Does outward foreign direct investment improve the performance of domestic firms? Case of Korea

• Published date: 01 December 2023
• Author: Soomin Han,Sunghyun Kim
• Date: 01 December 2023
• DOI: http://doi.org/10.1111/asej.12315

ORIGINAL ARTICLE

Does outward foreign direct investment improve the

performance of domestic firms? Case of Korea

Soomin Han

1

|Sunghyun Kim

2

1

BK21 Program, Economics Department, Sungkyunkwan University, Seoul, South Korea

2

Economics Department, Sungkyunkwan University, Seoul, South Korea

Correspondence

Sunghyun Kim, Economics Department, Sungkyunkwan University, 25-2 Sungkyunkwan-ro, Jongno-gu, Seoul

03063, South Korea.

Email: shenrykim@skku.edu

Abstract

In this article, we use firm-level data in Korea from 2010 to 2019 to analyze whether

outward foreign direct investment (OFDI) affects the productivity of domestic firms,

known as reverse knowledge spillovers. Using propensity score matching and

difference-in-difference regressions, we verify that OFDI improves the productivity

of parent companies. Considering the characteristics of OFDI and the parent com-

pany, these positive effects become greater when (1) parent company’s absorptive

capacity (technology level) is high, (2) OFDI is in the M&A form, and (3) OFDI is

toward developed countries. In addition to these direct effects, we investigate whether

OFDI improves the productivity of other domestic firms within and across industries,

known as horizontal and vertical spillovers. The results demonstrate strong evidence

of positive vertical spillovers but not horizontal spillovers. These evidence provide

important policy implications about the specifics of outward direct investment that

are beneficial to capital-exporting countries.

KEYWORDS

absorptive capacity, OFDI, productivity, propensity score matching, reverse knowledge spillovers

JEL CLASSIFICATION

D22, F21, F23

1|INTRODUCTION

Outward foreign direct investment (OFDI) has dramatically increased in Korea

since the 1990s, partly backed by a strong promotion by the Korean

DOI: 10.1111/asej.12315

© 2023 East Asian Economic Association and John Wiley & Sons Australia, Ltd.

Received: 19 October 2022; Accepted: 26 November 2023

Asian Econ. J. 2023;37:519–549. wileyonlinelibrary.com/journal/asej 519

government.

1

The OFDI/GDP ratio had been less than 1% until the mid-1990s;

it increased to 3.5% in 1999 and surpassed the amount of inward FDI in 2002.

The amount of OFDI reached a record high of USD 64 billion in 2019. As

OFDI increases, concerns are growing that relocating production lines overseas

could reduce domestic investment and employment. Several studies argue that

OFDI is responsible for decreasing exports, domestic investment, and job

opportunities.

2

However, on the positive side, OFDI can improve technology at

domestic firms engaged in OFDI (defined as “OFDI firms”or “parent com-

pany”hereafter) by acquiring access to advanced foreign technology.

3

Positive effects of OFDI typically originate from strategic assets, advanced

technology, and natural resources in foreign markets. This transmission channel

is known as “reverse knowledge spillovers,”which are based on the following

three mechanisms: (1) exposing OFDI firms to new technology, ideas, and man-

agerial expertise in host economies that are not available in a home country;

(2) increasing efficiency and reducing production costs by moving production

lines to another country with better resources; (3) partnering with foreign host

firms to achieve economies of scale, eliminate redundant processes, and acceler-

ate knowledge accumulation by sharing internal assets as well as core business

knowledge. Although a large body of literature has examined the effects of

OFDI on firm productivity, the literature on when, where, and how OFDI may

affect productivity is sparse. Previous literature typically regarded OFDI and

parent companies as homogenous and examined the OFDI effects only in the

manufacturing sector. Understanding heterogenous OFDI effects based on

characteristics of OFDI, destination country, and parent companies still need

further investigation.

In order to analyze the heterogeneous effects of OFDI in Korea, we first

construct a comprehensive firm-level dataset that integrates detailed OFDI

information in both manufacturing and service sectors in Korea. Then, we use

the propensity score matching (PSM) and differences-in-differences (DID)

approach to avoid a sample selection bias in measuring reverse knowledge spill-

overs by constructing a comparable control group (domestic firms) for the treat-

ment group (parent company). We consider key factors that can contribute to

the heterogeneous effects of OFDI, such as foreign market entry modes (M&A

vs. greenfield), destination countries (developing vs. developed), and parent

companies’characteristics (absorptive capacity). This analysis can provide clear

answers to which characteristics of OFDI and parent companies can explain dif-

ferent productivity effects of OFDI. Finally, we extend our analysis to study

1

The Korean government enacted the Foreign Exchange Transactions Act in April 1999 to simplify OFDI

procedures and to reduce investment-restricted areas.

2

For example, Al-Sadig (2013), and Jang and Hyun (2015) support the evidence of a “crowding-out effect”on

domestic investment by OFDI.

3

Some literature finds evidence for positive OFDI effects using the data of China (Dong et al., 2021) and Canada

(Rai et al., 2018).

520 HAN and KIM