DPRIETI Discussion Paper Series 11-E-063

Entry of Foreign Multinational Firms
and Productivity Growth of Domestic Firms:
The case of Japanese firms
ITO Keiko
RIETIThe Research Institute of Economy, Trade and Industry

http://www.rieti.go.jp/en/

RIETI Discussion Paper Series 11-E-063
August 2011

Entry of Foreign Multinational Firms and Productivity Growth of Domestic Firms:
The case of Japanese firms
ITO Keiko 1
Senshu University and RIETI

Abstract
This paper examines whether and how the entry of foreign multinational firms affects
productivity growth of domestically owned firms, using Japanese firm-level data for the period
2000-2007. Although there are a considerable number of studies conducting productivity
analyses on foreign multinationals and domestic firms for the manufacturing sector, there arefew such studies for the service sector. Against this background, the present paper focuses on
the role of foreign entry in the service sector, where cross-border trade is often difficult andfirms are therefore less likely to be exposed to international competition.
The results of the analysis suggest that foreign multinationals perform better thandomestically owned firms in many sectors. However, although the productivity levels of theformer tend to be higher than those of the latter, no significant difference in productivity growth
rates is found. Moreover, once firm-fixed effects are controlled for, foreign presence in aparticular industry tends to negatively affect the productivity growth rate of domestically owned
firms in the industry. However, firms that are catching up with the productivity frontier enjoy
positive FDI spillovers, implying that foreign entry accelerates productivity catch-up.
Keywords: foreign direct investment, service sector, productivity, and spillovers.
JEL classification: F21; L1; L23

RIETI Discussion Papers Series aims at widely disseminating research results in the form of professional papers,
thereby stimulating lively discussion. The views expressed in the papers are solely those of the author(s), and do not
represent those of the Research Institute of Economy, Trade and Industry.

This research was conducted as part of the project titled “Research on Productivity Growth in Service
Sector” for the Research Institute of Economy, Trade and Industry (RIETI). The author would like tothank Noor Aini Khalifah and participants at the 12th International Convention of the East Asian
Economic Association for helpful comments. The author is also grateful for the helpful comments andsuggestions made by seminar participants at the Research Institute of Economy, Trade and Industry(RIETI). In addition, financial support from the Japan Society for the Promotion of Science(KAKENHI #19683003, 23683003) is gratefully acknowledged.

11. Introduction

It has been argued that attracting foreign direct investment (FDI) can play an important role in acountry’s economic development and in productivity growth. In addition to the entry effects
associated with FDI – that is, the fact that the entry of high productivity foreign firms itself
raises the overall productivity level in the economy – another reasons why many countries haveadopted policies to promote FDI is the possible existence of positive spillover effects. FDI
spillovers can occur through various channels. For example, if a new technology is successfully
introduced by a foreign-owned firm, this will encourage domestic firms to adopt it. This channel,
the so-called demonstration or imitation effect, involves the spillover of technologies and/or
know-how. Another important channel is the increased competition induced by the entry of
foreign firms. Competition from foreign-owned firms provides an incentive for domestic firms
to be more productive by using existing resources more efficiently and adopting newtechnologies. However, FDI spillovers are not always positive and depend on various factors
such as the entry mode of FDI as well as the characteristics of foreign firms and of the domestic
economy, sector, and firms. 1 Although FDI spillovers have already been widely investigated,
empirical analyses based on firm-level data produce mixed results. For example, Aitken andHarrison (1999), examining Venezuelan manufacturing plants, found that foreign investment
negatively affected the productivity of domestically-owned firms, while other studies, such as
Haskel et al. (2007), who used plant-level data for U.K. manufacturing establishments, foundpositive spillover effects. Given these mixed results, a number of studies have examined theconditions under which FDI has positive spillover effects. Girma (2005), for example,
highlights the importance of the absorptive capacity of domestic firms. On the other hand,
Javorcik (2004) suggests that positive FDI spillovers may take place through backward linkages,
based on evidence that an increase in foreign presence in downstream sectors is associated witha rise in productivity of domestically-owned firms in supplying industries. 2 Another strand ofliterature focuses on the relationship between innovation incentives and FDI spillovers. Aghion
et al. (2009) find that the productivity growth of incumbent firms is positively correlated withlagged greenfield foreign firm entry in technologically advanced industries, but not in laggard
1

See Crespo and Fontoura (2007) for a survey of the literature on FDI spillovers.
Along similar lines, Kugler (2006) highlights the importance of outsourcing relationships offoreign multinational firms with local upstream suppliers as a channel for technology diffusion andargues that positive FDI spillover effects can be seen between industries but not within industries.
2

1

industries, suggesting that entry of technologically advanced foreign firms encourages
incumbent innovation and productivity growth in sectors that are close to the technologicalfrontier, whereas it discourages incumbent innovation and productivity growth in sectors further
behind the frontier. Thus, the empirical evidence available to date is insufficient to allow us todraw definitive conclusions regarding the factors resulting in positive FDI spillovers.
Moreover, most previous empirical studies are confined to analyses of the manufacturingsector. Therefore, particularly for the non-manufacturing sector, our knowledge on the issue
raised here is still limited and there remains ample room for research on what factors are
relevant in order for recipient economies to enjoy positive FDI spillovers.
In the case of Japan, the government set a target in 2003 to double inward FDI within five
years in order to provide a boost to the stagnant economy. Moreover, given the fact that theservice sector (including construction and utilities) accounts for nearly 80 percent of total GDP,raising productivity growth in the non-manufacturing sector has been one of the top policy
priorities to increase the long-term growth potential of the economy. For the non-manufacturingsector, foreign entry may be more important than for the manufacturing sector. Becauseinternational transactions are sometimes difficult for certain types of services, the service sector
is less likely to be exposed to international competition than the manufacturing sector and hence
to learn from foreign firms with advanced technology, management know-how, etc. In this sense,
foreign entry should be particularly important for the service sector to improve productivity
through competition effects and learning effects. 3 However, there are very few empiricalstudies on foreign entry effects in the service sector, mainly due to data constraints. One of the
few exceptions is Arnold et al. (2007). Focusing on the case of the Czech Republic, the study
finds that opening service sectors to foreign providers is a key channel through which services
liberalization contributes to improved performance in downstream manufacturing sectors.
However, the study did not examine FDI spillover effects on domestic firms in the service sector
itself.
In order to address the various shortcomings highlighted so far, this paper examines whether
the productivity of domestic firms is correlated with the presence of FDI in their industry
utilizing a Japanese large-scale firm-level dataset including data for firms in the service sector.
3

Ito (2007), using data on listed Japanese firms, found that firms in the non-manufacturing sector
achieved faster productivity growth at home than firms in the manufacturing sector after conducting
direct investment abroad. This result suggests that the learning effect of FDI is larger for services
firms than for manufacturing firms.
2

The major contribution of this paper is to add to the literature by examining the spillover effects
of foreign-owned firms on domestic firms in the service sector. Although at least some empiricalstudies on the manufacturing sector suggest that FDI improves productivity in the recipient
economy through technology diffusion and other channels, it is possible that such channels of
FDI spillover may not operate to the same extent in the service sector. Given the scarcity of
empirical evidence on the service sector, the main purpose of this paper therefore is to examine
the existence of FDI spillovers in the service sector. To the best of my knowledge, this study isthe first rigorous empirical analysis of FDI spillover effects based on large-scale firm-level
panel data for the service sector.
The major findings of this paper are as follows. Both for the manufacturing and the service
sector, negative FDI spillover effects on the productivity of domestically-owned firms are foundonce firm fixed effects are controlled for. Only firms whose productivity growth is relatively
high enjoy positive spillover effects from foreign-owned firms in the same industry. These
results imply that foreign entry will not raise the overall productivity level of domestic firms
unless low productivity firms are forced to exit or policies for raising the productivity levels of
less productive firms go hand-in-hand with foreign entry. Moreover, the negative FDI spillover
effect tends to be larger in the service than in the manufacturing sector, implying that there may
be systematic differences in FDI spillover effects in the manufacturing and thenon-manufacturing sector.
The remainder of this paper is organized as follows. Section 2 provides an overview of therole of foreign-owned firms in Japan in terms of employment and value added. Section 3 thendiscusses the theoretical background and presents the empirical model for the productivity
spillover analysis, while Section 4 presents the empirical results. Section 5 concludes.

