring to their local counterparts in the same industry. However if multinational plants had engaged into the exclusive contract with particular suppliers, Please see appendix A.1

3 who are usually a foreign invested plants, Markusen and Venables (1999) conclude that not only entrance of multinational plants would crowd out the domestic plant in final goods industry, but also local plants demand for intermediate goods. For the Spillover generated from the presence of foreign plants in upstream industries, Ethier (1982) firstly pointed out that the presence of MNE would lead to a greater variety of inputs which could lead to an improvement of local plants production. Initially, the empirical works in this field had dedicated to investigate the impact of FDI toward the local firms in the same industry. Lately, researchers have integrated the vertical spillover into their analysis. Summary of recent empirical works are shown in the following table. Table1. Summary of recent empirical works 3 Authors Studied Country Dependent variable Measurement of foreign presence Testing for Vertical spillover Results Aitken and Harrion (1999) Venezuela Output Foreign equity No (-) Crowding out effect Blomstrom and Soholm (1999) Indonesia VA/worker Output ratio No (+) Takii (2001) Indonesia VA Employment ratio No (+) overall, (-) industries with large technology gap Todo and Miyamoto (2002) Indonesia VA/worker Output ratio No (+) Blalock and Gertler (2005) Indonesia Output Output ratio No Javorcik (2004) Lithuania Output Output ratio Yes Ramstetter (2005) Thailand VA/worker(hour) Foreign equity No (+) more effect for local firm with low competency (+) only spillovers from MNCs in downstream ind. (+) small effect in the case of wholly-foreign MNC Tomohara & Yokota (2006) Du, Harrison & Jefferson (2012) Thailand Output Output ratio Yes Foreign Hongkong, Output equity, Output Macua, Taiwan ratio Yes (+) but not spillovers from FP in upstream industry Non or weak in horizontal spillover (+) in vertical spillover Xu and Sheng (2012) China Output, TFP Output ratio Yes (+) Horizontal (-) Vertical spillover Note: VA is value added of the plant, (+) means positive productivity spillover (-) mean negative productivity spillover. FP means foreign presence Most of the recent works had augmented the inter industry spillover to the analysis. For example Blalock and Gertler (2005), Tomohara and Yokota (2006), and Du, Harrison and Jefferson (2012), and they found that vertical spillover effects, especially spillover from the foreign plants in downstream industries, is more empirically supported than the horizontal of spillovers. Rather than employing share of foreign plants production, in Takii (2001), Wei and Liu (2006), share of labor employed by foreign plants has been used as the proxy for the presence of foreign plant in the industry to reflect the significant of labor mobility channel, as Hakker (1999) commented. As we can observe from the above table and review of conceptual frameworks, the presence of foreign-controlled plants does not always lead to the positive externalities toward local plant s productivity. In the next section, we discuss the estimating models.

4 4 3. Methodology To verify whether both horizontal and vertical spillovers exist, the following model, which is inspired by Javorcik (2004), is used as the baseline model ln( VA) Local Spillfromup ln( K) 2ln( L) DAge 6 DSize 7 Horizontalspill 3 DBOI 8 i i Spillfromdown 4 (1) Where is the value added of local plant i in industry, K is capital (measured as plant s beginning fixed asset), L is labor (measured as total labor hours), DAge DSize and DBOI are dummy variables on plant i s age (1 if plant i older than industry average, 0 otherwise), size (1 if plant i has larger fixed asset value than industry average, 0 otherwise) and whether the plant i had received BOI investment privileges. To have less restrictive assumption on constant return to scale as traditional Cobb Douglas production function require, a translog production based estimating model has mainly been employed and the above regression is adusted to the following regression. (2) ln( VA) Local Horizontalspill ln( K) 2ln( L) 3 ln(( K) ) 4 ln(( L) ) 5[ln( K) * ln( L) ] Spillfromdown 7 Spillfromup 8 DAge 9 10 DSize DBOI 11 i Table 2. Measurement of horizontal spillovers, spillovers from downstream and from upstream Type of Spillover Measurement Horizontalspill Share of output by foreign plants in industry Share of labour employed by foreign plants in industry Where MNC Output All Ouput k is portion of industry output to industry k k k if k Where k if k k Labor Labor MNC All is portion of industry output to industry k k Spillfromup Where MNC Output All Ouput m is portion of industry m output to industry m m if m Where m m if m Labor Labor MNC All is portion of industry m output to industry m

