Foreign Ownership and Firm Productivity in Bangladesh Garment Sector Hiau Looi Kee* May 2005 Abstract This paper studies the productivity advantage and spillover of FDI firms in Bangladesh garment sector. This is based on a newly collected exclusive firm level data, supported by a unique custom firm level export data. Firm productivity is first estimated from a firm production function, controlling for input endogeneity, selectivity, as well as firm and year fixed effects. Results show that FDI firms are on average 20 percent more productive than domestic firms. Moreover, there are statistical evidence suggesting that productivity spillover occurs such that domestic firms may benefit from the productivity increase in FDI firms. These findings support a more open FDI policy for the Bangladesh garment sector.
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Foreign Ownership and Firm Productivity in Bangladesh Garment Sector
Hiau Looi Kee*
May 2005
Abstract
This paper studies the productivity advantage and spillover of FDI firms in Bangladesh garment sector. This is based on a newly collected exclusive firm level data, supported by a unique custom firm level export data. Firm productivity is first estimated from a firm production function, controlling for input endogeneity, selectivity, as well as firm and year fixed effects. Results show that FDI firms are on average 20 percent more productive than domestic firms. Moreover, there are statistical evidence suggesting that productivity spillover occurs such that domestic firms may benefit from the productivity increase in FDI firms. These findings support a more open FDI policy for the Bangladesh garment sector.
__________________________________________* Development Research Group – Trade, the World Bank, 1818 H ST NW (MSN MC3-303), Washington, DC 20433, USA; Tel: (202) 473 4155; Fax: (202) 522 1159; E-mail: [email protected]; I thank the World Bank, CIDA and DFID for providing research funding. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author, and do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent.
Capital 0.025*** 0.017 0.013 0.021*(0.008) (0.022) (0.248) (0.011)
Age -0.173 0.032*(0.316) (0.019)
Investment 0.137(0.111)
Endogeneity correction1 No No Yes YesSelectivity correction2 No No No YesFirm fixed effects No Yes Yes YesYear fixed effects No Yes Yes YesObservations 1027 1027 1027 795Notes: Heteroskadasticity corrected white robust standard errors in parentheses. 1A 3rd order polynomial function of age, capital and investment are included. 2A 3rd order polynomial function of propensity to stay in business and the fitted output net of labor and capital are included.
Column (4) controls for selectivity bias by including a 3rd order polynomial
function of the estimated survival probability and the net fitted output. The resulting
estimated coefficient for capital is 0.02. All these coefficients are statistically significant,
and are in line with the estimates in the literature. Finally, with the sum of the estimated
coefficients of labor, capital and material equals to one, the production function in the
garment sector is found be constant returns to scale.
With these estimates, we constructed firm level productivity according to the
following equations:
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Comparing firm productivity across all firms in all sub-industries and locations
yields some interesting insights in terms of relative productivity of firms. When we
compare different firms across different sub-industries, on average, knitwear firms are
the most productive. An average knitwear firm has 10 percent higher productivity than a
woven firm, and 17 percent more productive than a sweater firm. Figure 10 presents the
distribution of the estimated firm productivity by the three sub-industries. In terms of
locations, productivity of firms located in Dhaka-EPZ is the highest, follow by firms in
Dhaka, Chittagong-EPZ and Chittagong. Figure 11 presents the distribution of firm
productivity by location.
Figure 10: Distribution of firm productivity in different sub-industries
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Firm Productivity by Sub-industries
2.45
2.5
2.55
2.6
2.65
2.7
2.75
Knitwear Sweater Woven
log
of T
FP
Figure 11: Distribution of firm productivity by location
Firm Productivity by Location
2.58
2.6
2.62
2.64
2.66
2.68
2.7
2.72
2.74
2.76
2.78
Chittagong Chittagong-EPZ Dhaka Dhaka-EPZ Others
Log
of T
FP
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Comparing firm productivity from year to year within firms also sheds some
interesting new lights. On average, garment firms are 3 percent more productive in 2003
than in 1999. The improvement in productivity is especially clear for the sample of
domestic firms -- on average, domestic firm productivity is 5.5 percent higher in 2003
than in 1999. Figure 12 presents the movement of firm productivity over time in the
different sub-industries. It is clear that most of the improvements are driven by firms in
the Sweater and Woven industries. These results purely reflect the growth in
productivity within a given firm, and thus are not contaminated by the composition of
firms in different industries. Such an increase in productivity within a firm suggests that
there are some exogenous factors pushing firms to be more productive over time. We
explore one such exogenous factors which is the productivity spillover effects of FDI
firms.