2. Data and Characteristics of Foreign-Owned Firms in Japan
2.1 Data
Before examining aggregate-level and firm-level productivity in Japan, this sub-section
briefly describes the data used in this study. The data used is the firm-level panel data
underlying the Basic Survey on Business Structure and Activities (BSBSA) collected annuallyby the Ministry of Economy, Trade and Industry (METI). The survey covers all firms with atleast 50 employees or 30 million yen of paid-in capital in the Japanese manufacturing, mining,

3and commerce sectors and several other service sectors. Although the survey started in 1992
(data for fiscal 1991), data for 2000-2007 are used for this study because observations for the
non-manufacturing sector – the main focus of this paper – increased substantially from the 2001
survey (data for fiscal 2000). 4 Observations for firms for which data on sales, number of
employees, total wages, tangible fixed assets, depreciation, or intermediate inputs are notpositive or are missing for at least one year are dropped from the dataset for the analysis in thispaper. After this screening, the unbalanced panel dataset contains approximately 24,000 firms,
half of which are service sector firms. 5
Utilizing the firm-level panel data, two kinds of productivity measures are constructed: laborproductivity and total factor productivity (TFP). Because information about working hours at
the firm level is not available, labor productivity is calculated as the real value added per
employee. Real value added is calculated as real output minus real intermediate input using
industry-level price deflators taken from the JIP Database 2009. TFP for each firm is calculated
based on the production function estimated using the semi-parametric estimation techniquesuggested by Levinsohn and Petrin (2003). 6

2.2 Productivity trends in the Japanese economy and the presence of foreign-owned firms
in Japan
While productivity in the Japanese economy overall has “only” stagnated since the 1990s,
productivity in the Japanese service sector has in fact fallen sharply and it has often been
pointed out that both the level and the growth rate of productivity in the Japanese service sector
are much lower than that in the manufacturing sector (e.g., Ministry of Health, Labour and4

The survey contains detailed information on firm-level business activities such as the 3-digit
industry in which the firm operates, its number of employees, sales, purchases, exports and imports,
R&D and patents, the number of domestic and overseas subsidiaries, and various other financial datasuch as costs, profits, investment, and assets. Although the survey also asks non-manufacturing firms
for information on exports and imports, they are required to provide the amount of trade in goods
only. The survey does not cover international transactions in services. The firm-level data of the
BSBSA were obtained through the Trade and Investment Facilitation Division, Trade and Economic
Cooperation Bureau, Ministry of Economy, Trade, and Industry (METI). However, the views
expressed in this paper are solely those of the author, and do not present those of the METI.
5
The industry classification and number of observations by industry are shown in Appendix Tables
1 and 2, respectively.
6
For details of the definition of and data source for each variable for the TFP calculation, see the
Appendix.
4

Welfare, 2008). 7

Moreover, an international comparative study on sectoral productivity levels

undertaken by the EU KLEMS project reports that the productivity level in some service
industries in Japan such as trade and business services is only around 40–50 percent of the U.S.
level in 1997 and that the relative productivity levels further deteriorated in 2005 compared withthe corresponding levels in 1997 for most of the sectors. 8
Against this background, it has often been argued that improving productivity particularly inthe service sector is a priority for the Japanese economy (METI 2007). 9 Inward FDI is expected
to raise productivity in the Japanese economy by intensifying market competition andgenerating knowledge spillovers to domestic firms. However, as discussed in Section 1, theeffects of foreign entry on the productivity of domestic firms are still unclear, particularly in thecase of service industries.
Let us begin by looking at the share of foreign-owned firms in the Japanese economy using
the firm-level data underlying the BSBSA. Table 1 shows the number of foreign-owned firms byindustry for the period 2000-2007. In this study, foreign-owned firms are defined as firms with
33.4 percent or more foreign ownership. 10 As can be seen in the table, the number offoreign-owned firms increased until 2005 but then decreased in the following years. 11

7

For example, Fukao et al. (2007) show that TFP growth in the service sector has been low sincethe 1970s and that it has further deteriorated since the 1990s. Similarly, Shinada (2003) shows that
service sector TFP in the Japanese service sector in the 1990s was substantially lower than in the
1980s. Furthermore, OECD (2001), comparing service sector labor productivity across countries,
reports that labor productivity growth in Japan drastically declined in major service industries. For
example, labor productivity growth in the wholesale and retail trade industry and the transportationand telecommunication industry stood at 4.4 percent and 4.1 percent, respectively, for the period
1979-89, the highest among the ten major developed countries. However, for the period 1990-97, thecorresponding growth rates dropped to 1.0 percent (placing Japan fifth among the ten countries) and
0.5 percent (the lowest among the ten countries), respectively. On the other hand, Morikawa (2007a),
using Japanese firm-level data for the period 2000-2004, finds that productivity levels in service
industries is not significantly lower than those in manufacturing industries, although the dispersion
in productivity within the former is greater than that in the latter.
8
In contrast, it has been pointed out that for the United States, services industries were the driversof overall productivity growth (see, e.g., Triplett and Bosworth 2006).
9
Morikawa (2008), for example, argues that in order to improve service sector productivity, thediffusion of best practice and greater firm- and industry-level dynamism through firm entry and exit
is necessary.
10
In Japan, the Commercial Law prescribes that important matters should be decided by obtaining
more than two-thirds of the voting rights at a shareholders’ meeting. Therefore, an ownership shareof 33.4 percent is critical in order to exercise a veto. For this reason, METI also defines
foreign-owned firms as firms with a foreign ownership ratio of 33.4 percent or more. However, thenumber and share of foreign-owned firms show a similar trend when defining foreign-owned firms
as firms with 50 percent or more foreign ownership.
11
In the dataset used for this study, the number of foreign-owned firms in the service sector is only
5

INSERT Table 1

Table 2 shows the shares of foreign-owned firms in total employment and in total real value
added by industry. Reflecting the fact that foreign-owned firms tend to be larger thandomestically-owned firms, the employment and value added shares of foreign-owned firms aremuch larger than the share of foreign-owned firms in terms of the number of firms. As for theemployment share, firms that are 33.4 percent or more foreign-owned account for 5.4 percent of
employment in all industries, which splits into 7.6 percent for the manufacturing sector and 3.5
percent for the service sector (Panel (a) of Table 2). As for value added, using the same
foreign-ownership ratio, share of foreign firms is much larger at 10.0 percent of total value
added in all industries and 14.5 percent and 5.1 percent in the manufacturing and the service
sector (Panel (b) of Table 2). The total value added share of foreign firms tends to be larger thanthe employment share in almost all industries, suggesting that foreign firms tend to have higher
value added per employee, i.e., higher labor productivity. Looking at the trend of foreign-owned
firms’ share in total employment, the share increased until 2005 but decreased thereafter, which
is similar to the trend in the number of foreign-owned firms. In the case of value added, theoverall share steadily increased until 2005, but then remained more or less unchanged.

INSERT Table 2

Thus, although the trends in the share of foreign-owned firms show somewhat different
patterns across sectors and depending on the indicator chosen, it seems safe to say that,particularly in terms of value added, the presence of foreign-owned firms increased during theperiod 2000-2007. These observations imply that foreign-owned firms tend to have higher laborproductivity and a higher growth rate of labor productivity than domestically-owned firms.
slightly larger than that in the manufacturing sector. In fact, however, both in Japan and otherdeveloped countries, foreign entry is more prominent in the service sector (see, e.g., Directory ofForeign-Owned Firms in Japan published by Toyo Keizai Shimposha.). The data used in this paper
cover only firms with 50 or more employees. Relatively small foreign-owned firms, which are likely
to be firms in the service sector, are not included in this dataset. Furthermore, in the case of several
service sectors such as transportation, telecommunication, financial intermediation, insurance, andreal estate, most of the firms are not covered in the BSBSA. The BSBSA only covers firms in these
sectors if they have an establishment in a sector administrated by METI. Refer to Ito and Fukao(2005) for more comprehensive statistics on foreign-owned firms in Japan.
6

These conclusions are in line with empirical studies for a variety of countries which showthat foreign-owned firms tend to outperform domestic firms. For Japan, studies that provide
evidence to this effect include Fukao et al. (2005) and Kimura and Kiyota (2007). In addition,although not shown here to conserve space, the data used in this paper show that foreign-owned
firms also outperform domestic firms in terms of a range of other performance measures such as
TFP, firm size, wages, and profitability. 12

3. Empirical Methodology
The previous section suggested that foreign-owned firms outperform domestic firms both in
the manufacturing and the service sector. This brings us to the question whether the presence of“superior”

foreign-owned

firms

contributes

toproductivity

improvements

amongdomestically-owned firms through learning and competition effects. This section presents theempirical methodology employed to address this question, that is, to test whether there arepositive spillovers from foreign-owned to domestically-owned firms.
As mentioned at the outset, there are several main channels for such spillover effects,
including demonstration/imitation effects or spillovers through backward and forward linkages.
In this paper, the baseline specification for the relationship between inward FDI and the
productivity growth of domestically-owned firms is as follows:∆PRODijt = β0 ∆FRPRODjt + β1 GAPijt−1 + β2 FDI sharejt−1 + β3 ∆MKT shareijt+μi + γj + ηt + εijt

(1)where i indexes domestically-owned firms, j indexes industries, and t indexes years. The
dependent variable (PROD) is the productivity of domestically-owned firms. FDIshare denotes
the foreign presence in the industry proxied by the employment share of foreign-owned firms. 13
In line with the majority of existing studies on the spillover effects of foreign entry, thecoefficient on the FDIshare variable, 𝛽2 , here is used as an indicator of the existence andmagnitude of spillover effects. Following Haskel et al. (2007), changes in market share

12

The results can be obtained from the author upon request.
To calculate FDIshare, a firm’s total number of employees is counted as foreign if the sum of theshare held by foreigners is 33.4 percent or more. The variable FDIshare is calculated as the total
number of workers employed by foreign-owned firms divided by the total number of employees in
the industry.