5 The presence of MNCs in the identical and related industries is measured as the above table, output and employment shares are employed as the foreign presence measurements in both horizontal and vertical spillovers analysis. In addition to above baseline and equation 2, labor productivity (with the list of adusted independent variables) and total factor productivity are alternatively employed as the dependent variables. Hence the above equation is adusted to the following regressions. 5 ln( VA / L) ' 4 Local Spillfromdown ' ' ln( K / L) 0 1 ' 5 ' 2 Spillfromup ln(( K / L) ' 6 ) DAge 2 ' 3 ' 7 Horizontalspill DSize ' 8 DBOI i (3) And ln( TFP) " 6 Local " Horizontalspill 0 " 1 ln( K) " 7 " 2 ln( L) Spillfromdown " " 3 8 ln(( K) ) 2 Spillfromup " 4 " ln(( L) ) 9 DAge 2 " 5 " 10 [ln( K) DSize *ln( L) ] " 11 DBOI (4) i As Xu and Sheng (2012), TFP is defined as residual from the operation of Translog production functions. To further enhance the comprehensiveness of the study; analysis would be conducted not only to all plants, but we also intend to investigate spillovers in capital, labor and natural resource intensive industries. Next we discuss the data and scope of the analysis. 4. Data and Scope The data from NSO 2005 s industrial census are employed throughout this study. Industrial in the census is classified by ISIC code. There are 23 ISIC main classified industries comprise of 457,968 plants of which 73,931 plant s information are in database. However there are large discrepancies between the report from NSO and statistical report from other organizations; for example, department of labor, as well as the problem of duplication of data due to the misperception by respondents; hence the removal of observation duplications are needed. If any two or more observations simultaneously have identical registered categories of industry, value of fixed asset, and gross sale, they would be treated as duplicated series, and one of them would be disregarded from the list. I intend to exclude Tobacco [16], publishing and printing [22], and recycling [37] industries from my analysis since there is limited no. of foreign controlled plants which could lead to insufficient no. of observation in the tests. In addition, in order to avoid disproportion representation of the firms and relatively untrustworthy response in some establishment. Thus I scope my analysis to plants with the size (classified by no. of labor) in categories 6 and above, which have no. of workers greater than 15, and establishment which has sale per labor above Baht 10,000, and fixed asset per labor above Baht 5,000 per year. While the input-output coefficients ( were obtained from NESDB (Thailand s Office of National Economic and Social Development Board). One of the challenges for investigation of vertical spillover is the integration of Input Output table to industrial census. To match with ISIC industry classification, we had complied NESDB s input output coefficients with the NSO industrial classification. The underlying advantage of using NSO industrial census is relatively large no. of observations which provide a great assistant to the outliner problem caused by either misfiling the answer or misunderstanding the question by respondents which is relatively common in paper based questionnaire survey. 5. Results Results are illustrated in accordance to developed hypothesis.

