Linkages and spillovers in global production networks: firm-level analysis of the Czech automotive industry

University of Nebraska at Omaha University of Nebraska at Omaha

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Linkages and spillovers in global production networks: >rm-level Linkages and spillovers in global production networks: >rm-level

analysis of the Czech automotive industry analysis of the Czech automotive industry

Petr Pavlinek

University of Nebraska at Omaha

, [email protected]

Pavla Žížalová

Charles University in Prague

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Linkages and spillovers in global production

networks: firm-level analysis of the Czech

automotive industry

Petr Pavlı

nek*

and Pavla Z

zˇalova

*University of Nebraska at Omaha, USA and Charles University in Prague, Czechia

**Charles University in Prague, Czechia and PricewaterhouseCoopers, Czechia

Corresponding author: Petr Pavlı

nek, Department of Geography and Geology, University of Nebraska at

Omaha, 6001 Dodge Street, Omaha, NE 68182-0199, USA. email 5[email protected]4

Abstract

The aim of this article is to analyze the linkages between and spillovers from foreign-

owned (foreign) to domestic-owned (domestic) firms in the Czech automotive industry.

Theoretically and conceptually, our research draws on two strands of literature:

spillovers, linkages and effects of foreign direct investment on domestic firms and

regional economic development; and literature on global production networks, global

value chains and industrial upgrading. Empirical analysis is based upon unique data

collected by the authors through a questionnaire completed by 317 foreign and

domestic firms in 2009 and on-site interviews with 100 firms conducted between

2009 and 2011. Data analysis has identified a low share of domestic suppliers in the

total supplies of Czech-based foreign firms and diverse spillover effects from foreign to

domestic firms. Domestic firms vary in their capabilities and absorptive capacity which,

along with the particular nature of the contemporary automotive value chain,

significantly influence their ability and potential to benefit from linkages and spillovers.

Keywords: Linkages, spillovers, automotive industry, domestic and foreign firms, Czechia

JEL classifications: L62, D24

Date submitted: 9 January 2014 Date accepted: 11 September 2014

1. Introduction

In an increasingly globalized economy, and especially in less developed and middle-

income economies, the role of transnational corporations (TNCs) is considered to be

crucial for economic development (Meyer, 2004; Jindra et al., 2009). Value creation is a

fundamental precondition for successful economic development (Henderson et al.,

2002; Coe et al., 2004) and TNCs can create or enhance opportunities for value creation

by their decisions to invest in particular countries, regions and localities. Through the

geographic diffusion of broadly defined technology, which in addition to production

methods and technologies includes production organization and management (Go

and Greenaway, 2004), foreign direct investment (FDI) has direct and indirect effects

on host economies. Direct effects include employment effects, trade effects, effects on

capital formation and tax revenues. Indirectly, FDI may influence the industrial

environment of host economies and the behavior and performance of host country

firms in the form of spillovers from foreign-owned (henceforth foreign) firms through

ß The Author (2014). Published by Oxford University Press

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Journal of Economic Geography 16 (2016) pp. 331–363 doi:10.1093/jeg/lbu041

Advance Access Published on 14 October 2014

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acquisition of skills, through imitation, competition and exports (Blomstro

m and

Kokko, 2001; Go

rg and Greenaway, 2004; Dunning and Lundan, 2008). In other

words, the productivity and/or efficiency of host country firms may increase following

the entry of foreign firms as foreign investors are unable to fully internalize their firm

specific advantages, such as superior process and product technology and marketing

skills, which may spill over to local firms (Blomstro

m et al., 2000; Blomstro

m and

Kokko, 2001; Dunning and Lundan, 2008).

The aim of this article is to analyze linkages between foreign and domestic-owned

(henceforth domestic) firms and spillovers from foreign to domestic firms in the Czech

automotive industry. The contemporary automotive industry is typified by the high

degree of vertical disintegration and, therefore, by strong backward linkages between

lead firms (assemblers) and hundreds of their component suppliers organized in

hierarchically structured production networks (Humphrey and Memedovic, 2003). The

automotive industry thus represents an excellent economic sector to study spillovers

from foreign to domestic firms. With the 2012 production of 1.2 million vehicles, the

Czech automotive industry provides a relevant example of the automotive industry

periphery that has been integrated into the European and global automotive production

networks through large inflows of FDI since the early 1990s (Pavlı

nek, 2002a, 2002c,

2003). However, despite the importance of the automotive industry for the Czech

economy and the dominant role of FDI in the sector (Pavlı

nek, 2008, 2012a, 2012b;

