Foreign Direct Investment and R&D: Substitutes or Complements - A Case of Indian Manufacturing After 1991 Reforms (Subash Sasidharan and Vinish Kathuria)


One of the objectives of the economic reforms undertaken in India since 1991 was to open the doors for foreign firms to invest in the country. As a result, the last 15 years has witnessed large scale FDI inflows to various industries in the Indian economy. Apart from the direct effect of bringing capital and technology, FDI is also an important channel which influences the R&D activities in an economy. The presence of foreign firms as well as the entry of foreign firms leads to an increase in the competition in the domestic market. Therefore, in order to compete with the MNCs the domestic firms have to undertake R&D activities or obtain technology from other sources. Under this backdrop, this study is an attempt to examine the relationship between FDI and R&D of the domestic firms in the postliberalization regime. To realise the objective, we have used an unbalanced panel data of 1843 Indian manufacturing firms operating during the period 1994-2005.

In order to see the influence of FDI on R&D behaviour, we controlled for the firm specific variables like size, exports, technology imports, vertical integration and age in determining the R&D activities. An important contribution of the present paper is to correct for the self-selection problem by using a Heckman-two step procedure. In the first stage, the analysis involving full sample firms produced no clear picture about the impact of FDI on the innovation strategies of domestic firms. In the second stage, when analysis was carried out according to different sub-samples, we find some interesting results. FDI inflow induces foreign-owned firms irrespective of the extent of ownership to invest in R&D. In all other specification, FDI inflow does not have any impact on the selection equation. For outcome equation, there is no impact of the inflow. Among other firm specific variables size (large firms) and age (older firms) consistently influence the probability to invest in R&D. All other variables like technology import or outward orientation or market concentration, only selectively affect the probability and R&D intensity. An important finding of the present study is that the technological efforts in the form of R&D have declined marginally for both categories of firms during the study period. This is a cause of concern for the policy makers. We also find that firms are increasingly depending on technology imports. The removal of restriction on the imports during the reform period might
have played a catalytic role for this phenomenon.

Working Paper