6 Hypothesis 1: Presence of foreign controlled plant could statistically influence the productivity of local plants, resided in the same industry. With the particular focus on horizontal spillovers, main equations 1 to equation 4 are tested without spillfromdown and spillfromup variables. As we can observe from the table in the next page, the presence of foreign-controlled plants in the same industry could statistically influence the production of local plants in both aggregately classified industry (2 digits ISIC) or disaggregate classified industry (4 digits ISIC). This conclusion remains valid for both Cobb Douglas and Translog production functions and regardless of whether the foreign presence in the industry is measured as foreign share of output or employment. In term of effect on local plants labor productivity, column 6 th, 7 th, 14 th, and 15 th in the table 3 reported that the existence of foreign-invested plant (either measured as output share or employment share) in the industry could statistically influence the local plants labour productivity. Moreover; their presence in the industry could influence local controlled plants TFP (column 8 th,9 th, 16 th, and 17 th ) as well. Results across various techniques do suggest that the effect of foreign-invested plant s presence toward local plants production and productivity is mostly stronger when the larger industry code classification (at 2 digits) is employed. It implies that the presence of the foreign controlled plants in the aggregate classified industry could generally affect the local plants more than the presence of foreign-invested plants influence in the disaggregate level (4 digits ISIC). With the consideration of all spillovers layers; results from the full operation of equation (2), (3) and (4), reported in the table 4,also report the consistent results of horizontal spillovers Hypothesis 2: Productivity of local plant is statistically affected by the presence of foreign plant in supplying industries. Table 4 reports results from the full operation of equations (2), (3) and (4). With the measurement of foreign plant s output share, we observe that the presence of foreign controlled plants in the upstream industries spilloverfromup variable could not statistically influence any of the performance indicator of local plants. This result is relatively contradicts to the suggested conceptual framework but it relatively conform to the previous finding by Javorcik (2004); as well as the recent work by Du, Harrison and Jefferson (2012). However; we found a negative influence on local plants performances when foreign plants employment share is used as the proxy for the foreign presence in the industry. Either local plants performances are measured as value added, labor productivity or TFP, a one percent increase in the foreign employment would deplete those local plants performance indicator. The plausible explanation for this negative influence on local manufacturers is the competition in labor market as foreign plants could easily outbid the offered wage by local plants as the average wage of foreign plants is greater than local plants by 54%. As we can observe by the following figure, foreign plants averagely possessed higher value added per worker than local plants by two times, and their capital intensity is higher than local manufacturer s capital intensity by three times. Baht 2,000,000 1,500,000 1,000, ,000 - Foreign, 1,617,725 Foreign, Local, 750, ,135 Local, 219,926 Fixed asset per labor Value of machine per labor Foreign, 1,212,750 Local, 516,645 Value added per labor Figure 1. Average fixed asset per labor, machine per labor, and value added per labor of local and foreign controlled plants.

7 Hypothesis 3: Productivity of local plant is significantly affected by the presence of foreign plant in the downstream industries. With the focus on the variable spillfromdown variable in table 4, and at 95% confidence level, we found that the presence of foreign plants in the downstream industries could significantly benefit the local plants production. In addition; with 90% confidence level, their presence could also statistically increase the labor productivity. Through the employment share as the foreign plants presence; a positive spillovers from foreign plants in downstream industries are found through the case of local plant s value added and labor productivity. Complied with the conceptual framework, the presence of foreign plants in the downstream industries, the existence of the foreign plants in the downstream industries automatically requires both higher quantity and better quality of outputs produced by local plants. Furthermore; the results from survey paper by Javorcik (2004) suggested that the corporation between foreign and local plants would likely to arise when foreign plants are the buyer of local plants product. Besides the Lithuania s finding by Javorcik, the previous finding in Thailand by Tomohora and Yokota (2006), the recent finding in China by Du, Harrison and Jefferson (2012) also found similar effect on local plants productivity from the presence of MNCs in the downstream industries.

8 8 Table 3. Horizontal spillover: Results from the operation of equations 1 to 4 with only horizontal spillover variable. Number in parenthesis is the p value of coefficients VA Cobb Douglas VA Translog LP Translog TFP Translog VA Cobb Douglas VA Translog LP Translog TFP Translog 1 st 2 Digits 2 nd 43 Digits 24 Digits 45 Digits 26 Digits 47 Digits 28 Digits 9 th 4 Digits 210 Digits 411 Digits 2 12 th Digits 413 Digits 214 Digits 415 Digits 16 th 2 Digits 417 Digits C (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) LOG(K) LOG(L) LOG(K)^2 LOG(L)^2 LOG(K)*LOG(L) LOG(K/L) LOG(K/L)^2 Dage Dsize DBOI (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.37) (0.33) (0.00) (0.00) (0.00) (0.00) (0.39) (0.26) (0.00) (0.00) (0.63) (0.61) (0.00) (0.00) (0.62) (0.63) (0.08) (0.02) (0.19) (0.21) (0.03) (0.01) (0.21) (0.29) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) 1.085* 1.087* 1.059* 0.236* Output ratio (2 digit) (0.00) (0.00) (0.00) (0.00) Labor share as foreign presence Output ratio 0.722* 0.729* 0.711* 0.241* (4 digit) (0.00) (0.00) (0.00) (0.00) Labor ratio 1.437* 1.432* 1.391* 0.380* (2 digit) (0.00) (0.00) (0.00) (0.00) Labor ratio Output share as foreign presence 0.899* 0.909* 0.883* 0.269* (4 digit) (0.00) (0.00) (0.00) (0.00) Adusted R Note: In the case of impacts on local plants labour productivity(lp) and TFP, only translog based estimation are reported in this table, CD based function are available upon the request.

