FDI, technical efficiency and spillovers: Evidence from Indian automobile industry

Abstract

Most emerging market economies intend to attract foreign direct investment (FDI), expecting that efficiency spillovers from FDI positively influence the productivity of domestic firms. The Indian automobile industry has been a key beneficiary of FDI, ever since the economy opened up since the early 1990s. Employing a stochastic frontier analysis (SFA), this paper first compares the technical efficiency of foreign firms (FFs) vis-à-vis domestic firms (DFs) in the Indian automobile industry for the period 2001–2014. Second, the paper identifies the key determinants, which explain the differences in technical efficiency between FFs and DFs. Finally, the paper analyses the transmission of spillovers from FFs to DFs in terms of competition, demonstration, and information effects. The results reveal higher technical efficiency (TE) of foreign firms over the domestic firms; that younger firms, both domestic and foreign, were relatively more efficient; and domestic automobile firms did not benefit from exporting activities, mainly due to their inward-orientation. The analysis in this paper suggests that the spillover effects is prominent only through demonstration effect. The competition and information effects are not significant channels for transmission of spillovers from foreign to domestic firms in the Indian automobile industry.

Keywords:

• foreign direct investment
• technical efficiency
• spillover effect
• stochastic frontier analysis
• automobile industry
• India

JEL classifications:

• D24
• F14
• L62

Public Interest Statement

The Indian automobile industry has been a key beneficiary of India’s liberalization and globalization process that started in early 1990s. The study investigates whether and how the domestic automobile firms benefitted from the higher levels of foreign direct investment in India’s automobile industry. One key finding of the study indicates the inability of the domestic firms to tap the overseas markets, primarily due to their inward-orientation. The results underscore the need for domestic firms to tap newer external markets through collaborations, and strengthen their research and development activities. With India’s renewed thrust on boosting domestic manufacturing and entrepreneurial activities, including in the automobile industry, the focus of public policy should be on skill development of the workforce, so that spillover benefits accruing from foreign direct investment maybe better reaped by domestic firms, households, and the economy at large.

Acknowledgements

We are grateful to the anonymous referees of the journal for their constructive and very useful comments, which helped us to improve the paper substantially. However, the authors remain solely responsible for any errors and omissions that may remain in the paper.

Notes

1. Since, this study focuses on a particular (automobile) sector, the intra-industry or horizontal spillovers is only considered as the inter-industry or vertical spillovers are out of scope of this study.

2. DEA is a widely used technique in productivity analysis and is a non-parametric method based on linear programming technique. It uses the envelopment technique and calculates the efficiency as the distance from the frontier. For a detailed exposition of DEA and SFA methodologies, see Zhu (2014) and Kumbhakar, Wang, and Horncastle (2015).

3. As pointed out by Wang and Schmidt (2002) the two-stage approach, is likely to yield biased estimates as the technical efficiency might be correlated with the production inputs. Furthermore, the OLS method becomes inappropriate in the two-stage method as the TE is assumed to have a one-sided distribution. Hence, the one-stage approach is preferred over the two-stage approach.

4. The complete description of Battese-Coelli model and derivation of the log-likelihood function and the variance parameters is given in Battese and Coelli (1993).

5. Though the trans-log form of production function is a popular choice in today’s empirical studies, for this paper, we choose the log-linear model primarily due to its simplicity in usage and interpretation. Although this confines the analysis to one particular form of the production function, studies by Kopp and Smith (1980), Krishna and Sahota (1991) and Driffield and Kambhampati (2003) suggest that other functional specifications vis-à-vis the log-linear form have negligible influence on the measured efficiency. More recent empirical studies, using stochastic frontier analysis in the context of manufacturing sector in Indonesia like Suyanto et al. (2014) has not reported any significant difference in the results obtained. Further, as the sum of factor elasticities is close to unity (Table 4), it signifies the production function exhibits constant returns to scale.

6. Since there exists no consensus in literature regarding the minimum proportion of share capital for classifying a firm as a foreign firm, we adopt the classification as given in the Centre for Monitoring Indian Economy (CMIE) Prowess database and match the classification with the Bloomberg database.

7. Since the beginning of this century, the Indian economy has witnessed some impressive growth figures, with 2004–08 recording one of the highest growth phases in the history of the Indian economy. Indian economy was also not majorly affected by the global financial crisis of 2007–08. According to Society of Indian Automobile Manufacturers (SIAM), the automobile industry witnessed a compounded annual growth rate of 9.4% during the period FY2006–16. This provided an increasing consumer base to the automobile firms, reducing the impact of CEF.

Additional information

Notes on contributors

Abhisek Sur

Abhisek Sur is a doctoral candidate in the Economics Area at the Indian Institute of Management (IIM) Ranchi. He received his BSc and MSc degrees from University of Calcutta, India. His current research interests include international trade and applied macroeconomics.

Amarendu Nandy

Amarendu Nandy is an assistant professor in the Economics Area at the Indian Institute of Management (IIM), Ranchi. He holds a PhD from the Lee Kuan Yew School of Public Policy from the National University of Singapore (NUS), Singapore and MSc and BSc degrees from University of Burdwan, India. His current research interests are in international trade, economic development, and labor economics.