World Economy Technology Spillovers

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 nonrival: ones 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.

World Economy Technology Spillovers

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

World Economy Technology Spillovers

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.

World Economy Technology Spillovers

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

World Economy Technology Spillovers

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=

m R & D
i j

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

World Economy Technology Spillovers

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

World Economy Technology Spillovers

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

World Economy Technology Spillovers

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

World Economy Technology Spillovers

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 firmlevel 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): 60518. 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.

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