9 9 Table 4. Results from operation of equation (2) to (4) with all type of spillovers Foreign presence as Output share Labor productivity TFP VA Foreign presence as Labor share Labor productivity VA TFP C (0.00) (0.00) (0.00) (0.00) (0.00) (0.01) LOG(K) (0.00) (0.00) (0.00) (0.00) LOG(L) (0.00) (0.35) (0.00) (0.43) LOG(K)^ (0.00) (0.58) (0.00) (0.80) LOG(L)^ (0.10) (0.22) (0.05) (0.23) LOG(K)*LOG(L) (0.00) (0.00) (0.00) (0.00) LOG(K/L) (0.00) (0.00) LOG(K/L)^ (0.00) (0.00) Dage (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Dsize (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) DBOI (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Spillfromup (Output share) (0.23) (0.24) (0.21) Horizontal spill 0.93** 0.91** 0.20** (Output share) (0.00) (0.00) (0.00) Spillfromdown 0.16** (Output share) (0.03) (0.09) (0.08) Spillfromup -1.50** -1.57** -0.57** (Labor share) (0.00) (0.00) (0.00) Horizontal spill 2.16** 2.18** 0.72** (Labor share) (0.00) (0.00) (0.00) Spillfromup (Labor share) 0.58** 0.54** 0.00 (0.00) (0.00) (0.88) Adusted R Note: Translog production function based results are reported in the above table, CD based are available upon the request. Number in parenthesis is the p value of coefficients 5.4. Spillovers and types of industry This study also investigate whether the effect of foreign controlled plants vary across different types of industry. Estimation models 2 to 4 are implemented to samples with the industry s type classification. Results are illustrated in Table 5. Either we use foreign employment ratio and output ratio as the representative of presence of foreign plants, results are relatively similar. For capital intensive industry; we found that both of the spillovers from upstream and horizontal spillovers are not significant in any measurements of local plants performances. In contrast; the validity of spillover from MNCs in downstream industries were found in every measurement of local plants performance indicators. It should be noted that the above claim are also true, when the employment share of the foreign

10 10 plant is used as the proxy for foreign presence. From the results, it is relatively clear that the local plants in the capital intensive industry would only benefited from the foreign presence in the buying capital intensive industries. As the nature of plants in capital intensive industries, the spillovers from downstream could potentially be in the form of technology transfer from their foreign clients who require sophisticated raw material from local suppliers. For instance; in order to comply with standard of the final product initiated by MNCs, their foreign plants in automotive industries are willing to cooperate with their local suppliers in fabricated steel industry. For labor intensive industry; In short; results from this section provide strong evidences on vertical spillovers and disregard the horizontal spillovers. A negative spillover from downstream industries is found. However; a positive spillover from the presence of foreign plants in the upstream industries is reported with strong magnitude of influences. As suggested by the Ethier(1982) s framework, the presence of foreign plants in the supplying industries would lead to greater variety raw materials which for local manufacturer to select. In addition; Their presence in those industries could also drive the existing local suppliers of local manufacturer to improve their productivity or their product quality through the competition effect (Glass and Saggi(2002)). The plausible explanation for the report of negative spillover from downstream industries is the destruction of local manufacturers existing buyers, which could result in sale depletion and eventually a reduction in the production of domestic manufacturers. This claim is particularly valid in the industries in which foreign plants productivity is equivalence as local plants productivity as previously reported in most of the labor intensive industries in Ramstetter (2005). By further looking at the input-output table, we could list the top 5 industries with largest within industries purchasing ratio in Appendix Table 3 (Appendix). For example; wearing apparels industry (ISIC 1810) and Knitting (ISIC 1730) mostly purchase their intermediate goods (77%) and (72%) within the labor intensive industries. We can further observe that foreign plants relatively plays small role in those top 3 industries (17.65% output share in Wearing Apparels, 12.04% in Knitting, and 3.95% in cordage rope). Their small participation in these buying industries could potentially explain why spillover effects from downstream industries are reported as negative. For resource intensive industry: a positive horizontal spillover effects is found in this industry cluster. It implies that an increase in market or employment share of foreign plants could statistically enhance the performance of local plants in the same industries as suggested by stated theoretical frameworks. An even stronger positive influence from their is found through case of spillovers from downstream industries; for example, an percentage increase in the output share of foreign plants could rise the value added of local plants in these natural resource based industries as 2.4%. As the previous stated empirical finding, foreign presence in buying industries yields a positive externality to local suppliers. On the other hand; an expansion of foreign plants market and employment share in the upstream industries would reduce the local plants performance. To explain these negative spillovers from downstream, the break down table on each industry (4 digits) is shown in the table 3 (Appendix). From the list, there are manufacture of Tobacco processing, manufacture of basic industrial chemical, manufacture of sugar and manufacture of synthetic resins and plastic. They are upstream producers. These are industries in which Thai authorities have applied strong protection mechanism; for example, basic industrial chemical and Synthetic Resin. Although foreign plants presence in those industries contribute to industries output and employment share as high as (34% and 26% of industries output respectively, their purpose of presence in Thailand is mainly to avoid those protection mechanisms. To further sustain this flow of FDI in these industries, the trade barriers are heavily conducted in these upstream product, which would eventually worst off the local manufacturer (for example; local plants in Plastic ware) who import these raw materials from To be specific; manufacture of Wearing apparel industries (1810) purchase 65% of their intermediate goods from weaving industries while manufacture of knitting (1730) industries purchase 34% from weaving industries.

