Foreign Direct Investment and Productivity of local manufacturing firms - Empirical Evidence from South Africa

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1 Foregn Drect Investment and Productvty of local manufacturng frms - Emprcal Evdence from South Afrca Amon Magwro Unversty of the Free State QwaQwa Campus Department of Economcs Prvate bag X13 Phuthadtjhaba South Afrca Tel: +27 (58) Mob: +27(0) E-mal: magwroa@ufs.ac.za / magwro@gmal.com Dwambuena Mabulango Josue Unversty of Quebec Canada E-mal: josuedwa@gmal.com Prof. Dr. rer. pol. habl. Henz Eckart Klngelhöfer Tshwane Unversty of Technology Ga-Rankuwa Campus Department of Manageral Accountng and Fnance Prvate Bag X680 Pretora 0001 South Afrca Tel.: +27 (0) Fax: +27 (0) Mob.: +27 (0) E-Mal: KlngelhoeferHE@tut.ac.za 1

2 Foregn Drect Investment and Productvty of Local Manufacturng Frms - Emprcal Evdence from South Afrca Abstract South Afrca s eager to attract more foregn Drect Investment (FDI) nflows to offset ts defct n domestc savngs and accelerate ts economc growth. Success n attractng hgher FDI nflows may be assocated wth negatve spllovers effects to local frms. To the extent that the growth of local frms s an mportant development objectve for the South Afrcan government, ths paper presents an n depth frm level cross sectonal analyss of the possble effects of FDI to local manufacturng frms n South Afrca. Results show that FDI frms are more productve than ther local counterparts. Furthermore, evdence of negatve ntra-ndustry spllovers effects as well as postve nter-ndustry spllovers effects s found but nsgnfcant. As such, the paper recommends to polcymakers to adopt nvestment polces that encourage synerges between MNCs and local frms busnesses n all manufacturng sectors. Keywords: Foregn Drect Investment, Input-Output Table, Techncal Coeffcents, Spllovers, Productvty 2

3 1. Introducton Foregn Drect Investment (FDI) s commonly defned as a long lastng nvestment by a foregn nvestor of at least 10 per cent of ordnary shares or votng powers n the management of a company that s resdent n the host country (IMF 1993; OECD, 1996). Hence, FDI may be vewed as an mportant strategy that developng countres lke South Afrca may use to reduce ther technology gap wth developed countres, to reduce ts defct n domestc savngs and promote ther economc development (Fndlay 1978, Strydom, 2007). FDI has also been reported to be an mportant source of external fnancng whch does not only boost domestc captal formaton of recpent countres but also enables the transfer of technology between the home and host countres (Gruben and Mcleod, 1998; Carkovc and Levne, 2002). Multnatonal corporatons (MNCs) are enterprses that control and manage producton enttes n at least two countres (Teece, 1985). Because of ther characterstcs, they are regarded as the chef condut for foregn drect nvestment (Caves, 1971:1). Agosn and Machado (2005) defne FDI as captal nflows that MNCs brng to the host country n the form of sophstcated new technology, manageral sklls and product desgn. By transferrng technology, FDI may affect the productvty of local frms. In ths regard, Cuyvers (2008) argues that technology transfer from MNCs to local frms, whch occurs through the ndrect effect of FDI, rases labour productvty of local frms and, thus, t s the most sgnfcant spllover effect. In the same breath, Groud (2013) also ponts out that through the establshment of lnkages n the host country, MNCs may dffuse technology to local frms. Lnkages may be defned as the drect relatonshps establshed by frms n complementary actvtes whch are external to pure market transactons (Lall, 1980: 204). Lnkages may be seen as drect relatonshp between MNCs afflates and local supplers or MNCs afflates and local customers. Followng on these successve arguments, t can be dscussed that the success n attractng hgher level of FDI nflows may be assocated wth some spllover effects and lnkages from whch local frms may beneft n order to rase ther productvtes. Productvty spllovers occur when local frms mprove ther productvtes through the use of MNCs afflate s technologcal advantages wthout ncurrng any cost that would offset ths mprovement (Blomström, Kokko and Zejan, 2000). They further defne spllover as a stuaton n whch MNCs afflates are not able to reap all the benefts due to ther nternalsaton advantage n the host country. Wth a vew to reapng all these spllovers benefts, developng countres n 3

4 general have put n place nvestment polces, through for nstance fscal and fnancal ncentves such as holday tax and; reducton n mport tax, that are favourable to attract more FDI n recpent countres (Oman 2000). In the last two decades, the amount of FDI nflows has consderably ncreased n South Afrca. For example, t has been recorded an ncrease n FDI nflows from ZAR 81 mllon n 1997 to 1,016 bllon n 2010`(Sandrey 2013:3, Arvants 2006:66). 1.1 Ratonale of the study A number of studes have been carred out n developed, developng and emergng economes to determne the extent to whch local frms may beneft from the presence of MNCs (FDI) through varous spllovers channels, affectng ther productvty (Caves, 1974; Globerman, 1975; Haskel et.al, 2002; Barros and Strobl, 2002; Haddad and Harrson, 1993; Blomström and Wolff, 1994; Blomström and Sjöholm, 1999; Hale and Long, 2006; Atken and Harrson, 1999; Knoshta, 2000; Javorck, 2004; Alfaro and Rodríguez, 2004; Buckley, Clegg and Wang, 2007; Javorck and Spateneanu, 2008; Blalock and Gertler, 2008, Belderbos, 2010, Nhamo, 2011). However, the fndngs of these studes have been found to be mxed and nconclusve. Ths suggests that the extent to whch local frms beneft from FDI spllovers may depend on country specfc requrements and condtons. Thus, t s mportant to assess the possble ndrect effects of FDI on the productvty of local manufacturng frms n South Afrca. The ratonale of ths paper s based on the dea that the growth of local frms through the mprovement n productvty s an mportant natonal development objectve for the South Afrcan government snce these frms are regarded as key drvers of job creaton n the country. Hence, the results of ths study should assst polcymakers to evaluate exstng nvestment polces and to formulate polces that are most lkely to attract FDI nflows n South Afrcan manufacturng sectors wth potental of strong postve spllover effects. 1.2 Problem nvestgated Followng the above dscusson, the man problem rased s that the success n attractng hgher level of FDI nflows (or the presence of MNCs) n the host country (South Afrca) may be assocated wth postve or negatve spllovers effects that may affect the productvty of local frms. Postve spllovers may occur through technology transfer, for nstance when local frms mtate the technologes and producton processes of MNCs, or through the mprovement n the allocaton of resources or effcency mprovement by local frms due to competton 4

