customers. The second type are _pecuniary externalities_ , which occur, for example, through price and competition effects — that is, if increased demand for inputs creates incentives for upgrading, or entry of foreign affiliates changes a market structure.

Inter‐industry spillover effects have been relatively well established, reflecting foreign firm incentives to interact with local suppliers, while preventing knowledge leaks to local competitors. Javorcik (2004) and Du, Harrison, and Jefferson (2012) find these vertical spillovers in China and Lithuania. Javorcik and Spatareanu (2009) find evidence in the Czech Republic for spillovers to suppliers of foreign firms through both selection and learning channels. Farole and Winkler (2014) use a cross‐section of more than 25,000 domestic manufacturing firms in 78 developing countries covered by the World Bank’s Enterprise Surveys. When coupled with sectoral country case studies, they find that supply chains—notably, backward linkages through local sourcing—appear to offer the most direct channel for gains from FDI spillovers, in particular for less productive firms.

With respect to vertical spillovers through forward linkages, several studies highlight productivity spillovers to the manufacturing sector through liberalization of services, including Arnold, Javorcik, and Mattoo (2011) for the Czech Republic, Fernandes and Paunov (2012) for Chile, and Javorcik and Li (2013) for Romania. These results are consistent with service sector liberalization—particularly FDI in the sector—being associated with improved availability, range, and reliability of services. These in turn contribute to better performance among manufacturing firms using services as inputs.

There is some evidence for intra‐industry spillovers from FDI, though earlier studies (such as Aitken and Harrison 1999; Haskel, Pereira, and Slaughter 2007) show contrasting results. Javorcik (2014) points out that effects may depend on the technological sophistication and competition levels in developed and developing host countries. For example, a meta‐study by Meyer and Sinnai (2009) suggests a U‐shaped relationship wherein FDI spillovers are larger for countries below the minimum threshold level (poor country contexts with basically no competition) and above the maximum threshold level (rich country contexts with dynamic competition) of development. Between these threshold levels, FDI spillovers are smaller because of a “crowding‐out” effect on local firms. Between these threshold levels, FDI spillovers are smaller because of a “crowding‐out” effect on local firms. However, any “crowding out” effects of FDI would only apply when investment operations are geared towards the domestic market of the host countries, leading the foreign firm to compete with local ones. This many not be the case of efficiency‐ seeking investment, where export‐oriented foreign enterprises locate in a given country not to supply that market, but rather international ones.

Studies also have to distinguish between the knowledge and competition effects of foreign direct investment, as these can go in opposite directions. World Bank surveys of Czech and Latvian entrepreneurs conducted in 2003 provide evidence suggestive of all the type of externalities noted (Javorcik and Spatareanu 2005). They confirm the existence of knowledge transfer both through the demonstration effect and the movement of labor. They observe the competition effect, which in the short run may have an adverse effect on some firms. Moreover, the relative prevalence of the two effects differs 8