11 abroad. Hence the presence of foreign plants in the upstream industries would indirectly worst of f the production of local plants Limitation and Further study Since there is a discrepancy between industry classification by NSO industrial census and industry classification used in the input-output table, the variables which require integration from these two sources of data could not be conducted at very disaggregate industry level. To better evaluate vertical spillovers, a further study should rematch the IO table and industry census data at 4 digits ISIC industry classifications. As Lipsey (2002); the relationship between plants in different industries could conceptually be separately verified by observation of variables that represent the different layer of spillover effect., Practically, plants in the same classified industry could interact as supplier-manufacture; hence a horizontal spillover effect could be overstated. We suggest any further researches to not only check industry classified code but also other type of establishment information; for example, product codes, in the data processing step. Most of the studies have rely on the industrial census to analyze the impacts of foreign plants presence toward the local manufacturing firms, because firms included in the industrial census are manufacturing firms only. Hence the result could be proected to the industrial sectors only, the results could not answer whether there is significant spillover from MNCs in the service sectors to the local units in the same industries or related industries. With the increasing presence of MNCs in hotel, commercial banks in Thailand, this extension could be the vital input for the policy makers to decide whether the privileges provided to those foreign-control service units are empirically ustified.

12 12 Table 5. Results from operation equation 2 to 4 with types of industry classification. C LOG(K) LOG(L) LOG(K)^2 LOG(L)^2 LOG(K)*LOG(L) LOG(K/L) LOG(K/L)^2 Dage Dsize DBOI Spillfromup (Outputshare) Horizontal spill (Outputshare) Spillfromdown (Outputshare) Spillfromup (Laborshare) Horizontal spill (Labor share) Spillfromdown (Labor share) Capital intensive ind. Labor intensive ind. Natural resource ind. Capital intensive ind. Labor intensive ind. Natural resource ind. VA LP TFP VA LP TFP VA LP TFP VA LP TFP VA LP TFP VA LP TFP (0.02) (0.00) (0.03) (0.00) (0.00) (0.00) (0.00) (0.00) (0.17) (0.01) (0.00) (0.03) (0.00) (0.00) (0.00) (0.00) (0.00) (0.15) (0.00) (0.00) (0.00) (0.00) (0.00) (0.01) (0.00) (0.00) (0.00) (0.00) (0.00) (0.01) (0.00) (0.26) (0.00) (0.58) (0.00) (0.74) (0.00) (0.25) (0.00) (0.50) (0.00) (0.70) (0.00) (0.00) (0.05) (0.19) (0.00) (0.03) (0.00) (0.00) (0.03) (0.25) (0.00) (0.03) (0.00) (0.84) (0.17) (0.01) (0.64) (0.96) (0.00) (0.86) (0.14) (0.01) (0.44) (0.91) (0.00) (0.15) (0.00) (0.00) (0.00) (0.35) (0.00) (0.15) (0.00) (0.00) (0.00) (0.37) (0.04) (0.00) (0.00) (0.04) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.46) (0.45) (0.31) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.55) (0.51) (0.34) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.33) (0.68) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.38) (0.72) (0.14) (0.10) (0.79) (0.00) (0.00) (0.00) (0.00) (0.00) (0.01) Labor share as foreign presence (0.32) (0.53) (0.68) (0.32) (0.09) (0.60) (0.00) (0.00) (0.04) (0.00) (0.00) (0.01) (0.00) (0.00) (0.00) (0.00) (0.00) (0.05) (0.29) (0.38) (0.88) (0.00) (0.00) (0.00) (0.02) (0.08) (0.04) Output share as foreign presence (0.08) (0.14) (0.74) (0.10) (0.02) (0.20) (0.00) (0.00) (0.06) (0.00) (0.00) (0.01) (0.00) (0.00) (0.00) (0.00) (0.00) (0.05) Adusted R Observations 3,714 3,714 3,744 3,806 3,806 3,824 4,233 4,233 4,254 3,714 3,714 3,744 3,806 3,806 3,824 4,233 4,233 4,254 Note: VA: Value added, LP: Labor productivity as dependent variable, Translog production function based results are reported in the above table, CD based are available upon the request.