13

7

(ΔMKTshare) are included in order to measure changes in competitive pressure. As argued, forexample, by Aitken and Harrison (1999), competition with foreign-owned firms may reduce themarket shares of domestically-owned firms and force them to operate on a less efficient scale,
resulting in increases in their average costs and lower productivity. MKTshare is measured as afirm’s sales as a proportion of the industry’s total sales. Because the market share variable isalso affected by technological differences between industries and may not be a good indicator ofmarket power, the difference variable (ΔMKTshare) is used for the analysis. This specification
does not take account of the heterogeneity in the correlation between inward FDI and the
productivity growth of domestically-owned firms suggested by Agihon et al. (2009). However,following neo-Schumpeterian models of endogenous growth (e.g., Acemoglu et al. 2006),
technological distance from the frontier firms in the industry (GAP) is included. The idea is thatfirms lagging behind the technological frontier can improve productivity by adopting advanced
technologies available in the market. Thus, firms’ productivity growth depends on both theability to catch up towards frontier firms and the ability of frontier firms to innovate. Therefore,
as a proxy for the innovative ability of frontier firms, the productivity growth of frontier firms(ΔFRPROD) is also taken into account. Frontier firms are defined as firms whose productivity
level is among the top 5 percent in each industry and in each year. 14 The productivity of frontierfirms is calculated as the average productivity of frontier firms, and the technological distancefrom the frontier is measured as the frontier’s productivity level minus a firm’s productivity
level (FRPROD –PROD). 15 Both FRPROD and GAP are expected to take a positive coefficient.
Both TFP and labor productivity are used for the productivity variables PROD and FRPROD,
and the productivity measures are in logarithm. μi, γj, and ηt are fixed effects for firms, industries,
and years, respectively. εijt is the error term. Firm fixed effects (μi) are included to capture
unobserved firm heterogeneity related to firm location, size, the sub-industry of operation,
managers’ characteristics, firm age, etc.
14

The frontier firms include some foreign-owned firms. If the 33.4 percent foreign ownership ratio
is applied, approximately 8 percent of the frontier firms are foreign-owned, while if the majority
foreign ownership definition is applied, approximately 5 percent of the frontier firms areforeign-owned. The frontier productivity growth indicates the growth potential of each industry andit seems reasonable to include foreign-owned firms among the frontier firms. However, the variable
FPROD proxies the productivity growth rate of foreign-owned firms when the frontier firms consist
largely of foreign-owned firms. Estimation using the FPROD variable calculated excluding
foreign-owned firms produces almost the same results as when using the FPROD variable calculated
including foreign-owned firms.
15
For frontier firms, the technological distance from the frontier (GAP) is set to zero.
8

4. Estimation Results
4.1 Baseline results
The estimation results of the baseline specification (1) are shown in Table 3. For thebaseline estimation, the one-year difference of the productivity and market share variables isused. In order to take endogeneity into account, the FDIshare and GAP variables are lagged by
one year. The results of the TFP specification are presented in panel (a), while the results of thelabor productivity specification are presented in panel (b). In both panels, columns (1) – (3)present the OLS results without firm fixed effects, and columns (4) – (5) present the panel
fixed-effect estimation results taking firm fixed effects into account.
The results in Table 3 suggest that the FDI spillover effects are negative in many cases
when firm fixed effects are controlled for, while the FDI spillover effects tend to be positive
when firm fixed effects are not controlled for. These results suggest that only firms which
potentially realize higher productivity growth because of firm specific characteristics enjoy
positive spillovers from foreign-owned firms in the same industry.

INSERT Table 3

4.2 Heterogeneity of the effects of FDI
The

estimation

resultsforthebaseline

specification

indicatethat

whetherdomestically-owned firms enjoy positive spillover effects appears to depend on firm specificcharacteristics. In order to take this heterogeneity in the correlation between inward FDI and the
productivity growth of domestically-owned firms into account, the baseline specification ismodified as follows:<Modified specification 1>∆PRODijt = β0 ∆FRPRODjt + β1 GAPijt−1 + β2 FDI sharejt−1 + β3 ∆MKT shareijt+β4 CATCHijt ∙ FDIsharejt−1 + β5 CATCHijt + μi + γj + ηt + εijt

<Modified specification 2>

9(2)

∆PRODijt = β0 ∆FRPRODjt + β1 GAPijt−1 + β2 FDI sharejt−1 + β3 ∆MKT shareijt+β4 GAPijt−1 ∙ FDIsharejt−1 + μi + γj + ηt + εijt

(3)

The variable CATCH is a dummy variable which takes one for catch-up firms and zerootherwise. Catch-up firms are defined as firms that reduced the gap with the frontier during thepreceding year. 16 That is, firms that reduced the distance to the frontier from year t-1 to year t
are defined as catch-up firms in year t. The modified specification 1 (equation 2) is estimated inorder to examine whether catch-up firms enjoy positive spillovers. On the other hand, Aghion etal. (2009) argue that the threat from frontier entrants leads incumbents in sectors that are
initially close to the technology frontier to innovate more, and this triggers productivity growth.
In sectors close to the frontier, incumbent firms know that they can escape and survive entry byinnovating successfully, and so they react with more intensive innovation activities. However, insectors further from the frontier, the entry threat reduces the expected rents from conducting
R&D for incumbent firms, because incumbents have no hope to win against an entrant.
Therefore, the FDI spillover effect is heterogeneous across sectors and firms, depending on the
distance from the technology frontier. To incorporate Aghion et al.’s (2009) argument, themodified specification 2 (equation 3) includes an interaction term of the GAP and FDIsharevariables. However, in contrast with Aghion et al. (2009), who test for heterogeneity acrossindustries and consider the distance to the world technological frontier by industry, assumingthat U.S. industries represent the world technological frontier, this paper considers each firm’s
technological distance to the national frontier in each industry (GAP) instead of theindustry-level technological distance to the world frontier. In addition to data constraints, thereason is that this paper focuses on the heterogeneity of FDI spillover effects across firms within
an industry. Based on Aghion et al. (2009), firms closer to the national frontier may be expected
to be more actively engaged in innovative activities and more likely to enjoy positive FDI
spillovers as a result than firms further from the frontier.
Table 4 shows the fixed effect estimation results of the modified specifications 1 and 2. As
for catch-up firms, they enjoy positive FDI spillovers and the effect is statistically significant inall cases (columns 1–3 in both panels). On the other hand, the interaction term of technologicaldistance and FDI does not have a statistically significant coefficient in most cases (columns 4–5

16

The definition of catch-up firms here follows Arnold et al. (2008).
10

in both panels). The only exception is the TFP specification for the service sector (column 6 ofpanel a). In this case, only firms closer to the technological frontier can enjoy positive FDI
spillovers, which is consistent with the results obtained by Aghion et al. (2009). However, thisdoes not apply to all other cases, so that the evidence on whether firms closer to thetechnological frontier enjoy positive spillover effects is not conclusive.
As for other explanatory variables, both the variable for frontier productivity growth(FRPROD) and that for technological distance from the frontier (GAP) have a positive andsignificant coefficient, as expected. The market share variable (MKTshare) also has a positiveand significant coefficient, suggesting a positive correlation between market share growth andproductivity growth. 17

INSERT Table 4

4.3 Robustness checks
Estimating the relationship between foreign entry and the productivity of domestic firms
raises a number of important econometric issues concerning the possible endogeneity of FDI
and the direction of causality. That is, although a considerable number of studies have found asignificant correlation between firm productivity and foreign entry, changes in the presence of
foreign firms may be endogenous to shocks to firm productivity. Moreover, it is often difficult
to determine the direction of causality between the presence of foreign firms and productivity.
That is, foreign firms may be attracted to industries with high productivity growth. Alternatively,
foreign firms may enter industries with low productivity growth in order to reap greater gains
from their competitive advantage. Several previous empirical studies address these issues, forexample by employing an instrumental variable (IV) regression approach (e.g., Haskel et al.
2007, Aghion et al. 2009, Vahter 2010) and/or by employing longer time lags (e.g., Haskel et al.
17

Supplementary analysis of extensions of the models above that include various measures ofindustry-level competition, such as the Herfindahl index (calculated by industry using the firm-level
dataset), the import penetration ratio (calculated using the JIP Database 2009), and regulation
weights (taken from the JIP Database) show that the Herfindahl index tends to be negatively
correlated with firm productivity, suggesting that competition promotes productivity growth.
However, the import penetration ratio is negatively associated with firm productivity growth, while
the regulation weight is positively associated with firm productivity growth, suggesting thatcompetition restrains firm productivity growth. Although it is difficult to obtain a conclusive result
regarding market competition effects on firm productivity, the estimated coefficients on the FDI
variable are mostly consistent.
11

