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doi: 10.1111/apel.12135

Death of linkages in host countries? A firm-level

study on the channels of productivity spillovers in
the Malaysian manufacturing sector

Andrew Jia Yi Kam*

Productivity spillovers from multinational corporations (MNCs) to local

firms have been an area of keen research interest in developing economics.
Claims of positive spillovers in the form of technology transfers have been
questionable, in part because of the many ambiguous conclusions obtained.
The paper argues that the lack of focus in the mechanisms underpinning
spillovers may be one of the reasons for the ambiguity. Using local input–
output linkages as the mechanism for technology transfer, this study exam-
ines the presence and the enabling conditions for spillovers. Accounting
for the variations in firms’ characteristics, the findings show that skills-
oriented MNCs participating in international production networks transmit
horizontal spillovers to local establishments. Vertical spillovers from MNCs
are mostly relevant only to lower-skilled establishments. For skilled and
export-oriented local establishments, technologies learned from producing
for international production networks are more significant than forming
linkages with MNCs in the domestic market.

the impact of spillovers.1 Their argument

Introduction
Over the years, ‘extravagant’ claims about positive
spillovers from foreign direct investment (FDI)
through foreign firms or multinational corpora-
tions (MNCs) have been questioned because of
the paucity of evidence (Rodrick 1999). Re-
searchers have provided various explanations
for this uncertainty. Giroud and Scott-Kennel
(2006) argued that the use of inappropriate
definitions may have misled conclusions about
reflects Javorcik’s (2004) claim that ‘researchers
[may] have been looking for FDI spillovers in
the wrong place’.
Previous studies also often overlooked the role
of firm characteristics in affecting transmission
channels. For example, MNCs operating in
enclaves2 may hinder productivity spillovers
to local industries (Kokko 1994; Javorcik 2004;
Jabbour and Mucchielli 2007). MNCs’ decisions
on whether to procure from local firms generally
affect the extent of technology transfers and

* Andrew Jia Yi Kam, Research Fellow, Institute of Malaysian and International Studies, National University of Malaysia,
E-mail: Andrew@ukm.edu.my. The author thanks Universiti Kebangsaan Malaysia for providing funding for the research
via GGPM-2014-002. Responsibility for any errors is the author’s alone.

1 ‘Linkages’ are a direct mechanism for spillovers and occur through inter-firm transactions, interactions, and ongoing
relationships; while spillovers occur as a by-product of MNC activity in the host economy.
2 Isolated clusters of MNCs with technologies and scales of operation different from local firms. An example would be MNCs
clustered around free trade zones.

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 ASIAN-PACIFIC ECONOMIC LITERATURE

information sharing in the host economies
(UNCTAD 2000). MNCs would also have an in-
centive to withhold their technology in order to
safeguard their proprietary assets. Knowledge-
sharing basically hinges on the strength of
supplier–distributor relationships with locals.
Hence, technology transfers and the impact of
spillovers could be more prevalent in a ‘vertical’
setting (Caves 1974; Javorcik 2004; Jabbour and
Mucchielli 2007).
The focus on linkages as a spillover channel is
pertinent to Malaysia because its extensive
experience in hosting FDIs since the 1970s.
Linkage-formation plans were embedded in
many Malaysian development strategies. Since
the introduction of the Investment Incentives
Act 1968 and the creation of Free Trade Zones
in the 1970s, policymakers in Malaysia have
put great faith in FDI as one of its early sources
of industrial upgrading. While the country
aspires to achieve advanced nation status by
the year 2020, industrial upgrading efforts that
spanned more than three decades was ineffective,
judging by the current dilemma of being stuck
in the ‘middle income trap’.3 This outcome
has left policymakers questioning whether its
previous policies have enabled local firms to
reap productivity gains from the MNCs.
Thus, instead of making the assumption that
foreign presence automatically benefits domestic
firms’ productivity, the transmission channels
of spillovers should be further explored.
The paper addresses this issue by asking
whether linkages facilitate foreign-to-local
productivity spillovers. If so, what are the firm
characteristics that may facilitate the process.4
Although it is important to address the terminol-
ogy differences highlighted by Giroud and
Scott-Kennel (2006), data limitations have
restricted disentanglement of the terms spill-
overs, productivity, and technology transfers.
Therefore, this paper uses them interchangeably,
maintaining that positive spillovers from FDI
such as improvements in technology, marketing
techniques, and management skills constitute a
form of productivity and technology transfer
‘spilling over’ from MNCs to local firms/
industries.5 In addition, the terms MNCs and
foreign firms are also used interchangeably.
Section 2 presents the analytical framework
and literature reviews on linkages and spillover
channels. Sections 3 and 4 explain the database
and methodology used. Section 5 presents the
findings from the estimations, while section 6
concludes the study and examines whether
linkages or policies promoting linkage formation
are still relevant.
Analytical framework
Channels of spillovers
Positive FDI spillovers occur when the presence
of MNCs in the host economy directly or indirectly
increases the productivity growth of local
firms. Although productivity spillovers could
occur through other channels (for example,
innovation cooperation or technology licensing),
this study focuses on the direct/indirect input–
output linkages formed between MNCs and
local firms. The a priori assumption is that
MNCs possess technology, management
techniques, and marketing networks that are
superior to those of local firms. The analytical
framework is explained using Figure 1.
Indirect or horizontal linkages. Horizontal
linkages measure the impact of foreign presence
in each sector. They could be in the form of a
collaborative relationship between firms or an
indirect demonstration effect from MNCs
(UNCTAD 2000). The demonstration effect al-
lows local firms to improve their productivity
through imitating, learning, adopting, adapting,
and reverse engineering of the management and

3 Unable to remain as a low-cost and high-volume producer, yet unable to move up the value chain and enter high-value
markets for knowledge and innovation-based products and services (Schellekens 2009).
4 This paper extends Khalifah et. al (2015) by identifying the impact of specific establishment characteristics as part of the
push/pull factors for technology transfer, rather than only explaining foreign presence through wage and capital proxies.
5 This is a broad description and it does not account for how the technology is being used. However, the paper is focused on
how the technologies are being transferred. We leave the use of the transferred technologies to further study.

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 KAM — CHANNELS OF PRODUCTIVITY SPILLOVERS IN THE MALAYSIAN MANUFACTURING SECTOR

Figure 1
Analytical framework for channels of spillovers through linkages.

production techniques introduced by the MNCs. local producers use these higher technology
It also includes trained ex-employees of MNCs inputs to produce higher quality goods.
becoming new local players in the industry.