5 pressure. Negatve spllovers may occur for example when MNCs take demand away from local compettors and drve less effcent local frms out of the market. 1.3 Research objectve of the study The prmary purpose of ths study s to examne whether there s any productvty dfference between MNCs and local manufacturng frms n South Afrca. In addton, the paper ams to nvestgate whether there are any horzontal (ntra-ndustry) and vertcal (nter-ndustry) spllover effects from MNCs to local frms. 1.4 Research Hypothess In ths paper, we hypothesze that because of technology ownershp, MNCs wll be more productve than local frms. Furthermore, we expect that on one hand, there wll be postve nter-ndustry spllover effects from MNCs to local frms n South Afrca whereas on the other hand, there wll be negatve ntra-ndustry spllover effect from MNCs to local manufacturng frms. The reason s that wth MNCs lnkages (backward and forward lnkages), MNCs are more wllng to share technology wth local frms n downstream and upstream ndustres. Nonetheless, for horzontal ndustry, t s expected that MNCs wll be reluctant to share technology wth local frms gven that these latter are consdered as local compettors. The rest of ths paper proceeds as follows: secton (2) revews the lterature (both theoretcal and emprcal) on FDI and productvty spllovers channels (both ntra-ndustry and nterndustry), secton (3) explans the methodology. In secton (4), the econometrc analyss s carred out and, concludng, secton (5) also derves recommendatons and polcy mplcatons. 2. Lterature revew 2.1 Theoretcal lterature Lterature postulates that local frms may beneft from FDI technology spllovers, thus mprovng ther productvtes through a number of channels. However, the lterature dstngushes between ntra-ndustry spllover effect (these occur when MNCs and local frms operate wthn the same ndustry) and nter-ndustry spllover effects (these occur when MNCs transfer technology to local frms(supplers and customers) va backward and forward lnkages) (Dwambuena, Klngelhöfer and Kaggwa, 2014:4). Both forward and backward lnkages are defned and dscussed later n ths paper. Below both the ntra-ndustry and nter-ndustry spllover channels are explaned. 5

6 2.1.1 Horzontal or ntra-ndustry spllovers The lterature dentfes four channels that allow technology transfer from MNCs afflates to local frms wthn the same ndustry. These channels are (1) demonstraton effects, (2) labour turnover, (3) competton effects, and (4) geographcal proxmty or regonal dmenson: The demonstraton effects are defned as effects on local frms by observng MNCs. These effects may occur through mtaton, nnovaton and reverse engneerng (Suyanto and Bloch, 2009). Imtaton occurs when local frms repeat the same technology used by MNCs n ther producton of output whle nnovaton occurs when a local frm adopts the technology of a foregn frm as a startng pont n order to develop mproved technologes to be used for ts producton of goods, e.g. by reverse engneerng to dscover the processes behnd ther products (Blankestjn, 2012). Thus, the demonstraton effect channel emphasses that local frms may beneft from technology spllovers from MNCs by mtatng ther producton technques, knowledge, and new technologes so that they wll rase ther output and decrease ther cost of productons (Blomström and Kokko, 1998; Görg and Greenaway, 2004; Alfaro et al., 2004; Atken and Harrson, 1999). However, Görg and Greenaway (2004:173) argue that the degree of mtaton of MNCS technologes by local frms depends on the level of complexty of ther products and processes. The labour moblty (turnover) channel explans that local frms may beneft from technology spllovers from MNCs by hrng workers and managers who were prevously employed (and traned) by MNCs afflates (Gerschewsk, 2013:69). These MNCs former employees enable local frms to produce goods more effcently, hence mprovng ther productvtes (Gerschenberg, 1987; Alfaro et al., 2004; Atken and Harrson, 1999; Meyer, 2004). As an example, Blomström (1989) reports that n Mexco, most managers of local frms start ther career n MNCs afflates. Thus, through the use of management practces acqured at MNCs, these managers may substantally mprove the productvty of local Mexcan frms. In addton, Hale and Long (2006) also pont out that through learnng and nteracton actvtes between local frs employees (managers and engneers) and ther MNCs colleagues, local frms may ncrease ther productvtes. Hale tres to explan that by nteractng wth people who are workng for MNCs through for nstance attendng semnars, shows and conferences, local frm s employees are exposed to advanced technologes and management practces used by MNCs afflates. Thus, they may adopt these new technologes, processes and practces n ther own frms and mprove ther productvty ( network externalty effect ). Nevertheless, Glass and Sagg (2002) dscuss that MNCs afflates may lmt technology transfer to local frms va 6

