Market Structure, Technological Gap and Vertical Linkage Effects from Foreign Direct Investment

This paper is based on the model of backward linkages from foreign direct investment (FDI) Lin/Saggi (2003), where the market structure of the final goods sector is represented by a monopoly or Cournot oligopoly, and the supplier sector – by a pure monopoly. We extend this model by examining cases of perfect competition and a vertically integrated domestic company in the intermediate goods market. Our analysis shows that coming of foreign companies to the final goods sector provides positive backward linkage effects. Although this result doesn’t depend on the market structure in the final goods sector, the latter significantly affects the size of FDI linkage effects – the more competitive is the intermediate goods sector, the larger are the backward linkage effects. They reach their maximum under perfect competition in the intermediate goods market, minimum – under monopoly in this sector, and medium size - when a vertically integrated local firm exists in the market. We have also discovered that a more competitive market structure per se doesn’t guarantee larger positive effects of FDI. It is important that in addition to a competitive structure local firms do not significantly lag behind foreign firms in their technological level.