The Potential Horizontal and Vertical Spillovers from Foreign Direct Investment on Indonesian Manufacturing Industries

Abstract

This study investigates the potential horizontal and vertical spillovers from FDI towards firms' efficiency level on Indonesian manufacturing industries, using firm-level panel data. The result suggests that positive evidence of horizontal spillovers arise instantaneously, but the impacts of vertical spillovers appear a year later. These indicate that foreign competitors cause local firms more efficient in the same industry. Furthermore, after one period of time MNCs running their business in Indonesia, they bring positive impacts on downstream markets but deteriorate manufacturing industries in the upstream markets. Therefore, the Indonesian government must ensure that overall benefits from promoting FDI must overweight their negative impacts.

Does competition and foreign investment spur industrial efficiency?: firm-level evidence from Indonesia

“…Establishments reporting missing or zero values, and those with typographical mistakes in either of the inputs or output values are excluded. A ratio of material over output is employed, removing observations when the rate of material input is below 10 percent or higher than 90 percent, as suggested by previous studies employing industrial data from Indonesia ( Sari, 2019 ; Sari et al., 2016 ).…”

“…(2012) found sizeable positive labor mobility effects in Indonesia, although suspecting low demonstration effects. Other studies do not differentiate between the transmission channels within horizontal externalities, generally concluding that FDI leads to lower inefficiency in firms via horizontal spillover effects ( Sari, 2019 ; Sari et al., 2016 ). Our paper posits that a highly competitive environment may help to increase efficiency within the sector.…”

“…The entrance of foreign firms into the domestic market could lead to the market-stealing phenomenon, as production costs increase as a consequence of firms competing for workers and resources ( Spencer and Spencer, 2008 ), leading to higher cost (lower profits), and possibly the crowding out of domestic players ( Aitken and Harrison, 1999 ). Stronger competition may also compel domestic players to defend their market share by adopting new technology and management methods to increase efficiency ( Görg and Greenaway, 2004 ; Sari, 2019 ). Besides, foreign and domestic goods become substitutes for one another, leading to more competition across firms.…”

“…Vertical spillovers capture the effects through linkages created by foreign-owned firms with domestic firms in the upstream sectors (backward) or downstream (forward) ( Orlic et al., 2018 ). Horizontal spillovers, by contrast, capture effects derived from within the same sector of investment, in the form of demonstration effects, labor mobility, and competition ( Sari, 2019 ). Some studies investigating the relation between FDI and efficiency in Indonesia suggest that FDI supports efficiency through horizontal spillovers ( Sari, 2019 ; Sari et al., 2016 ; Suyanto et al., 2014 ).…”

“…Horizontal spillovers, by contrast, capture effects derived from within the same sector of investment, in the form of demonstration effects, labor mobility, and competition ( Sari, 2019 ). Some studies investigating the relation between FDI and efficiency in Indonesia suggest that FDI supports efficiency through horizontal spillovers ( Sari, 2019 ; Sari et al., 2016 ; Suyanto et al., 2014 ). Still, there is a notion of foreign firms taking market share from domestic players via competition channels (e.g., the pharmaceutical sector in Suyanto and Salim, 2011 ; e.g., electronics in Suyanto et al., 2012 ; the food sector in Setiawan and Lansink, 2018 ).…”