Innovation, productivity and foreign direct investment-induced R&D spillovers

This article examines the effect of foreign direct investment on innovation and productivity in the host and home countries. I investigate how the flows of knowledge transmitted through FDI affect the production of knowledge in both source and recipient countries, as well as how these flows affect productivity. Using patent citations within FDI as the measure of the degree of 'access' that one nation gains to the R&D knowledge of another, and new patents as the measure of innovation, results reveal that there are large differences in the way FDI affects innovation and productivity between countries that are technological leaders, and technological followers. Both inward and outward FDI are found to have a strong positive effect on domestic innovation and productivity in countries that are technological followers. For technological leaders, outward FDI is highly conducive to increased domestic innovation, while inward FDI seems to increase competition between domestic and foreign firms, making it more difficult to come up with new viable ideas. As for domestic productivity, inward FDI is highly beneficial for technological leaders, while outward FDI does not have a significant effect. I conclude that technological followers have much to gain from FDI-induced R&D spillovers, and therefore governments in these countries will find it worthwhile to attract foreign multinationals, while those in the more technologically advanced economies need to weigh the costs and benefits of FDI carefully.