Does FDI Crowd Out Domestic Firms? Micro-Level Evidence from the Republic of Korea

Abstract

This report analyzes the impact of foreign investment on the exit and sales of domestic firms, using 2006-2013 Korean firm-level data. The results show that the crowding-out and market-stealing effects are more severe for small firms. While foreign firms drive small domestic firms out of the domestic market and take away domestic market shares, large firms rather enjoy the spillover effects from foreign firms. The baseline estimation is further investigated by dividing the full sample into manufacturing vs. service sectors and low-export vs. high-export groups. The crowding-out effect related to exits is more severe in the service sector, while the market-stealing effect on domestic firms' sales is larger in the manufacturing sector. On the other hand, both of the crowding-out and market-stealing effect appear to be larger in high-export groups. To summarize, foreign firms have negative impacts, in particular, on small firms, whereas larger firms rather benefit from the positive externalities of foreign firms. It may be that large firms possess enough ability to compete with foreign firms, and also to learn and apply the advanced technology the foreign firms bring in. The result also shows that since domestic firms in the service sector tend to be small, their survival is vulnerable to the presence of foreign firms, whereas since market competition is more severe in the manufacturing sector, domestic firms' market share loss is more severe in the manufacturing sector. Lastly, we found that domestic exporting firms are in more intense competition with foreign firms.

Keywords: FDI, Crowd-out effect, Market-stealing effect, SMEs