Does foreign presence induce host country firms’ exit?

  • Paula Sarmento e Rosa Forte
  • 18 November 2019

An opinion article by Paula Sarmento and Rosa Forte, Assistant Professors at the University of Porto.

In the last decades, there has been a growing importance of multinational enterprises in the world economy, as evidenced by some indicators of the foreign affiliate activity such as sales, employment, exports, value-added and assets. Multinational firms’ activities might have effects on survival and exit of domestic firms’ and subsequently on host country industry dynamics.

Multinational firms’ activities might affect the host country industry dynamics due to two main opposing effects. On one hand, foreign presence may induce less efficient domestic firms to exit the market (what in economics is called crowding-out effect) as multinationals are generally more efficient, have aggressive business practices (e.g. predatory conduct), have access to less expensive inputs, among others. These strategies may lead to a “market-stealing effect” with foreign firms capturing part of the market share previously held by domestic firms.

On the other hand, the presence of multinationals firms contributes to the transfer of technology, advance knowledge and of best practices to local firms which will be reflected in an improvement of the of domestic firms’ productivity, reducing firms’ exit (spillover effect). Either the crowding-out effect and the spillover effect have been found by empirical studies, but their relative importance depends on the countries, sectors and period of analysis.

Given the opposing effects of foreign presence on host country firms’ exit, we further developed this subject by estimating an econometric model based on a large sample of Portuguese firms from manufacturing and services over the period 2008–2012. This period was characterized by a strong internal economic crisis. Our work focused on two different perspectives regarding the effects of foreign presence on domestic firms’ probability of exit. We adopted an aggregate perspective studying how the sectorial presence of foreign firms affected the probability of firm exit, concluding that foreign presence at the industry level increases a host country firm’s probability of exit from manufacturing sectors.

This result supports the crowding-out effect referred to above. Furthermore, we adopted an individual perspective investigating how a firm’s foreign ownership [1] affects the probability of exit, concluding that firms with foreign ownership have a lower probability of exit than purely domestic firms. This result supports the argument that firms with foreign ownership may have specific features that make them more resistant to exit, as for instance, their linkage to companies involved in international activities with greater financial robustness or with higher commitment regarding investments. These two conclusions were found both in the manufacturing and services sectors.

To the economic policy debate, both results emphasize the importance of discussion the foreign investment attraction strategies. One effective way to reinforce the resistance of firms to periods of economic crisis might be the promotion of cross firm’s ownership between foreign capital and domestic capital. Of course, we may argue that attract foreign capital interested in sharing the firm’s ownership with local investors might be more difficult than attract direct investment to projects with total foreign ownership, because, among other reasons, in the latter foreign investors have full control over management decisions. Even though, there are many policies that might be pursued by the Government in parallel with more traditional incentive policies (as tax holidays, direct subsidies, among others). For instance, the promotion of entrepreneurship events, with the purpose of connecting ideas and entrepreneurs might contribute to increase the cross-ownership. Moreover, in addition, to strengthen of firm´s resistance to exit there may be other positive effects resulting from the cross-ownership, such as learning effects, higher connection with local market or deeper knowledge spillovers that can have a positive impact on firms’ productivity.

[1] Following international standards we consider as foreign a firm where foreign shareholders own at least 10% of the capital.

  • Paula Sarmento
  • Assistant Professor at the Faculty of Economics of the University of Porto
  • Rosa Forte
  • Assistant Professor at the Faculty of Economics of the University of Porto