Figure 12: Productivity Growth of Domestic Firms by Sub-industries
22
Productivity Growth of Domestic Firmsby sub-industries
2.4
2.45
2.5
2.55
2.6
2.65
2.7
2.75
1999 2000 2001 2002 2003
KnitwearSweater
Woven
Are FDI firms more productive?
We relate the firm level productivity, Ait, to the ownership of the firms. As shown in
Figure 13, on average, productivity of firms with foreign equity are about 20 percent
higher than purely domestically owned firms.
Figure 13: Productivity of Firms with Different Ownerships
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Productivity vs Firm Ownership
0
2
4
6
8
10
12
14
16
18
20
Domestic firms FDI firms
tota
l fac
tor
prod
ucti
vity
(in
unit
of o
utpu
t)
What could have explained the 20 percent productivity advantage of FDI firms?
Column (1) of Table (6) regress the estimated lnTFP of firms on a FDI indicator
variable, controlling for industry, year and location fixed effects. This is to isolate the
effect of foreign ownership from the influences of sub-industries, investment climate of
the locations, and the macro economic shock in each year. Given that ownership seldom
change within firms in our sample, between-firms variation in foreign ownership is used
to identify the effect of FDI dummy on productivity. The result shows that a FDI firm is
still about 20% more productive than a domestic firm in the same industry, location and
year. This shows that the effect of foreign equity on firm productivity is independent on
the location of the firms, the sub-industry of the firms and the macro economic
fluctuations. Columns (2) and (3) further include age and export destinations of the
firms in both the between and the OLS regressions. It is clear that FDI firms do have a
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higher level of productivity, even after we take into account the export destinations and
thus the potential demand shocks of the firms, as well as the experience of the firms as
proxied by age. Moreover, the OLS results show that firms export to US tend to be more
productive, which concurs our previous finding using firm export data from EPB.
Columns (4) to (6) repeat the exercise by using the actual foreign equity share in
the regressions instead of a FDI dummy variable. The results are strikingly similar. This
could be because most of the FDI firms in Bangladesh garment sector have 100 percent
foreign equity, only 7 FDI firms are jointly venture firms with foreign equity no less than
25 percent.
Thus overall there is convincing and statistical significant evidence suggesting
that FDI firms are more productive than otherwise identical domestic firms operating in
Bangladesh. This result is robust after taking into account the effects of locations, sub-
industries, macro fluctuation, export destinations and experience.
Table 6: Dependent Variable – log of TFP
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(1) (2) (3) (4) (5) (6)Between Between OLS Between Between OLS
Age 0.001 0.000 0.001 0.000(0.003) (0.001) (0.003) (0.001)
Export share of US 0.234 0.229*** 0.237 0.234***(0.166) (0.063) (0.166) (0.064)
Export share of EU 0.144 0.130** 0.144 0.132**(0.160) (0.053) (0.160) (0.053)
Region fixed effects Yes Yes Yes Yes Yes YesYear fixed effects Yes Yes Yes Yes Yes YesIndustry fixed effects Yes Yes Yes Yes Yes YesObservations 1027 1013 1013 1027 1013 1013Notes: Asymptotic standard errors in parentheses in Columns (1), (2), (4) and (5). Heteroskadasticity corrected white robust standard errors in parentheses in Columns (3) and (6). Total number of firms in the unbalanced panel is 232 in Columns (1) and (4), and 227 for the rest . Dependent variable is constructed based on Column (4) of Table 5.
Productivity Spillover: Can Domestic Firms Benefit from FDI Firms?
Many countries provide special incentives such as tax holidays or subsidies, and
import duty exemptions to attract FDI, with the assumptions that the presence of FDI will
benefit domestic economy through the some unmeasured “spillover effects.” To date,
there is evidence of “vertical” spillover effects through the contact of domestic upstream
suppliers to the downstream FDI firms (Javorcik, AER, 2004), evidence of “horizontal”
spillover effects however have been quite elusive.
To study whether such effects exists in Bangladesh’s garment sector, we first
relate the estimated TFP of the domestic firms to the presence of FDI firms in the sub-
industries. Presence of FDI firms in sub-industry j, FPjt, is captured by the share of
employment of FDI firms collectively in the sub-industries in a given year, adjusted by
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the percentage of foreign ownership of FDI firms, FSit, for all firm i in sub-industry j.
This measure of the influence of FDI firms has been used in the literature (Aitken and
Harrison, AER, 1999).
In addition, we further relate the estimated TFP of domestic firms to the TFP of
FDI firms in the same sub-industry and year. In order to capture the economic influence
of the productivity of FDI firms, we weight the TFP of FDI firms with the share of
foreign equity and the share of employment in the industry. Weighting by capital or
output would not change the results.
