tech spillovers

World Economy Technology Spillovers 1

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technology spillovers

Technology spillovers are the beneficial effects of new technological knowledge on the

productivity and innovative ability of other firms and countries. Technology is “non-

rival”: one’s use of a technology does not limit its use by others and the cost for an

additional agent to use an existing technology is negligible compared to the cost of

inventing it. Hence, not all the benefits of technological knowledge are appropriated by

the inventor; technological investments typically generate social returns that far outweigh

private returns. Technology, once invented, can be used and diffused internationally with

small added cost but substantial added benefit.

Technological research and innovation is mostly undertaken by firms and

governments in the leading world economies that are also the world technological

leaders. Then technology diffuses to the rest of the world though the main channels of

trade, migration, foreign direct investment (FDI), and technological licensing (patents

and copyrights).

International technology spillovers have received much attention in the recent

economic research both from theoretical and empirical perspectives. Theory identifies

them as a key mechanism for the sustained growth of productivity and its diffusion across

countries. From an empirical point of view, economists have studied how to measure

technology spillovers and what channels are conducive to them. From a policy point of

view, countries desiring greater technology spillovers use policies to promote trade and

FDI and to promote better conditions for taking advantage of spillovers by absorbing

them into domestic productivity gains.


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Theory of Technology Spillovers

Recent theories of economic growth and income differences across countries (see Eaton

and Kortum 2002 and Klenow and Rodriguez-Clare 2005 for reviews) identify available

technological and scientific knowledge as the most important determinants of

productivity in a country. Scientific and technological innovation are the main engines of

productivity growth in the rich countries (Europe, Japan, and North America). Their

diffusion to industrializing countries, accompanied by investments in physical and human

capital, is the main reason for the growth in productivity and income per capita of those

economies. Yet some countries seem stuck far behind the technology frontier. The

process of technological diffusion has a central position in the recent literature on

development and growth. A better understanding of the nature of technology spillovers

should help shed light on why some countries grow faster than others.

Due to its non-rival nature, technological knowledge can be used by producers

other than the inventor to increase their productivity. Hence it generates two types of

benefits called “spillovers”.

i) First, new technological knowledge can be used in any country to produce

more efficiently or higher quality goods. This spillover increases the labor

productivity of the country that adopts it.

ii) Second, technological knowledge can be used in any country to produce new

ideas or new applications in research and development (R&D). This increases

R&D effectiveness in receiving countries.

Inventors usually appropriate at least part of the benefits from the first type of spillovers,

either by producing goods with the new technology and exporting them to foreign


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markets (trade) or by setting up production that uses the new technology in other

countries (FDI) or by licensing out the new technology and receiving royalty payments

for it. International trade, FDI and international patents and copyrights are therefore

common channels for diffusing the benefits of technological innovations to consumers in

other countries. At the same time those flows carry the knowledge related to the new

technology either embodied in goods, or in machines, or in instructions. This new

knowledge enables receiving countries to benefit from the second type of technological

spillovers: other firms and producers may learn and improve their productivity as a

consequence of exposure to better technology. The first type of technology spillovers are

usually mediated by market mechanisms (trade, investments and intellectual property

rights) and are sometimes called technology diffusion. The second type of technology

spillovers involve diffusion of knowledge to other firms of the receiving country via

mobility of workers, learning, imitation, sub-contracting and are considered technology

externalities.

In the light of these beneficial effects on productivity and growth, international

technological spillovers (even more than international trade of goods and international

movements of capital per se) have been identified as potentially the most beneficial

aspect of globalization. The empirical research has consequently focused on measuring

the intensity, quantifying the effects and identifying the most relevant channels of these

spillovers. At the same time researchers and policy makers have analyzed what are the

characteristics that make a receiving country best positioned to receive the benefits from

those spillovers.


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Empirical Analysis of International Technology Spillovers

Technology spillovers are not recorded in the data. However the channels of their

transmission (trade, FDI, patents) and their consequences (productivity benefits) can be

recorded and measured. The recent empirical analysis has used a plurality of data and

approaches to qualify and quantify the intensity and productive impact of those spillovers

across countries.

Measuring Technology Spillovers

Technological and scientific knowledge is an intangible asset not measurable directly.

Economists have used measures of R&D resources (input) or measures of innovations

such as patents or productivity (output) to approximate it. Aggregate studies have used

country-level data, while micro studies have used firm-level data. Two general methods

are used to identify spillovers. The first method considers the effects of R&D done in

some countries (or firms) on the productivity of other countries (or firms) that are linked

to the former via trade, FDI, or technological/geographical proximity. The basic features

of this approach were first developed in a very influential paper by Coe and Helpman

(1995) and will be described in the next section. The second approach considers directly

the association between the presence/intensity of trade and FDI (channels of technology

spillovers) and the productivity of the importing/receiving country or firms there. Both

methods infer the existence of spillovers indirectly from the effects on productivity in

firms of the receiving economy.

