Does Foreign Entry Spur Innovation?

Using large firm-level and industry-level data sets from eighteen countries, we find that foreign direct investment (FDI) and trade have positive spillover effects on product and technology innovation by domestic firms in emerging markets. The FDI effect is more pronounced for firms from advanced economies. However, while we detect the spillover effects with micro data at the firm-level, when we use linkage variables computed from input-output tables at the industry level we find much weaker, and usually insignificant, effects. These patterns are important for policy, suggesting that spillovers are localized to firms engaged directly with multinationals and in trade, rather than affecting all domestic firms in industries with FDI presence.