Direct linkages. As illustrated in Figure 1, direct Data

linkages are formed between foreign firms and
their local suppliers, customers, or distributors
within a vertically integrated production network.
If it involves a direct relationship between MNCs
and local suppliers, it is called a backward linkage.
The relationship between MNCs and their prod-
uct distributors/customers is a forward linkage.
Backward linkages are a relationship in
which MNCs (in downstream industries)
procure parts, components, materials, and
services from local suppliers. Spillovers from
backward linkages may stem from technology
transfers by the parent MNCs to enhance the
output of local establishments. A forward
linkage is a relationship whereby local firms (as
customers) buy intermediate or final products
produced by foreign firms. Rodriguez-Clare
(1996) argued that inputs supplied by foreign
firms are specialised inputs that are of higher
quality than those produced locally. Productivity
spillovers from forward linkages occur when
The study uses unpublished 2000–08 data from
the Annual Survey of Manufacturing Industries
(ASMI), a survey conducted annually by the
Department of Statistics Malaysia (DOS) that fo-
cuses only on establishments in the manufactur-
ing sector. While it contains comprehensive sets
of variables, not all information is accessible to
the public and is controlled under the Statistics
Act 1965 (revised in 1989). Variables from two
categories of firms are available: ‘majority local
owners’ and ‘majority foreign owners’. Enter-
prises where the majority of owners are local
(above 50 per cent) are classified as ‘majority lo-
cal owned’ (hereafter, local establishments). A
similar classification is applied to ‘foreign estab-
lishments’. This is not a setback considering that
the bulk of foreign affiliates already have major-
ity ownership.6 Data prior to 2000 and after 2008
are omitted because they have different classifi-
cations, and key information on firm

6 One of the prerequisites for local firms to be eligible for the Industrial Linkages Program is that at least 51 per cent of the
company’s shares is owned by Malaysians. With our data from the DOS matching this prerequisite, we are assured that
linkage creation with MNCs has occurred because by definition these local firms are eligible for the program.

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 ASIAN-PACIFIC ECONOMIC LITERATURE

Table 1
Construction of variables
Value of exports, deflated using the export deflator indicator derived from Bank Negara Malaysia’s annual
Exports report and re-based to the year 2000
Skill Share of skilled workers in total employment. Skilled workers are managers, professionals and executives,
technicians, and associate professionals (DOS 2008)
Sales Sales of goods manufactured/processed/assembled (including duties and taxes) by firms; net of non-
processing re-sales, subsidies, rebates on price, discounts, and allowances on returned goods allowed to the
customers (DOS 2008).
IFN IFN = (MF/Q)*X. IFN is the production fragmentation indicator; MF represents imported intermediate goods;
and Q is gross output (which embeds both domestic and foreign intermediate goods). The share of
intermediate goods in gross output (MF/Q) is used as a weight to represent the share of imported intermediate
goods processed into exported output X
SP Refer to Equations 2 (horizontal), 3 (backward), and (4) (forward linkages)
Gap Differences in TFP between foreign and local firms
Comp Dummy variable where 1 = sales growth of local firms > sales growth of foreign firms (competitive local) and
0 = otherwise (less competitive)
Pol Proxy by year dummy for foreign firms from 2004 to 2008 (assuming the impact of the policy is only evident a
year later)
ICT Industry dummy variable (MSIC 30 and 32)
Scale In this study, the scale or the size of the firms (scale) is proxied by the number of employees per output.

IFN = international fragmentation network, MSIC = Malaysian Standard Industrial Classification, TFP = total factor productivity.

characteristics is unavailable. The study focuses
on the manufacturing sector, defined as Indus-
tries 15–36 of the Malaysian Standard Industrial
Classification (MSIC) 2000.
vertical linkages are constructed using the
input–output (I/O) tables. A foreign production
component is incorporated to indicate a foreign
presence in the upstream and downstream
industries (Table 1).

Methodology Horizontal linkages (indirect impact of foreign

Construction of key variables
Productivity growth. To estimate total factor
productivity growth (TFPG), information on
capital, labour, and intermediate inputs was ex-
tracted from the ASMI. TFPG was estimated
using the simple growth accounting method.7
Horizontal and vertical linkages. To measures
horizontal and vertical linkages, the study com-
bines methods from Rasmussen (1956); Ghosh
(1958), and Javorcik (2004). The indicators of
presence). Horizontal linkages capture foreign
presence in sector j at time t. The variable shows
the impact of foreign establishments’ participation
across industries; meaning that it captures the
impact on competitors, alliances, or even unre-
lated establishments. The study re-constructed
Jarvorcik’s (2004) indicator by disregarding the
calculation of ownership shares because all
foreign establishments in the database have above
50 per cent ownership. Horizontal linkage is there-
fore represented by the share of foreign output in
the total output of the sector. The expression in pa-
renthesis on the right side of Equation 1 represents
the foreign presence in the economy:

7 See Kam (2014) for the calculation of skills and capital-adjusted TFPG. The growth accounting method is the method used by
Malaysian officials in estimating productivity. Other methods such as stochastic frontier analysis (SFA) and that of Olley and
Pakes (1996) were considered. SFA is more suitable if firm-level data are available (see Coelli et al. 2005). The latter method
assumes that firms will adjust inputs based on their productivity. It is not used because the database available for this study is
a collective representation of firms.

