The impact of foreign direct investment spillovers and international trade on innovation capability in Turkey and comparative emerging markets

Abstract

Foreign direct investment (FDI) has emerged as a very important source of external resource flows to emerging markets and has become a significant part of capital formation in these countries besides financing current account deficit. There are two competing hypotheses regarding the impact of FDI on innovation capability: it may improve the innovation capability of host countries via spillover channels such as reverse engineering, skilled labor turnovers, demonstration effect, and with vertical linkages from foreign firms to their suppliers, or may lead to crowding-out effect through import of technologies via joint ventures. In this study, the spillover effects of FDI and international trade on innovation capability in Turkey, Hungary, Poland and Czech Republic are analyzed for the period 1995- 2005. Panel data models are employed to test two competing hypotheses. The effect of FDI on innovation in Turkey and comparative emerging markets is analyzed by testing different econometric models such as Ordinary Least Square (OLS), Fixed Effects Model (FEM) and Random Effects Model (REM). The empirical evidence support that FDI inflows generate spillover effects on domestic innovation capability in Turkey, and comparative emerging countries. This result supports the hypothesis that inward FDI brings knowledge spillovers, new technologies and products into the host country and promote domestic firms' innovation capability. On the other hand, the hypothesis of crowding-out effect of FDI on innovation is rejected for the given sample. With respect to the impact of intcrnational trade on innovation capability, import of R&D intensive sectors have positive influence whereas export of R&D sectors have a negative impact. Two periods of empirical results are largely consistent with each other. However, Fixed Effect Model results provide the best fit for the period 2000-2005.