Multinational companies frequently benefit from tax breaks and other incentives by host governments in the hope that they can generate benefits to the local economy. Many countries also require them to enter into joint ventures or contractual agreements with local producers to maximise efficiency gains at recipient firms. For instance, Jiang et al. (2018) document substantial technology transfer to joint venture partners in China.
However, evidence is mixed on how multinational activity affects productivity and competitiveness in host economies. Do foreign owners actually improve efficiency at acquired firms, or are they driven more by considerations of market power? Does multinational activity generate efficiency gains regardless of ownership structure, or are some ownership structures more beneficial to host economies than others?
The role of ownership structure in reaping the benefits of FDI
In a recent paper (Bircan 2019), I answer these questions and document how multinational ownership affects productivity, competition, and selection in the local economy. I argue that ownership structure plays a crucial role in determining the benefits from foreign direct investment (FDI). I take advantage of a new dataset from Turkey’s manufacturing census to strip the effect of changes in market power on productivity. The dataset provides variation in multinationals' ownership structure within plants and multinational activity within industries over time. This variation is important because it shows that multinationals choose to hold a range of equity ownership at affiliates even in the absence of a policy requirement on shared ownership.
It has been a major challenge empirically to isolate the productivity effects of FDI and acquisitions from market power considerations. For instance, acquisitions that increase market power tend to raise output prices, which are reflected as a productivity gain in a typical revenue-based measure even in the absence of changes to technical efficiency (Braguinsky et al. 2015). Therefore, I first separate a typical productivity measure into its technical efficiency and price components.
My first set of findings documents the impact of multinational investment on acquired plants. Following acquisitions, revenue productivity at target plants rises by up to 9%. However, this figure masks considerable variation in the underlying components of revenue productivity. Target plants in fact see improvements in physical productivity by 13%, which is accompanied by a drop in real output prices by 4% on average. Their markups are only slightly higher following acquisition, suggesting that most of the cost-savings reflected by the rise in physical productivity is passed on to acquired plants' customers. Less than a fifth of the post-acquisition effect is due to multinationals' targeting plants with relatively high levels of prices and markups prior to acquisition.
I extend my analysis by studying how ownership structure affects acquired plants. Physical efficiency gains and reductions in price are much higher in the case of majority-owned affiliates. My findings suggest that ownership structure affects how multinationals identify investment targets and what they change at acquired plants. For instance, majority-owned affiliates are much more likely to start exporting and become importers of intermediate inputs following an acquisition.
I also find that multinationals from countries that invest more in research and development (R&D) or that are members of the EU increase physical productivity more than revenue productivity in the sample. These results are consistent with the view that ownership structure affects the degree of technology transfer and the distribution of gains from FDI (Asiedu and Esfahani 2001). They also suggest that the effects may extend beyond the investment targets if the rest of the industry responds to price and employment dynamics due to multinational activity.
My second set of findings documents how multinationals impact on domestic plants operating in the same industry through horizontal spillovers. Acquired plants increase competition by lowering output prices. This is expected to have two effects:
- First, it may induce a price reduction at surviving domestic plants and a corresponding increase in physical efficiency to meet the profitability threshold for survival.
- Second, cutoff productivity for survival may increase and inefficient domestic businesses that cannot compete may be driven out.
My results provide strong evidence for the first prediction. Greater presence of multinationals is associated with higher physical productivity and lower prices at domestic plants in the same industry, especially when multinational affiliates are majority-owned. Physical efficiency at domestic plants responds by a larger extent than the drop in price, which translates into positive but insignificant spillovers of revenue productivity. A back-of-the-envelope calculation suggests that increased multinational activity accounts for just over 10% of the rise in average physical productivity of domestic plants over the sample period.
I also find suggestive evidence for the second prediction. Domestic plants that operate in industries with greater multinational presence also display higher technical efficiency and lower prices.
There are three separate theoretical frameworks that generate predictions consistent with these empirical findings. First, Shimomura and Thisse (2012) present a model in which a few big firms set prices strategically and compete with smaller firms that are unable to do so. In their model, the entry of big firms leads them to sell more through a market expansion effect generated by the shrinking of the monopolistically competitive fringe. Big firms therefore have an incentive to lower prices and drive less efficient businesses out of the market, which leads to a reduction in the aggregate price index. As I show in my paper, multinationals are typically big players in their industries and industry-level prices grow at a lower rate in industries with greater multinational presence.
Second, results are in line with what Foster et al. (2016) call “demand accumulation by doing”: new entrants in a market may lower prices today to attract buyers and build a customer base at the expense of current profits. I show in my paper that majority foreign-owned affiliates, for which there is a strong negative price drop following an acquisition, are also those that experience a considerable increase in market share.
Third, Chevalier and Scharfstein (1996) show that liquidity constraints affect pricing behaviour in a model of product market competition in which firms need to raise external funds to finance operations and they price for market share. In line with the suggestion that financial frictions affect pricing behaviour, I find that acquired plants lower their prices by more in industries that are more dependent on external finance. I find this pro-competitive effect to be especially strong when multinationals take a majority equity share, which provides firms a healthy financial injection.
These findings have important implications for the evolution of aggregate productivity and the role multinational activity plays in driving it. They suggest that the effects of FDI on productivity growth may be previously under-estimated. Ownership structure is linked to foreign affiliates' ability to lower prices and affect market shares, which in turn affects the selection of domestic plants for survival. More importantly, domestic plants that compete in the same product markets with multinationals have to raise their technical efficiency in order to survive. Hence, my findings point to a more prominent role of selection and reallocation between firms in explaining the effects of FDI on aggregate productivity than previously thought.
Asiedu, E and H S Esfahani (2001), “Ownership structure in foreign direct investment projects,” Review of Economics and statistics 83(4): 647-662.
Bircan, Ç (2019), “Ownership structure and productivity of multinationals,” Journal of International Economics 116 125-143.
Braguinsky, S, A Ohyama, T Okazaki and C Syverson (2015), “Acquisitions, productivity, and profitability: evidence from the Japanese cotton spinning industry”, American Economic Review 105(7): 2086-2119.
Chevalier, J A and D S Scharfstein (1996), “Capital-Market Imperfections and Countercyclical Markups: Theory and Evidence,” The American Economic Review 86(4): 703-725.
Foster, L, J Haltiwanger and C Syverson (2016), “The slow growth of new plants: Learning about demand?” Economica 83(329): 91-129.
Jiang, K, W Keller, L D Qiu and W Ridley (2018), “International Joint Ventures and Internal vs. External Technology Transfer: Evidence from China,” NBER Working Paper No. w24455.
Shimomura, K I and J F Thisse (2012), “Competition among the big and the small,” The Rand Journal of Economics 43(2): 329-347.