Given that both the presence of FDI in the industry and the productivity of FDI
firms in the industry do not vary within each firm observation, and are specific to each
industry-year, we have aggregate variables in micro unit, which will artificially deflate
the standard errors of the firm level panel regression (Moulton, RESTAT, 1990). We
correct for such problem nonparametrically by clustering the standard errors of the
regressions by industry-year.
Table 7 presents the regression results. Column (1) shows that controlling for
firm and year fixed effects, productivity of domestic firms increases with the presence of
FDI firms in the sub-industry. However, while the effect is positive, it is not statistically
27
significant. This is quite in line with the finding of the previous literature, and is robust
to the inclusion of other control variables such as age and export destinations in Column
(2). The more interesting result is presented in Columns (3) where we find positive and
significant effects of the productivity spillover of FDI firms on the domestic firms in the
same sub-industry. For every 10 percent increase in the productivity of FDI firms, the
productivity level of domestic firms in the same sub-industry improves by 1.4 percent.
This result is robust to controlling for export shares and age of the firms as shown in
Column (4).
Columns (5) to (8) repeat the same exercise, but instead of using log of TFP as
dependent variable, we use the level of TFP. This is closer to the usual notion of
productivity (Olley and Pakes, Econometrica, 1996). In these specifications, both the
presence of FDI firms and the productivity of FDI firms have positive and statistically
significant effects on the productivity of domestic firms in the same sub-industry.
Overall, there are sufficient statistically evidence suggesting that domestic firms
may benefit from the productivity growth of FDI firms in their sub-industries. Thus, not
only are FDI firms more productive than domestic firms, productivity growth of FDI
firms may spillover to the domestic economy to benefit the domestic firms.
Table 7: Foreign Productivity Spillover
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Dependent Variable ltfp ltfp ltfp ltfp tfp tfp tfp tfp(1) (2) (3) (4) (5) (6) (7) (8)Within Within Within Within Within Within Within Within
FDI share in industry 0.332 0.354 8.790* 8.967**(0.224) (0.223) (4.156) (4.167)
Productivity of FDI 0.142** 0.150** 0.251** 0.253** in industry (0.063) (0.063) (0.097) (0.097)
Age -0.005*** -0.006*** -0.0678** -0.117***(0.002) (0.001) (0.024) (0.024)
Export share of US 0.000 0.000 -0.010 -0.011(0.001) (0.001) (0.043) (0.043)
Export share of EU -0.001 -0.001 -0.016 -0.015(0.001) (0.001) (0.038) (0.038)
Firm fixed effects Yes Yes Yes Yes Yes Yes Yes YesYear fixed effects Yes Yes Yes Yes Yes Yes Yes YesObservations 878 878 878 878 878 878 878 878Notes: Both FDI presense and productivity are specific to industry and year. To correct for correlation of errors within industry-year, we cluster the standard errors in parentheses for each sub-industry-year. Sample consists of an unbalanced panel of 196 wholely domestic owned firms.
Conclusions
This paper studies the relationship between foreign equity and firm productivity of
Bangladesh garment sector. Firm productivity is measured by the total factor
productivity (TFP), which is the level of output that is not explained by inputs, reflects
efficiency in production of the firms. Using between firm variations, we show that FDI
firms on average are 20 percent more productive than domestic firms in the same sub-
industry and location. Furthermore, there is statistically significant evidence suggesting
that domestic firms may benefit from the productivity spillover from the FDI firms. For
every 10 percent increase in FDI firm productivity, the productivity of domestic firms
improve by 1.4 percent. The findings of this paper support a more open FDI policy in
Bangladesh garment sector.
References
29
Aitken, Brian J. and Ann E. Harrison (1999). “Do Domestic Firms Benefit from Direct
Foreign Investment? Evidence from Venezuela,” American Economic Review 89, no. 3,
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Eaton, Jonathan, Samuel Kortum, and Francis Kramarz (2004). “Dissecting Trade:
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154.
Javorcik, Beata (2004). “Does Foreign Direct Investment Increase the Productivity of
Domestic Firms? In Search of Spillovers through Backward Linkages,” American
Economic Review 94, no. 3, 605-627.
Kee, Hiau Looi (forthcoming). “Firm Performance in the Services Sector,” in Malaysia:
Firm Competitiveness, Investment Climate, and Growth, the World Bank.
Moulton, Brent R. (1990). “An Illustration of a Pitfall in Estimating the Effects of
Aggregate Variables on Micro Unit,” Review of Economics and Statistics, 334-338.
Olley, G. Steven and Ariel Pakes (1996). “The Dynamics of Productivity in the