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 KAM — CHANNELS OF PRODUCTIVITY SPILLOVERS IN THE MALAYSIAN MANUFACTURING SECTOR
 
Foreign Output
Horizontaljt ðHozÞ ¼
Total Output jt
(1)
Backward linkages (foreign presence in downstream
industries). Backward linkages represent the in-
terconnection of a firm in the sectors from which
it purchases inputs. They capture the relation-
ships with domestic suppliers, with MNCs as
the customers:
 
n Foreign output - Imported input
BLj ¼ ∑ gij
i¼1 Total output - Imported input jt
(2)
where BLi is an indicator of foreign presence in
downstream industries, with sector i being
supplied by sector j. gij is the ijth element of
the Ghosh inverse matrix (I-Ā)1 with Ā as the
direct-output coefficient matrix (using the I/O
table). It shows the proportion of total output
of sector i supplied to sector j. n is the number
of sectors.
Here, foreign presence (in parenthesis) is
calculated net of imported intermediate inputs.
This is to ensure that backward linkages only
involve inputs supplied locally. This method
shows that the share of an industry’s demand
for an input is weighted by the amount of
output produced by foreign establishments in
the host economy.
Forward linkages (foreign presence in upstream
industries). Forward linkages are the intercon-
nections between input producers from a partic-
ular sector to final-goods sectors. They are
defined as a weighted share of output in
upstream (or supplying) sectors.
 
n Foreign output - Exports
FLj ¼ ∑ αij
i¼1 Total output - Exports jt
(3)
where FLj indicates foreign presence in the
upstream sector. αij is the ijth element of the
Leontief inverse matrix (I-A)1 with A as the
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direct-input coefficient matrix (using the I/O
table). It shows the proportion of i input
purchased by industry j.
Foreign establishments now play the role of
input suppliers to local final goods producers.
The impact of foreign presence is measured net
of exports to ensure only foreign-produced
intermediates sold in the domestic market are
included.
The αij and gij coefficients were generated
using the 2005 I/O table. The I/O table was
matched with the MSIC 2000.
Profile of the manufacturing sector
Tables 2 and 3 provide an overview of the
manufacturing sector in Malaysia based on the
ASMI. Columns 1 and 2 show the output share
of local and foreign establishments, respectively,
in the manufacturing sector. Foreign establish-
ments are mostly concentrated in the manufacture
of office, accounting, and computing machinery
(MSIC 30) and manufacture of radio, television,
and communication equipment and apparatus
(MSIC 32) industries (hereafter, MSIC 30 and
MSIC 32 are known as Information and Commu-
nications Technology (ICT)). Foreign firms have
higher output than local establishments in machin-
ery and equipment (MSIC 29), textiles (MSIC 17),
and manufacture of medical, precision, and optical
instruments, watches, and clocks (MSIC 33), and
the manufacture of other transport equipment
(MSIC 35) industries. Foreign establishments have
the least output contribution in the publishing,
printing, and reproduction of recorded media
industry (MSIC 22). Local establishments are
concentrated more in the resource-based sectors.
On average, the technology gap between for-
eign and local establishments has increased
since 2000. The technology gap is most signifi-
cant in MSIC 33, followed by manufacture of
furniture (MSIC 36) and manufacture of
chemicals and chemical products (MSIC 24).
Local establishments have technological advan-
tages in manufacturing of clothing and apparel
(MSIC 17 and 18). The technological gaps in
the ICT industries are relatively low. This
implies that foreign establishments in ICT indus-
tries may only be investing in areas with lower
technology requirements. A case study by
 Table 2
2(a)Market characteristics of the Malaysian manufacturing sector

Technology gap Intermediate input sources (Local firms) (4) Intermediate input sources (Foreign firms) (5)
(TFPForeign—
Local output Foreign output
Total output (1) Total output (2) TFPLocal) (3) Import Local Import Local Import Local Import Local
Year
Industry 2000 2008 2000 2008 2000 2008 2000 2000 2008 2008 2000 2000 2008 2008
15 0.79 0.82 0.21 0.18 0.25 0.29 11.2 62.5 5.3 51.1 10.7 50.7 13.5 39.7
16 0.74 0.88 0.26 0.12 0.40 0.89 27.5 20.0 4.3 35.1 46.7 11.7 17.6 48.2
17 0.37 0.39 0.63 0.61 0.36 0.27 28.4 25.5 18.7 24.7 32.0 19.3 17.6 31.3
18 0.70 0.78 0.30 0.22 0.40 0.45 26.6 27.4 13.5 23.4 38.3 21.8 29.2 9.9
19 0.62 0.63 0.38 0.37 0.14 0.29 6.9 49.4 9.6 40.4 33.7 26.6 22.5 15.8
20 0.85 0.88 0.15 0.12 0.10 0.15 2.0 57.0 1.8 43.0 7.7 50.0 3.0 36.8
21 0.84 0.74 0.16 0.26 0.18 0.32 16.6 38.2 10.0 36.4 30.4 28.6 16.4 24.5
22 0.90 0.88 0.10 0.12 0.40 0.23 10.8 34.5 11.1 31.7 30.0 12.3 20.3 22.5
23 0.74 0.81 0.26 0.19 0.07 0.21 15.5 48.5 0.1 28.6 31.6 59.6 21.5 13.6
24 0.50 0.61 0.50 0.39 0.20 0.34 10.5 35.9 16.5 21.4 29.8 36.0 20.3 24.0

70
25 0.71 0.70 0.29 0.30 0.28 0.22 10.5 45.0 10.8 39.0 17.9 30.2 17.1 30.1
26 0.74 0.76 0.26 0.24 0.16 0.20 7.2 29.8 3.6 31.5 19.7 10.7 12.1 17.0
27 0.73 0.79 0.27 0.21 0.02 0.42 23.4 46.3 21.6 34.5 43.1 25.4 43.4 13.5
28 0.66 0.77 0.34 0.23 0.11 0.32 13.5 47.5 8.2 37.4 40.3 19.9 22.5 21.8
29 0.34 0.48 0.66 0.52 0.01 0.25 12.6 46.2 16.6 38.9 27.0 32.9 21.1 36.7
30 0.12 0.07 0.88 0.93 0.05 0.13 40.2 37.7 38.2 31.4 45.1 37.4 48.2 16.8
31 0.47 0.54 0.53 0.46 0.13 0.15 29.5 39.6 26.9 37.8 36.2 24.6 37.9 23.9
32 0.23 0.23 0.77 0.77 0.16 0.41 34.2 34.1 38.2 17.5 47.7 27.7 44.5 15.3
ASIAN-PACIFIC ECONOMIC LITERATURE

33 0.17 0.25 0.83 0.75 0.03 0.75 17.8 42.2 53.2 12.6 41.2 25.2 37.1 19.8
34 0.92 0.81 0.08 0.19 0.50 0.01 29.1 46.0 18.0 47.3 39.4 20.9 40.3 19.9
35 0.82 0.69 0.18 0.31 0.40 0.13 20.8 25.0 16.2 27.3 40.7 7.4 17.2 21.9
36 0.74 0.86 0.26 0.14 0.31 0.50 9.7 48.9 11.2 47.9 19.0 34.9 18.3 31.7
Average 0.62 0.65 0.38 0.35 0.04 0.06 18.4 40.3 16.1 33.6 32.2 27.9 24.6 24.3
Median 0.72 0.75 0.28 0.25 0.11 0.18 16.0 40.9 12.4 34.8 32.9 26.0 20.7 22.2

Note: Refer to Appendix 6.1 for industrial codes. Source: Author’s calculation from ASMI 2000–08, I/O 2000 and I/O 2005.
TFP = total factor productivity, ASMI = Annual Survey of Manufacturing Industries.