7 the labour turnover channel by payng hgher wages to ther workers relatve to ther local compettors. Wth regard to the competton effect channel, accordng to Caves (1974), the presence of MNCs asssts local frms n mprovng ther effcency n resource allocaton n the recpent country. He argues that by enterng nto a the local market wth hgher entry barrers, MNCs reduce the market power of local frms, compete for factor nputs wth local frms and force local frms to mprove the use of ther exstng resources n the host country. In the same breath, some authors argue that the presence of MNCs helps to mprove the techncal and allocatve effcency of local frms through compettve pressures (Blomström and Kokko, 1998; Görg and Strobl, 2001; Glass and Sagg, 2002). They stress that the entry of MNCs n monopolstc market s expected to rase competton n the host country, force local frms to protect ther market share and profts, hence becomng more effcent. The explanaton could be that competton enhances the pace of mtaton of new technologes by local frms (Görg and Strobl, 2004:174). However, the competton effect may also have adverse effects on the productvty of local frms n the host country. Ths effect s referred to as the market stealng effect by Atken and Harrson (1999). It s argued that because MNCs have ownershp of specfc advantages over local frms, they are able to reduce ther margnal and average costs and take demand away from local frms. MNCs may also take demand away from ther local compettors by ntroducng dfferentated products and adoptng new process nnovaton system (as one could see wth the ntroducton of the Just n Tme producton system n the 20th century), whch may lead to a fall n the prce of products n the host country (Buckley et al., 2006). It s further stressed that the presence of MNCs forces local frms to ncrease ther average and overall cost of producton whch force them to cut ther producton. Thus, through ths effect, MNCs reduce the growth opportuntes of local frms and obtan ther economes of scale whch cause, less effcent local frms to drve out of the market (Atken and Harrson, 1999; Konngs, 2001; De Backer and Sleuwaegen, 2003; Belderbos and Van Roy, 2010:5-6). Fnally, apart from outcompetng local frms, MNCs are also reported to create monopoles that assst them n repatratng profts and avodng taxes n the host country through transfer prcng practce (Blomström and Kokko, 1998). The geographcal proxmty or regonal dmenson channel hghlghts that the dssemnaton of technology from MNCs to local frms requres ntense contact between MNCs and local frms. Hence, local frms that locate closer to MNCs beneft more from the technology spllovers 7

8 (Arrow, 1971; Ponomareva, 2000), because t s cheaper for them to mtate the technologes of MNCs, vst and communcate wth MNCs workers and organse specal tranng for local workers n collaboraton wth MNCs afflates (Lang, 2008:11-12). The geographcal proxmty channel s reported to be an mportant prerequste for the demonstraton effect, especally mtaton, to be effectve (Sagg, 2002). It has also been dscussed that the extent to whch local frms may beneft from FDI spllovers effects depend on the mnmum absorptve capacty of local frms (Lall, 1996; Crespo and Fontoura, 2007). For nstance, the necessary human captal, physcal nfrastructure, research and development actvtes (R&D) and dstrbuton networks to sustan nward FDI (Glass and Sagg, 1998). Thus, ths argument suggests that the lack of mnmum absorptve capacty, through hgher technology gap, mples lower qualty of technology or knowledge to be dffused to local frms (Görg and Greenway, 2004) Vertcal or nter-ndustry spllovers In contrast to horzontal spllovers, vertcal spllovers are argued to occur through lnkages. We dstngush two types of lnkages: backward and forward lnkages. Backward lnkages occur when there s a contact between domestc supplers of ntermedate nputs and ther MNCs customers n downstream sectors n the recpent country, forward lnkages when there s a contact between MNCs supplers of ntermedate nputs and ther clents n upstream sectors n the host country whle (UNCTAD, 2001). Backward lnkage Backward lnkages occur when MNEs establsh drect relatonshp wth local supplers of ntermedates nputs (UNCTAD, 2001). Earler models called love of varety and postve development effect theorem by Rodrquez-Clare (1996) and Markusen and Venables (1999) respectvely help to crtcally understand backward lnkage. In hs model, Rodrquez-Clare dscusses that MNCs produce sophstcated products and thus, they requre complex and dverse nputs. As a result, through the establshment of local supplers, the demand for these sophstcated nputs wll provde opportuntes for local producton of nputs and employment of local workers, hence leadng to an ncrease n the demand for factor nputs n the host country (Groud, 2003). Markusen and Venables (1999) further support that backward lnkage wll nduce managers of local frms to work effcently and make ratonal decsons on nvestments. It s also dscussed that through backward lnkage, MNCs may transfer knowledge to local supplers whch wll help them mprove ther management as well as technology capactes and 8

9 thus, become more effcent (Gerschewsk, 2013). Ths transfer may occur by (1) provdng them wth management tranng and techncal assstance throughout the entre producton process, (2) helpng them buy raw materals and montorng qualty control and (3) By mposng hgher requrement for product qualty and on tme delvery of nputs. Fnally, Katz, (1969:154) and Javorck (2004) argue that the presence of MNCs may force local frms to modernse ther producton technques whch may lead to economes of scale. Ths may occur for example by upgradng ther producton management and qualty standards, or by ntroducng on tme delvery As an example of backward lnkage n the US automotve sector, Chung (2003) mentons Japanese transplants n the USA that encourage ther local supplers of automotve components nputs to adopt and mplement new operatng practces smlar to those used n Japan. Another example s provded by Javorck (2004:608). He explans that t s accustomed that every tme a Czech automotve suppler of alumnum alloy castngs sgns ts frst agreement wth ts MNCs clent, the MNCs workers would vst the Czech frm s ste for two days each month over a long perod of tme. They (both MNCs and local frms employees) work on mprovng the qualty control system. After the tranng, the Czech frm apples these mprovements to ts other producton lnes. Furthermore, t s also dscussed that strong backward spllovers are most lkely to come from local frms that have mxed ownershp (UNCTC, 2001; Javorck, 2004). In ths regard, UNCTC (2001) reports that strong spllover lnkages effects are most lkely to occur from local frms wth some form of partal ownershp,.e. when MNCs enter the host country through jont venture or mergers and acqustons (M&A), rather than from those wth full foregn ownershp such as Greenfeld projects. The argument s that wth the former, MNCs are most lkely to source locally rght at the begnnng of ther operatons,.e. they may take over the exstng suppler of the acqured frm, whereas wth the latter, they must put more effort nto developng new local lnkages (Javorck, 2004). However, ths vew s not shared by Blomström and Sjöholm (1999) who ponts out that t s very dffcult to talk about full foregn ownershp n the host country because host governments do not often accept full foregn ownershp frms n ther countres. For nstance, they may only allow M&A as a form of MNCs entry (Gerschewsk, 2013:71). Forward lnkage 9