2007). Because suitable instruments are not readily available, the approach taken here to checkthe robustness of the results is to use longer time lags. 18
In the baseline estimation and the modified estimations presented above, one-year lagged
values of the variables representing foreign presence are used instead of contemporaneous
values in order to address the endogeneity issue. However, for robustness checks, the samemodels (equations 1, 2, and 3) using a longer time lag are estimated to take account of thepossibility that foreign presence may be correlated with productivity shocks in the near future.
Moreover, longer lags may be more appropriate if spillovers take time to materialize. The
baseline results when taking three-year differences and using three-year lagged values forforeign presence are presented in Table 5. The modified specifications are also estimated withthree-year differences and lagged values and the results are shown in Table 6. The results inTable 5 are very similar to those in Table 3, confirming that FDI spillover effects are negative
once firm fixed effects are controlled for. The results in columns (1)–(3) in Table 6 are also
consistent with those in columns (1)–(3) in Table 4, suggesting that only catch-up firms enjoy
positive FDI spillovers. Moreover, these results suggest that negative spillover effects are larger
in the service sector than in the manufacturing sector.
On the other hand, as for technological distance and FDI effects, the results in Table 6 are
not consistent with those in Table 4. Columns (4)–(6) in Table 6 show that firms further from thefrontier enjoy positive FDI spillovers, particularly in the case of the manufacturing sector. This
result is at odds with Aghion et al. (2009) and suggests that, in the long run, firms further fromthe frontier may be able to improve productivity by adopting advanced technology
demonstrated by foreign-owned firms. Such demonstration and imitation effects may be larger
for firms lagging further behind than firms close to the frontier. However, in the case of theservice sector, the interaction term of technological distance and FDI does not have astatistically significant coefficient and the overall effects of foreign presence are still negative.

18

Possible candidates for an instrument may include inward FDI in the United States or indicatorsof regulation. However, there are several difficulties in employing these variables as instruments. For
example, inward FDI in the United States is not highly correlated with inward FDI in Japan,
suggesting that the inward FDI in the United States may not work well as an instrument. In addition,although an instrumental variable should be correlated with foreign entry but not with the
productivity of domestic firms, it is extremely difficult to find a proxy for regulations which only
affect foreign entry and does not affect productivity of domestic firms. Nevertheless, althoughemploying an IV approach presents considerable difficulties, doing so in the future would be aworthwhile exercise.
12

INSERT Tables 5 & 6Finally, as another robustness check, it is examined whether the results depend on how
foreign-owned firms are defined, since this is not a straightforward matter. In the analyses so far,foreign-owned firms were defined as firms with 33.4 percent or more foreign ownershipfollowing the official Japanese government definition, and therefore, firms in which foreign
portfolio investment exceeds this threshold are included as foreign-owned firm. 19 In order to
exclude such cases as much as possible, equations (1)–(3) above are estimated using a new
FDIshare variable which is calculated based on the majority ownership definition (50 percent ormore foreign ownership). 20 The results are largely consistent with those in Tables 3–6. 21

4.4 Further discussion and interpretation of the results
The analysis in this paper suggests that FDI spillover effects on the productivity growth ofdomestically-owned firms are negative. Negative FDI spillovers are possible when the presenceof foreign-owned firms causes significant losses in the market shares of domestically-owned
firms and prevents the latter from operating on an efficient scale. The analysis here, however,indicates that FDI spillovers are negative even after controlling for changes in market shares.
Possible explanations include the following. First, an increase in the presence of foreign-owned
firms may increase demand for highly-skilled workers and reduce the ability ofdomestically-owned firms to attract highly-skilled workers. As a result, the quality of labor atdomestically-owned firms may decline and their productivity growth deteriorate. Second,
competition with foreign-owned firms may promote product diversification and/or productswitching at domestically-owned firms. Although in the analysis here firms’ sales and purchases
are deflated using industry-level price deflators, the industry of a firm is defined by the productmaking up the largest share of sales. Therefore, the effects of product diversification and/or
19

It should be noted, though, that in Japan (as in many other countries), a substantial share of thestocks issued by listed firms is owned by foreign institutional investors in the form of portfolio
investment.
20
Definitions of foreign-owned firms in official statistics vary across countries. For example, in the
United States, foreign-owned firms are defined as firms with 10 percent or more ownership by asingle foreigner or foreign firm, while in Japan foreign-owned firms are defined as firms with 33.4
percent or more ownership by one or several foreigners. In some countries, firms are considered as
foreign-owned for any foreign ownership share, or for ownership shares of at least 5 percent or 10
percent. However, the majority ownership definition is widely employed worldwide.
21
The results are shown in Appendix Tables 3–6.
13

product switching on firm productivity are not fully captured. Third, domestically-owned firms
may react to greater competition with excessive levels of investment in order to retain theirmarket share, resulting in lower productivity. The results of this paper suggest that negative FDI
spillover effects are particularly large in the case of service sector firms. If firms facing greater
competition increase investment such as ICT (information and communication technology)
investment and job training for workers in order to improve the quality of services, theirproductivity level should in theory also improve. However, it is extremely difficult to measureservice quality and to calculate productivity reflecting quality changes. 22
While the results suggest that the overall spillover effects of inward FDI are negative, theytend to be positive for firms with high productivity growth. This suggests that the presence of
foreign competitors is favorable for such firms and helps them to further improve theirproductivity. Moreover, some of the estimation results indicate that, in the case of the
manufacturing sector, foreign entry tends to accelerate productivity growth for firms lagging
behind the technological frontier in the long run, suggesting that learning effects from advanced
foreign-owned firms do exist. If foreign entry accelerates productivity catch-up, then it is likely
to contribute to long-run economic growth by affecting firm dynamics. However, it should be
noted that the overall effect of inward FDI is still negative and it is therefore necessary to
examine what factors contribute to FDI spillovers being positive.
Previous studies such as Javorcik (2004), Javorcik et al. (2004), and Barrios et al. (2009)
focus on inter-industry linkages. Although examining the role of inter-industry linkages isbeyond the scope of this study, it seems likely that both intra- and inter-industry transaction
relationships among firms are important channels of technology diffusion. That in the analysis
here the magnitude of negative FDI spillover effects was found to be larger for services thanmanufacturing firms may reflect the fact that service firms tend to have fewer transaction
relationships with other firms, especially when compared with firms in assembly-type industries
such as the automobile, electronics, and machinery industries. In fact, the service sector has ahigher value-added to output ratio than the manufacturing sector, suggesting that the service
sector uses less intermediate inputs than the manufacturing sector and has fewer intra- andinter-industry transaction relationships. 23 This suggests that services firms have less22

For a more detailed discussion of the various problems involved in the measurement of
productivity in services see, for example, Hartwig (2008) and Inklaar et al. (2008).
23
Based on the firm-level panel data used in this study, the value-added to output ratio is 28
14

opportunity to receive spillovers from upstream firms. Moreover, a large part of total demand in
the service sector is final demand, while in the manufacturing sector it is intermediate demand. 24
These relatively limited forward and backward linkages with other firms may prevent service
sector firms from absorbing advanced technology or know-how from foreign-owned firms.
Finally, even though foreign entry does not have a positive effect on domestically-owned
firms’ productivity growth, it may nevertheless affect their behavior. Vahter (2010), analyzing
Estonian firm-level data employing a specification à la Aghion et al. (2009), concludes that
although FDI entry does not have a significant short-term effect on productivity growth, it ispositively associated with process innovation at domestically-owned firms. For Japanese firms,
Todo (2006) found a positive association between the R&D stock of foreign-owned firms andthe productivity of domestically-owned firms, while there was no such association in the case of
the capital stock of foreign-owned firms, suggesting that foreign-owned firms’ knowledge spills
over through their R&D activities. These results imply that FDI spillovers are closely associatedwith knowledge flows to domestically-owned firms, and positive FDI spillovers may be seen
explicitly if focusing on knowledge flows instead of just looking at foreign penetration in termsof employment or sales. Although knowledge flows from foreign-owned to domestically-owned
firms are an interesting issue for future research, defining knowledge flows would be extremely
difficult for service sectors.