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 Table 3
2(b)Market characteristics of the Malaysian manufacturing sector (continued)
IFN* (6) Share of skilled workers (7)
Local Foreign Local Foreign
Local Foreign Local Foreign firms firms firms firms
Total 2000 2000 2008 2008 2000 2000 2008 2008
15 1.8 5.1 2.2 9.7 15.2 22.5 14.0 26.6 Manufacture of food products and beverages
16 0.6 33.0 0.1 7.5 7.9 45.6 10.8 26.6 Manufacture of tobacco products
17 7.6 26.9 3.5 3.4 16.2 16.6 14.0 28.0 Manufacture of textiles
18 11.9 21.9 5.3 13.3 8.0 10.3 6.2 11.0 Manufacture of wearing apparel; dressing and dyeing of fur
19 0.9 21.6 1.3 3.1 11.0 4.6 9.9 18.5 Tanning and dressing of leather; manufacture of luggage, handbags,

© 2016 Crawford School of Public Policy,

saddlery, harness, and footwear
20 1.1 5.2 0.9 2.1 8.6 7.1 9.2 8.7 Manufacture of wood and products of wood and cork, except
furniture; manufacture of articles of straw and plaiting materials
21 2.5 12.7 0.7 3.5 16.8 16.7 17.4 22.6 Manufacture of paper and paper products
22 0.4 18.5 0.3 2.0 17.9 12.8 23.2 17.0 Publishing, printing, and reproduction of recorded media
23 5.0 4.5 0.1 3.1 30.6 48.8 81.0 17.2 Manufacture of Coke, refined petroleum products, and nuclear fuel
24 2.7 11.6 3.1 8.8 26.7 36.1 29.3 34.4 Manufacture of chemicals and chemical products
25 3.3 11.1 3.5 9.0 13.9 14.7 16.0 16.4 Manufacture of rubber and plastic products

71
26 1.5 6.2 0.3 3.2 18.8 14.9 17.1 26.8 Manufacture of other non-metallic mineral products
27 4.5 19.3 3.0 14.5 19.3 25.5 23.5 23.3 Manufacture of Basic Metals
28 2.0 23.2 1.4 15.4 16.5 17.3 15.6 24.0 Manufacture of fabricated metal products, except machinery and
equipment
29 1.4 17.1 4.4 9.1 18.7 21.6 20.7 21.6 Manufacture of machinery and equipment n.e.c.

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30 23.7 37.7 13.6 23.8 15.3 18.0 25.5 32.4 Manufacture of office, accounting, and computing machinery
31 10.8 24.4 4.4 16.7 14.7 18.7 17.7 20.0 Manufacture of electrical machinery and apparatus n.e.c.
32 24.0 39.8 15.1 25.7 17.4 21.2 27.8 28.6 Manufacture of radio, television and communication equipment,
and apparatus
33 6.3 27.5 24.4 15.4 18.1 21.0 20.0 19.0 Manufacture of medical, precision and optical instruments, watches,
and clocks
34 5.6 14.0 0.3 7.4 17.2 15.9 21.7 22.3 Manufacture of motor vehicles, trailers, and semi-trailers
35 1.1 35.6 1.4 5.4 22.0 15.7 22.9 39.3 Manufacture of other transport equipment
36 3.5 14.4 3.3 10.6 11.0 10.9 11.0 15.1 Manufacture of furniture; manufacturing n.e.c.
Average 5.6 19.6 4.2 10.9 16.4 19.8 20.7 22.7
Median 3.0 18.9 2.6 9.1 16.7 17.0 17.6 22.4
KAM — CHANNELS OF PRODUCTIVITY SPILLOVERS IN THE MALAYSIAN MANUFACTURING SECTOR

Note:
*The indicator for international fragmentation network (IFN) is constructed based on the equation in Appendix 6.2. It is basically the imported input content of exported output.
Source: Author’s calculation from ASMI 2000–08, I/O 2000 and I/O 2005.
 ASIAN-PACIFIC ECONOMIC LITERATURE
Driffield and Noor (1999) showed that MNCs
only employ older technologies in order to foster
input linkages with domestic suppliers. This is
common when MNCs mainly focus on labour-
intensive assembly, and low value-added
production of parts and components.
Columns 4 and 5 in Table 2 compare the
different sources of input procurement (as a
share of total output) by foreign and local estab-
lishments. On average, local establishments use
more local intermediate inputs than foreign
establishments, while foreign establishments
have higher imported input content in their
production. This implies relatively weak back-
ward linkages. It is not surprising that foreign
and local establishments in ICT industries are
highly dependent on foreign sourcing because
of the outward-oriented nature of this industry.
The decline in the average share of domestic
input procurement suggests a weakening in
backward linkage formation with local estab-
lishments since 2000.
There are also foreign establishments that
have switched their preferences from imported
inputs to locally made inputs. This switch
suggests local establishments have entered
foreign establishments’ production networks.
Foreign establishments in industries such as
tobacco (MSIC 16) and MSIC 35 have reduced
their dependence on foreign inputs, while
deepening backward linkages with local estab-
lishments. Column 6 shows that both local and
foreign establishments in ICT are integrated into
international fragmentation networks (IFNs).8
Although the shares of their involvement de-
creased from 2000 to 2008, this industry is still
very dependent on foreign demand and sourc-
ing. Foreign establishments may retain doubts
on the quality of local production (Leslie 1993).
Column 7 shows that foreign establishments
in the manufacture of chemicals and chemical
products (MSIC 24) hire more skilled workers
than local establishments. MNCs often offer
higher wages and better benefits to retain
human capital in an effort to prevent skills
mobility and knowledge leakage to competitors.
However, protected, government-linked
8 International production fragmentation is defined similarly to vertical specialisation (Hummels et al. 2001), a situation where
imported intermediate parts and components are used to produce goods for export.
72
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corporations (GLCs) in steel, petrol, and automo-
tive industries (MSIC 23, 27, and 34) have the
resources to compete with MNCs in employing
skilled engineers, scientists, and managers. In
ICT industries, the share of skilled labour to total
employment is only marginally higher for foreign
establishments. This is consistent with the data in
Column 3 that shows technology gaps between
foreign and local establishments in ICT are low.
Variable specification and model structure
The model to estimate the impact of foreign
presence and establishment characteristics on
the productivity growth of local establishments
consists of five elements:
TFPG= ƒ{Establishments’ characteristics
(FC), spillover channels (SP), inter-
action between establishments’
characteristics and spillover chan-
nels (FC*Sp), comparative effect
(DE), and indirect effect (IE)}
Where:
FCown Export intensity (Exp) or skilled-
orientation (Skill) or sales intensity
(proxy for output) (Sale) or IFN par-
ticipation (IFN)
SP Horizontal (Hoz), backward (BL),
and forward (FL) channels. Foreign
presence in upstream and down-
stream industries. Positive coeffi-
cient of these variables shows the
channel of spillovers.
FCown*SP Interaction terms identifying the
impact of Sale, Exp, Skill, and IFN-
oriented establishments in different
SP channels on TFPG. Positive signs
in the interaction variables show the
channels and firm characteristics
that facilitates productivity spill-
overs from foreign to local establish-
ments.
CE Impact of TFPG gaps between for-
eign and local establishments (Gap).
Proxy for establishments’ absorptive
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 KAM — CHANNELS OF PRODUCTIVITY SPILLOVERS IN THE MALAYSIAN MANUFACTURING SECTOR