10 Blomström (1991) supports the dea of forward lnkage and thus of the ncreasng role of MNCs-customer contacts n host countres. He explans that compared to local frms, MNCs are the only ones who have the necessary fund to nvest n research and development (R&D) that enable them to develop and produce complex nputs and products of hgher qualty. Hence, ths may suggest that MNCs should be supplers of ntermedate nputs. The use of sophstcated applcatons n producton such as computer based automaton, nformaton technologes n the producton of output, would requre the expertse from the manufacturers. Thus, the relatonshp between MNCs supplers and local clents s very mportant. In the same breath, Lang (2008:6) argues that through forward lnkage, foregn supplers provde ther local customers wth the necessary technology support and tranng when they buy these ntermedate nputs. As a result, local frms may ncrease ther productvtes by usng hgh qualty nputs from foregn supplers. Smlarly, Javorck (2004) dscusses that by buyng new, superor and less costly ntermedate nputs manufactured by MNCs, local frms may ncrease ther productvtes because the sales of ntermedate nputs by MNCs s often accompaned wth the provson of supplementary servces that may not be avalable through the mport of these nputs. 2.3 Emprcal revew Emprcal evdence for ntra-ndustry spllovers A number of emprcal studes on FDI and productvty of local frms n horzontal ndustry have been carred out n developng and emergng countres. These studes sought to nvestgate the exstence of horzontal spllovers n these countres, but ther fndngs have been mxed and nconclusve. These studes used dfferent methodologes. For nstance some of them used the cross sectonal method (Haddad and Harrson, 1993; Kokko, 1994; Blomström and Wolff, 1994; Kokko et al., 1996; Blomström and Sjöholm, 1999; Chuang and Ln, 1999; Dmels and Lours, 2004) whle others used the panel data estmaton method (Atken and Harrson, 1999; Konngs, 2000; Djankov and Hoekman, 2000; Flores et al., 2000; Kathura, 2000; Knoshta, 2000). Furthermore, they also dffered n usng ether ndustry data or frm level data. Table 1 reports these studes based on ther methodologes. Ths s followed by a bref dscusson of ther fndngs. 10

11 Table 1: Summary of some ntra-ndustry spllovers studes Authors Countres Perod Method Aggregaton level Result Haddad and Morocco Cross Frm and - 1 Harrson (1993) 1989 sectonal ndustry Blomström and Mexco Cross Industry + 2 Wolff, (1994) 1975 sectonal Chuang and Ln (1999) Chuang and Hsu (2004) Tawan 1991 Cross sectonal Chna 1995 Cross sectonal Frm + Frm +? 3 Atken and Harrson (1999) Venezuela Panel Frm - Konngs (2000) Romana, Bulgara Panel Frm - and Poland 1997 Kathura (2000) Inda Panel Frm - Djankov Hoekman (2000) and Czech Republc Panel Frm + Ponomareva (2000) Russa Panel Frm + Lutz and Tavalera (2003) Chudnovsky et al. (2008) Ukrane Argentna Panel Frm + Panel Frm +? Source: Dwambuena, Klngelhöfer and Kaggwa (2014:12) 1 Negatve spllovers. 2 Postve spllovers. 3 Postve, but condtonal on technology gap, ownershp structure, absorptve capacty. 11

12 As t can be seen, earler studes used cross sectonal methods and found mxed results. For example, n ther semnal work, Haddad and Harrson (1993) examned the effects of FDI on the Moroccan manufacturng ndustry. They found that FDI had an adverse effect on the productvty of local frms, hence, evdence of negatve FDI spllovers on local frms. However, startng from one year later, Blomström and Wolff (1994) examned the effects of the presence of MNCs on the productvty of local frms n Mexco, Chuang and Ln (1999) on the productvty of local frms n the Tawanese manufacturng ndustry and Chuang and Hsu (2004) on the relatonshp between FDI, trade and spllover effcency n the Chnese manufacturng ndustry. They dscovered postve, the latter addtonally even and sgnfcant FDI spllovers to local frms whch have a low technology gap from MNCs afflates. Other studes used the panel data method, but also found nconclusve results. For example, Atken and Harrson (1999) nvestgated whether local frms n Venezuela benefted from the presence of MNCs, Konngs (2000) on the effects of FDI on the productvty of local frms n three emergng European countres (Romana, Bulgara and Poland), and Kathura (2000) on the effects of FDI on the productvty of local frms n Inda. They all found n general that the success n attractng a hgher level of FDI had negatve spllover effects on local frms n these countres. The only excepton s Poland where Konngs found no evdence of such spllovers. In contrast, Djankov and Hoekman (2000), Ponomareva (2000), Lutz and Tavalera (2003), and Chudnovsky et al. (2008) studed the effects of foregn nvestment on the productvty of local frms n Czech Republc; n the Russan manufacturng ndustry, n Ukrane and the Argentnean manufacturng ndustry respectvely. They all dscovered that ths effect was postve and that there were postve spllovers effects from MNCs to these local frms. The only excepton s Argentna where Chudnovsky et al. (2008) found that postve effects were dependent on local frms absorptve capactes Emprcal evdence on Inter -Industry spllovers The majorty of productvty spllovers studes have sought to examne the exstence of horzontal spllovers. As a result, few studes have been carred out to nvestgate the exstence of vertcal spllovers through forward and backward lnkages. Of those few, recent studes have found evdence of backward and forward lnkages. For nstance, Javorck (2004) studed the effects of FDI on the productvty of local frms n upstream sectors n Lthuana, Tomohara and Yokoto (2006) the effects of FDI on the productvty of local frms n Thaland; Buckley; Clegg and Wang (2007) on the relatonshp between nward FDI and host country productvty n the Chnese electronc ndustry, and Javorck and Spateneanu (2008) on FDI and 12

