Study Overview
We explore how firm capabilities affect the diffusion of technology brought with foreign direct investment (FDI). Using a panel dataset on Indonesian manufacturers from 1988 to 1996, we measure how the productivity of differing domestic firms responds to the entry of multinational competitors. We find that firms with investments in research and development and firms with highly educated employees adopt more technology from foreign entrants than others. In contrast, firms that have a small “technology gap,” meaning that they are close to the international best-practice frontier, benefit less than firms with weak prior technical competency. This finding suggests that the marginal return to new knowledge is greater for firms that have more room to “catch up” than it is for already competitive firms.
Study Results
Our major result is to find that firm capabilities affect technology adoption in three ways. Firms with greater absorptive capacity, higher levels of human capital, but with lower prior technical competency, are the prime beneficiaries of technology from FDI. Whereas one might initially think that more competent firms could benefit the most from FDI, the evidence suggests that firms far from the best-practice frontier gain more. We believe the “low hanging fruit” idea explains this result: firms with poor initial technology are more likely to encounter new processes that yield high returns at low cost. This explanation is partly conditional on the idea that technology brought with FDI is relatively mature and can be adopted without extensive further development.