Does FDI Spur Innovation, Productivity and Knowledge Sourcing by Incumbent Firms? Evidence from Manufacturing Industry in Estonia

Does FDI affect innovation, productivity growth, and knowledge sourcing activities of domestic firms? This study employs detailed firm-level panel-data from Estonia’s manufacturing sector to investigate different channels through which FDI can affect domestic firms. Instrumental variables approach is used to identify the effects. There is no evidence of an effect of FDI entry on local incumbents’ TFP and labour productivity growth in the short term. However, there are positive spillovers on process innovation. These effects do not depend on the local firms’ distance to the productivity frontier. The results show significant positive correlation between the entry of FDI in a sector and the more direct measures of spillovers in subsequent periods. This is consistent with the view that FDI inflow to a sector intensifies knowledge flows to domestic firms