capacity (A. Kokko 1994) and com-
petition (Comp).
IE Policy and ICT-dummy (Pol and
ICT), Scale and Demand.
Subscript own represents the types of estab-
lishments in the analysis: local (L) or foreign (F)
establishments. T represents the combined
database of F and L.
There are four establishment characteristics
(FCown) and three channels of FDI spillovers
(SP) of interest in this study. These channels of
technology spillovers (horizontal, backward,
and forward linkages) are explained in
section 2. This study adds to the literature by in-
cluding interaction terms between spillover
channels and firm characteristics (FC*SP). The a
priori understanding is that the foreign establish-
ments in upstream/downstream industries
have an impact on the productivity of local es-
tablishments based on the characteristics of both
kinds of establishments.
Export-intensive foreign establishments (ExpF)
may have lesser interactions with local estab-
lishments because they generally operate in
enclaves such as export processing zones
(EPZs). MNCs located in EPZs may not form
linkages with local establishments because the
duties exemptions on imported inputs are more
attractive. Their counterpart, export-intensive
local establishments (ExpL), is exposed to inter-
national production standards and therefore
has higher absorptive capacities. Unless domestic
vertical linkages are formed with the MNCs in the
country, these local establishments may not rely
on them as the main source of technology. There-
fore, horizontal linkages may also create spillovers
as ExpL have the capacity to learn by exporting.
As shown in Table 3, foreign establishments
with higher numbers of skilled workers (SkillF)
are in high-tech and knowledge-based indus-
tries. Compared with labour-intensive and
assembly oriented industries, high-tech foreign
establishments have the potential to add value
to the learning curve of local suppliers/
producers. However, local establishments with
a higher share of skilled workers (SkillL) have
better capacities to imitate, adapt, and even
innovate on the technologies from the MNCs.
Hence, here the relationship between linkages,
establishment skills, and spillovers is
ambiguous.
Productivity spillovers are also driven by
sudden increases in demand generated by FDIs
(Javorcik 2004; Jabbour and Mucchielli 2007).
Local establishments will increase productivity
in profitable markets where MNCs enter. To con-
trol for shifts in market demand, this study uses
establishment sales (Sale) as a proxy (Harabi
1992). Growth in sales also represents the estab-
lishments’ output growth, which can be loosely
argued in the context of Verdoorn’s Law.9 The
indicator also enables the study to examine
whether foreign (local) high-performing and
market-competitive establishments are dissemi-
nating (absorbing) technology.
Previous studies argued that local sourcing
by foreign establishments will increase the
possibilities for spillovers compared with
foreign establishments that rely solely on foreign
inputs (Driffield and Noor 1999). However, with
the increasing access to the IFNs, internal link-
ages with the domestic economy may be con-
fined to a small basket of local inputs. Foreign
establishments that are integrated into global
production networks (IFNF) have greater access
to foreign inputs. Therefore, interactions with
the local economy are much less and hence
minimise the potential for spillovers. The IFNs
also provide opportunities for local establish-
ments (IFNL) to form external linkages with other
global MNCs. Hence, domestic vertical linkages
with foreign establishments are also unnecessary,
thus invoking the phrase ‘death of linkages’.
One uncontrolled element in this study is the
level of import protection. Import protection

9 According to this law, faster growth of output (in this context, sales) increases productivity because of increasing returns. The
impact of sales on TFPG is therefore expected to be positive.
10 Since 1992 tariff reduction has been on-going through AFTA’s Common Effective Preferential Tariff (CEPT) scheme.
Integration with the regional/global economic system has been on going (being a signatory of the WTO Information
Technology Agreement since 1994; becoming a member of the WTO in 1995; being a member of the ASEAN-China FTA since
2005; and a member of the Trans-Pacific Partnership Agreement 2015).

