Technology Diffusion from Foreign Direct Investment through Supply Chains Garrick Blalock and Paul Gertler * July 20, 2002 Abstract This paper examines how the technology that accompanies foreign di- rect investment (FDI) diffuses in the host economy. We ask if local ven- dors that sell to multinational entrants acquire technology through supply chain linkages. Using a panel dataset of Indonesian manufacturing estab- lishments from 1988 to 1996, we measure the effect of downstream FDI on local firm productivity and find strong evidence that vertical supply chains are a channel for technology transfer. In contrast, prior studies that measure the horizontal spillover of technology from foreign entrants to do- mestic competitors find mixed evidence of technology transfer. We conclude that considering only horizontal spillover underestimates technology trans- fer from FDI. This finding is consistent with the incentives of multinational enterprises: whereas they attempt to minimize technology leakage to com- petitors, they often deliberately transfer technology to suppliers with the aim of reducing the price and raising the quality of inputs. * Cornell University and University of California, Berkeley (gb78@cornell.edu and gertler@haas.berkeley.edu). We are indebted to Indra Surbakti, Fitria Fitrani, Iwan Hermanto, Rifa Rufiadi, Kai Kaiser, and Jack Molyneaux for their assistance in obtaining and understand- ing the data. We received helpful advice from David Levine, David and Janet Mowery, Pranab Bardhan, Guy Holburn, Haryo Aswicahyono, and Thee Kian Wei. We thank the Institute of Business and Economic Research (IBER) and Management of Technology (MOT) program, both at the University of California, Berkeley, for their generous financial support. Finally, we are grateful to the factory managers in Indonesia who kindly participated in interviews. 1