Does market characteristic determine foreign direct investment spillovers?

This study examines the significance of foreign direct investment (FDI) and market characteristics both within and across industries in determining the productivity and efficiency of firms. This study also measures the total factor productivity (TFP) growth and its components for both foreign and domestic firms. Using Indonesian annual medium and large manufacturing establishments surveys, wholesale price index, and input-output (I-O) table, the authors calculate the horizontal and vertical spillovers and undertake stochastic frontier analysis to estimate the production and inefficiency function. The results show that the less concentrated market of domestic firms within the industry and suppliers reduces productivity and efficiency, while domestic buyers’ less concentrated markets could have the opposite effect. Most domestic and foreign firms still experience deterioration in TFP growth. The policy recommendation is to encourage firms to improve technological progress, such as upgrading machines and investing in human resources, by providing training workers aiming at mastering better managerial expertise. Policymakers should also ensure that the benefits of FDI spillovers outweigh their disadvantages.This study contributes to extending recent empirical literature on the possibility of spillovers in the Indonesian automotive industry not only from foreign firms within the industry, but also from potential externalities arising from downstream and upstream markets using stochastic frontier analysis (SFA). Generally, studies on FDI spillovers examine the role of FDI in explaining the efficiency differences measured by the distance to the frontier; however, few studies consider the impact of efficiency improvement and technological progress on productivity gains from FDI. This study attempts to capture the sources of productivity gains through both channels. The other studies have never discussed, based on author knowledge, the impact of spillovers regarding domestic firms’ specific market concentration as competitors, buyers, or sellers to foreign firms on efficiency and productivity.This study aims to fill this gap and analyze the importance of market characteristics in determining spillovers, VTI, trade openness, and foreign ownership. Previous studies on market concentration employ the Herfindahl-Hirschman Index (HHI), while this study utilizes the relative entropy coefficient (RE) to provide another approach to measure market concentration.In this study, the industry-specific characteristic is controlled using the inclusion of firm size and industrial dummy variables. The SFA estimation results are calculated to measure output elasticity with respect to each input and total factor productivity (TFP) growth. The discussion provides TFP decompositions, which are technical efficiency change (TEC), technological progress (TC), and scale efficiency change (SEC).