13 productvty of local Romanan frms. They all found the exstence of postve vertcal spllovers effects through backward lnkage, but only for projects wth partal foregn ownershp. Only Negara and Latf (2012) dscovered postve forward spllovers effects from FDI to local frms (n Indonesa). 3. Research Methodology Ths paper uses cross sectonal frm level data collected from the World Bank enterprse survey (WBES). The survey s conducted by the World Bank to obtan data on growth obstacles, productvty constrants and the effects of busness envronment to a country s busness and nternatonal compettveness (World Bank Enterprse Survey, 2009). It was done n South Afrca n 2007 and covered 1056 frms. These data have been collected usng the stratfed random samplng methodology 4 and they are grouped accordng to the Internatonal Standard Industral Classfcaton (ISIC, revson 3.1). In the next sub secton, some descrptve statstcs of our data are shown. 3.1 Descrptve statstcs Table 2: Productvty means (MNCs versus Local frms) Nature of Frm Mean Standard Devaton Frequency Local Frms MNCs Grand Mean Productvty Source: Author s own analyss from WBES data (2007) From our Productvty analyss as summarzed n table 2, t appears that frms wth FDI nflows tend to have hgher average of productvty rate (1.6985) than local frms (1.5855). The average productvty of MNCs s even hgher than the average one of all manufacturng frms ncluded n the survey. In addton, the values of the standard devatons, whch are statstcally the same for MNCs and local frms, suggest that ndeed the productvty means are sgnfcantly dfferent from each other. Table 3: Dstrbuton of frms accordng to sze 4 Further detals on ths methodology can be found at Informaton on data collecton can be checked usng the WBES samplng note and the mplementaton note for South Afrca. 13

14 Sze of frms Medum and Large Frms Small Frms Nature of Frm Local Frms MNCs Local Frms Frequency Percent Cumulatve Percent MNCs 46 Total 1056 Source: Authors own analyss from WBES data (2007) In the WBES, frms are grouped nto small frms (1-19 employees), medum (20-99 employees) and large frms (100 employees and above). From table 3, t appears that MNCs prefer to nvest ther captal n medum and large frms. There are nnety (90) FDI frms under medum to large scale frms as compared to only fourty-sx (46) FDI frms under the small frms category. A possble nterpretaton could be that MNCs would lke to enjoy economes of scale. Table 4: Regonal dstrbuton of frms Regon Nature of Frm Frequency Percent Cumulatve Percent Johannesburg Local Frms Cape Town, Port Elzabeth and Durban MNCs Local Frms MNCs Total 1056 Source: Authors own analyss from WBES (2007) Table 4 shows that out of a sample of 718 frms, about 107 or 15% of them are MNCs and are located n Johannesburg. In contrast, the table exhbts that out of a sample of 338 frms; only about 29 of these frms or 9% of them are MNCs and are based n the other three regons (Cape Town, Port Elzabeth and Durban). The nterpretaton could be that the cty of Johannesburg tends to attract a hgher number of MNCs n South Afrca compared to other ctes. Johannesburg s the cty where the majorty of busness actvtes n South Afrca are located and as such, t may present better opportuntes for foregn nvestors than any other regon. However, our nterpretaton should not be regarded as f the other regons (Cape Town, Port Elzabeth and Durban) are unattractve to foregn nvestors. 14

15 Sectoral dstrbuton of MNCs n manufacturng ndustry 1 6% 3% 20% 21% 1% 2% 19% 16% 2% 11% Other manufacturng Food Textles Garments Chemcals Plastcs and rubber Non metallc mneral products Fabrcated metal products Machnery and equpment Electroncs (31 & 32) Fgure 1: Sectoral dstrbuton of MNCs n SA Manufacturng ndustry Source: WBES (2007) The above fgure shows that the majorty of MNCs are manly concentrated n the followng manufacturng sectors: the fabrcated metals products sector (21%), the other manufacturng sector (20%), the food sector (19%), the chemcal sector (16%), and the garment sector (11%). However, the presence of MNCs n the remanng sectors (machnery and equpment, nonmetallc mneral products, electroncs, and plastcs and rubber) s only about 14%. 3.2 Varables Measurement and Econometrc model In ths sub secton, we start by explanng how our varables of nterest are measured. Ths s followed by the dscusson of the econometrc model used Varables Measurement In ths sub secton, the measurement of productvty s dscussed. In addton, all mportant explanatory varables dentfed n the emprcal lterature are also dscussed. In ths study, productvty 5 (our dependent varable) s measured by the rato of frms sales to frms labour nput.. Captal s measured by the replacement value of fxed assets (Hale and Long 2007; 5 In emprcal lterature, Productvty has been measured ether by Total Factor Productvty (TFP: total sales adjusted by changes n nventroy) or labour productvty. Of these two measures, TFP s regarded as the best measure and the most common method of capturng productvty. However, due to dffcultes n obtanng accurate measure of captal stock(especally because of deprecaton), labour productvty s mostly preferred. 15