5. Conclusion
This paper examined the FDI spillover effects on productivity growth of domestic firms,
using a large-scale Japanese firm-level dataset which covers a large number of service sector
firms. The analysis was motivated by the fact that although FDI in the service sector is apotentially important channel of international technology diffusion – especially given that
services are often difficult to trade – there has been little empirical research on the effects ofsuch FDI. Yet, such research is essential for a better understanding of FDI spillovers and theformulation of economic and industrial policies.
percent for manufacturing firms, while it is 46 percent for services firms. The industry-level datafrom the 2005 Input-Output Tables show similar figures. At the aggregated level, the grossvalue-added to domestic output ratio is approximately 30 percent for the manufacturing sector andapproximately 60 percent for the service sector.
24
For example, according to the 2005 Input-Output Tables, the share of final demand in total
demand is 44 percent for the manufacturing sector while the corresponding figure for the service
sector is 58 percent.
15

The analysis found no evidence of positive FDI spillover effects on the productivity growthof domestically-owned firms. In fact, the results suggest that the presence of foreign-owned
firms tends to be negatively associated with the productivity growth of domestically-owned
firms, both in the manufacturing and the service sector. However, the magnitude of the negative
effect is larger in the case of the service sector, implying that FDI spillover effects areheterogeneous across sectors and depend on the characteristics of sectors. Various possible
sources for the heterogeneity were discussed, and these sources deserve further scrutiny infuture research.
While the results suggest that the overall spillover effects of FDI are negative, they tend to
be positive for firms with high productivity growth. This finding implies that foreign entry
potentially raises industry- or macro-level productivity if firms with low productivity growthpotential are forced to exit from the market. Alternatively, the results suggest that to raiseindustry- or macro-level productivity growth, a policy scheme to encourage less productive
firms to improve their productivity should be introduced along with the promotion of inward
FDI. On the other hand, in the case of the manufacturing sector, in the long run, firms lagging
behind the technological frontier are found to be more likely to see an improvement inproductivity through learning from foreign-owned firms. These results imply that foreign entry
possibly contributes to long-run economic growth by affecting firm dynamics. However, theoverall effect of inward FDI is still negative and further investigation on factors which lead topositive FDI spillovers are desirable.
Lastly, some limitations of this study and remaining issues should mentioned. First, although
it is difficult to solve the endogeneity problem mentioned in Section 4, further robustness
checks of the estimation results are necessary. Second, as mentioned in Section 2, the coverageof the BSBSA is not sufficiently large, particularly in the case of the service sector and forsmall-sized firms. Given the importance of the potential effects of foreign entry in the service
sector, expanding the industries and firms surveyed and further empirical studies using such an
expanded dataset are necessary to gain a deeper understanding of the spillover effects of foreign
entry.

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16

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19

Appendix: Variable construction and data sources

Output: Except for the commerce sector, gross output is defined as firms’ total sales. For thecommerce sector, gross output is measured as sales minus expenses for purchased materials.
Gross output is deflated by the output deflator taken from the JIP Database 2009 for years 2000
to 2006. For 2007, the output deflator was extrapolated using the growth rate of various priceindexes from 2006 to 2007 published by the Bank of Japan. The output price index was used for
manufacturing industries, and the corporate service price index was used for service industries.

Intermediate inputs: For the commerce sector, intermediate inputs are calculated as (Cost of
sales + Operating costs) – (Wages + Depreciation costs + Expenses for purchased materials).
The intermediate inputs of other sectors are defined as (Cost of sales + Operating costs) –(Wages + Depreciation costs). Intermediate inputs are deflated by the intermediate input deflator
taken from the JIP Database 2009 for years 2000 to 2006. For 2007, the intermediate input
deflator was extrapolated using the growth rate of various price indexes from 2006 to 2007
published by the Bank of Japan. The input price index was used for manufacturing industries.
For service industries, the intermediate input deflator for 2007 was calculated using the output
deflator and the 2006 JIP Input-Output Table.

Labor input: Labor input is calculated as each firm’s total number of workers multiplied by thesector’s working hours taken from the JIP Database 2009 for years 2000 to 2006. For 2007, thedata on working hours by sector are extrapolated using the growth rate of working hours from2006 to 2007 taken from the Monthly Labor Survey published by Ministry of Health, Labourand Welfare.

Capital Stock: For capital stock, the only data available are the nominal book values of tangible
fixed assets. Using these data, the net capital stock of firm i in industry j in constant 2000 prices
is calculated as follows:

K it = BVit ∗ ( INK jt / IBV jt )where BVit represents the book value of firm i’s tangible fixed assets in year t, INKjt stands forthe net capital stock of industry j in constant 2000 prices, and IBVjt denotes the book value of20

industry j’s capital. INKjt is calculated as follows. First, the data on the book value of tangible
fixed assets in 1975 from the Financial Statements Statistics of Corporations published by
Ministry of Finance were taken as a benchmark. Then, the book value of year 1975 wasconverted into the real value in constant 2000 prices using the investment deflator taken fromthe JIP Database 2009. Second, the net capital stock of industry j, INKjt, for succeeding years
was calculated using the perpetual inventory method. The sectoral depreciation rate used was
taken from the JIP Database 2009.

21

Table 1. Number of foreign-owned firms

1-48 All industries
1-30 Manufacturing33-48 Services
37
38

Wholesale
trade
Retail trade40-42 Businessservices
44

Information
services(Upper row: No. of firms; Lower row: %)2000-07
2004
2005
2006
2007
average
533
560
494
466
474
(2.22) (2.38) (2.08) (1.88)(2.00)
266
264
243
235
234
(2.31) (2.33) (2.18) (2.02)(2.07)
267
296
250
231
239
(2.15) (2.43) (2.00) (1.77)(1.95)
158
171
142
124
146
(3.18) (3.53) (3.01) (2.56)(2.95)
33
39
32
32
29
(1.12) (1.33) (1.11) (1.07)(0.98)

2000

2001

2002

2003

407
(1.74)
202(1.76)
205(1.74)
141(2.68)
23(0.79)

441(1.85)
222(1.93)
219(1.79)
149(2.89)
22(0.73)

450(1.93)
213(1.90)
236(1.96)
151(3.02)
27(0.94)

437(1.93)
230(2.13)
206(1.75)
131(2.72)
21(0.75)

11

15

17

17

25

28

21

22

20

(1.41)
27(2.12)(1.67)
28(2.06)(1.80)
33(2.37)(1.66)
26(1.89)(2.20)
31(2.01)(2.35)
35(2.37)(1.76)
33(2.25)(1.70)
27(1.67)(1.84)
30(2.08)

Note: Figures in parentheses are the share of foreign-owned firms in the total number of firms.

Table 2. Share of foreign-owned firms in total employment and in total value added(a) Share in employment (33.4 % or more foreign-owned)

1-48 All industries
1-30 Manufacturing33-48 Services
Wholesale
37
trade
38 Retail trade
Business
40-42
services
Information
44
services

2000

2001

2002

2003

2004

2005

2006

2007

3.56
5.59
1.56

3.81
6.01
1.76

4.20
5.44
3.14

6.11
8.82
3.79

6.31
9.05
4.07

6.77
9.06
4.94

6.09
8.99
3.96

5.69
7.88
4.06

(%)
2000-07
average
5.36
7.60
3.49

2.82

3.21

3.57

3.04

3.52

4.31

3.61

4.85

3.61

0.66

0.40

2.20

3.34

2.66

4.03

3.23

2.80

2.49

0.67

2.30

2.99

2.91

5.77

6.73

4.11

3.33

3.88

3.27

3.88

5.23

7.06

5.35

5.59

6.46

4.65

5.25

2000

2001

2002

2003

2004

2005

2006

2007

5.16
7.64
2.22

6.15
9.04
3.17

5.52
6.45
4.64

10.00
14.55
5.23

10.97
15.20
6.38

12.89
18.39
7.08

12.19
19.27
4.38

12.90
18.24
6.01

（%）
2000-07
average
10.02
14.52
5.08

5.21

5.14

5.29

5.00

5.94

7.99

7.43

10.31

6.51

1.33

0.98

2.45

3.72

4.06

5.43

5.27

4.68

3.57

0.35

6.26

7.59

7.89

7.20

7.25

2.39

6.28

5.85

4.16

4.60

10.88

12.00

10.53

10.59

13.45

11.59

9.95

(b) Share in total value added (33.4% or more foreign-owned)

1-48 All industries
1-30 Manufacturing33-48 Services
Wholesale
37
trade
38 Retail trade
Business
40-42
services
Information
44
servicesTable 3. Estimation results(a) Dependent variable: TFP growth ijt
(1)
(2)
All
Mfg.
0.862***
0.880***
d.FRPRODjt(0.007)(0.007)0.169***
0.174***GAPijt-1(0.006)(0.011)
0.941***
1.155***
FDI sharejt-1(0.139)(0.179)6.391***
6.456***
d.MKTshareijt(1.086)(2.069)(3)Services
0.815***(0.016)
0.162***(0.007)0.659***(0.199)6.630***(1.255)(4)All
0.952***(0.002)
0.788***(0.007)-0.130***(0.046)
3.827***(0.860)(5)
Mfg.
0.960***(0.003)0.767***(0.012)0.039(0.060)4.051***(1.315)(6)Services
0.923***(0.004)0.816***(0.008)-0.256***(0.062)4.032***(0.697)

