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# **1. Introduction**

The attraction of foreign direct investment (FDI) constitutes a central component of the development strategies of most developing and emerging economies.<sup>1</sup> The reason why is because the entry and operations of MNC affiliates can generate a variety of economic benefits, generating higher levels of capital investment, introducing new industrial activities, and creating direct and indirect employment (Dunning and Lundan 2008; Barba-Navaretti and Venables 2004). By locating components of global value chains (GVCs) in different countries and regions in the world economy, MNCs provide domestic firms with opportunities to link into international markets (Taglioni and Winkler 2016). Furthermore, important dynamic effects can occur when domestic firms learn from and adopt technologies incorporated into MNC affiliates, thereby upgrading their capabilities and benefitting from productivity spillovers. It is this latter effect that is increasingly seen as the most important impact of FDI, fostering technological development and long-term growth in host economies (Keller 2010; Alfaro 2017).

In line with this growing understanding, the past few decades have seen a surge of empirical studies on productivity spillovers from MNC affiliates in a variety of host economy settings. Despite the popularity of development policies attracting MNC investments, the evidence on productivity spillovers is mixed and inconclusive, especially for horizontal spillovers between FDI and domestic firms that operate in the same industries (Irsova and Havranek 2013). In comparison, findings on vertical productivity spillovers between MNC affiliates and domestic firms that supply inputs to or purchase inputs from these affiliates show that that this type of spillover occurs more frequently. In particular, a number of studies identify positive productivity effects between MNC affiliates and domestic firms operating in industries that supply inputs, suggesting that supply linkages between local suppliers and their foreign-owned client firms lead to the dissemination of technologies that foster performance improvements among domestic firms (Havranek and Irsova 2011; Jordaan 2016).

However, the evidence also indicates that vertical productivity spillovers are specific to a given context and do not materialize automatically. Previous surveys have identified a number of factors that influence the materialization of productivity spillovers, but have focused mainly on drivers of horizontal spillovers.<sup>2</sup> This paper conducts a new and comprehensive survey of empirical evidence focusing especially on drivers of productivity spillovers that occur between MNC affiliates and local

> 1 In this paper, a multinational company (MNC) refers to a company with one or more affiliates located in countries (host economies) other than where the company’s headquarters are located (home economy). FDI or MNC affiliates refer to the affiliates located in host economies; local and domestic firms refer to companies that are indigenous to the host economies.

> 2 For studies that focus on horizontal FDI spillovers, see, for example, Aitken and Harrison (1999), Keller and Yeaple (2009), Abraham, Konings, and Slootmaekers (2010), and Monastiriotis and Alegria (2011).