Sandra Batten and Dena Jacobs

Many governments around the world pursued policies to free up capital flows from the late 1970s to early 1990s with the aim of boosting productivity. There’s now a debate raging about the costs and benefits of globalisation. While detractors highlight concerns about inequality, supporters of capital liberalisation point to the productivity growth it has fostered. Drawing on a unique UK firm-level dataset that merges data from the ONS business and innovation surveys, we show that foreign-owned companies are more productive than domestically owned firms and that their presence boosts domestic labour productivity. We suggest three reasons why: foreign-owned companies invest more in R&D; they are better managed; and they collaborate with other organisations and promote the diffusion of ideas.

Foreign owned firms are more productive than their domestic counterparts.

There is a substantial body of evidence showing that foreign-owned firms are more productive than domestically owned ones (see example Griffith et al. (2004)) and that their presence can boost the spread of knowledge and productivity. For example, Haskel et al. (2007) document the existence of knowledge spillovers from foreign companies located in the UK to domestic companies. And Griffith et al. (2002) find that greater foreign presence within an industry increases the speed with which technology in that industry converges towards that of the world’s most productive firms.

We draw on data from around 40,000 UK companies and show that foreign-owned firms are around twice as productive as domestically owned companies in the UK, consistent with the literature (Chart 1). Some of this reflects the fact that foreign firms tend to be large and to be exporters and both of these characteristics are associated with higher productivity levels. But even controlling for size, whether they export, age, and sector we find foreign companies to be around 50% more productive than domestically owned ones.

Moreover, foreign-owned firms’ productivity growth is stronger. Among a sample of surviving companies, foreign firms contribute around 30% of total productivity growth, while on average they only account for around 16% of total employment.

Chart 1: Distribution of labour productivity by type of ownership

Source: ONS research datasets.

* Chart shows 2013 figures, though the distribution does not change materially across years. The charts and analysis shown contain statistical data from ONS which is Crown Copyright. The use of the ONS statistical data in this work does not imply the endorsement of the ONS in relation to the interpretation or analysis of the statistical data. This work uses research datasets which may not exactly reproduce National Statistics aggregates.

Why are foreign-owned firms more productive and how does that boost aggregate UK productivity?

They invest more in R&D.

A greater proportion of foreign-owned firms engage in R&D activity than domestic companies (Chart 2a) and they spend more on R&D (Chart 2b). On average, foreign-owned firms spend around five times more on R&D than domestic companies. Even controlling for size, sector and whether they export, foreign firms spend more on R&D per employee than domestically owned firms. In aggregate, foreign-owned firms are important drivers of R&D in the UK, accounting for 50% of total R&D spending.

Chart 2a – Proportion of firms engaging

in R&D by ownership type Chart 2b – Average spending on R&D per firm by ownership

* Charts show 2014 data, which is the latest vintage. Source: ONS research datasets.

Earlier vintages of these data show foreign firms

spend between three and five times more on R&D

than domestic firms.

Chart 3 – Proportion of innovating firms by ownership type

Source: ONS research datasets.

Consistent with that spending, foreign firms are also more likely to innovate, that is introduce new products and/or processes, than their domestic counterparts (Chart 3). The link between innovation and productivity has been well-documented in the literature – see for example Hall (2011), Haskel and Wallis (2010) or Elnasri and Fox (2014). Within firms, new processes can increase productivity by increasing the efficiency with which goods and services are produced and delivered. And at the aggregate level, the introduction of new products raises productivity by replacing existing products with new and more efficient ones.

There’s some evidence that they may be better managed.

Foreign-owned firms’ higher productivity levels might also reflect better management practices. Bloom et al (2007) find that family run firms, in particular those in which the role of CEO is passed to the eldest son, are much less productive than firms in which management is chosen on merit. Those authors also find that family-run firms are more prevalent among UK-owned companies than German or American businesses. Therefore, management practices could also account for some of the difference in domestic and foreign-owned firms’ productivity levels.

They promote the diffusion of ideas.

The presence of foreign-owned firms boosts knowledge diffusion. Literature on this issue suggests that there are many different channels through which this can occur (see for example Krammer (2014)). These channels include: adoption or imitation of foreign technology by local firms; movement of workers with new knowledge from foreign to domestic employers; increased competition from foreign firms incentivising local firms to improve their efficiency. An additional channel is collaboration. More foreign-owned firms collaborate with other organisations compared to domestically-owned companies (Chart 4). Collaboration with universities, the government, their suppliers and customers, exposes these companies to new technology and ideas being developed in other parts of the economy, therefore facilitating innovation.

Chart 4 – Foreign firms are more likely to collaborate with all groups of potential partners

Source: ONS research datasets.

Conclusion

We find that foreign-owned firms are more productive than domestically-owned ones and there are several channels through which their presence can boost aggregate productivity. It is true that large productive foreign-owned firms are able to expand and invest in overseas branches located in the UK and this boosts UK productivity by simply raising the average. But this is only one part of the story. Foreign-owned firms also make a significant contribution to UK R&D spending and promote the diffusion of ideas through their collaborative activities. Continued foreign investment and the presence of foreign-owned firms will therefore be important for the UK’s productivity outcomes.

Sandra Batten works in the Bank’s Structural Economic Analysis Division and Dena Jacobs works in the Bank’s Inflation Report and Agency Intelligence Division.



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