While many studies have documented the superior performance of foreign affiliates, establishing a causal relationship between foreign ownership and affiliates’ productivity is challenging because of selection bias: multinationals could have simply cherry-picked the best-performing local producers as foreign acquisition targets, or chosen to invest in the most productive industrial niches.
Researchers have dealt with this selection issue by constructing a counterfactual: using the performance of a carefully selected control group as a good approximation of how acquisition targets would have performed without foreign ownership. A common estimation technique combines propensity score matching with a difference-in-difference approach, though each study differs in terms of how the matching is done and who is included in the control group.
Arnold and Javorcik (2009) were the first to apply this methodology to study foreign acquisitions. The authors use Indonesian Manufacturing Census data to compare the performance of acquired plants with similar domestic plants operating in the same industry in the same year, over the period 1983-2001. They find that a change from domestic to foreign ownership leads to improved plant productivity, reaching a 13.5% increase in the third year under foreign ownership. These productivity improvements take place alongside increases in machinery and equipment investment, employment, average wages, and output, suggesting an on-going restructuring process. Plants receiving foreign investment also become more integrated into the global economy by exporting a larger share of their output and sourcing a larger share of their inputs from abroad. Acquired plants thus receive technology transfers through machinery and equipment as well as imported inputs. The authors also find that foreign privatizations result in better firm performance than domestic privatizations, which suggests that these beneficial effects are due to foreign ownership rather than an ownership change in general.
Proprietary technologies only constitute part of multinationals’ ownership advantages. Tacit knowledge, know-how, management techniques, and marketing strategies may be equally important drivers of multinationals’ success. The transfer of these intangible assets can be very valuable to FDI recipients in developing countries. Arnold and Javorcik’s research finds evidence of such a transfer: foreign ownership leads to higher labour productivity (and total factor productivity) without increasing the skill intensity of the labour force (defined as the share of white-collar workers in total employment) or the capital-to-labour ratio.
J. Wang and X. Wang (2015) build on Arnold and Javorcik (2009)’s approach by comparing the impact of foreign acquisitions to that of domestic acquisitions, focusing on Chinese manufacturing firms over the 2000-2007 period. They find evidence that both types of ownership changes are beneficial for target firms. Compared to domestic acquisitions, foreign ownership does not necessarily increase target firms’ productivity, but it does improve their financial condition (measured by the leverage and liquidity ratios), and also boosts their exports, output, employment, and wages. In contrast, Chen (2011), who uses data from the US for 1979-2006, finds that acquisitions by firms from industrialized countries lead to a 13% higher labour productivity increases in the target firms three years after the ownership change than acquisitions by domestic firms. Foreign ownership also tends to increase their targets’ employment and sales.
Several explanations are consistent with the observed patterns. It is likely that new foreign owners introduce organizational and managerial changes that make the production process more efficient by reducing waste, lowering the percentage of faulty products and using labour more effectively[1]. It is also possible that although foreign owners do not alter the skill composition of labour, they are able to attract more experienced and motivated employees. They may also substitute expatriate staff for local managers and introduce pay scales linked to performance. This would be consistent with the earlier observation that acquired plants hire a large number of new workers and increase the average wage[2]. Finally, foreign owners may invest more in staff training[3]. Another possibility is that the use of higher-quality inputs or more suitable parts and components translates into higher productivity, which is consistent with the observed increase in the use of imported inputs after foreign acquisition.
Foreign ownership can also benefit consumers. Stiebale and Vencappa (2018) study the impact of foreign acquisitions in India over the period 1998-2011. A unique feature of their dataset is that it contains product-level information (prices and quantities) for each firm, as well as standard measures of firms’ input expenditures, which allows them to measure product quality and a firm’s cost structure (marginal costs of production and product markups).
Relative to a carefully-chosen comparison group of non-acquired firms, foreign acquisitions result in a large increase in sales, which are mainly driven by higher sales of existing products, with no impact on productivity. The impact on product quality and costs provides more interesting insights. Foreign acquisitions, especially from technologically advanced countries, lead to significant decreases in marginal costs that are fully offset by higher markups, resulting in only small changes in prices on average. This increase in prices and markups seems to be driven by enhanced product quality rather than market power. Sales increase upon acquisition, both in absolute terms and conditional on prices, which is consistent with quality upgrading. The average unit value (total value of sales divided by quantity) of material inputs increases post-acquisition, suggesting that input quality is reflected in both input prices and output quality. Overall, their results indicate that knowledge transfer from foreign acquirers to domestic firms can result in both cost savings and improvements in quality, benefitting both firms and consumers.
Bircan (2019)’s study on Turkish plants during 1991-2001 is very similar to that of Stiebale and Vencappa (2018) in terms of data and methodology, except that it focuses entirely on firm-level outcomes (rather than outcomes at the firm and product level). Bircan’s findings suggest that following a foreign acquisition, revenue productivity at target plants rises by up to 9%: a 13% improvement in physical productivity, which is accompanied by a 4% drop in real output prices. Firms’ post-acquisition markups are only slightly higher, suggesting that customers also benefit from the cost-savings associated with greater physical productivity.
In sum, the evidence from the existing literature indicates that knowledge transfer takes place between headquarters and foreign affiliates, which then gives foreign affiliates the potential to become sources of knowledge externalities. We will return to this point in Section IV.
[1] Sutton (2005) gives a relevant example of organizational changes introduced by a foreign investor in its Chinese affiliate. According to the interviewed engineer, what mattered was not the obvious alteration to the physical plant, but rather the shift in work practices. This shift involved a move away from traditional notions of inspection at the end of the production line to a system in which each operator along the line searched for defects in each item as it arrived and as it departed. Constant monitoring avoided further resource wastage on defective units, and resulted in a lower share of products that needed rejection at the final quality control stage. More importantly, this system allowed the sources of defects to be quickly identified and rectified.
[2] Cho (2018) provides empirical evidence of the prevalence and importance of manager transfers to affiliates of multinational corporations. The study, using data on foreign affiliates of Korean MNCs, finds that most foreign affiliates have managers transferred from their parent companies. These transferred managers at first comprise a significant portion of the managerial positions at foreign affiliates, but gradually become outnumbered by local managers as the affiliates grow. Despite the transferred managers being comparatively few in number, they are positively associated with the growth of the affiliates’ productivity.
[3] Koch and Smolka (2019) show that foreign-acquired firms in Spain actively raise the skills of their workforce by providing worker training
