Does Foreign Direct Investment Lead to Productivity Spillovers? Firm Level Evidence from Indonesia

Whether spillovers from foreign direct investment (FDI) make any contribution to host countries’ productivity growth, remains a contentious issue in the literature. This paper aims to contribute to this debate by empirically examining the specific contribution of FDI to productivity growth in the Indonesian chemical and pharmaceutical firms using plant-level survey data from the Indonesia’s Central Board of Statistics (BPS). A unique balanced panel dataset is constructed that covers 568 firms for the period of 1988-2000. The spillover effects from FDI are analyzed using a stochastic frontier approach and productivity growth is decomposed using a generalized Malmquist output-oriented index. The results show positive productivity spillovers from FDI in the chemical and pharmaceutical sector; higher competition is associated with larger spillovers; and domestic firms with R&D gain more spillover benefits compared to those without R&D. Furthermore, technological progress is the major driver of productivity growth in the chemical and pharmaceutical firms. FDI spillovers are found to be positive and significant for technological progress. FDI is also positive, but not significant, for technical and scale efficiency change. These findings provide rationale for policies that attract FDI and support R&D in the manufacturing sector in Indonesia and elsewhere