Natalia Davidson
Graduate School of Economics and Management
Ural Federal University
9 November 2013
The impact of foreign firms’ spatial concentration on national enterprise
performance in Russia
Factors behind enterprise performance are studied with the aim to shed some light on the
reasons for differences in productivity among enterprises and on possibilities for improvement of
their performance. The effects arising from concentration of national and foreign firms are
considered. The main objective is to understand the effects of foreign firms’ concentration on the
national firms’ performance, taking into account home market potential of cities, human capital,
regional road infrastructure and business environment risks.
‘Circular logic’ of foreign direct investment (FDI) implies that higher level of economic
growth and development makes a country or a region able both to attract FDI and to benefit from
it due to better absorptive capacity. Increase in FDI inflow stimulates economic development of
a country (Ledyaeva et al., 2010). Then the process continues. Such logic is similar to that
typical for agglomeration effects. Overall, agglomeration effects and FDI stimulate growth of
output, revenue, wage, employment, in the cumulative process.
Current state of research on agglomeration economies. Marshall (1920) assumed that
among the reasons behind industrial concentration were ‘the mysteries of trade’. Positive and
negative effects of scale and scope resulting from economic activity concentration are referred to
as agglomeration externalities (Neffke, 2009). They arise from concentration of similar firms
(localization; Marshall – Arrow – Romer (MAR) externalities) or of firms belonging to various
industries (diversity and urbanization; Jacobs externalities). For example, productivity premium
received due to doubling of a city size in USA varies from 3 to 8% (survey by Rosenthal and
Strange, 2004). New Economic Geography proposes the concept of Home market potential
(HMP), stating that if two-region economy and the industries with imperfect competition are
considered, more than proportionate share of firms locates in a region with larger local demand
(Krugman, 1991; Ottaviano, Thisse, 2004).
As for Russia, the size and scope of cities and spillovers on growth from one region to
another are important (Russian Economic Report, 2007). The Institute for Analysis of
Enterprises and Markets, Higher School of Economics in cooperation with World Bank, IMF and
‘Levada-Center’ carried out research on Russian enterprises of manufacturing industries and
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found that doubling the city size leads to 5% increase in productivity (Enterprises and markets,
2010). Vorobyev et al. (2010), based on data on Russian manufacturing firms, years 2001-2004,
found inverted U-shaped localization economies and positive diversity economies.
Current state of research on FDI. FDI effects occur as direct effects and productivity
spillovers (horizontal, vertical and supply-backward ones) (Merlevede, Schoors, 2008).
Horizontal spillovers are related to localization effects (Blomström and Kokko, 2003). Vertical
spillovers can be related to diversity economies. Firms in the developed countries tend to have
larger FDI spillovers, probably due to their higher absorptive capacity (Aitken and Harrison,
1999; Smarzynska-Javorcik, 2004; Bode et al., 2009). Attracting FDI into a certain industry may
enhance productivity in this industry and lead to a change in comparative advantage for a
country or a region (Crozet et al., 2004).
In the beginning of transition period, there was more evidence on positive vertical
spillovers than on positive horizontal spillovers (Altomonte and Resmini, 2001; Merlevede and
Schoors, 2008; Elmas and Degirmen, 2009; Smarzynska-Javorcik, 2004; Stancik, 2007).
Damijan et al. (2013) find positive horizontal spillovers for transition countries, with growing
importance during the recent ten years. For Russia, both positive and negative FDI spillovers are
found (Yudaeva et al. (2003), Kadochnikov and Drapkin (2007), Drapkin et al. (2011a). Drapkin
et al. (2011a) find positive horizontal FDI effects in the Russian regions with diversified
economic structure, and negative effect in specialized regions for the years 1999-2008.
Methodology and data. The effects of spatial concentration on enterprise performance are
analyzed as agglomeration effects and the effect of home market potential. Agglomeration is
subdivided into localization, urbanization and diversity. Mechanisms behind the agglomeration
economies are considered. The effects arising from national and foreign firms’ concentration in
cities are studied. A number of agglomeration indices are analyzed; a variation of a diversity
index proposed by Vorobyev et al. (2010) is applied.
Research is based on the SPARK-Interfax firm level data augmented with Rosstat city
and regional data, for years 2002-2008. Panel data model is estimated. First differencing is
applied to deal with endogeneity arising from unobserved heterogeneity. Instrumental variables
(agglomeration variables with 2 period lags) and GMM were used to deal with endogeneity
arising from simultaneity.
The effects are analyzed for different groups of industries, types of cities, types of firms.
Industries are subdivided into five groups: traditional, basic material industries, basic machinery,
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integrating machinery and science based. Cities and towns are classified into agglomeration
centers (the cities with population over 1 mn people and/or high level of economic activity),
cities and towns belonging to the agglomerations (located within 60 km from an agglomeration
center), and monotowns (specialized towns, where economy is dominated by a single industry).
Main results. Urbanization economies arising both from national and foreign firms are
found to be positive, while those arising from foreign firms are relatively larger. This effect
holds both for the sample of national and foreign firms. Large and robust effects from
urbanization can be explained by the increased opportunities for knowledge spillovers, input
sharing and to a certain degree for matching (or labour market pooling) in large cities.
Localization economies arising from national firms’ concentration are characterized by
inverted U shape. Though diminishing, localization economies stay positive for the actual
localization levels in the sample. Localization effects arising from the foreign firms’ presence are
contradictory for national firms, being positive, however, for the national firms located in the
agglomeration centers. HMP is found to be positive. Results confirm negative effect of regional
business environment risks on the firms’ performance.
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