Analysis of developments in the fields of direct investment and M&A — Part II: Foreign firms’ contributions to EU economic performance

financial-markets-and-institutions||38
Sector: Financial markets and Institutions
Client: EC DG Internal Market and Services
Published: December, 2013
Document type: Report 
Tagged: analysis of economic developments EC/EEA

Part II of Analysis of developments in the fields of direct investment and M&A considered the performance of foreign firms that are recipients of FDI.

 

Domestic firms far outweigh foreign-owned firms in the EU; however, the contributions of foreign-owned firms to economic performance are disproportionately high in terms of productivity, employment generation and the creation of value added.

 

However, it is not clear what the policy implications of these observations might be. Investors may participate in the ownership and control of firms outside of their home country that are particularly effective (a ‘cherry picking’ effect) or enter more productive sectors (a ‘sector mix’ effect) that cannot be observed through aggregate data.

 

To understand the value of foreign ownership at the micro-level, foreign-owned firms were compared against domestic firms that are otherwise similar. This is achieved econometrically using propensity score matching in a difference-in-differences framework. A new micro-dataset constructed using Bureau van Dijk’s Orbis dataset was used, consisting of observations on over 50,000 firms prior to and since the onset of the global financial crisis (GFC).

 

The findings suggest that foreign firms did not contribute more to the economic performance of their host economies than domestic firms over this period. However, in some CEE Member States foreign firms appear to have contributed more meaningfully through creating employment. This is important for two reasons. Firstly, in the context of the GFC, employment is especially important to household welfare. And secondly, as foreign firms are generally thought to be more productive than domestic firms, it is plausible that jobs created by foreign firms are more likely to be sustainable.

 

The findings are also relevant to access to finance problems firms have had over the GFC. Treating the onset of the GFC in 2008 as an exogenous shock to credit supply allowed for the difference-in-differences results to be interpreted in terms of the resilience of foreign versus domestic firms. The evidence shows credit constraints worsened during the crisis and domestic firms particularly would benefit from greater access to short-term finance.