Pavlı

nek and Z

enka, 2010, 2011), FDI’s effects on domestic firms in the Czech

automotive industry have not been systematically studied. In this article, we employ the

qualitative research methodology to focus on backward linkages between TNCs’

foreign subsidiaries and domestic suppliers through buyer–supplier relationships,

because they are considered to be the most important channel through which spillovers

develop (Javorcik, 2004; Ivarsson and Alvstam, 2005; Blalock and Gertler, 2008). We

have collected unique data about the effects of foreign investors on domestic

automotive firms through a questionnaire completed by 317 foreign and domestic

firms in 2009 and on-site interviews with 100 automotive firms between 2009 and 2011.

Our main goal is to evaluate the extent to which linkages and spillovers from foreign to

domestic firms have developed in the Czech automotive industry after its liberalization

in the early 1990s and through which mechanisms they occur because the study of

mechanisms of FDI spillovers has been neglected (Meyer, 2004; Spencer, 2008;

Contreras et al., 2012; Hallin and Lind, 2012). Specifically, we focus on three questions:

First, how strong are the linkages between foreign and domestic firms and what kind of

spillovers can be identified in the Czech automotive industry? Second, what are the

effects of these linkages and spillovers on technological, organizational and strategic

competences of domestic suppliers? Third, why are some domestic suppliers able to

benefit from linkages with foreign firms to enhance their competitiveness and improve

their position in the automotive value chain while others are unable to do so?

Theoretically and conceptually, our research draws on two strands of literature. First

is vast literature on spillovers, linkages and effects of FDI on domestic firms and

regional development (e.g. Firn, 1975; Dicken, 1976; Britton, 1980; Hayter, 1982;

Phelps, 1993; Amin et al., 1994; Aitken and Harrison, 1999; Blomstro

m and Kokko,

2001; Hansen et al., 2009; Jindra et al., 2009). Second is literature on global production

networks (GPNs,) global value chains (GVCs) and industrial upgrading (e.g.

Kaplinsky, 2000; Henderson et al., 2002; Humphrey and Schmitz, 2002; Gereffi

et al., 2005).

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We argue that spillover effects from FDI at the firm level vary significantly across the

Czech automotive industry and are strongly affected by differences in the capabilities

and absorptive capacity of domestic firms and by the changing organization of the

automotive industry. Our analysis suggests that domestic firms were affected by

horizontal and vertical spillovers in the 1990s and 2000s. Indirect horizontal and

vertical spillovers were more important than direct vertical spillovers in the form of

direct technology and knowledge transfer from foreign to domestic firms despite the

integration of domestic firms into automotive GPNs through the development of

supplier linkages with foreign firms. The importance of direct spillovers varies with the

capabilities of domestic firms to exploit them and is related to the position of firms in

the automotive value chain and the supplier hierarchy.

The article is organized as follows. We begin with a discussion of the relationship

among FDI, linkages and spillovers in which we emphasize the importance of linkages

between foreign and domestic firms for the potential development of spillovers. Next,

we demonstrate how changes in the organization of the contemporary automotive

industry undermined the position of domestic firms in the automotive GPNs and with it

the potential for spillovers from foreign to domestic firms. In the fourth section, we

briefly analyze the general effects of FDI in the Czech automotive industry and we

argue that FDI resulted in productivity spillovers but not necessarily in technology

spillovers. In the fifth section, we present an empirical analysis of linkages between

foreign and domestic firms based on our unique quantitative firm-level data. In the

sixth section, we examine spillovers from foreign to domestic firms. We summarize the

main findings of the article in the conclusion.

2. FDI, linkages and spillovers

After decades of research following the work of Caves (1974), there is no academic

consensus about the benefits and drawbacks of FDI for host economies generally and

for productivity of domestic firms in the form of spillovers specifically. This lack of

consensus has been explained, for example, by the different ways in which FDI

spillovers are measured. Differences in research design, methodology and data can

influence research results (Barrios et al., 2011). While analyses using cross-sectional

data tend to find statistically significant spillovers on productivity of domestic firms,

panel data econometric techniques tend to find statistically negative or insignificant

spillovers (Go

rg and Strobl, 2001; Javorcik, 2004; Meyer, 2004). The lack of consensus

on FDI spillovers also reflects the fact that FDI effects on host economies depend on a

