Firm Capabilities and Productivity Spillovers from FDI: Evidence from Indian Manufacturing Firms

Using a panel dataset on Indian manufacturing firms from 1994 to 2010, the present paper examines the productivity spillovers from the foreign direct investment (FDI) through various channels of horizontal and vertical linkages. In addition, the study also focuses on the influence of domestic firms’ initial capabilities in absorbing FDI-induced technological benefits. Firm productivity has been measured by using the semi-parametric Levinsohn–Petrin methodology. Using the fixed-effect panel model to estimate spillover models, the initial results show that the productivity growth of Indian firms is adversely affected by various horizontal spillover channels, while the vertical linkages are found insignificant. Interestingly, the second part of the study reveals that only the domestic firms with some initial technological capabilities (proxied by initial three years’ R&D activities), low technology gap with the foreign firms in the initial periods and high complementary capabilities (proxied by initial three years’ average firm size) gain productivity benefits from FDI spillover channels as compared to other firms within the industry. Essentially, the study brings out the importance of domestic firms’ need to encourage internal R&D activities in absorbing technological benefits from foreign presence and their economic activities in the domestic market.