Spillover Effects of FDI and Absorptive Capacity of Iranian Industrial Domestic Firms (1997-2007)

In recent decades, foreign direct investment (FDI) has played a vital role in economic growth of developed and developing countries. FDI brings new capital and technology to the host country beside a possibility of spillover to local firms. Hence, FDI is considered as an important channel of technology transfer. However, in empirical studies, the size and direction of effects of FDI on productivity of host country firms is in doubt. Furthermore, the absorptive capacity of domestic firms is also important in determining the direction and size of the spillover effect to the host country’s domestic firms. In this study, we examine spillover effects of FDI in a number of industry sub-sectors over the period 1997-2007, using a panel data model. Moreover, the human capital and R&D expenditures are considered as indicators of the absorptive capacity of the domestic firms. The results show that horizontal linkages between foreign and domestic firms reduce the productivity of domestic firms, while vertical linkages increase it. Gradual increase of human capital investment can reverse the negative effects of horizontal linkages.