Industry effects
Year effects
Firm effects
Observations
F statistic
R-squared

Yes
Yes
No
72,566
89.0
0.647

Yes
Yes
Yes
142,1363344.3
0.881

Yes
Yes
Yes
69,5704961.6
0.905

Yes
Yes
Yes
72,5661359.70.757(b) Dependent variable: Labor productivity growth ijt
(1)
(2)
(3)
All
Mfg.
Services
0.343***
0.381***
0.323***
d.FRPRODjt(0.014)(0.024)(0.019)0.192***
0.196***
0.187***GAPijt-1(0.007)(0.011)(0.009)0.091
0.221*-0.088
FDI sharejt-1(0.092)(0.118)(0.110)2.424***
3.744***
1.811***
d.MKTshareijt(0.445)(1.133)(0.442)(4)All0.705***(0.008)0.742***(0.008)-0.267***(0.044)
1.538***(0.396)(5)
Mfg.
0.728***(0.014)0.736***(0.013)-0.166***(0.056)2.737***(0.784)(6)Services
0.710***(0.011)
0.763***(0.009)-0.247***(0.061)1.181***(0.374)

Industry effects
Year effects
Firm effects
Observations
F statistic
R-squared

Yes
Yes
Yes
142,515
180.8
0.407

Yes
Yes
Yes
69,595
171.1
0.408

Yes
Yes
Yes
72,581
180.9
0.408

Yes
Yes
No
142,136
269.9
0.795

Yes
Yes
No
142,515
31.3
0.141

Yes
Yes
No
69,570
699.8
0.855

Yes
Yes
No
69,595
34.9
0.144

Yes
Yes
No
72,58135.1
0.138

Note: Heteroskedasticity-robust standard errors (clustered within a sector and year for equations (1)-(3)) arein parentheses. ***, **, and * indicate significance at the 1, 5, and 10 percent level, respectively.

Table 4. FDI spillovers and catch-up firms(a) Dependent variable: TFP growth ijt(1)All
0.956***
d.FRPRODjt(0.002)0.620***GAPijt-1(0.009)-0.229***FDI sharejt-1(0.049)0.434***CATCHijt-1 *FDI sharejt-1(0.042)0.252***CATCHijt-1(0.003)GAPijt-1 *FDI sharejt-1

(2)
Mfg.
0.963***(0.003)0.601***(0.015)0.006(0.063)0.385***(0.049)0.262***(0.005)(3)Services
0.934***(0.004)0.646***(0.010)-0.556***(0.067)0.509***(0.062)0.235***(0.003)d.MKTshareijt

3.201***(0.707)

Observations
F statistic
R-squared

142,1363611.1
0.905

(4)
All

(5)
Mfg.

(6)
Services

0.952***(0.002)0.790***(0.008)-0.081(0.096)0.960***(0.003)0.758***(0.013)-0.129(0.117)0.923***(0.004)0.832***(0.009)0.371**(0.161)3.160***(1.068)-0.025(0.054)3.498*** 3.821***(0.616) (0.860)

0.082(0.062)
4.108***(1.321)-0.401***(0.107)4.040***(0.704)69,5705022.10.924

72,5661630.30.805

142,136
3298.00.881

69,5704867.50.905

72,5661333.50.758(b) Dependent variable: Labor productivity growth ijt
(1)
(2)
All
Mfg.
0.760***
0.791***
d.FRPRODjt(0.008)(0.014)0.585***
0.574***GAPijt-1(0.009)(0.015)-0.329***-0.150**
FDI sharejt-1(0.048)(0.060)0.342***
0.319***CATCHijt-1 *FDI sharejt-1(0.041)(0.048)0.260***
0.263***CATCHijt-1(0.003)(0.005)GAPijt-1 *FDI sharejt-1(3)Services
0.757***(0.010)0.605***(0.010)-0.499***(0.068)0.422***(0.067)0.251***(0.003)

(4)
All

(5)
Mfg.

(6)
Services

0.704***(0.008)0.749***(0.008)-0.107(0.095)0.725***(0.014)0.742***(0.014)-0.058(0.116)0.710***(0.011)0.765***(0.010)-0.161(0.135)-0.064(0.074)2.707***(0.782)-0.066(0.105)
1.183***(0.375)69,595168.6
0.408

72,581
177.2
0.408

d.MKTshareijt

1.096***(0.339)1.935***(0.677)0.823**(0.334)-0.097(0.063)
1.525***(0.396)

Observations
F statistic
R-squared

142,515
607.6
0.524

69,595661.7
0.523

72,581478.3
0.525

142,515
182.5
0.407

Notes: Firm fixed effects are controlled for. Year and industry dummies are included. Heteroskedasticityrobust standard errors are in parentheses with ***, **, and * indicating significance at the 1, 5, and 10 percent
level, respectively.

Table 5. Estimation results (3-year lagged)(a) Dependent variable: lnTFPijt - lnTFPijt-3
(1)
(2)
All
Mfg.
0.880*** 0.894***
d3.FRPRODjt(0.007)(0.008)0.246*** 0.259***
GAPijt-3(0.009)(0.017)1.037*** 1.282***
FDI sharejt-3(0.175)(0.200)5.307*** 6.261***
d3.MKTshareijt(1.007)(1.678)

(3)
(4)
(5)
(6)
ServicesAll
Mfg.
Services
0.839*** 0.990*** 1.003*** 0.957***(0.015)(0.003)(0.003)(0.006)0.231*** 1.053*** 1.088*** 1.002***(0.010)(0.009)(0.014)(0.009)0.592* -0.329***-0.110-0.748***(0.339)(0.059)(0.075)(0.082)
5.169*** 2.932*** 2.739*** 3.465***(1.228)(0.652)(1.008)(0.465)

Industry effects
Year effects
Firm effects
Observations
F statistic
R-squared

Yes
Yes
No
45,783
119.9
0.689

Yes
Yes
No
91,385
432.3
0.826

Yes
Yes
No
45,6021137.8
0.874

Yes
Yes
Yes
91,3853624.2
0.92

Yes
Yes
Yes
45,6025803.7
0.939

Yes
Yes
Yes
45,7831288.00.8(b) Dependent variable: lnLPijt - lnLPijt-3
(1)
(2)
All
Mfg.
0.372*** 0.396***
d3.FRPRODjt(0.014)(0.028)0.281*** 0.288***
GAPijt-3(0.010)(0.015)0.048
0.181
FDI sharejt-3(0.103)(0.126)
2.191*** 3.076***
d3.MKTshareijt(0.454)(0.960)

(3)
(4)
(5)
(6)
ServicesAll
Mfg.
Services
0.349*** 0.862*** 0.895*** 0.828***(0.016)(0.010)(0.017)(0.013)0.272*** 1.023*** 1.066*** 0.972***(0.014)(0.010)(0.016)(0.011)-0.216-0.236***-0.075-0.478***(0.146)(0.057)(0.071)(0.079)1.599*** 1.152*** 2.012*** 1.237***(0.534)(0.341)(0.599)(0.354)

Industry effects
Year effects
Firm effects
Observations
F statistic
R-squared

Yes
Yes
No
45,801
101.9
0.228

Yes
Yes
No
91,644
73.31
0.248

Yes
Yes
No
45,643
69.57
0.246

Yes
Yes
Yes
91,644
264.2
0.543

Yes
Yes
Yes
45,643
277.7
0.572

Yes
Yes
Yes
45,801240.6
0.504

Note: Heteroskedasticity-robust standard errors (clustered within a sector and year for equations (1)(3)) are in parentheses. ***, **, and * indicate significance at the 1, 5, and 10 percent level,
respectively.

Table 6. FDI spillovers and catch-up firms (3-year lagged)(a) Dependent variable: lnTFPijt - lnTFPijt-3
(1)
(2)
All
Mfg.
0.988***
0.998***
d3.FRPRODjt(0.002)(0.003)0.866***
0.900***GAPijt-3(0.012)(0.021)-0.530*** -0.257***
FDI sharejt-3(0.064)(0.079)0.717***
0.572***CATCHijt-3 *FDI sharejt-3(0.065)(0.075)0.239***
0.241***CATCHijt-3(0.004)(0.007)GAPijt-3 *FDI sharejt-3(3)Services
0.962***(0.005)0.819***(0.011)-1.083***(0.095)1.015***(0.099)0.230***(0.004)

(4)
All

(5)
Mfg.

(6)
Services

0.990*** 1.003*** 0.958***(0.003)(0.003)(0.006)1.039*** 1.073*** 0.999***(0.008)(0.013)(0.009)-0.738*** -0.427*** -0.900***(0.111)(0.126)(0.184)d3.MKTshareijt

2.656***(0.587)2.408***(0.933)

3.166***(0.409)0.222***(0.060)2.961***(0.653)0.162***(0.063)2.807***(1.018)0.100(0.111)
3.466***(0.463)Observations
F statistic
R-squared

91,3854001.50.932

45,6026234.50.947

45,7831529.20.833

91,3853579.10.920

45,6025631.20.939

45,7831268.40.800(b) Dependent variable: lnLPijt - lnLPijt-3(1)All0.884***
d3.FRPRODjt(0.009)0.837***GAPijt-3(0.013)-0.399***FDI sharejt-3(0.062)0.614***CATCHijt-3 *FDI sharejt-3(0.064)0.255***CATCHijt-3(0.004)GAPijt-3 *FDI sharejt-3

(2)
Mfg.
0.910***(0.015)0.877***(0.022)-0.253***(0.077)0.557***(0.073)0.245***(0.007)(3)
Services
0.856***(0.012)
0.794***(0.013)-0.629***(0.087)0.753***(0.101)0.255***(0.005)

(4)
All

(5)
Mfg.