A third approach aimed at identifying more directly the linkages that reveal

technology spillovers, analyzes citations from a patent to previous patents considering

them as tangible sign of a knowledge spillover (Jaffe and Trajtenberg 2002). An existing


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idea recorded in a patent contributes to the development of a new idea (new patent), and

the citation link reveals this spillover. This method isolates only spillovers of the second

type described above (from R&D to R&D) and tends to emphasize the geographic

localization of those technology spillovers. This method complements (but cannot

substitute for) the other type of studies, as it only identifies the intensity and

characteristics of technological spillovers but cannot quantify their impact on

productivity.

Trade and Technology Spillovers

A popular approach for analyzing the presence and the intensity of technology spillovers

has been to analyze the association (correlation) between productivity in country j (or

industry or firm) and the R&D activity in countries (industries or firms) other than j that

are linked to j by potential channels of spillovers. The basic empirical procedure,

presented in Coe and Helpman (1995) and expanded and updated since then, is to

estimate some version of the following regression: Productivityj = Function(Xj, R&Dj,

R&Dspillovers). The variable “Productivityj” represents some measure of the productivity

(usually total factor productivity or labor productivity) of country (industry, firm) j. The

vector Xj is an array of country (industry, firm) characteristics relevant for its

productivity. R&Dj is a measure of research and development activity performed in the

country (industry, firm) j and R&Dspillovers= ji

ii DRm & is a weighted sum of R&D

activity in other countries. The key feature that identifies this term as capturing

technology spillovers is that the weights mi are constructed to reflect the intensity of

potential spillover channels between country (industry, firm) j, the receiver, and country

(sector, firm) i, the sender. In the original work of Coe and Helpman (1995) mi was


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measured as the share of imports from country j among trade partner of country i

assuming that imports are the most relevant channel of technology spillovers. Subsequent

research has experimented with different weights to capture other potential spillover

channels. Some alternative measures of mi have been the share of FDI from country j in

total capital formation of country i, the share of imports of capital goods (rather than all

goods) and the share of direct and indirect trade (i.e. trade through third-country

mediation). More recently Keller (2002) has constructed the weights mi based on

geographical proximity between country j and i. This approach is based on the

assumption that a whole array of potential spillover channels (trade, FDI, migration,

technological licensing, business travel and others) are strongly enhanced by

geographical proximity. A popular variation of the approach described above, mostly

used on individual firm data, is to measure the effect of technological spillovers on

production costs rather than productivity.

The limit of this type of approach is that the identification of externalities is based

on correlations and it is not easy to establish a real causation link. To address the limits of

the reduced form approach, recent research by Jonathan Eaton and Samuel Kortum has

studied the relationship between R&D technology diffusion and domestic productivity in

the context of general equilibrium models. In those models one can analyze and simulate

the impact of increased research and trade liberalization on technology spillovers and

productivity.

Overall the findings of this literature point to two rather robustly estimated

regularities. First, the effect of R&D spillovers on productivity is consistently larger than

zero and significantly positive for the average OECD country. Second, while for the


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leading economies (G-7 countries), the impact of domestic R&D on productivity is

consistently larger than the spillover effects from other countries, for smaller and less

advanced economies (other OECD countries) the impact of spillovers is larger than the

impact of domestic R&D on productivity. These findings confirm that technological

leaders tend to perform most of the R&D and innovation in the world and spillovers from

those technologies are a major source of productivity growth for other countries.

FDI and Technology Spillovers

A second approach to identifying and quantifying international technology spillovers is

based on the idea that FDI is an explicit activity set up to transfer technology across

national borders (e.g. Markusen, 2002). Hence FDI is a direct carrier of technology flows.

The question is how much these flows benefit the productivity of the receiving economy

and what are the features or policies of the receiving economy that enhance the positive

effects of technology spillovers. Several theoretical models argue that multinational

enterprises should generate technology spillovers to local firms through several channels

and many of them have been studied in detail using firm-level data. Imitation, learning,

and acquisition of human capital through worker turnover are considered as the most

important channels of spillovers. Competition, sub-contracting and supply of high quality

intermediate inputs are market-mediated mechanisms that make better inputs available to

the local firms, stimulate more efficient technologies, and may also have positive

productivity effects.

The typical empirical approach for identifying technological spillovers through

FDI estimates the following model: Productivityjk = Function(Xj, FDIk). The term

(Productivityjk) measures the productivity of firm j in sector k and the right hand side of


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the expression implies that it is a function of a vector of firm characteristics Xj and of

some measure (usually the share of employment or of sales) of the presence of

multinational enterprises in sector k, (FDIk). Usually these studies analyze firm-level data

for one country at a time (hence no country subscript) and often they consider

geographical proximity as a requisite for (or enhancer of) the technology spillovers:

multinationals have larger productivity effects if they are located in the same region or

area as the potential spillover-receiving firm j. Another relevant dimension of the

spillovers is whether they benefit domestic firms “horizontally”, namely those in the

same industry or “vertically”, namely those that supply inputs to or buy inputs from the

multinational enterprise.

