Foreign Direct Investment Spillovers in Kenya’s Manufacturing Sector: an Empirical Analysis

Abstract

There is consensus among researchers that foreign direct investment has direct and/or indirect effects on the host economy's domestic firms through technology and knowledge transfer. The empirical literature on FDI-induced spillovers is yet to fully analyze the channels through which inward FDI impacts the activities of domestically-owned firms. This research investigates the transmission channels for FDI-induced productivity, wage, and export spillovers as well as the importance of firm heterogeneity on the behaviour of the various spillover channels, thus providing a more nuanced picture of FDI-induced spillovers. We analyze a firm-level panel dataset for the manufacturing sector firms in Kenya for the period 2007–2018, collected from the World Bank database. Employing fixed effects and the Two-Step System GMM models to analyze productivity and wage spillovers and the double hurdle model to analyze export spillovers, we demonstrate the importance of alienating four channels for horizontal (intra-industry) spillovers−labour mobility, demonstration, competition and information effects and one channel for FDI-induced vertical spillovers (inter-industry) spillovers, that is, backward linkages. We endeavour to address possible endogeneity of FDI in order to arrive at more consistent and unbiased estimates. We employ various measures for these spillover channels and show that the significance and size of spillovers vary from one channel to another. Overall, our results suggest that demonstration, labour mobility, and backward linkage channels are the most important channels for FDI-induced productivity and export spillovers, whereas there is no evidence of wage spillovers. Our findings also show that spillovers on the technology levels of domestically-owned firms and not on their sizes. Finally, our analysis entails further empirical investigations, including robustness checks. The results show robustness to the use of alternative outcome variables and non-linear estimations. The findings of the thesis suggest the need for policymakers to comprehensively understand the workings of various channels for FDI spillover transmission in order to develop appropriate policies and redesign existing ones in efforts aimed at enhancing the productivity, wages, and exports of domestically-owned firms. Specifically, the findings suggest the need to develop policies and programmes that aim to improve the technological levels of domestically-owned firms, enhancing backward linkages with foreign firms, increasing value addition, and boosting their absorption capacities if the firms are to optimize benefits accruing from inward FDI and mitigating possible negative effects on the Kenyan economy.