The value of _φfdi_ (or similar elasticities) has been the subject of extensive empirical research in the FDI literature. While economic theory has proposed multiple channels of potential FDI spillovers, econometric evidence of their existence is far from conclusive.<sup>45</sup> Using cross-sectional data, earlier studies on the subject have found positive productivity spillovers at the sector level. These include Caves (1974) and Globerman (1979), who provide evidence of a positive relationship between higher subsidiary shares and increased productivity levels in Australia and Canada, respectively. For developing countries, Blomstrom (1986) and Blomstrom and Wolff (1994) show that the share of foreign subsidiaries has a positive effect on efficiency and the rate of productivity catch-up in Mexico. However, these and other cross-sectional studies cannot establish causality: it is not clear whether the relationship between foreign ownership and productivity is positive because foreign investment generates significant spillovers or because FDI is attracted to more productive sectors. In order to address this issue, more recent research has focused on firm-level panel data, but the evidence in favor of positive spillovers is much less clear. For example, Haddad and Harrison (1993) find no evidence that foreign entry has had an effect on productivity growth of Moroccan firms, although the higher degrees of foreign ownership are associated with lower productivity dispersion. Aitken and Harrison (1999) establish a positive relationship between foreign equity participation and productivity for the foreign subsidiary plants, but negative spillovers for domestic firms in Venezuela. Similarly, Djankov and Hoekman (1999) find a positive effect of foreign investment on productivity of firms in the Czech Republic, but the relationship turns insignificant when the sample is reduced to domestic firms only. Other studies have instead focused on vertical (mostly downstream) rather than horizontal spillovers and have found a positive relationship between foreign investment and productivity growth in domestic firms. These include Blalock (2001) for Indonesia and Smarzynska (2002) for Lithuania.

Although the previous paragraph mentions only a few (out of the many existing) studies on the subject, one can already see three broad patterns emerging. First, the existence of productivity spillovers to domestic firms is uncertain, while the evidence for higher productivity among foreign affiliates is much more robust. Second, if productivity spillovers exist, they are much more likely to be found among firms that have backward linkages to foreign affiliates rather than firms in the same sector as the foreign subsidiaries. Third, the existing studies relate productivity spillovers to the share of foreign-owned firms in a sector, or the percentage of output sold to foreign-controlled subsidiaries, rather than FDI itself. Therefore, it is difficult to translate the findings of this literature into a value (or a range of values) for the _φfdi_ parameter. This paper sets the _φfdi_ parameter equal to 0.0005; given the baseline time paths for labor productivity and FDI, the average elasticity of _λ_<sup>_L_</sup> _i,l_ with respect to foreign direct investment in the _IBL_<sup>_λL_scenario turns out to be approximately 0.003.46</sup> The elasticity estimates with respect to foreign ownership shares reported in the studies referenced above usually range between 0.03 and 0.06. Therefore, if one assumes that a one percent rise in net FDI inflows results in a less than one percentage point increase in the share of foreign ownership (at the economy-wide level), then our parameter choice is roughly consistent with the existing literature. In any case, given the large data requirements and complicated econometric techniques needed to generate point estimates of the _φfdi_ parameter for Honduras, properly quantifying this elasticity would be beyond the scope of this paper. The aim of this simulation is to simply illustrate the qualitative importance of productivity spillovers.

> 45The following discussion is based on Iacovone and Perini (2007).

> 46Note that this elasticity is positive only for the manufacturing and service sectors; labor productivity in agriculture remains exogenous in this simulation.

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