13 13 7. Policy implication An increase in local s firm productivity is possible through spillover effects. From the hypothesis; we had learned that the existence of foreign plants in the same industries could influence the local plants performances. From hypothesis 2 and 3 s results, authority should particularly concern the expansion of the foreign plants employment share in upstream industries; this employment expansion could statistically lead to an erosion of local manufacturers performance. However their output expansion of local plants (either measured as foreign output share or employment share) in downstream industries would generally benefit the local plants value added. With separated observations to industry s main characteristic, the presence of the foreign plants in downstream industries in capital and natural resource based industries should be encouraged because there is evidence on positive spillovers from the presence of foreign plant downstream industries. To further enhance this existing of spillover from downstream in capital and natural resource based industries, a privileges should be further given to the foreign controlled plants that had developed a relationship with their local suppliers. From the following figures; we found that the most important industries in capital intensive industry, an electronic component industry (ISIC 321) has export ratio as high as 75%; and these electronic components would be transferred to multinational plants in other nations as work in progress. The evidence of positive spillovers from foreign plants presence in downstream industries suggested that authorities should not only support the export of the firm in this of industries. However; they should encourage the FDI in the capital intensive industries (for example; foreign plants presence in manufacture of radio, TV and communication equipment and apparatus) as local plants in electronic component industries would received a gain in their productivity through the spillovers from the presence of those foreign plants in these downstream industries. Figure 2(Left): 3 Digit ISIC industries& their output in relative to total output in capital intensive industries Figure 2(Right): Export & Import in relative to their output of Top ten industries (ISIC 3 digits) in capital intensive industries However; for labor intensive industries, authority should note that the foreign plants presence in the downstream industries could potentially deteriorate the performance of local manufacturers. Instead, the presence of foreign plants in labor upstream industries; for example, spinning and weaving (ISIC 171) should be encouraged. From the above statements; authority should design different target industry for different types of industries rather than promoting FDI in a single target industry As we can observe from part appendix A.5, most of the textile, Wearing apparel, and Footwear obtain their output from Spining and weaving industries