Using cross-section and panel data from several different industrialized and

industrializing countries, many researchers have estimated technology spillovers through

FDI using the method described above. Interestingly, the evidence in favor of positive

effects of technology spillovers on productivity of domestic firms is scant, especially

when considering developing countries. Blomstrom and Kokko (1998) and more recently

Gorg and Greenway (2004) review dozens of such studies and conclude robust evidence

of positive effects of FDI spillovers is found mainly for industrialized countries. For

developing countries results are much less clear. A typical example of those studies is the

influential article by Aitken and Harrison (1999) that analyzing evidence from FDI in

Venezuela does not find any positive effect on productivity of local firms. In fact the

study finds some negative effects on domestic firms and attributes them to increased

competition from FDI and crowding out of domestic firms.

Absorptive Capacity


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These findings have prompted research on the role of the receiving firm or country in

determining the impact of technology spillovers. While the potential for technology

spillovers is intrinsic to FDI activity, the actual impact on productivity of domestic firms

depends on the absorptive capacity of those firms. Human capital and investment in R&D

by the receiving country (firm) are important pre-requisite to experience positive effect of

technology spillovers on productivity. Insufficient human capital in local firms could be

the explanation for the lack of spillovers from FDI in developing countries. Using firm-

level data, several articles (e.g. Glass and Saggi, 1998) confirm that firms using low

skilled workers and backward technology are unable to benefit from FDI technology

spillovers.

Conclusion and Policy Considerations

Foreign direct investments are seen by government of several industrializing countries, as

highly beneficial to the domestic economy. Technology spillovers are only one of their

effects, as those investments bring also employment opportunities, higher consumption

and higher government income. However technological spillovers generate probably the

most important and lasting effects in the long run as they channel technological transfer

and induce productivity growth. In the light of the empirical findings, policies promoting

higher education and skill-formation of workers and R&D investment of domestic firms

are needed complements to policies that attract FDI, if a country is to maximize the

absorption of technological spillovers. At the same time some policies such as R&D

requirements, technology transfer requirements and local hiring targets on multinational

enterprises can increase the intensity of technological activity and the benefits for the


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local economy. Probably, however, a general framework of openness towards

international flows and free competition in trade, FDI and technological licensing is the

most important component for a country to attract technology spillovers and benefit from

improved technologies as they become available to the global economy.

Annotated References Aitken, Brian, and Ann Harrison. 1999. “Do Domestic Firms Benefit from Foreign Direct

Investment? Evidence from Venezuela.” American Economic Review 89(3): 605-

18. One of the most cited and influential articles on FDI spillovers in developing

countries.

Blomstrom, Magnus, and Ari Kokko. 1998. “Multinational Corporations and Spillovers.”

Journal of Economic Surveys 12(3): 247-77. An early comprehensive survey of

the literature on FDI and technology spillovers

Coe, David, and Elhanan Helpman. 1995. “International R&D Spillovers.” European

Economic Review 39(5): 859-87. The initial and still one of the most influential

articles on trade and technology spillovers

Eaton, Jonathan, and Samuel Kortum. 2002. “Technology, Geography and Trade.”

Econometrica 70(5): 1741-79. A sophisticated theoretical and empirical analysis

of technological diffusion and technology spillovers.

Glass, Amy, and Kamal Saggi. 1998. ‘International Technology Transfer and the

Technology Gap.” Journal of Development Economics 55(2): 369-98. One of the

most influential recent articles on the role of absorptive capacity in determining

the impact of FDI spillovers.


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Gorg, Holger, and David Greenway. 2004. " Much Ado About Nothing? Do Domestic

Firms Really Benefit From Foreign Direct Investment?" World Bank Research

Observer 19(2): 171-97. The most comprehensive recent review of the role of

FDI in promoting technological spillovers.

Jaffe, Adam, and Manuel Trajtenberg. 2002. Patents Citations and Innovations. A

Window on the Knowledge Economy. Cambridge Ma, MIT Press. The most

comprehensive collection of research on the use of patent data and patent citations

to measure technology spillovers.

Keller, Wolfgang. 2002. “Geographic Localization and International Technology

Diffusion.” American Economic Review 92 (1): 120-42. A very influential paper

measuring the importance of geographical proximity for technological diffusion.

Keller, Wolfgang. 2004. “International Technology Diffusion.” Journal of Economic

Literature 42(3): 752-82. A comprehensive literature review on international

technology diffusion.

Klenow, Peter and Andres Rodriguez-Clare. 2005. “Externalities and Growth.” In Aghion

Philippe and Steven Durlauf ed. The Handbook of Economic Growth. Amsterdam

Elsevier. An excellent review of the most relevant theoretical models of

technological spillovers and economic growth.

Markusen James. 2002. Multinational Firms and the Theory of International Trade.

Cambridge Ma, MIT Press.

A very influential, mostly theoretical, book on multinational firms and international trade


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Giovanni Peri

Department of Economics, University of California, Davis and NBER

Bio:

Giovanni Peri is Associate Professor of Economics at the University of California, Davis

and Research Associate at the National Bureau of Economic Research. He received his

Ph.D. in UC Berkeley and he does research in the fields of International Technological

Diffusion, Human Capital, International Migrations and Productivity. He has published

in several internationally refereed journals such as the Review of Economic Studies,

Review of Economics and Statistics, Economic Journal, and European Economic Review.

tech spillovers

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