Countries are actively seeking ways to attract foreign direct investment (FDI) as a crucial instrument for economic growth, and Korea is no exception. The Korean government has been an ardent supporter of FDI after switching its stance on FDI as a key source of materializing its growth potential after the 1997 Asian Financial Crisis. Currently, Korea implements a wide range of support measures, such as location choice assistance by establishing Free Trades Zones, Foreign Investment Zones, and Free Economic Zones, tax reductions and exemptions, and cash grants. However, despite its extensive efforts, the inflow of FDI remains small, while the outflow of FDI by domestic firms continues to rise.

Underlying this stance is a hypothesis that the gain outweighs the cost, which means the positive ripple effects of FDI on the overall Korean economy are greater than the monetary value of incentives given to foreign investors. Still, that hypothesis needs to be verified. As for the productivity spillover effects of FDI in Korea, the prior empirical studies show mixed results, both positive and negative or ineffective. Also, previous studies empirically comparing foreign-invested enterprises’ performance with domestic firms had contradictory results.

Such conflicting conclusions are primarily due to statistical restraints. The scope of data on foreign-invested firms studied previously is narrow because information disclosed by the government is extremely limited. In order to overcome this shortfall, this study employs a complete enumeration of data on foreign-invested enterprises operating in Korea, provided by the Ministry of Trade, Industry and Energy, to analyze their business performance as follows. First, an analysis method of propensity score matching is used to see if there is a significant difference in operational performance between foreign-invested and domestic companies in the manufacturing and services industries at the enterprise level. Second, it also estimates the effect of FDI on the productivity of domestic firms in the manufacturing industry. Accordingly, this study calculates their firm-level productivity to estimate the effect of productivity spillovers from FDI, taking into account foreign-invested companies’ impacts on their local competitors as well as on upstream and downstream domestic companies.

This study analyzes firms operational on the 2019 KIS-DATA using a control group of domestic firms similar to foreign-invested firms in terms of firm age, size, wage level, and debt ratio. The results are summarized as follows. First, as to two productivity indicators, labor productivity and per capita operating profit, it finds no empirical evidence to support the hypothesis that foreign-invested companies perform better than domestic ones in manufacturing and service industries. Rather, domestic firms outperformed their foreign competitors in the service industry. Second, in terms of growth potential measured by the average annual growth rates of per capita value-added and sales over the past five years (2015-2019), there is no empirical evidence to support the hypothesis of better growth potential among foreign-invested companies. Third, as to innovation capacity measured by the proportion of R&D expenditures and costs of education and training to sales, no empirical evidence is found to support the hypothesis of a higher level of innovation for foreign-invested firms in the manufacturing industry than their domestic counterparts. However, the analysis finds that R&D intensity in the service industry was much more significant for foreign-invested companies.

This study also examines business establishments operational on Statistics Korea’s 2003-2009 Mining and Manufacturing Survey to see the effect of FDI enterprises on the productivity of domestic manufacturing firms. First, it finds the productivity of foreign-invested companies in the mining and manufacturing industries to be 8% higher than that of local competitors after controlling for other effects. Second, the analysis using level statistics finds the impact of FDI on the production of domestic firms to be negative in all cases of the competition effect on the same industry, forward linkage effect on the productivity of the downstream sectors as foreign-invested companies supply intermediate goods to them, and backward linkage effect on the productivity of the upstream industries as foreign-invested companies consume the output from them. However, large-sized foreign-invested enterprises positively impacted the productivity of other firms in the same industry. Third, the result shows that the growth of highly productive foreign-invested companies positively influenced the productivity of upstream firms. Such a positive effect appears to grow over time and become stronger for the larger foreign-invested firms. While no positive effect was observed for the same industry and downstream industries with time, FDI had a significantly more positive impact on the productivity growth rate of industries with a high share of the production of intermediate goods.

In conclusion, the finding that FDI negatively impacts the productivity of domestic firms raises a serious question as to whether Korea’s foreign investment support policy has effectively achieved its intended goals. A key implication from the results of this study is that future FDI policies should focus more on quality over quantity. To this end, the Korean government needs to develop a comprehensive index model that can measure not just the total amount of FDI but also the positive effect of foreign-invested companies on the Korean economy in various aspects like productivity and employment. Moreover, this index should be utilized to evaluate and further advance FDI support policies. Currently, the criteria for government assistance to attract foreign investment are confined to the amount of investment and the size of employment, but more diverse indicators need to be incorporated, taking into account growth potential. Furthermore, the government should shift its focus to attracting quality multinationals as well as creating a business environment conducive to their growth and sustainable development in the host country.

Publisher's Note
Summary

Chapter 1: Introduction
　1. 1: Korea's Foreign Direct Investment Policy
　1. 2: Basic Data on Korea's Foreign Direct Investment

Chapter 2: Comparison and Analysis of Foreign-Invested Corporations and Domestic Corporations
　2. 1: Introduction
　2. 2: Establishment of Quantitative Analysis Models
　2. 3: Data and Descriptive Statistics
　2. 4: Empirical Analysis Results
　2. 5: Summary

Chapter 3: Productivity Spillover Effects of Foreign-Invested Corporations
　3. 1: Introduction
　3. 2: Establishment of Quantitative Analysis Models
　3. 3: Data and Descriptive Statistics
　3. 4: Empirical Analysis Results
　3. 5: Summary

Chapter 4: Conclusion

References
Abstract