Efficiency spillovers from FDI in the Indian machinery industry: a firm-level study using panel data models

Adopting a micro-level framework of impact of FDI in an industry, this study empirically examines the following three issues in the context of Indian machinery industry (IMI) - division 28 of National Industrial Classification, 2008. First of all, it compares the technical efficiency of foreign affiliates of multinational enterprises (FAs) against the domestic firms (DFs) to know if there are spillovers from MNEs to their affiliates. Secondly, it identifies the differences in the determinants of technical efficiency between FAs and DFs. Finally, it examines the presence (or absence) of efficiency spillovers from FAs to DFs in terms of its two major sources: competition effect and demonstration and imitation effect. To examine these issues, we first compute the firm- and year-specific technical efficiency by estimating a stochastic frontier production function with the help of an unbalanced panel of data on a sample of 177 firms for 7 years covering FY 2000/01 to FY 2006/07. Thereafter, we estimate random-effect panel data models of the determinants of firm-level technical efficiency. One of the important finding of the study is that the FAs as a ownership group maintains higher level of technical efficiency than DFs even after controlling for the additional determinants (both observed and unobserved) of technical efficiency. Another significant aspect of the finding is that the competition effect generated by FAs does not play a positive role in enhancing the efficiency of DFs. Probably, the inefficient DFs have been ousted on account of competitive pressure from the efficient FAs. On the other hand, the demonstration and imitation effects generated by FAs through their R&D activities (i.e. knowledge spillover) act as the important channel in enhancing the efficiency of DFs. In sum, FDI is found to have efficiency enhancing effect in the IMI. This finding has considerable policy implication for the IMI, which suffers from the adverse impact of high level of imports of finished goods, limited technological capabilities and operational inefficiency. In the post-WTO era, restricting imports and implementation of trade related investment measures are not the feasible options. Beside, this study also indicates that the import of disembodied technology has no impact on technical efficiency despite the IMI entering into maximum number of foreign technological collaboration agreements during August 1991 to July 2007. Given the current policy of Indian Government for 100 per cent equity participation through FDI on an automatic basis in the manufacturing sector including IMI, the firms desiring to expand their base in this industry may consider the option of attracting FDI for building additional capacities and for enhancing their efficiency levels (viz. from knowledge spillovers from MNEs) and thereby upgrading this industry for facing the challenges of the global competition