Do Foreign Firms Crowd Out Domestic Firms? The Evidence from the Czech Republic

This paper analyzes the effect of foreign presence on the growth and survival of domestic firms. I separate the two opposing effects that foreign firms are expected to have on domestic firms: a negative “market stealing or crowding out” effect and a positive “technology spillover” effect. Unlike previous studies, however, which analyzed the spillover question by estimating firm production functions, I use a model that combines a dominant firm/competitive fringe framework with a model of firm and industry dynamics by Jovanovic (1982) and Sun (2002), from the industrial organization literature. In my model foreign firms as a group are represented by a dominant firm that moves first and sets prices in the industry. Domestic firms, which form a competitive fringe, take these prices as given in their maximization process. As in Jovanovic (1982), domestic firms face uncertainty about their production efficiency and learn about it while operating in the industry. Following Sun (2002) I also assume that domestic firms’ production is affected by cumulative technology shocks (technology spillovers). The results of the model are then used to derive empirical predictions for growth and exit of domestic firms. I test these using a unique firm-level panel dataset on foreign and domestic firms’ operations in the Czech Republic during 1994-2001. I estimate the domestic firm growth equation using Tobit and linear models. Firm survival/exit equations are estimated with the Weibull, Lognormal and discrete regression models. In all specifications I control for the endogeneity problem due to firm-level unobserved heterogeneity. The empirical analyses do not show any evidence that foreign expansion leads to contraction in the sales of domestic firms over time, or a ”dynamic crowding” out effect. Instead, crowding out appears to be a short-term or static phenomenon: initial foreign entry leads to increased exit of domestic firms, but over time growth of the foreign industry segment actually relates positively to the growth rate and survival of domestic firms. I also find that firms in industries without foreign presence have higher exit rates than firms in industries with foreign presence. While findings on crowding out effects are robust across different subsamples, the results also suggest that the primary beneficiaries of technology spillovers are firms in more technologically advanced industries.