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 ASIAN-PACIFIC ECONOMIC LITERATURE

distorts resource allocation of MNCs and Model 1: Spillovers from linkages with different
impedes productivity improvements (Truong types of foreign establishments.
et al. 2015). However, in Malaysia, efforts to
remove import protection have long been in TFPGL;it ¼ α þ α1 lnFCF;it ðþÞ þ β1 Hoz þ β2 BL (6)
place.10 Despite some industries being more ðþ=Þ ðþ=Þ

protected than others, Table 2 shows that, on av- þβ3 FL þ θ1 Hoz*lnFCF;it þ θ2 BL*lnFCF;it
erage, foreign establishments have a higher share ðþ=Þ
ðþ=Þ ðþ=Þ

of imported inputs than locally made inputs. This þθ3 FL*lnFCF;it þ γ1 Gapit þ γ2 Compit
implies that, in general, import protection is not ðþ=Þ ðþ=Þ ðþ=Þ

overly restrictive for foreign establishments in þϕ 1 Scale þ ϕ 2 Polt þ ϕ 3 ICT t þ εit

Malaysia. The IFN indicator thus controls for ðþÞ ðþÞ

the impact of import restrictions as they may af-
fect the operations of a production network.
Comparative effects (CE) are variables that
affect TFPG because of differences in competi-
tive advantages between foreign and local estab-
lishments. The first indicator is the difference in
technology gaps (Gap) between foreign and local
establishments. Significant technological differ-
ences imply weak domestic absorptive capaci-
ties, which impede technological transfers
(Kokko 1994). The second CE is market competi-
tion11 (Comp). Previous studies suggest that local
competition will force foreign establishments
into bringing in newer technologies to protect
market share. However, this variable may not
be relevant in a highly open economy where
competition stems from international rather
than domestic markets.
Indirect effects (IE) are the indirect factors
affecting TFPG in the presence of MNCs. For
example, investment liberalisation policies
implemented by the Malaysian Industrial
Development Authority (MIDA) in 2003 aimed
where subscripts i and t represent establish-
ments and year.
Model 1 tests the impact of the MNCs’
presence and their characteristics on the TFPG
of local establishments. The model aims to
identify the types of foreign establishments that
affect local TFPG and through which channels
spillovers will most likely occur. The interaction
indicators explain the impact of linkages with
the MNCs, conditional on their characteristics.
For example, Hoz*lnExpF represents the
horizontal impact of foreign export-oriented
establishments on local TFPG. BL*lnExpF
measures the impact of export-oriented foreign
establishments in downstream sectors on local
establishments, while FL*lnExpF measures the
impact of export-oriented foreign establish-
ments in upstream sectors on local firms.
Model 2: Local establishments and linkages
TFPGL;it ¼ α þ α1 lnFCL;it ðþÞ þ β1 Hoz (7)
ðþ=Þ

to attract foreign investors into the manufacturing

þβ2 BL þ β3 FL þ θ1 Hoz*lnFCL;it
sector. This policy indirectly created more ðþ=Þ ðþ=Þ
ðþ=Þ

opportunities for foreign-to-local spillovers. The þθ2 BL*lnFCL;it þ θ3 FL*lnFCL;it

model also controls for the Malaysian ICT sector ðþ=Þ ðþ=Þ

because of the heavy concentration of foreign þγ1 Gapit þ γ2 Compit þ ϕ 1 Scale þ ϕ 2 Polt
presence in the industry. Finally, by definition, ðþ=Þ ðþ=Þ ðþÞ

TFPG is an indicator of residual, where an þϕ 3 ICT t þ εit

increase in output due to economies of scale ðþÞ

may artificially increase TFPG values. Therefore,

economies of scale are being controlled as well. where subscripts i and t represent industry
Two model specifications were proposed: (collective establishments) and year.

11 The commonly used Herfindhal index or the CR4 index is not used here because firm-level data (market share of firms) is not
available in the ASMI. The alternative used here is to proxy competition with intra-industry sales growth between foreign and
local firms. Local firms in the same industry with higher sales growth than foreign firms are considered more competitive than
foreign firms. A positive value may also indicate a change in the technology used due to market competitive pressures.
Therefore, a caveat is that the indicator used is unable to ascertain the dynamics of technology utilization.

74

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 KAM — CHANNELS OF PRODUCTIVITY SPILLOVERS IN THE MALAYSIAN MANUFACTURING SECTOR

Model 2 tests the impact of foreign presence

on local establishments with differentiated
characteristics. This model focuses on the
values of θ1, θ2, and θ3 in identifying the
types of local establishments that have experi-
enced the most profound changes in their pro-
ductivity growth when MNCs are present. The
explanations for the interaction terms mirror
those in Model 1 with the impact now based
on local establishments’ characteristics. For
example, BL*lnExpL represents the impact of
foreign presence in downstream industries on
the local export-oriented establishments’ pro-
ductivity growth.
The lin-log model is used to reduce the
variation (or stabilise the variances) for a
better fit of the model. Each FC enters the
model separately to prevent multicollinearity
problems. The standard Hausman test is first
applied in examining whether unique errors
are correlated with the regressors. The
Breusch–Pagan Lagrange multiplier (LM) test
is used to determine whether random effects
estimation is preferred over pooled estima-
tion methods. The estimation is undertaken
using heteroskedasticity-robust standard
errors. The Levin–Lu-Chu stationarity test is
also deployed (with ‘demean’ for scale to
mitigate cross-sectional dependence, because
the size of establishments may also affect
linkages).
Finally, in analysing the interaction terms,
the paper uses the data ‘centring’ method
(Aiken and West 1991). ‘Centring’ involves
subtracting their mean value from the inde-
pendent variables and re-estimated again so
that the analysis is undertaken ‘on average’.12
The benefits of estimating the centred model
is that the t-statistics and the level of statistical
significance have taken account of the overall
joint effect.
Results
Model 1: Spillovers from linkages with
different types of foreign establishments
Model 1 examines the impact of foreign estab-
lishments with different characteristics on the
productivity growth of local firms. In Table 4,
all indicators of foreign characteristics (without
interaction terms) are insignificant. This result
was expected because the FCF variables have
excluded linkage/spillover effects (SP = 0) from
local establishments. However, using the center-
ing method (results with the ‘(b)’ label),
Equations (2b), (3b), and (4b) suggest that
skilled, sales and IFN-oriented foreign establish-
ments on average have a positive impact on the
productivity growth of local establishments;
with skills-oriented foreign establishments regis-
tering the largest impact.13
On backward linkages, export-oriented
foreign establishments (Equations (1) and (1b))
have the most profound impact on local
establishments, followed by skill-intensive
establishments, and, as expected, the impact of
IFN-oriented establishments is the least. By
construction, the IFN variable assumes establish-
ments to have high procurement of foreign inputs
(meaning low local input procurement). There-
fore, linkage formation with locals is less and
spillovers are not evident. Market-driven foreign
establishments with high sales also form
backward linkages with local establishments in
order to utilise local resources and minimise
production costs.
Productivity spillovers from skill-oriented
foreign establishments (the interaction term)
are stronger through the horizontal channel
even though skill-oriented foreign establishments

12 For example, the impact of FC on TFPG is as follows: ∂TFPG/∂FC = α1 + θ1Hoz + θ2BL + θ3FL where the impact of FC is
subjected to the channels of foreign spillovers (conditional effect). Without centring, α1 is the impact of FC on TFPG when
all three channels of spillovers are equal to zero. With centring, α1 is the impact of FC when all three channels of
spillovers are equal to their mean values. It is similar to putting mean values of Hoz, BL and FL into the partial derivative
expression above.
13 A caveat to this finding is that different industries may exhibit different outcomes. For example, Khalifah et al. (2015) found
negative spillovers in E&E industries, in part due to the lack of demand from foreign firms for locally supplied intermediate
goods.