16 Cuyvers et al., 2008; Nhamo, 2011); Labour s proxed to frms labour costs; materal s measured by frms total cost of raw materals and ntermedate goods used n producton (Cuyvers e al., 2008). FDI (or foregn ownershp) s dummy varable where 1 shows the presence of foregn ownershp and 0 means absence of foregn ownershp; sze s a dummy varable where 1 means medum and large frms and 0 means small frms. Absorptve capacty s measured by the rato of sklled producton workers to total number of employees. Age s measured as the dfference between the year the frm started operatons and the year the survey was done (Hale and Long, 2006). Regon stands for regonal dummes where Reg1, Reg2, Reg3 take on the value of 1 f frms are respectvely based n Johannesburg, Cape Town, Port Elzabeth and 0 f otherwse. The omtted regon s the benchmark regon (Durban).Horzontal spllover effect s proxed to the rato of foregn frms output to the total output (Blomström and Sjöholm,1999). Backward spllover effect s measured by the share of ntermedate goods that each ndustral subsector suppled to MNCs afflates n downstream ndustres (Javorck, 2004; Belderbos, 2010). Forward spllover effect s measured by the proporton of ntermedate goods purchased by each ndustral subsector from MNEs afflates n upstream ndustres (Javorck, 2004; Belderbos, 2010) Econometrc Model The choce of our model has been guded by the emprcal revew. Accordng to the emprcal lterature, the parametrc approach, whch uses the Cobb Douglas producton functon, s approprate for estmatng productvty. However, t s argued that the Cobb Douglas producton functon omts mportant explanatory varables and as a result, t results n msspecfcatons errors. Thus, to overcome the msspecfcaton problem, many studes used an augmented Cobb Douglas producton functon (a Cobb Douglas functon whch s augmented by all mportant explanatory varables dentfed n the emprcal lterature) because t provdes effcent estmates (Wang & Schmdt, 2002; Harrs & Tranor, 2005). Hence, ths paper used the approach followed for nstance by Cuyvers et al., (2008); Nhamo (2011) and Negara and Latf (2012). The econometrc model has been constructed from the typcal Cobb Douglas producton functon below: Y A K L M e 1,2,... n n X 0 1 (1) 16

17 where Y s the output of frm, K s the fxed captal stock of frm, L s the number of workers or labour of frm, M s the amount of materal nputs used by frm,,, are the output elastctes wth respect to captal, labour and materal nputs respectvely, 0 s the constant, X s a vector of observed explanatory varables dentfed n the lterature. These nclude such as FDI, age, regon, sze, absorptve capacty, horzontal spllover, backward spllover and forward spllover and explanatory varables that may affect output of each frm. s the error term representng all the unobserved In order to obtan labour productvty (LP), we dvde both sdes of equaton (1) by L and get equaton (2) below Y L A K L M e L n X 0 1 2) After mechancs of mathematcs that nclude takng logs of both sdes and lnearzaton, we end up wth a smplfed model below (see appendx 1) ln ( Y ) = γ L 0 + β ln ( K ) + φ ln ( M ) + (β + φ + λ 1)lnL L L + =1 π X + ε (3) where: n Y L s labour productvty (the rato of total sales to total labour cost) K L s captal ntensty (the rato of the replacement cost of fxed assets to total labour cost) M s materal ntensty (the rato of total cost of raw materals and ntermedate goods used n L producton to total labour cost) L s the labour nputs (the total labour cost) 0 s the constant 17

18 ,, 1 are labour productvty elastctes wth respect to captal ntensty, materal ntensty and labour nput respectvely. X s a vector of observed explanatory varables dentfed n the emprcal revew. These nclude such as FDI, age, regon, sze, absorptve capacty, horzontal spllover, backward spllover and forward spllover wth ther effects equal to 1 Rewrtng model 3 wth all observed explanatory varables affectng productvty results n equaton 4 lnprod = β 0 + β 1 lncapnt + β 2 lnmatnt + β 3 lnl + β 4 FDI + β 5 Sze + β 6 Abscap + β 7 Age + β 8 Regon + β 9 Horspl + β 10 Forward + β 11 Backward + ε (4) Where: lnprod: log of labour productvty (the rato of sales to labour), lncapnt: log of captal ntensty (rato of replacement value of fxed assets to labour), lnmatnt: log of materal ntensty (rato of total cost of raw materal and ntermedate goods used n producton s dvded by labour), lnl: log of total labour cost; FDI: dummy of foregn ownershp where 1 means presence of foregn ownershp and 0 f otherwse; Sze s a dummy varable where 1 means medum and large frms and 0 means small frms; Abscap: stands for absorptve capacty(the rato of sklled producton workers to total number of employees); age s the age of frms (the dfference between the year the frm started ts operatons and the year of the survey); Horspl: ntra-ndustry FDI spllover effect defned as follow: Horspl FDI * Y Y Where: j j FDI * Y : Foregn frms output Y j : Total output Backward: Backward spllover effect defned as below: Backward jk Horspl k k 18

19 Where: jk : s the proporton of sector j s output suppled to sector k (wth FDI presence). Ths excludes any ntermedate nputs suppled wthn the same sector as these are captured n the horzontal spllover effect. Thus, the proporton s the product of the techncal coeffcent and the horzontal spllover. The techncal coeffcent s constructed from the 2005 Input Output (I-O) table of South Afrca extracted from OECD 6, followng the approach by Lenaerts and Merlevede (2011:6-8).The proporton s a matrx where each cell of the I-O table s dvded by ts row total.(see appendx 2) Forward : Forward spllover effect gven by Forward jk Horspl k k Where: jk : s the proporton of ntermedate nputs purchased by sector j from sector k (wth FDI presence) out of total nput sourced by sector j. Smlarly, ths excludes ntermedate nputs suppled wthn the same sector (Javorck, 2004). Ths s the product of the techncal coeffcent and the horzontal spllover. Followng Lenaerts and Merlevede (2011:6-8) approach, t s a matrx where each cell of the I-O table s dvded by ts column.(see appendx 2)

20 4. Econometrc Analyss 4.1 Introducton Ths secton s dedcated to analysng our cross sectonal data. Gven that the presence of multcollnearty and heteroscedastcty are often suspected when cross sectonal data are used, we decded to carry out the multcollnearty test (va the Varance Inflaton Factor analyss) and the heteroscedastcty test(va the Breusch-Pagan 7 test) to avod neffcent estmates, hence obtanng msleadng econometrc results (Cuyvers et al., 2008:28; Nhamo, 2011:88-89). These tests are reported as part of our post-regresson dagnostcs. However, we dscuss some of the fndngs here. Wth regard to the multcollnearty test, we found the horzontal and backward spllover varables to be hghly correlated. Ths should be expected from the varable constructon pont of vew (see equaton4). In addton, gven that the backward and forward spllover varables were also constructed n the same way (see equaton 4), we also concluded that they were hghly correlated. Thus, to address ths ssue, Gujarat & Porter (2009:343) recommend droppng one of the collnear varables. Thus, we decded to drop the forward spllover effect varable n our lnear regresson. 4.2 Econometrc Estmaton Results Before carryng out our regresson, we show the lnear correlatons that exst among some of our varables through the use of the bvarate correlaton matrx. The results are reported n Table 5. Table 5: The correlaton matrx lnprod lncapnt lnlabour lnmatnt FDI Sze Abscap Age lnprod 1 lncapnt lnlabour lnmatnt FDI Sze abscap Age Source: Authors calculaton from WBES (2007) 7 The alternatve test s the Whte s test for heteroscedastcty. However, t s dscussed to be less powerful than the Breusch-Pagan test (Gujarat & Porter (2009:389) 20

