Productivity and technology diffusion in India: The spillover effects from foreign direct investment

In this paper, we examine the spillover effects from foreign direct investment (FDI) in the Indian manufacturing industries under the capital liberalisation period using macro aggregated panel data (1995–2004). In the first step, we estimate the total factor productivity (TFP) of each industry using a Cobb–Douglas-type production function. In the second step, we examine the relationship between the level of TFP and the level of FDI in each industry, where we distinguish FDI spillover effects two types: short run and long run. In addition, we test FDI spillover both as an intra-industry effect and an inter-industry effect, also called backward linkage. Our main findings are that the FDI stock increases the TFP, especially through backward linkage, although the TFP level fell in the short run.