Knowledge Diffusion Through FDI: Worldwide Firm-Level Evidence

IMF Working Papers, July 12, 2024

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Research question: impact of Foreign Direct Investment (FDI) on knowledge diffusion as measured by cross-border patent citations.
Dataset: novel firm-level panel combining worldwide utility patent and citations data with project-level greenfield FDI and crossborder mergers and acquisitions (M&A) data over the past two decades, covering firms across 60 countries.
Methodology: new local projection difference-in-differences (LP-DiD) approach applied at the firm level.
Main headline result: citation flows between investing firms and host countries increase by up to around 10.6% to 13% in five years after the initial investment.

Data components:
- Worldwide utility patent and citations data.
- Project-level greenfield FDI data.
- Crossborder M&A data.
- Firm-level panel spanning the past two decades and 60 countries.
Empirical approach:
- Local projection difference-in-differences methodology tailored to capture dynamic effects of firm-level FDI on cross-border patent citation flows.

Magnitude and timing:
- Citation flows between investing firms and host countries increase by up to around 10.6% to 13% in five years after the initial investment.
Directionality:
- FDI significantly enhances knowledge flows both from and to the investing firms (i.e., inward and outward citation effects).
Heterogeneity:
- Effects are stronger when host countries have higher innovation capacities.
- Effects are stronger when host countries are technologically more similar to the investing firm.
Spillovers:
- Knowledge spillovers extend beyond targeted firms and industries in host countries.
- Spillovers are particularly pronounced for sectors closely connected in the technology space.

Enhancing host-country innovation capacity can amplify the knowledge-diffusion benefits of attracting FDI.
Policies that increase technological similarity or connectivity between domestic industries and foreign investors may strengthen cross-border knowledge flows.
Consideration of sectoral technology linkages is important: sectors closely connected in the technology space experience larger spillovers, suggesting targeted industrial policies could magnify benefits.