75

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 ASIAN-PACIFIC ECONOMIC LITERATURE

0.223 (0.68)
0.178 (0.47)
0.233 (0.38)

0.996** (2.74)
also transfer technology to local firms through

0.102 (0.56)
0.340** (4.95)
0.213** (3.49)
0.0474 (0.04)

0.398** (2.62)

0.0503 (1.37)

0.263* (2.35)
0.168 (1.51)
backward linkages. Horizontal indirect linkages
tfpg
4(b)

180
such as through demonstration effects are evi-
dent in shared training programs in facilities such
as the Penang Skills and Development Center.
0.00301 (0.03)

5.402** (2.71)
1.502 (0.55)
0.233 (0.38)

0.996** (2.74)
0.102 (0.56)
0.340** (4.95)

3.082 (0.34)

0.398** (2.62)

0.0503 (1.37)

0.263* (2.35)
0.168 (1.51)
Also, in-house training centres of skill-oriented
tfpg

MNCs facilitated horizontal spillovers as many

(4)

180
ex-MNC-trained local employees set up local es-

Corrections added on 24 June 2016, after first online publication: the missing columns for Equations: 3-4(b) and IFN have now been added in Table 4.
tablishments such as Unisem, Carsem, and
Globtronics in the same industry (Best and
lnscale
lnIFN
H
B
F
H*IFN
B*IFN
F*IFN

N
ict
tgap

comp
pol
IFN

Rasiah 2003). This is contrary to the findings of

Khalifah et al. (2015), while augmenting the spill-
0.627 + (1.92)
0.500 (0.45)
0.307 (0.86)

0.235 (0.35)
Impact of foreign presence and foreign firms’ characteristics on local firms’ TFPG

0.000580 (0.00)
0.389** (4.65)
0.233** (3.10)

0.0993 (0.26)

0.657** (3.29)

0.0321 (0.91)

0.243* (2.15)
0.0660 (0.56)

over literature whereby accounting for workers’

skills (instead of only wages or capital) may pro-
tfpg
3(b)

180

vide better evidence of productivity spillovers in

the Malaysian manufacturing sector.
Another important observation is the ab-
0.0773 (0.73)

10.31** (3.28)

0.235 (0.35)

0.627 + (1.92)
0.000580 (0.00)
0.389** (4.65)

3.080 (0.28)

0.0904 (0.03)

0.657** (3.29)

0.0321 (0.91)

0.243* (2.15)
0.0660 (0.56)

sence of spillovers through forward linkages in

tfpg
(3)

180

all the four characteristics of interest. This may

be due to MNC’s production of specialised in-
puts being mostly not tailor-made for domestic
Sales (sal)

producers. Apart from being more expensive

F*sal
H
B
F
H*sal

N
B*sal

ict
lnscale
lnsale

tgap

comp
pol

(Khalifah et al. 2015), these specialised parts

are likely to be exported to international mar-
Table 4

kets. In addition, there are also restrictions (such

3.939** (3.06)
5.252** (3.61)

0.0362 (0.10)
0.845** (4.05)
0.577* (2.46)

2.255** (2.62)
0.688 (1.43)
2.821** (2.90)
0.717 + (1.80)

0.0639 + (1.96)

0.179 (1.64)
0.393 (1.06)

as import duties) on local consumption because

TFPG = total factor productivity growth, IFN = international fragmentation network.
tfpg
2(b)

180

Malaysian law states that procuring inputs from

MNCs located in free trade zones is akin to
importing. Therefore, the presence of technol-
0.113 (0.49)
27.23** (3.73)
3.334 (1.06)

3.939** (3.06)

ogy spillovers from MNCs in upstream indus-

0.0362 (0.10)
0.845** (4.05)

0.406 (0.17)
2.821** (2.90)
0.717 + (1.80)

0.0639 + (1.96)

0.179 (1.64)
0.393 (1.06)

tries may not be captured in the model.

Tfpg
(2)

180

Model 2: Impact of local establishments’

characteristics
Skill (skil)

F*skil
lnskil
H
B
F
H*skil
lnscale

B*skil

N
ict
tgap

comp
pol

Results from the second model (Table 5) analyse

local firms’ absorption of technology/produc-
2.702 (1.03)

0.0332 (0.06)
0.454 (0.39)

2.150* (2.23)

tivity spillovers from foreign establishments.

0.377 (1.38)
1.043+ (1.79)
0.327 (1.32)

1.473 (0.80)

0.720 + (1.77)

0.0533 (0.89)

0.214+ (1.77)
0.589 + (1.84)

The specification of Equation 6 suggested that

Tfpg
1(b)

180

local skill-intensive (lnskil) establishments have

**p values < 0.01, *p < 0.05, +p < 0.10.

sufficient ability to improve productivity

growth without forming local linkages with
0.133 (0.47)

8.871 + (1.73)
5.459 (1.31)
0.454 (0.39)

2.150* (2.23)
0.377 (1.38)
1.043+ (1.79)

3.819 (0.23)

0.720 + (1.77)

0.0533 (0.89)

0.214+ (1.77)
0.589 + (1.84)

foreign affiliates. On the contrary, the negative

tfpg
(1)

180

coefficient signs from the interaction terms in

the results for Equations 6 and (6b) indicate
linkage formation with foreign establishments
Techgap (tgap)
Horizontal (H)

may only be relevant for local establishments

Backward (B)
Exports (ex)

competition
Policy (pol)
Forward(F)

that have lesser skills requirements. Low-skilled

Equations:
lnscale

local producers usually require lesser start-up

H*ex
Lnex

B*ex
F*ex

capital, hence the low initial technological base.

ict
N

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 KAM — CHANNELS OF PRODUCTIVITY SPILLOVERS IN THE MALAYSIAN MANUFACTURING SECTOR

0.356 (1.62)

0.282* (2.17)

0.162 (0.58)
0.137 (-1.00)
Therefore, even if MNCs bring in lower or dated

0.307** (4.86)
0.0632 + (1.73)
0.756 (1.00)
0.190 (0.68)

0.0420 (1.39)
1.500** (3.25)

0.0924 (0.83)
0.227* (2.00)
TFPG
technologies (by MNC’s standards), linkage
8(b)

180
formation with foreign establishments has a
significant impact on the TFPG of low-skilled
17.10** (3.31) local producers.

