Sandra Batten and Dena Jacobs
Many governments around the world pursued policies to free up capital flows from the late 1970s to early 1990s with the aim of boosting productivity. There’s now a debate raging about the costs and benefits of globalisation. While detractors highlight concerns about inequality, supporters of capital liberalisation point to the productivity growth it has fostered. Drawing on a unique UK firm-level dataset that merges data from the ONS business and innovation surveys, we show that foreign-owned companies are more productive than domestically owned firms and that their presence boosts domestic labour productivity. We suggest three reasons why: foreign-owned companies invest more in R&D; they are better managed; and they collaborate with other organisations and promote the diffusion of ideas.
Foreign owned firms are more productive than their domestic counterparts.
There is a substantial body of evidence showing that foreign-owned firms are more productive than domestically owned ones (see example Griffith et al. (2004)) and that their presence can boost the spread of knowledge and productivity. For example, Haskel et al. (2007) document the existence of knowledge spillovers from foreign companies located in the UK to domestic companies. And Griffith et al. (2002) find that greater foreign presence within an industry increases the speed with which technology in that industry converges towards that of the world’s most productive firms.
We draw on data from around 40,000 UK companies and show that foreign-owned firms are around twice as productive as domestically owned companies in the UK, consistent with the literature (Chart 1). Some of this reflects the fact that foreign firms tend to be large and to be exporters and both of these characteristics are associated with higher productivity levels. But even controlling for size, whether they export, age, and sector we find foreign companies to be around 50% more productive than domestically owned ones.
Moreover, foreign-owned firms’ productivity growth is stronger. Among a sample of surviving companies, foreign firms contribute around 30% of total productivity growth, while on average they only account for around 16% of total employment.
Chart 1: Distribution of labour productivity by type of ownership
Source: ONS research datasets.
* Chart shows 2013 figures, though the distribution does not change materially across years. The charts and analysis shown contain statistical data from ONS which is Crown Copyright. The use of the ONS statistical data in this work does not imply the endorsement of the ONS in relation to the interpretation or analysis of the statistical data. This work uses research datasets which may not exactly reproduce National Statistics aggregates.
Why are foreign-owned firms more productive and how does that boost aggregate UK productivity?
They invest more in R&D.
A greater proportion of foreign-owned firms engage in R&D activity than domestic companies (Chart 2a) and they spend more on R&D (Chart 2b). On average, foreign-owned firms spend around five times more on R&D than domestic companies. Even controlling for size, sector and whether they export, foreign firms spend more on R&D per employee than domestically owned firms. In aggregate, foreign-owned firms are important drivers of R&D in the UK, accounting for 50% of total R&D spending.
Chart 2a – Proportion of firms engaging
in R&D by ownership type Chart 2b – Average spending on R&D per firm by ownership
* Charts show 2014 data, which is the latest vintage. Source: ONS research datasets.
Earlier vintages of these data show foreign firms
spend between three and five times more on R&D
than domestic firms.
Chart 3 – Proportion of innovating firms by ownership type
Source: ONS research datasets.
Consistent with that spending, foreign firms are also more likely to innovate, that is introduce new products and/or processes, than their domestic counterparts (Chart 3). The link between innovation and productivity has been well-documented in the literature – see for example Hall (2011), Haskel and Wallis (2010) or Elnasri and Fox (2014). Within firms, new processes can increase productivity by increasing the efficiency with which goods and services are produced and delivered. And at the aggregate level, the introduction of new products raises productivity by replacing existing products with new and more efficient ones.
There’s some evidence that they may be better managed.
Foreign-owned firms’ higher productivity levels might also reflect better management practices. Bloom et al (2007) find that family run firms, in particular those in which the role of CEO is passed to the eldest son, are much less productive than firms in which management is chosen on merit. Those authors also find that family-run firms are more prevalent among UK-owned companies than German or American businesses. Therefore, management practices could also account for some of the difference in domestic and foreign-owned firms’ productivity levels.
They promote the diffusion of ideas.
