Engaging in FDI is costly because it requires setting up new productive facilities. Moreover, foreign affiliates are disadvantaged relative to indigenous competitors, who are more familiar with the local rules and regulations and consumers’ preferences. Therefore, only the most productive firms or firms that possess "ownership advantages" are able to successfully compete in foreign markets (Dunning 1988). According to Dunning, these ownership advantages are intangible assets that can take the form of new technologies, know-how or management techniques, and well-established brand names. These assets are developed in headquarters but can easily be transferred to foreign subsidiaries without compromising productivity. The more recent theory of heterogeneous firms predicts that multinationals have higher productivity than other firms in their country of origin because only the most productive establishments can afford the extra cost of setting up production facilities abroad (Helpman, Melitz, and Yeaple 2004).
Consistent with the existence of ownership advantages, the data confirm that multinationals have, and continue to be, heavily involved in creating new knowledge by engaging in research and development (R&D) activities. In 1995, more than 80% of global royalty payments for international transfers of technology were made from foreign subsidiaries to their parent firms (UNCTAD 1997). In 2002, just 700 firms (almost all of them multinational corporations) accounted for 46 percent of the world’s total R&D expenditure and 69 percent of the world’s business R&D spending (UNCTAD 2005). In 2018, the top 100 global companies invested more than $350 billion in R&D, representing over a third of business-funded R&D worldwide (UNCTAD 2019).
In sum, multinational corporations are major producers of knowledge and innovation, but do they transfer this knowledge to developing countries where they operate? This is the question to which we turn next, by focusing on the impact of foreign ownership on firm productivity.