0.137 (1.00)
0.282* (2.17)

0.162 (0.58)
0.0420 (1.39)
0.307** (4.86)
0.0748 (0.95)

2.996* (2.15)
1.815 (1.14)

1.500** (3.25)

0.0924 (0.83)
0.227* (2.00)
Equations (5b) and (8b) show that export and

Corrections added on 24 June 2016, after first online publication: the missing columns for Equations: 5-6(b), Skill and Sales have now been added in Table 5.
TFPG

(8)

180
IFN-oriented local establishments are able to in-
crease productivity even without forming link-
ages with foreign establishments. However, the
F*IFN
lnIFN
H

N
B

H*IFN
B*IFN

tgap
lnscale

ict
pol
comp
impact on local export-oriented establishments
IFN

is much stronger if backward and forward link-

ages are formed with foreign establishments.
0.578 + (1.94)
3.501* (1.99)

0.0804 (0.12)
2.646** (3.13)

0.00163 (0.04)

0.458 (0.67)
0.905** (3.72)

0.643* (2.50)
1.676** (3.18)
1.194 (1.42)

0.305* (2.56)
0.889* (2.13)

Backward linkages are significant because

TFPG

7(b)

180

export-intensive local establishments are more

Impact of foreign presence on local firms’ characteristics and local TFPG

competitive in nature and have sufficient ab-

sorptive capacity to learn management tech-
1.386** (3.94)

25.28** (3.00)
10.25* (2.24)
2.646** (3.13)

0.00163 (0.04)

0.458 (0.67)

niques and production technologies from their

0.905** (3.72)

38.31** (2.69)

0.643* (2.50)
1.676** (3.18)

0.305* (2.56)
0.889* (2.13)

foreign partners. The impact of foreign presence

TFPG

(7)

180

is most prevalent for export-oriented local firms

and least for IFN-oriented local firms.
Equations 7 and (7b) show that local estab-
Sales (sal)

lishments with high sales growth (lnsal) have

lnscale
lnsale
H
B

H*sal
F

B*sal
F*sal

N
tgap

ict
comp
pol

negative productivity regardless of the linkages

with foreign establishments. This can be
Table 5

0.108 (0.78)

0.493 + (1.75)
0.158 (0.45)
0.00442 (0.14)

explained by the mechanics of growth account-

0.196 (0.32)
0.175 (0.67)

1.061 (1.00)

0.0567 (0.24)
0.268** (4.10)
0.124* (2.08)

0.191 + (1.66)
0.0811 (0.72)

ing. If sales is a proxy for output and increases

TFPG

6(b)

180

TFPG = total factor productivity growth, IFN = international fragmentation network.

with a reduction in its residual (TFPG), it means

capital and labour has to increase to offset the
decline in the residual. This implies sales growth
8.835 (0.98)

0.493 + (1.75)
0.158 (0.45)
0.00442 (0.14)
0.319* (2.46)

0.0567 (0.24)
4.372 + (1.82)
0.268** (4.10)

1.238 (0.42)
1.061 (1.00)

0.191 + (1.66)
0.0811 (0.72)

is more input-driven and less productivity-

TFPG

driven, which is more commonly the case in

(6)

180

Malaysian manufacturing sector (Tham 1997;

Kam 2013). Hence, local establishments with
high sales growth may not necessarily allocate
Skill (skil)

tgap

ict
lnskil
H
B
lnscale

comp

N
F
H*skil
B*skil
F*skil

pol

the revenues from sales into technology-

intensive and R&D activities.
Even in the absence of internal vertical link-
2.467 + (1.69)

3.011** (3.69)

0.00340 (0.09)

1.216 (1.64)
3.241 (1.16)
0.717* (2.41)
1.112** (4.83)

0.137 (0.21)

2.066** (4.17)

0.271* (2.28)
0.356+ (1.87)

0.193 (0.49)

ages, external linkages formed through IFNs

TFPG

5(b)

have allowed local establishments to improve

180

**p values < 0.01, *p < 0.05, +p < 0.10.

their productivity through horizontal channels

(for example, learning effects and imitation
effects). Equation (8) suggests that being
0.141 (0.64)

31.38** (3.90)
4.838 (1.49)
3.011** (3.69)

0.00340 (0.09)

1.216 (1.64)
45.39** (3.32)
1.112** (4.83)

2.066** (4.17)
0.356 + (1.87)

0.271* (2.28)
0.193 (0.49)

integrated into the IFN enabled them to source

TFPG

(5)

180

cheaper and higher quality inputs from abroad,

hence assigning internal linkages to a lesser role
in productivity growth. Local establishments
Techgap (tgap)
Horizontal (H)

producing for IFNs are also more competitive

Backward (B)
Forward (F)
Exports (ex)

competition
Policy (pol)

and capable in constantly revising their produc-

Equations:
lnscale

tion techniques to match the needs of the

H*ex
B*ex
F*ex
lnex

network.
ict
N

77

© 2016 Crawford School of Public Policy,

The Australian National University and John Wiley & Sons Australia, Ltd
 ASIAN-PACIFIC ECONOMIC LITERATURE
In summary, local establishments generally
absorb technology from foreign establishments
through horizontal linkages. Therefore, are do-
mestic linkages dead? With the proliferation of
trade agreements in the region, the focus of local
establishments on forging internal linkages is
becoming less important than the international
linkage-creation process. Hence, local establish-
ments need to increase exporting activities and
skill-oriented investments and seek new market
opportunities in order to fully reap the benefits
of FDI.
Conclusions and policy implications
The notion that all foreign firms will automati-
cally contribute to productivity upgrading of
local firms is misleading. The findings indicate
that foreign firms that are export-oriented,
skill-intensive, and market-driven have different
magnitudes of impact on local TFPG through
backward linkages—with foreign firms produc-
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