Technology gaps, absorptive capacity and the impact of inward investments on productivity of European firms *

Using a balanced panel of firm-level data on the manufacturing industry in France, Italy and Spain over the 1993-1997 period, this paper examines the impact of foreign presence on the productivity of domestic enterprises. We find positive and significant externalities on Italian firms and negative or non-significant effects on Spanish and French firms. A generalisation of the results obtained for individual countries is attempted by introducing two key variables in the analysis of the impact of inward investments on domestic performances: productivity gaps between foreign and domestic firms, and absorptive capacity of domestic firms. It is shown that high gaps tend to favour positive effects of FDI; while on the contrary absorptive capacity, as measured by local firms’ productivity levels, appears to inhibit externalities from FDI. This would confirm the “catching up” hypothesis, which identifies a positive relation between the size of technological gaps and growth opportunities induced by foreign investments; and would contradict the “technological accumulation” hypothesis, which stresses the role of domestic absorptive capacity and of coherence between foreign and domestic technology as determinants of virtuous effects of inward investments. Nevertheless, we show that this result hides some sectoral specificities. In fact, this pattern is reversed in science based industries, where FDI contribute more to domestic firms’ productivity the higher is their absorptive capacity and the lower is their gap from the average TFP of foreign firms in the sector.