Foreign Direct Investment Effects on Domestic Firm Performance

Foreign direct investment (FDI) plays a pivotal role in shaping the competitive landscape and technological frontier of host economies. When multinational enterprises (MNEs) establish affiliates abroad or acquire domestic firms, they often introduce advanced production processes, enhanced management practices and deeper integration into global value chains. These dynamics can boost productivity, stimulate capital deepening and foster technological progress. Local firms may benefit from knowledge spillovers—both horizontal, within the same industry, and vertical, across supply chains—as well as from improved access to export markets and higher quality inputs. However, the magnitude of these gains depends on the absorptive capacity of domestic firms, determined by their human capital, research and development capabilities and existing technological sophistication. Competitive pressure from foreign investors can also induce efficiency improvements among indigenous firms, although it may lead to crowding out when local firms lack the capacity to adapt. Empirical evidence reveals considerable heterogeneity by sector, firm size and country context: high-technology industries tend to attract larger productivity gains, whereas low-tech sectors may experience limited spillover benefits. Policymakers aiming to maximise the developmental impact of FDI often focus on strengthening domestic innovation systems, improving workforce skills and ensuring a regulatory environment that balances competition with collaboration. Concrete examples from manufacturing, automotive and high-value services illustrate how FDI has driven productivity convergence in emerging and advanced economies alike, underscoring its global significance and practical applications in development strategy.

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Technical terms

Foreign direct investment (FDI): Cross-border investments by firms to establish or acquire lasting interests in enterprises abroad.

Productivity spillover: The transfer of technology or know-how from foreign to domestic firms, boosting local efficiency.

Absorptive capacity: The ability of a firm to recognise, assimilate and apply external knowledge.

Horizontal spillover: Knowledge diffusion among firms operating in the same industry.

Vertical spillover: Knowledge transfer along supply chains, from suppliers to buyers or vice versa.

Cross-border acquisition: A form of FDI in which a foreign investor purchases a controlling stake in a domestic firm.

References

1. Internationalisation as a boost for many firms: evidence from Germany. Review of World Economics (2024).
2. The effects of cross‐border acquisitions on firms' productivity in the EU. World Economy (2023).
3. Vertical spillovers from multinational enterprises: Does technological gap matter?. Panoeconomicus (2016).