14 14 8. Conclusion Given with one of the most frequently used rational to induce FDI to every host nations, an anticipation for technology transfer to local firms, this paper investigate whether the claimed externalities toward local plants is statistically exist. The testing is based on the firm level data from the latest industrial census, and the latest input-output table had been integrated in order to conduct vertical spillover impacts analysis. Thorough various specifications of productivity, presence of foreign plants and testing models, results revealed that the presence of foreign-invested plants could increase the value added and productivity of local plants in the same industries. An even stronger magnitude of positive horizontal spillovers could be found if foreign plants expand their employment share instead of the output share expansion in the industry. Interestingly, the results on vertical spillover vary across industry s characteristics. The positive effects from the presence of foreign plants in the client industries (spillover from downstream) are reported in the capital and natural resources based industry, while the performances of local plants in labor intensive industries would be harmed by the expansion of foreign plants in the downstream industries. This paper partially raises the soundness of the FDI promoting through the empirical proofs of spillovers, especially the horizontal spillover effects. However results generally suggested that authority should particularly concern the possibility of negative productivity externalities to local plants in particular type of industries which potentially exist through the vertical spillover effects. Acknowledgement I sincerely appreciate valuable advice from my Ph.D. dissertation advisor, Associate professor Dr. Paitoon Wiboonchutikula and co-advisor Assistant professor Dr. Bungon Tubtimtong and I would also like to thank Prof. Eric D. Ramstetter for his advice on this work. Reference Aswicahayono, Hill and Naroko (2011), Indonesia Industrialisation: Jobless growth? in Manning and Summato, Employment, living standards, and poverty in contemporary Indonesia, ISEAS publishing, p.133 Aitken, and Harrion (1999), Do domestic firms benefit from direct foreign investment? Evidence from Venuzuela, American economic review, vol.89, p Aitken, Hanson, and Harrion (1997), Spillovers foreign investment and export behavior, Journal of international economics 43 (1997),p Belderbos, Capennelli, and Fukao (2000), Local content of Japanese Electronics manufacturing operation in Asia, Nber Books, University of Chicago Press, January (2000), p.9-47 Blalock, and Getler.(2005), Welfare gain from foreign direct investment through technology transfer to local suppliers, Working paper, Cornell university (2002) Blomstrom M. and Wang Y.(1992), Foreign investment and technology transfer: A simple model European economic review (1992) 36, p Blomström, Magnus and Fredrik Söholm (1999), Technology Transfer and Spill-overs: Does Local Participation with Multinationals Matter? European Economic Review, 43 (4-6): p Ethier, Wilfred J, "National and International Returns to Scale in the Modern Theory of International Trade,"American Economic Review, American Economic Association, vol. 72(3), p

15 15 Fosfuri,Motta and Ronde (2001), Foreign direct investment and spillovers through worker s mobility Journal of International Economics, Vol 53, p Glass A., and Saggi K. (2002), Multinational firms and Technology transfer, Scandinavian Journal of Economics, Vol. 104, p Haacker, Marcus(1999), Spillover from foreign direct investment through labor turnover, the supply management skills. CEP discussion paper/london school of economics(1999) Javorcik (2004), Does foreign direct investment increase the productivity of domestic firm? In search of spillovers through backward linkages, American economic review (June 2004) 94(3), p Ramstetter, Eric (2005), Are productivity differential important in Thai Manufacturing? in Eric D. Ramstter and Fredrik Sohom, eds., Multinational Corporation in Indonesia and Thailand: Wages, Productivity, and Exporsts. Hampshire, UK: Palgrave Macmillan, p Robert Lipsey (2002), "Home and Host Country Effects of FDI,"NBER Working Papers 9293, National Bureau of Economic Research, Inc. Markusen and Venables (1999), Foreign direct investment as a catalyst for industrial development., European economic review (1999) 43(2),p Takii, Sadayuki (2001), Productivity Spillovers and Characteristics of Foreign Multinational Plants in Indonesian Manufacturing , Working Paper , International Centre for the Study of East Asian Development, Kitakyushu. Todo, Yasuyuki and Koi Miyamoto (2002), Knowledge Diffusion from Multinational Enterprises: The Role of Domestic and Foreign Knowledge-Enhancing Activities,OECD Technical Paper No. 196, OECD Development Centre Tomohara A. and Yokota K (2006), Does foreign direct investment benefit domestic companies via increased productivity: Horizontal Backward, and Forward Linkages. The international centre for the study of East Asian development, Kitakyushu, (2006). Wei and Liu 2006), Productivities spillovers from R&D, exports, and FDI in China manufacturing sector, Journal of international business studies 37, No 4,p Appendix A. A.1. Aitken and Harrison (1999) s framework In general, as purposed by Aitken and Harrison (1999) who found that the positive externalities due to the proprietary knowledge, technology spillover would shift the AC curve of domestic firm inward. Then the unit cost, with given quantity of output, would drop from point A to B in the following figure. However, the presence of Foreign-invested firm does not only shift this AC curve inward but it also crowd out the demand for the product of this domestic firm. The following figure shows the situation in which the change in demand eventually lead to a higher unit cost of production (Point C) than the initial unit cost (Point A). Hence it is a general dilemma scenario for the domestic firm whether to perceive the existing of foreign invested firm as the complement or the threat to their performance.

