because of the significant public goods characteristics of knowledge, which prevent the firm from fully protecting its intangible knowledge assets in arms length transactions, and which lead it to deploy those assets within the protective boundaries of its own affilitates, through FDI.<sup>14</sup> FDI is expected to bring several potential benefits. Foreign affiliates of MNCs have easier access to superior parent company technology and achieve higher productivity in their operations, which, in a competitive environment, translates into higher wages for employees and

**<mark>Exhibit 5</mark>**

**Sectoral Composition of FDI Stock in 2002**

<!-- Start of picture text --> Services<br>Manufacturing<br>Primary<br><!-- End of picture text --> higher welfare for consumers through making available better quality goods and services at lower prices. FDI may also enhance productivity in the rest of the economy by increasing competition, or through spillovers of technology and expertise. Here we review evidence for two propositions: does foreign ownership convey productivity benefits for the local firms or operations that are acquired or established by the MNC, and, if these benefits exist, do they “spillover” to other domestic non-acquired firms?

First, does FDI convey large productivity benefits for the local operations that it acquires? There is much evidence that such operations generally have higher labor productivity, total factor productivity and wages than local firms. What has not been clear is whether this superiority is due to restructuring and infusion of new technology by the new foreign owners, or, instead, it simply reflects foreign firms acquiring already superior local firms. Recent research addresses this question using firmlevel data from the Census of Indonesian Manufacturing Plants from 1983 to 1996. (Arnold and Javorik, 2004; World Bank, 2005b).<sup>15</sup> The analysis shows that Indonesian plants receive a rapid and large improvement in total factor productivity from foreign acquisition, averaging about 46 percent. (Exhibit 6). In the 1-2 years after acquisition, the acquired plants experience more rapid growth in output, employment, investment and wages than similar local plants. The proportion of skilled workers in the plant labor force increases, as does export orientation and use of imported intermediates, all of which is consistent with significant plant restructuring after acquisition.

14 See for example Caves (1996) and Markusen (2002).

> 15 Arnold and Javorcik (2004) “use a non-parametric matching estimator to calculate the causal effect of foreign ownership on plant productivity. The matching technique creates a missing counterfactual of an acquired firm had it remained under domestic ownership.  It does so by pairing up each future acquired plant with a domestic plant from the same sector and year that had observable characteristics very similar to the acquisition target prior to the foreign acquisition. ... The causal effect of foreign ownership is hence estimated by the average divergence of the TFP growth paths between each acquired plant and its matched control plant, starting from the pre-acquisition year.”

15