(6)
Services

d3.MKTshareijt

0.861***(0.312)

1.479***(0.561)

Observations
F statistic
R-squared

91,644506.3
0.614

45,643578.0
0.631

0.865*** 0.900*** 0.829***(0.010)(0.017)(0.014)1.010*** 1.052*** 0.967***(0.008)(0.013)(0.011)-0.614*** -0.355*** -0.696***(0.116)(0.132)(0.177)0.983***(0.311)0.244***(0.076)
1.169***(0.341)0.172**(0.080)2.062***(0.604)0.170(0.132)1.235***(0.354)45,801375.2
0.589

91,644293.4
0.543

45,643312.4
0.572

45,801242.6
0.504

Notes: Firm fixed effects are controlled. Year and industry dummies are included. Heteroskedasticity-robust
standard errors are in parentheses, with ***, **, and * indicating significance at the 1, 5, and 10 percent level,
respectively.

Appendix Table 1. List of industries
1-48
1-30

33-48

JIP2006
1-108
8-59
8-13
15
16, 17
18-19
20
23-27
28
29
28
30,31
58
22
32-35
36,37
38,39
40,41
42
43
45
44
46
47
49
48,50
51,52
53
54,55
56
57
21, 5960-10760
62,63,64
74,77
78,79,9067

All industries
Manufacturing
1 Food products and beverages
2 Textiles
3 Lumber and wood products
4 Pulp, paper, and paper products
5 Printing
6 Chemicals and chemical fibers
7 Paint, coating, and grease
8 Pharmaceutical products
9 Miscellaneous chemical products
10 Petroleum and coal products
11 Plastic products
12 Rubber products
13 Ceramic, stone and clay products
14 Iron and steel
15 Non-ferrous metals
16 Fabricated metal products
17 Metal processing machinery
18 Special industry machinery
19 Office and service industry machines
20 Miscellaneous machinery
21 Electrical machinery and apparatus
22 Household electric appliances
23 Communication equipment
24 Computer and electronic equipment
25 Electronic parts and devices
26 Miscellaneous electrical machinery
27 Motor vehicles and parts
28 Other transportation equipment
29 Precision machinery
30 Miscellaneous mfg. industries
Services
33 Construction
34 Electricity, gas, and water supply
35 Transport and storage
36 Telecommunications and broadcasting
37 Wholesale trade
3701 General merchandise
3702 Textile products3703 Apparel accessories and notions
3704 Agricultural, animal and poultry farm and aquatic products
3705 Food and beverages
3706 Building materials
3707 Chemicals and related products
3708 Minerals and metals
3709 General machinery and equipment
3710 Motor vehicles
3711 Electrical machinery
3712 Miscellaneous machinery and equipment
3713 Fixtures and house furnishings
3714 Drugs and toiletries
3715 Other products
38 Retail trade
3801 General merchandise
3802 Dry goods, apparel, and apparel accessories
3803 Food and beverages
3804 Motor vehicles and bicycles

683805 Furniture, fixture, and household utensil
3806 Appliance stores
3807 Drugs and toiletry stores
3808 Fuel stores
3809 Stores, n.e.c.
39 Financial intermediation and real estate
40 Advertising
41 Rental of office equipment and goods
42 Other business services
43 Entertainment
44 Information services
4401 Information services and internet-based services
4402 Computer programming
4403 Motion pictures
45 Eating and drinking places
46 Accommodation
47 Personal services
48 Services, n.e.c.
31 Agriculture, hunting, forestry, and fishing
32 Mining and quarrying

69,71
85
86
87,88
89
91,92,93
91
91
92,93
94
95
96,97
66,80,81,82,84
1,2,5,6
7

Appendix Table 2. Number of observations by industry and year

1-48 All industries
1-30 Manufacturing33-48 Services
33 Construction
34

35
36
37
38
39
40
41

42
43

Electricity, gas,
and water supply
Transport andstorage
Telecommunicati
ons andbroadcasting
Wholesale trade
Retail trade
Financialintermediation
Advertising
Rental of officeequipment andgoods
Other businessservices(Number of firms)
2000-072007
average
24,73823,628
11,661
11,32913,031
12,245
320
381

2000

2001

2002

2003

2004

2005

2006

23,324
11,478
11,782
348

23,803
11,47812,258430

23,308
11,225
12,024416

22,607
10,815
11,738372

23,995
11,502
12,447401

23,54911,315
12,185369

23,703
11,161
12,494
390

103

101

103

105

113

109

111

121

108

57

116

123

127

139

110

129

104

113

12

22

29

51

58

61

76

57

46

5,268
2,906

5,163
3,014

5,006
2,882

4,816
2,783

4,961
2,959

4,844
2,940

4,714
2,874

4,849
2,995

4,953
2,919

114

129

124

123

129

131

124

129

125

136

137

134

136

161

155

169

188

152

230

230

250

262

275

285

297

291

265

415

531

559

626

700

750

729

814

641

428

387

355

303

300

279

315

347

339

1,276

1,360

1,392

1,376

1,543

1,478

1,467

1,620

1,439

324

394

404

402

439

406

415

472

407

23

46

47

49

49

55

54

52

47

46

Entertainment
Information
services
Eating anddrinking places
Accommodation

47

Personal services

124

168

148

161

162

149

449

484

231

48

Services, n.e.c.

18

30

52

46

58

64

181

188

80

31

Agriculture,hunting, forestry,
and fishing

8

13

16

16

12

16

15

13

14

32

Mining andquarrying

56

54

43

38

34

33

33

33

41

44
45

Appendix Table 3. Estimation results (Based on the majority ownership definition)(a) Dependent variable: TFP growth ijt
(1)
(2)
All
Mfg.
0.857***
0.871***
d.FRPRODjt(0.008)(0.008)0.170***
0.178***GAPijt-1(0.006)(0.011)
0.247
0.254
FDI sharejt-1(0.169)(0.253)6.486***
6.766***
d.MKTshareijt(1.031)(1.926)(3)
Services
0.817***(0.016)
0.162***(0.007)0.299(0.211)
6.614***(1.211)(4)All
0.952***(0.002)
0.787***(0.007)0.001(0.067)3.739***(0.797)(5)
Mfg.
0.959***(0.003)0.768***(0.011)-0.076(0.122)
3.898***(1.139)(6)Services
0.923***(0.004)0.815***(0.008)-0.037(0.074)
3.992***(0.673)

Industry effects
Year effects
Firm effects
Observations
F statistic
R-squared

Yes
Yes
No
72,834
89.82
0.645

Yes
Yes
Yes
143,058
3332.2
0.881

Yes
Yes
Yes
70,2244866.4
0.905

Yes
Yes
Yes
72,8341365.40.756(b) Dependent variable: Labor productivity growth ijt
(1)
(2)
(3)
All
Mfg.
Services
0.339***
0.362***
0.324***
d.FRPRODjt(0.014)(0.024)(0.018)0.192***
0.195***
0.188***GAPijt-1(0.007)(0.011)(0.009)-0.0070.030
0.107
FDI sharejt-1(0.123)(0.250)(0.110)2.443***
3.717***
1.851***
d.MKTshareijt(0.430)(1.035)(0.435)(4)All0.710***(0.008)0.741***(0.008)0.182***(0.067)1.504***(0.377)(5)
Mfg.
0.733***(0.014)0.734***(0.012)0.293**(0.118)2.632***(0.694)(6)Services
0.711***(0.011)0.764***(0.009)0.053(0.078)1.179***(0.367)

Industry effects
Year effects
Firm effects
Observations
F statistic
R-squared

Yes
Yes
Yes
143,441
183.2
0.406

Yes
Yes
Yes
70,251
175.7
0.407

Yes
Yes
Yes
72,849
182.2
0.408

Yes
Yes
No
143,058
232.9
0.793

Yes
Yes
No
143,441
31.12
0.14

Yes
Yes
No
70,224
442.5
0.852

Yes
Yes
No
70,251
32.6
0.141

Yes
Yes
No
72,84935.75
0.138

Note: Heteroskedasticity-robust standard errors (clustered within a sector and year for equations (1)-(3)) arein parentheses. ***, **, and * indicate significance at the 1, 5, and 10 percent level, respectively.