The presence of foreign-owned firms boosts knowledge diffusion. Literature on this issue suggests that there are many different channels through which this can occur (see for example Krammer (2014)). These channels include: adoption or imitation of foreign technology by local firms; movement of workers with new knowledge from foreign to domestic employers; increased competition from foreign firms incentivising local firms to improve their efficiency. An additional channel is collaboration. More foreign-owned firms collaborate with other organisations compared to domestically-owned companies (Chart 4). Collaboration with universities, the government, their suppliers and customers, exposes these companies to new technology and ideas being developed in other parts of the economy, therefore facilitating innovation.
Chart 4 – Foreign firms are more likely to collaborate with all groups of potential partners
Source: ONS research datasets.
Conclusion
We find that foreign-owned firms are more productive than domestically-owned ones and there are several channels through which their presence can boost aggregate productivity. It is true that large productive foreign-owned firms are able to expand and invest in overseas branches located in the UK and this boosts UK productivity by simply raising the average. But this is only one part of the story. Foreign-owned firms also make a significant contribution to UK R&D spending and promote the diffusion of ideas through their collaborative activities. Continued foreign investment and the presence of foreign-owned firms will therefore be important for the UK’s productivity outcomes.
Sandra Batten works in the Bank’s Structural Economic Analysis Division and Dena Jacobs works in the Bank’s Inflation Report and Agency Intelligence Division.
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Great thoughts about productivity and the benefits of globalisation, thanks a lot.
The UK dependence on inward investors is often underestimated. The sheer scale dwarfs that for other large economies : our stock of FDI is more than 50% of annual GDP (comparable figure for Japan is 3%). Many sectors – eg auto manufacturing and investment banking – are dominated by foreign owned firms. This report usefully highlights the qualitative benefits of these firms.
Crucially, the investors are here for access to the EU Single Market. That is the promise offered by successive UK Governments and Development Agencies for over 40 years. Inevitably many are closely interwoven with EU ‘Value Chains’ : OECD estimates that 75% of all world trade is within GVCs (Global Value Chains) and most of these – for obvious reasons – are concentrated regionally.
Brexit threatens this investment with potentially devastating consequences for the UK economy. No amount of attractive trade deals with other markets can compensate for the 60% plus of our trade that is with the EU or countries currently enjoying some kind of EPA with it. Nor will foreign owned companies seek to access other – more distant – markets from a relatively expensive UK base. Exports stats are inexact, but some estimates suggest over 60% of UK’s gross exports come from foreign investors.
This report deserves to be widely publicised along with explanation of the importance of FDI to the UK. Parliament needs to consider carefully before committing to withdrawal from the Single Market with potentially dire consequences.
Andrew Fraser.
CEO, Invest UK; 1994-2000
This article has been widely reported in the press, but as a policy recommendation seems evidence of a lack of awareness of development economics, a lack which is also evident in our politicians of all parties. Any study of development economics will show that foreign ownership has the same effect as a parasite, vastly weakening the host. Many of the poorest people in the world live in asset rich countries where these assets are owned by foreign investors. These foreign investors/institutions find all sorts of ways to prevent profit from these assets being used for any public good and terrible impoverishment results. It is happening now in the UK. I find the lack of understanding of this effect of foreign investment extraordinary and frightening.
Sorry but what you are citing as evidence of foreign firms being more efficient, is simple hearsay and not an empirical study.
You would need to do a like for like comparison of the effectiveness in the market of equivalent business local and foreign owned, over a number of years.
Without that, what you have is rather meaningless and subject to bias. The bias is because, as anyone who has worked in the the local offices of foreign firms can attest, the leaders in the local offices have a tendency to hype up their adoption and innovation in order to be promoted regionally, or conversely, in order not be be fired/restructured by their higher bosses. This does not mean the management is better – unlike local companies, the local arms of global companies aren’t directly accountable for the companies bottom line in most cases.
The increased we-are-innovating hype coming from the local managers of global firms is simply that – hype – because financial performance is not as high on the measurements-of-success radar as it is for a local firm.
I don’t feel like it is fair to compare the productivity of family businesses with those of multinational companies, given that the latter would seem to be a heavily selected group requiring much higher than average levels of professionalism.
Are there any numbers on the performance of foreign owned firms vs domestic firms which have expanded into other countries? I’d be interested in whether or not this shows up a peculiarly British disease of lower productivity in comparably managed companies.