Foreign Direct Investment, Foreign Aid and Domestic Entrepreneurship

Abstract

Entrepreneurship is a vital component of economic development through innovation, job creation and efficient allocation of resources. Hence, many governments play a proactive role in facilitating entry of new firms and nourishing an entrepreneurial culture. These objectives became more relevant in recent years since fostering entrepreneurship is viewed as the cure to the global economic slowdown. This thesis addresses an essential but neglected aspect of entrepreneurship development: the impact of capital flows in the form of FDI and foreign aid on domestic firm creation. What is common to FDI and aid is that capital, skills, technological and organizational know-how move across national boundaries, altering the balance of local resources available to prospective entrepreneurs. In Chapter 2, we exploit cross-country and cross-country-industry variation over time in FDI via M&A and entrepreneurship. Results suggest that adverse effects of FDI counterbalance positive spillovers, leaving the net impact on entrepreneurship negative—though it is economically very small—both at the aggregate and industry level. Nascent entrepreneurship is affected the most by FDI, with the size of the negative effect decreasing as new firms advance in age. In the literature, heightened competition ensuing FDI is documented as the main cause of crowding-out of domestic firms. Chapter 3 thus takes a step towards understanding factors governing the FDI-entrepreneurship nexus of which we consider industry competition (concentration) and wages. We find that FDI is positively associated with both elements in Dutch manufacturing industries, which translates into increases and reductions in entry rates, respectively. This suggests that lucrative rents in concentrated markets are accessible to both foreign and domestic firms. Findings also imply that higher industry wages attract would-be entrepreneurs into wage-employment rather than pursuing a career as a new venture owner. Once the channel effects are isolated, there is no direct relationship between FDI and Dutch firm entry. Chapter 4 considers the role of industry linkages between foreign and indigenous companies in entrepreneurship development in Turkey. We contend that increased demand of foreign firms for local inputs (backward linkages) and the availability of new goods and services introduced by foreign suppliers (forward linkages) stimulate domestic firm entry. While entrepreneurship is unresponsive to backward and horizontal linkages, industries with large forward linkages with foreign firms accommodate more new businesses. Foreign firms’ high import propensities and improvements in the competitive position of Turkish firms provide an intuitive explanation for the lack of FDI effects via backward and horizontal linkages, respectively. Foreign aid is complementary to FDI in countries where investors show little interest due to the risky economic environment. Therefore, sizable aid flows are channelled into areas deemed important for unleashing the entrepreneurial potential of the poor. Specifically, in Chapter 5, we argue that purpose-specific aid targeted at education, physical infrastructure and institutional reforms are of central concern to entrepreneurship in aid-receiving countries. Aid has a positive association with entrepreneurship but only at the aggregate level with no discernible impact of sectoral aid. This supports the idea that the fungibility of aid flows plays a role in the results.