21 The results of Table 5 show that most of the varables have expected sgns n ther correlaton coeffcents wth productvty except for the case of absorptve capacty and sze. In addton, these varables are found to be weakly correlated wth one another. After showng the lnear relatonshp among some of our varables, we run our regresson model. The fndngs are reported n Table 6. Table 6: Lnear Regresson Results lnprod coeffcent Standar error t value P value Beta lncapnt * lnlabour * lnmatnt * FDI sze abscap * age * Reg * Reg Reg horzman backward cons Source: Authors own analyss from WBES (2007) R 2 = , F (12, 1043) = Prob > F = Thus, the estmated model (5) s wrtten below: Lnprod = lncapnt lnlabour lnmatnt FDI sze abscap age reg reg reg Backward Horzman Dscusson of fndngs The regresson results confrm the expected sgn fndngs of the bvarate correlaton matrx reported n Table 5. The regresson results show postve effects that captal ntensty (lncapnt), 21

22 materal ntensty (lnmatnt) and backward spllover effect have on productvty of local frms n South Afrca. The same s true for the age of frms and the regonal dummes for Johannesburg, Cape Town and Port Elzabeth. All these varables are found sgnfcant n explanng productvty of local frms. However, for the regonal dummes, Johannesburg shows to have a much hgher postve and sgnfcant effects on productvty of local frms n South Afrca than Cape Town and Port Elzabeth. Ths may mply that local frms that are based n Johannesburg may have ntense contact wth MNCs and, as such, be more exposed to new technologes and producton processes than local frms n other regons. As a result, they have hgher productvty. The coeffcents of lncapnt and lnmatnt are postve and sgnfcant. Thus, ths means that an ncrease n captal and materal ntensty rases productvty of local frms n South Afrca. The coeffcent of age s postve and sgnfcant. Hence, t may mply that experenced frms (frms wth many years n operatons) tend to have hgher productvty due to knowledge accumulaton over tme than new frms. The postve coeffcent of FDI could express that MNCs are more productve than local frms. However, t s found nsgnfcant n explanng productvty of local frms. Ths may suggest that local frms do not beneft much from FDI spllovers n South Afrca. The postve but nsgnfcant backward spllover effect (backward) on productvty of local frms n South Afrca has mplcatons. On one hand, ths may ndcate - that MNCs have establshed local supplers of ntermedate nputs (downstream sectors) only n some of the manufacturng sectors n South Afrca, and - that those local supplers have been able to produce and supply hgh qualty ntermedate nputs for MNCs. However, ts nsgnfcance could be nterpreted that: - MNCs have not been successful n establshng local supplers n all sectors wthn the manufacturng ndustry. - There s a very lmted number of local supplers n the manufacturng ndustry and these supplers have not been able to supply ntermedate nputs to MNCs wthn the entre manufacturng As explaned above, due to hgh multcollnearty between backward and forward spllover, the forward spllover varable was removed from our regresson analyss. Hence, by assocaton, t 22

23 can also be concluded that local frms n upstream ndustres also experence hgher productvty. Ths may suggest that local frms (customers) have been able to ncrease productvty by buyng ntermedate nputs from MNCs. On the other hand, the fndngs show negatve effects of labour (lnlabour), frm s sze (sze), horzontal spllover effect and absorptve capacty of local frms (abscap) on the productvty of local frms n South Afrca. The coeffcent of sze suggests that medum and large frms do not contrbute much to productvty of local frms as compared to small frms. However, ts coeffcent s found nsgnfcant. The coeffcent of labour s sgnfcant. In addton, t has the expected sgn as t s expected that an ncrease n labour cost wll, ceters parbus, lead to fall n productvty of local frms. The negatve coeffcent of absorptve capacty ( ) s sgnfcant. Ths could be nterpreted that South Afrcan local manufacturng frms dd not have the mnmum prerequstes (e.g. the necessary human captal, physcal nfrastructure, research and development actvtes (R&D) and dstrbuton networks to sustan nward FDI) that allow them to take advantage of FDI spllovers. Ths supports the problem of sklled labour n South Afrca. Fnally, as explaned above, we found that the coeffcent of FDI to be postve. Ths could express that MNCs are more productve than South Afrcan local manufacturng frms. However, the negatve and nsgnfcant coeffcent of horzontal spllover effect suggests that there are negatve ntra-ndustry spllover effects from FDI to local frms n South Afrca but MNCs do not affect much the productvty of local frms. Ths s expected n the theoretcal lterature snce MNCs are expected to be reluctant to share technology wth local frms gven that these latter are seen as local compettors 5. Post regresson dagnostcs As explaned n the precedng secton, the multcollnearty and the heteroscedastcty tests were carred out to ensure that our fndngs are credble. Ths secton summarzes the fndngs of these two tests Varance Inflaton Factor (VIF) test As a rule of thumb, Gujarat & Porter (2009:340) suggest that f the VIF of a varable s above 10, then the varable should be sad to be hghly collnear. They further suggest that the tolerance ndex (the recprocal of the VIF) can be used as an alternatve. In ths case, the closer 23