16 16 Figure 1(Appendix). Aitken and Harrison (1999) s framework A.2. Type of industry classification Based on Aswicahayono, Hill and Naroko (2011), the classification of industry to it type is illustrated in the following table. Table 1(Appendix). Industries with its type Capital Intensive Labor Intensive Natural resources 1 Non Metallic Mineral (26) Textiles (17) Foods and related products (15) 2 Basic Metal (27) Garments (18) Paper (21) 3 Fabricated metal (28) Footwears (19) Chemical (24) 4 General Machine (29) Wood product (20) Rubber and Plastic product (25) 5 Electronic related (30-33) Furniture (36) 6 Automotive and other transports (34-35) Miscelleneous man. (369) Toy and Jewellery There are 10 industries (3,714 establishments) as classified by NSO in the capital intensive industries, 6 industries, composed of 3,806 establishments in labor intensive industries, and 4 industries (4,254 establishments) are classified as resource intensive industries A.3. Foreign output and employment share Labor share Output share Labor share Output share Labor share Output share Figure 2(Appendix). Employment share and Output share of foreign controlled plants in each type of industry Capital intensive industries have largest foreign output share (61.47%) and foreign employment share (49.79%), while the foreign plants output contribute 23.65% of the output in the labor intensive industries, and only 18.40% in the labor intensive industries employment.

17 17 A.4. Further breakdown on spillover from downstream in labor intensive industries Table 2(Appendix). Top 5 industries in labor intensive industries with highest purchasing within the industry ratio. Purchase from which Industry with largest % Purchase % Purchase Foreign Foreign industries (% of within Labor from other Output Labor purchasing ratio within purchase) intensive industry share share Spillover from downstream industry to 1. Wearing Apparels Except Footwear 77.03% 27.51% 17.65% 12.43% Weaving ind.(65.81%) 2. Knitting 72.49% 27.51% 12.04% 5.49% Spinning (33.71%) 3. Cordage Rope and Twine Products 63.41% 36.59% 3.95% 2.84% Spinning (27.10%) 4. Made-up Textile Goods 65.26% 34.74% 26.66% 26.66% Weaving ind.(34.66%) 5. Carpets and Rugs 59.49% 40.51% 65.60% 47.57% Spinning (39.92%) Wearing apparels except footwear (1810) largely purchase (77%) their input from the industries within labor intensive industries, weaving industry in particular (65.8%). While foreign plants production contributes to 17.65% of Wearing apparels industry. The foreign presence in these buying industries (1 st column) would be classified as spillovers from downstream industries to local plants in Weaving and Spinning industries (last column). A.5. Further breakdown on spillovers form upstream in natural intensive industries Table 3(Appendix). Top 5 industries in resource intensive industries with highest sale ratio within the industry. Industry with largest sale to industries within resource intensive industries % Sale within resource intensive industries % Sale to other industries Foreign Output share Foreign Labor share Sale to which industries (% of sale) Spillover from upstream to 1.Tobacco Processing % 32.56% Tobacco Product (67.41%) 2.Other Vegetable Animal Oils % 41.23% 7.63% 17.61% Animal Feed (44.67%) Chemical pro. (5%), 3.Basic Industrial Chem % 51.65% 34.37% 21.52% Drugs (4.5%) Soft drinks (13%) 4.Sugar % 54.40% 2.74% 2.30% Diary pro.(7.8%) 5.Synthetic Resins & Plastics % 55.95% 26.50% 19.80% Plastic wares(15%) Other Vegetable animal (1514) largely distribute their output (67.55%) to the other resource intensive industries, and their large destination is Manufacture of animal feed industry. While foreign plants production contributes to 7.63% of other vegetable animal oil s production. The foreign presence in these supplying industries (1 st column) would be classified as spillovers from upstream industries to local plants in animal feed industries (last column).