Abstract Many countries strive to attract foreign direct investment (FDI) in hope that knowledge and technology brought by multinationals will spill over to domestic enterprises and increase their productivity. Whether foreign enterprises have positive or negative spillover effects depends on a number of factors, such as the technological gap and business linkages between domestic and foreign enterprises. The spillover effects will take place through several ways, including 1) new comers into the industry will result in more fierce competition that will make a change for the resource allocation and finally improve the efficiency of the whole industry; 2) foreign firms will push the domestic ones to improve their technology and management in order to survive in the market; 3) domestic enterprises will imitate and learn from the foreign firms; 4) the domestic firms improve their technology and management from forward and backward industrial linkages; 5) the technology transfer is followed by the job-hopping from foreign to domestic firms. Foreign enterprises can also take the advantages of their technologies, management, capital and market to get the domestic firms out of market. Many previous studies find that there are significant spillover effects on domestic firms from FDI. However, few studies distinguish the different ways of the spillover effects. This paper investigates the influence of horizontal, forward and backward industrial linkages on the spillover effects of FDI. It is hypothesized that foreign enterprises are likely to improve the labor productivity of domestic enterprises when they source intermediate goods from domestic enterprises or they sell to them. It is also proposed that horizontal linkages between foreign and domestic enterprises facilitate the technological transfer and enhance labor productivity of domestic enterprises. The authors believe that horizontal linkages between foreign and domestic enterprises hurt domestic enterprises and thereby foreign enterprises generate significant crowding out effects for domestic enterprises. This may be due to the fierce intra-industry competition associated with the introduction of FDI, particularly those from the large multinationals. Statistical analysis,however, indicates that local sourcing of foreign enterprises from domestic enterprises would significantly improve the labor productivity of domestic enterprises. Foreign enterprises may transfer advanced technology to their suppliers or set higher product quality standard for the local suppliers, stimulating the improvement of labor productivity of domestic suppliers. Results suggest that the purchase of intermediate goods from foreign enterprises has not contributed to the improvement of labor productivity of domestic enterprises.
2008, Vol. 23 
