Multinationals and domestic total factor productivity: Competition effects, knowledge spillovers and foreign ownership

We explore the role of multinational enterprises (MNEs) in Total Factor Productivity (TFP) of domestic firms by addressing some of the long‐standing controversies in the literature, drawing attention to the foreign ownership structure. First, we study the impact of foreign ownership structure on FDI gains. Second, we differentiate between competition effects (CE) and knowledge spillovers (KS). The former induces pro‐competitive improvements by making domestic firms charge lower price mark‐ups and the latter highlight the importance of learning gains through intra‐industry (horizontal) and inter‐industry (vertical) spillovers. We investigate whether KS can potentially vary with the degree of foreign control. Using a sample of manufacturing firms from six European countries, we find that the higher presence of MNEs in the domestic market makes domestic firms charge lower mark‐ups. Only majority and wholly owned MNEs generate economically weak horizontal spillovers that become stronger after controlling domestic firms' absorptive capacity. Backward spillovers from MNEs in downstream industries are domestic firms' primary source of TFP gains. Forward spillovers depend on direct linkages with MNEs and the scope of product differentiation.