24 the tolerance ndex to zero (0), the bgger the degree of collnearty of the varable wth other explanatory varables we may not suspect any multcollnearty.. From the results of Table 7, backward and horzontal Spllover varables have VIF of above 10. Thus they are hghly correlated. Ths should be expected from the varable constructon pont of vew. As explaned above, because the backward and forward spllover varables were also constructed n the same way (see equaton 4), we also concluded that they were hghly correlated. Thus, to address ths ssue, we followed the approach by Gujarat & Porter (2009:343) who recommend droppng one of the collnear varables. Thus, the forward varable was dropped. However, the other varables have VIFs below 10. Hence, they are not correlated. Most mportantly, the overall VFI mean (4.25) s also below 10. Thus, we can confrm that there s no multcollnearty among our the varables. Therefore, our regresson results can be reled upon. Table 7 summarzes the results of the multcollnearty test through the Varance Inflaton Factor analyss (VIF). Table 7: Varance Inflaton Factor (VIF) fndngs Varables VIF Tolerance ndex(1/vif) Horzman Backward Lnlabour Reg Sze Reg Reg Abscap FDI Lncapnt Lnmatnt Age Mean VIF 4.25 Source: WBES (2007): Authors own analyss Heteroscedastcty As mentoned above, cross-sectonal data are usually assocated wth the problem of heteroscedastcty. Snce the presence of heteroscedastcty s assumed n our data, t was mportant to do a frst round regresson wthout robust resduals n order to test for heteroscedastcty. The Breusch-Pagan-Godfrey test returned a verdct of heteroscedastcty presence n the error terms. Ths means that the resduals were found to have unequal varances. 24

25 As a result, we run a second regresson wth robust resduals as a means to correct for the heteroscedastcty problem. 6. Conclusons, Recommendatons and Polcy mplcatons The purpose of ths paper was to examne whether there are productvty dfferences between MNCs afflates and local manufacturng frms n South Afrca. In addton, the paper purports to nvestgate the exstence of ntra-ndustry or nter-ndustry spllover effects from FDI to local frms. In the ntroducton of ths paper, we have hypotheszed that because of more advanced technology, MNCs would be more productve than local frms. However, on the one hand, we expected postve spllover effects from FDI to local frms n downstream and upstream ndustres (backward and forward lnkages). On the other hand, negatve ntra-ndustry spllover effects were expected from FDI to local frms. Regardng these expectatons, usng a sample of 1057 frm level cross sectonal data, our emprcal fndngs show that n fact MNCs are more productve than local manufacturng frms n South Afrca. Nevertheless, ths productvty dfference s found nsgnfcant to explan productvty of local manufacturng frms. Furthermore, although nsgnfcant, our results support on the one hand that there are postve nter-ndustry spllover effects (backward varable) from FDI to local frms whle on the other hand, there are negatve ntra-ndustry spllover effect (Horzman varable) from FDI to local frms n South Afrca (most lkely from the competton effect channel). Hence, based on ths, we can conclude that our emprcal fndngs support our earler hypothess that MNCs would be more productve than local frms. In addton, t also supports our other hypothess that on the one hand, there would be negatve ntra-ndustry spllovers from FDI to local frms whle on the other hand, there would be postve nter-ndustry spllovers from FDI to local frm. In ths study, we have also dscovered that the coeffcent of absorptve capacty s negatve and sgnfcant. Ths ndcates that South Afrcan local frms do not have the mnmum prerequstes (e.g. the necessary human captal, physcal nfrastructure, research and development actvtes (R&D) and dstrbuton networks to sustan nward FDI) that allow them to take advantage of FDI spllovers. In addton, we have found that frms who are based n Johannesburg tend to enjoy hgher productvty than frms n other regons. Obvously, ths supports the geographcal proxmty spllover channel: local frms who are closer to MNCs tend to enjoy much hgher productvty. 25

26 The fndngs of ths study do have some polcy mplcatons. Because MNCs are found to be more productve than local frms, we recommend to polcymakers to contnue attractng more FDI nflows n South Afrca n general and the manufacturng ndustry n partcular. We beleve by encouragng more FDI nflows n South Afrca and gven that a lot of MNCs have the more updated technologes, local frms wll somehow take advantage of these technologes from MNCs presence n the country. However, gven that on the one hand, there s some evdence of negatve ntra-ndustry spllover effects and on the other hand, there s evdence of postve nter-ndustry spllovers, natonal efforts to attract more FDI nflows n South Afrca should be encouraged n nter rather than ntra ndustres (.e. polcymakers should encourage more backward lnkages projects rather than Greenfeld nvestment projects n South Afrca). Ths can be done for nstance by encouragng M&A or jont venture between MNCs and local supplers. Snce backward spllover effects are found nsgnfcant n ths paper, t could be translated that MNCs afflates have not been able to establsh strong lnkages wth local frms n downstream ndustres. Therefore, t s recommended to polcymakers to adopt nvestment polces that encourage synerges between MNCs and local busnesses (.e. M&A or jont venture between MNCs and local frms) n all the manufacturng sectors of South Afrca. However, t s mportant to menton that the fndngs of ths study are only applcable to the South Afrcan manufacturng frm level cross sectonal data. Thus, future studes are encouraged to use frm level panel data for South Afrca to nvestgate the exstence of ntra and nter ndustry spllover effects from FDI to local frms n the country. Furthermore, gven that these fndngs are only applcable to the manufacturng ndustry, future studes may also am to examne the nteracton between FDI and local frms n other ndustres. For nstance, the relatonshp between FDI and productvty of local frms n the servce ndustry may be studed. In addton, to gan deeper nsght and derve strong recommendatons, future studes may also assess the nter-relatonshp between FDI, absorptve capacty and productvty of local frms. References Agosn, M., & Machado, R "Foregn Drect Investment n Developng countres: Does t crowd n Domestc Investment." Oxford Development studes 33(2): Atken, B. J. & Harrson, A "Do Domestc Frms Beneft from Drect Foregn Investment?Evdence from Venezuela." Amercan Economc Revew, 89: