Foreign direct investment, agglomerations, and demonstration effects: An empirical investigation

Abstract

Many previous studies have shown that the localisation of firms can be an important factor in attracting new foreign direct investment into a host country. What has been missing in this literature thus far, however, is an investigation into the reasons why industry clusters attract firms. We distinguish between "efficiency agglomerations" as firms locating close to each other because they can increase their efficiency by doing so, and "demonstration effects", whereby existing firms send signals to new investors as to the reliability of the host country and newly entering firms follow previous firms. In this paper we try to disentangle these two effects, by examining the location of US and UK firms in Ireland.We calculate proxies for "efficiency agglomerations" and "demonstration effects" and include these proxies in an empirical model of the location decision of firms. For US firms, we find that both efficiency agglomeration and demonstration effects are important determinants of entry. For UK firms, however, the evidence is not as clear cut.JEL classification: F23

Foreign Direct Investment and Local Economic Development: Beyond Productivity Spillovers

“…This may not be surprising given that there is a fair amount of evidence that linkages, either horizontal or vertical, between production units are mostly local in nature. This may be even more so when one considers effects arising from foreign direct investment as multinationals are considered to be more R&D intensive than local firms (see Markusen, 1995), and there is plenty of support according to which knowledge flows measured through R&D are subject to distance decay effects (see Bottazzi and Peri, 2001 (Görg and Ruane, 2001) as well as the possible benefits from agglomeration economies (Barry et al, 2003), can be expected to have impacted upon the contribution of MNCs to indigenous development. 15 This implies that our empirical results, while they may in some senses be encouraging for other countries attempting to embark on industrial development with the help of attracting MNCs, may not be the same for other countries.…”

Foreign Direct Investment in the Western Balkans: What Role Has it Played During Transition?

“…Examples of mechanisms for positive external spillovers from FDI in the literature include those through the dissemination of new higher levels of technological productivity on locally-owned firms (Ayyagari and Kosova, 2010;Barrios et al, 2005), via demonstration effects or reverse engineering (Barry et al, 2003). This can occur when foreign firms augment the knowledge base in the local market by introducing new products, processes, management techniques and workforce skills.…”

Clustering or Competition? The Foreign Investment Behaviour of German Banks

“…(For recent contributions and surveys of the literature see Barry et al (2001) and Crozet et al (2003).) Reasons for the presence of agglomeration effects, which are stressed in the theoretical literature, are knowledge spill-overs between firms, access to labour markets in specialised factors, the scope for backward and forward linkages, and signalling 2 effects which lower information costs (Barry et al 2001).…”

“…(For recent contributions and surveys of the literature see Barry et al (2001) and Crozet et al (2003).) Reasons for the presence of agglomeration effects, which are stressed in the theoretical literature, are knowledge spill-overs between firms, access to labour markets in specialised factors, the scope for backward and forward linkages, and signalling 2 effects which lower information costs (Barry et al 2001). Empirical work testing the presence of these agglomeration effects has so far focused mainly on manufacturing firms, finding evidence in favour of agglomeration effects for British and US investment in Ireland (Barry et al 2001), foreign direct investment in France (Crozet et al 2003), for Japanese investment in Europe (Head and Mayer 2002), or for Japanese firms in the United States (Head et al 1995).…”

“…However, the authors also argue that the hypothesis that observed agglomeration merely reflects omitted exogenous location attributes cannot be falsified. Barry et al (2001) try to distinguish empirically between an 'agglomeration' and a 'demonstration' effect. The 'agglomeration' effect is related to knowledge spill-overs, access to a thick labour market, and to the scope for exploiting backward and forward linkages.…”