Intra- and Inter-industry Externalities from Foreign Direct Investment in the Mexican Manufacturing Sector: New Evidence from Mexican Regions JACOB A. JORDAAN * Free University of Amsterdam, Amsterdam, The Netherlands Summary. — This paper presents new empirical evidence on externalities from Foreign Direct Investment (FDI) in several Mexican regions in the early 1990s. The main findings are threefold. First, the presence of FDI creates negative externalities within industries and positive externalities between industries through backward linkages. Second, FDI-externalities are stimulated by large technological differences between FDI and Mexican firms and by geographic concentration of industries. Third, we identify a substantial level of regional heterogeneity of the externality impact of FDI, in line with the notion that FDI may have contributed to processes of changing regional prosperity under trade liberalization. The findings also imply that maquiladora firms in the border states are generating positive externalities. Ó 2008 Elsevier Ltd. All rights reserved. Key words — FDI, maquiladora, externalities, technology gap, geographic concentration, Mexico, Latin America 1. INTRODUCTION Recent research on the impact from Foreign Direct Investment (FDI) is exploring avenues to improve the statistical identification of FDI spillovers. One development is to broaden the scope of the estimations, by controlling for the full industry dimension of these externali- ties. The recognition of the importance of this dimension translates into distinguishing be- tween intra- and inter-industry FDI externali- ties (e.g., Blalock & Gertler, 2008; Driffield, Munday, & Roberts, 2004; Smarzynska, 2004). A second development is that empirical stud- ies are focusing on identifying structural factors that influence the occurrence and the nature of FDI externalities (Blomstro ¨m & Kokko, 2003; Crespo & Fontoura, 2007). Two factors appear to be commonly accepted as potential determi- nants. The first factor is the concept of absorp- tive capacity, which proposes that only those domestic firms or industries in a host economy that possess sufficient technological knowledge and skills are able to absorb new technologies from foreign-owned firms. The second factor is the extent to which FDI and domestic firms are located in geographic proximity. In line with evidence that proximity between economic agents may foster the creation and the trans- mission of knowledge spillovers (Audretsch & Feldman, 2004), the hypothesis that FDI spill- overs are facilitated by such proximity between FDI and domestic firms is easily put forward. The purpose of this paper is to build and ex- tend on these recent developments in empirical research on FDI externalities. Using unpub- lished and thus far unexplored regional data from the 1994 Mexican manufacturing census, we estimate FDI spillovers in detailed manufac- * I would like to thank Gilles Duranton, Paul Cheshire, Vassilis Monastiriotis, Erik Bartelsman, and Chris Elb- ers for valuable comments, and the editor of this journal and three anonymous referees for their very constructive comments and helpful suggestions. Of course, the usual disclaimers apply and all remaining errors are mine. Final revision accepted: February 14, 2008. World Development Vol. 36, No. 12, pp. 2838–2854, 2008 Ó 2008 Elsevier Ltd. All rights reserved 0305-750X/$ - see front matter www.elsevier.com/locate/worlddev doi:10.1016/j.worlddev.2008.02.006 2838