Appendix Table 4. FDI spillovers and catch-up firms (Based on the majority ownership definition)(a) Dependent variable: TFP growth ijt(1)All
0.956***
d.FRPRODjt(0.002)0.621***GAPijt-1(0.009)-0.073
FDI sharejt-1(0.072)0.293***CATCHijt-1 *FDI sharejt-1(0.062)0.264***CATCHijt-1(0.003)GAPijt-1 *FDI sharejt-1

(2)
Mfg.
0.961***(0.003)0.607***(0.015)0.064(0.121)0.313***(0.102)0.276***(0.004)(3)
Services
0.934***(0.004)0.646***(0.010)-0.242***(0.086)
0.349***(0.077)0.244***(0.003)d.MKTshareijt

3.155***(0.665)Observations
F statistic
R-squared

143,0583525.9
0.904

(4)
All

(5)
Mfg.

(6)
Services

0.952***(0.002)
0.788***(0.007)0.124(0.152)0.959***(0.003)0.773***(0.012)0.333(0.259)0.923***(0.004)0.813***(0.008)-0.172(0.169)3.124***(0.942)-0.081(0.100)3.490*** 3.736***(0.602) (0.796)-0.266(0.170)3.883***(1.135)0.089(0.112)
3.995***(0.673)70,2244748.80.923

72,8341630.20.803

143,058
3288.70.881

70,2244741.30.905

72,8341338.90.756(b) Dependent variable: Labor productivity growth ijt
(1)
(2)
All
Mfg.
0.762***
0.782***
d.FRPRODjt(0.008)(0.014)0.585***
0.575***GAPijt-1(0.009)(0.015)0.042
0.300**
FDI sharejt-1(0.073)(0.121)
0.198***
0.240**CATCHijt-1 *FDI sharejt-1(0.062)(0.096)0.270***
0.275***CATCHijt-1(0.003)(0.004)GAPijt-1 *FDI sharejt-1(3)Services
0.757***(0.010)0.606***(0.010)-0.165*(0.091)0.231***(0.083)0.259***(0.003)

(4)
All

(5)
Mfg.

(6)
Services

0.710***(0.008)0.744***(0.008)0.364**(0.156)

0.731***(0.014)0.747***(0.014)1.086***(0.288)0.711***(0.011)0.760***(0.009)-0.180(0.175)-0.695***(0.251)2.633***(0.695)0.183(0.143)1.181***(0.367)70,251
171.2
0.407

72,849178.9
0.408

d.MKTshareijt

1.101***(0.326)

1.937***(0.611)0.845**(0.332)-0.149(0.127)1.503***(0.377)

Observations
F statistic
R-squared

143,441
607.3
0.522

70,251663.5
0.521

72,849474.7
0.523

143,441181
0.406

Notes: Firm fixed effects are controlled for. Year and industry dummies are included. Heteroskedasticity-robust
standard errors are in parentheses with ***, **, and * indicating significance at the 1, 5, and 10 percent level,
respectively.

Appendix Table 5. Estimation results (3-year lagged, Based on the majority ownershipdefinition)(a) Dependent variable: lnTFPijt - lnTFPijt-3
(1)
(2)
(3)
(4)
(5)
(6)
All
Mfg.
ServicesAll
Mfg.
Services
0.875*** 0.887*** 0.839*** 0.992*** 1.003*** 0.957***
d3.FRPRODjt(0.008)(0.009)(0.015)(0.003)(0.003)(0.006)0.246*** 0.261***
0.246
0.261
0.230***
0.230
1.050***
1.050
1.086***
1.086
0.999***
0.999
GAPijt-3(0.009)(0.016)(0.010)(0.009)(0.014)(0.009)0.590***
0.665*
0.621**
0.157*
0.198
0.023
FDI sharejt-3(0.226)(0.391)(0.273)(0.090)(0.161)(0.097)5.427*** 6.721*** 5.062*** 2.910*** 2.903*** 3.389***
d3.MKTshareijt(0.957)(1.600)(1.171)(0.615)(0.934)(0.462)
Industry effects
Year effects
Firm effects
Observations
F statistic
R-squared

Yes
Yes
No
92,052
352.7
0.824

Yes
Yes
No
46,081
681.2
0.872

Yes
Yes
No
45,971
125.4
0.686

Yes
Yes
Yes
92,0523598.6
0.92

Yes
Yes
Yes
46,0815710.5
0.939

Yes
Yes
Yes
45,9711295.1
0.798(b) Dependent variable: lnLPijt - lnLPijt-3
(1)
(2)
All
Mfg
Mfg.
0.369*** 0.382***
d3.FRPRODjt(0.014)(0.026)
0.279*** 0.284***
GAPijt-3(0.010)(0.015)0.048
0.292
FDI sharejt-3(0.175)(0.338)2.295*** 3.308***
d3.MKTshareijt(0 451)(0.451)(0.948)(0 948)(3)Services
0.351***(0.016)
0.272***(0.014)0.069(0.137)1.593***(0.523)(0 523)(4)All0.869***(0.010)1.024***(0.010)0.211**(0.093)1.226***(0.345)(0 345)

(5)
Mfg.
Mfg
0.897***(0.016)
1.066***(0.015)0.311**(0.158)2.223***(0.602)(0 602)(6)Services
0.832***(0.013)0.974***(0.011)
0.060(0.102)
1.197***(0.358)(0 358)Industry effects
Year effects
Firm effects
Observations
F statistic
R-squared

Yes
Yes
No
45,989
93.39
0.226

Yes
Yes
Yes
92,313
269.5
0.543

Yes
Yes
Yes
46,123
282.9
0.572

Yes
Yes
Yes
45,989
246.5
0.505

Yes
Yes
No
92,313
68.57
0.247

Yes
Yes
No
46,12367.15
0.244

Note: Heteroskedasticity-robust standard errors (clustered within a sector and year for equations(1)-(3)) are in parentheses. ***, **, and * indicate significance at the 1, 5, and 10 percent level,
respectively.

Appendix Table 6. FDI spillovers and catch-up firms (3-year lagged, Based on the majority ownershipdefinition)(a) Dependent variable: lnTFPijt - lnTFPijt-3
(1)
(2)
(3)
(4)
(5)
(6)
All
Mfg.
ServicesAll
Mfg.
Services
0.988***
0.998***
0.960***
d3.FRPRODjt
0.992*** 1.003*** 0.958***(0.002)(0.003)(0.005)(0.003)(0.003)(0.006)0.864***
0.900***
0.815***GAPijt-3
1.039*** 1.074*** 0.988***(0.012)(0.020)(0.011)(0.009)(0.015)(0.009)-0.189*-0.153-0.271** -0.731*** -0.812*** -0.871***
FDI sharejt-3(0.098)(0.170)(0.106)(0.175)(0.271)(0.218)0.690***
0.973***
0.592***CATCHijt-3 *FDI sharejt-3(0.102)(0.189)(0.106)0.254***
0.253***
0.247***CATCHijt-3(0.004)(0.007)(0.004)GAPijt-3 *FDI sharejt-3
0.614*** 0.735*** 0.596***d3.MKTshareijt

2.670***(0.561)2.641***(0.886)

3.109***(0.420)(0.119)2.942***(0.615)(0.196)2.920***(0.932)(0.143)3.429***(0.462)

Observations
F statistic
R-squared

92,0523960.70.932

46,0816133.20.947

45,9711521.90.831

92,0523552.40.92

46,0815542.80.939

45,9711282.80.798(b) Dependent variable: lnLPijt - lnLPijt-3(1)All
0.887***
d3.FRPRODjt(0.009)0.839***GAPijt-3(0.013)-0.039FDI sharejt-3(0.100)0.533***CATCHijt-3 *FDI sharejt-3(0.099)0.268***CATCHijt-3(0.004)GAPijt-3 *FDI sharejt-3

(2)
Mfg.
0.906***(0.015)0.876***(0.022)-0.047(0.169)0.943***(0.176)
0.257***(0.007)(3)
Services
0.857***(0.012)0.796***(0.013)-0.061(0.110)0.336***(0.111)0.270***(0.005)

(4)
All

(5)
Mfg.

(6)
Services

d3.MKTshareijt

0.968***(0.324)

1.796***(0.586)

Observations
F statistic
R-squared

92,313498
0.613

46,123572.7
0.63

0.869*** 0.896*** 0.833***(0.010)(0.016)(0.014)1.013*** 1.050*** 0.964***(0.010)(0.016)(0.011)-0.589*** -0.791*** -0.624***(0.171)(0.275)(0.209)0.964***(0.323)0.661***(0.137)1.242***(0.345)1.001***(0.241)2.229***(0.600)0.530***(0.165)
1.218***(0.359)45,989376.6
0.589

91,644293.4
0.543

45,643312.4
0.572

45,801242.6
0.504

Notes: Firm fixed effects are controlled. Year and industry dummies are included. Heteroskedasticity-robust
standard errors are in parentheses, with ***, **, and * indicating significance at the 1, 5, and 10 percent level,
respectively.