higher wages and have much higher import and export propensities.12
A more interesting question is whether local firms benefit from spillovers generated by their
foreign counterparts. Aitken and Harrison (1994) test this hypothesis by assuming that, if knowl-
edge is transmitted from foreign to local firms, then the productivity of the latter should be higher
in sectors with a larger foreign presence. They use a panel of Venezuelan firms to estimate the
following Cobb-Douglas production function:
log Yijt = log Aijt + a1 log SLijt + a2 log ULijt + a3 logMijt + a4 logKijt (17)
Here, Yijt is output of firm i in sector j at time t, A is total factor productivity, SL is skilled labor,
UL is unskilled labor, M is raw materials, and K is capital stock. In order to capture the effect of
foreign presence on local firms’ TFP, A is modeled as follows:
logAijt =b1+b2FDIjt+b3Dj+b4Dt+eit (18)
where F DIjt is the share of foreign firms (as measured by the share of foreign assets in total sector
assets) in sector j at time t, Dj and Dt are sector and time dummies, respectively, and eit is an
error term. A positive effect of foreign presence on local firms’ TFP should show up as a positive
and significant coefficient b2.
Estimation results critically depend on whether or not sectoral dummies Dj are included in the
regression. When sectoral dummies are excluded, the coefficient b2 is positive and significant. This
suggests a positive correlation between foreign presence and local firms’ efficiency. The correlation
may be spurious, however, since foreign firms may be attracted to sectors in which local firms
make higher profits. In fact, when controlling for unobserved fixed industry characteristics through
sectoral dummies, b2 turns negative and highly significant. Notice that in this case only temporal
12 The evidence on total factor productivity growth is mixed. In particular, only in the case of Venezuela TFP
growth is higher for foreign firms. The converse is true for Mexico, and the difference is insignificant for Cote
d’Ivoire.
26
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