Multinational Companies and Productivity Spillovers : Is There a Specification Error?

Recent empirical works on the within-sector impact of inward investments on domestic firms' productivity have found rather robust evidence of no (or even negative) effects. This paper argues that a specification error might characterise those studies. In fact, measuring foreign presence as the share of foreign to total sectoral activity (e.g. foreign employment share) in a sector, existing literature implicitly assumes that changes in the same proportion of both foreign and aggregate activities within a sector have no effect on the productivity of local firms. It is shown that this is a restrictive assumption which is very likely to cause a downward bias on the estimate of the inward FDI externality, thus increasing the probability of finding negative or non-significant effects. We propose a more general specification, which includes the commonly adopted measure of foreign presence as a special case. Using data on Italian manufacturing firms, we find positive externalities only once we allow for the more flexible specification