Foreign Direct Investment Spillover Effects on Domestic Firm Productivity

Foreign direct investment (FDI) can enhance the productivity of domestic firms through multiple spillover channels. When multinational enterprises enter a host economy, domestic firms gain access to superior technologies, managerial practices and production processes. Such transfers may occur horizontally across firms in the same industry, vertically through supplier–buyer linkages or via demonstration and competition effects that stimulate domestic firms to innovate. Empirical evidence points to gains in total factor productivity, improvements in technical efficiency and the emergence of new entrants in sectors exposed to foreign presence. The magnitude of these effects depends on host-country characteristics such as human capital, institutional quality and firms’ absorptive capacity. In regions with well-developed infrastructure and supportive policies, the benefits of FDI tend to be more pronounced and long-lasting.

Globally, insights into FDI spillovers inform policy debates on trade liberalisation, investment promotion and skill development. By understanding how foreign investors influence domestic performance, governments can design targeted interventions—such as incentives for technology adoption, joint training programmes and measures to foster linkages—to maximise developmental impact while mitigating potential crowding-out of local enterprises. This body of research underscores the importance of a balanced policy mix that leverages the strengths of multinational firms and nurtures the capabilities of domestic industries.

Research from Nature Portfolio

Recent studies have examined micro-level data to assess how FDI shapes innovation outcomes within domestic manufacturing. One analysis of Chinese firms highlights that foreign investment not only elevates overall innovation performance but also operates through distinct spillover and competition effects. High-productivity, capital-intensive and export-oriented domestic enterprises experienced particularly strong benefits, while non-coastal and privately owned firms also saw marked improvements. The findings reveal heterogeneity in how local firms absorb foreign knowledge, emphasising the role of firm size, ownership structure and market positioning in mediating productivity gains.

Foreign Direct Investment Spillover Effects on Domestic Firm Productivity publication trend

The graph below shows the total number of articles in foreign direct investment spillover effects on domestic firm productivity across all publications each year (not limited to Nature Index journals).

Technical terms

Spillover effect: The impact of foreign-owned firms on the productivity and performance of domestic firms through knowledge and technology transfer.

Total factor productivity (TFP): A measure of output growth that accounts for the combined contributions of labour and capital inputs.

Demonstration effect: The process by which domestic firms learn by observing foreign firms’ technologies, practices and organisational methods.

Competition channel: The mechanism through which increased foreign presence intensifies market rivalry, motivating domestic firms to enhance efficiency and innovation.

Absorptive capacity: The ability of a firm to recognise, assimilate and exploit external knowledge and technologies for productivity improvements.

References

1. The Effects of Joining Multinational Supply Chains: New Evidence from Firm-to-Firm Linkages*. The Quarterly Journal of Economics (2022).
2. Improving the developmental impact of multinational enterprises: policy and research challenges. Journal of Industrial and Business Economics (2018).
3. Foreign direct investment and knowledge diffusion in poor locations. Journal of Development Economics (2022).
4. The FDI Spillover Effect on the Efficiency and Productivity of Manufacturing Firms: Its Implication on Open Innovation. Journal of Open Innovation: Technology, Market, and Complexity (2022).
5. Foreign direct investment and the innovation performance of local enterprises. Humanities and Social Sciences Communications (2022).