The impact of direct foreign investment on the manufacturing total factor productivity of developing countries: A case study of Korea and Taiwan

This study examines the impact of direct foreign investment (DFI) on the total factor productivity of host countries. Time series analyses are performed on the manufacturing industries in Korea and Taiwan. Various models are used for estimation: the models that include or exclude the licensing variable, the models that include the capacity utilization, and the model for testing the direction of causality between DFI and productivity.;The overall assessment of the estimation results is that DFI does affect the total factor productivity of host countries. Both in Korea and Taiwan, evidence is found that the variations in total factor productivity are positively associated with changes in DFI stock. No strong evidence is detected for a negative impact of DFI on the productivity of host countries.;The DFI effect is realized through intra-industry and inter-industry spillover effects. The intra-industry effect is found in industries that received a relatively large share of DFI. DFI in industries that have close linkages with other industries shows a stronger inter-industry effect.;The models incorporating the capacity utilization also demonstrate that DFI contributes to the improvement of productivity. Direction of causality runs from DFI to productivity, and not from productivity to DFI. The regression analyses to check the difference in DFI impacts among nationality of source countries or among industry characteristics such as capital intensity or export orientation do not show a consistent pattern.;The policy implication of the study is that DFI can be an important source of productivity improvement in developing countries. Therefore, the host country government should institute appropriate policies for encouraging, not restricting DFI.