large number of different factors, such as FDI characteristics, the size of host country

firms, the nature of vertical linkages between foreign and domestic firms, worker

mobility, the technological gap between foreign and host country firms and the

absorptive capacity of domestic firms (Blomstro

m and Kokko, 2001; Go

rg and

Greenaway, 2004; Crespo and Fontoura, 2007; Smeets, 2008; Havranek and Irsova,

2011). Spillovers also differ within individual countries depending on the industry, the

nature of operations, the mode of entry of foreign investors, the length of time since the

original investment, the domestic or export market orientation of foreign firms, and

other factors (e.g. Amin et al., 1994; UNCTAD, 2001; Carrillo et al., 2004; Scott-

Kennel, 2007; Dicken, 2011). Furthermore, Meyer and Sinani (2009) have argued that

spillovers vary according to the level of economic development of host countries with

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very rich and very poor countries benefiting from inward FDI, while middle income

economies being negatively affected by FDI. In contrast, according to Blomstro

m and

Kokko (2001), the poorest developing countries do not benefit from FDI spillovers but

middle-income economies do. There are also important differences within individual

countries with more developed regions benefitting economically more from foreign

subsidiaries than less developed regions (Dimitratos et al., 2009). Potential benefits of

FDI for host economies thus strongly depend on the context of the individual countries

and are, therefore, highly spatially variegated. Despite this lack of academic consensus

on the effects of FDI in host economies, policy makers tend to assume generally positive

FDI effects on host economies and host country firms, especially in terms of FDI’s

potential for technology and knowledge transfer (Harding and Javorcik, 2011; Hallin

and Lind, 2012). This belief has translated into economic policies that are supportive of

FDI in the majority of countries and in vast public expenditures to attract FDI in both

more and less developed countries (Meyer, 2004; Harding and Javorcik, 2011;

UNCTAD, 2012).

In this article, we differentiate between productivity and technology spillovers.

Productivity spillovers are defined as the effect of the presence of foreign firms on

productivity in domestic firms (Go

rg and Strobl, 2001) in the form of increased

availability of information regarding more efficient production processes of foreign

firms in a host economy. The presence of foreign firms also increases the pressure on

domestic suppliers to become more efficient through productivity improvements in the

form of better machinery and organization of production. Foreign firms typically have

specific requirements on domestic suppliers in terms of the quality of supplied parts and

components, such as technology audits and quality certificates, before they can start

supplying foreign firms. Meeting these requirements increases the productivity and

competitiveness of domestic firms, which can be achieved without the direct or indirect

transfer of technological knowledge and know-how from foreign firms. Domestic firms

thus become more efficient by imitating the process technologies of foreign firms while,

at the same time, lacking innovation capabilities to further exploit, advance or develop

these technologies. As such, productivity spillovers are especially related to process

upgrading in domestic firms. Technology spillovers refer to the diffusion of technology

and know-how from foreign to domestic firms (Hatani, 2009) in such a way that will

make them not only more efficient producers but also increase their innovation

capabilities through the transfer of technological know-how. For example, new

specialized software will allow domestic firms not only to contribute to cost reductions

and increased efficiency but will also allow them to design and produce their own tools

or molds they used to buy from other firms, which will increase the value-added of their

production. Thus, technology spillovers, in addition to process upgrading, may also

encourage product and functional upgrading in domestic firms. By distinguishing

between productivity and technology spillovers we are trying to distinguish between

more efficient production on one side and increased technological capabilities on the

other side that would allow domestic firms to narrow the gap between them and foreign

firms. We argue that more efficient production and the use of better technologies

broadly defined do not necessarily increase the technological capabilities of domestic

firms. At the same time, we recognize that productivity and technology spillovers are

closely interrelated.

Spillovers from foreign to host country firms have two basic forms, horizontal and

vertical. Horizontal spillovers are mostly unintentional spillovers to firms in the same

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industry, including competitors, while vertical spillovers are unintentional and

intentional spillovers to domestic suppliers and customers (Blalock and Gertler, 2008;

Hallin and Lind, 2012). Vertical spillovers to a large extent depend on the development

and intensity of forward and backward linkages between TNCs’ foreign subsidiaries

and domestic firms through buyer–supplier relationships in the host economy

(UNCTAD, 2001; Giroud and Scott-Kennel, 2009; Hansen et al., 2009). These forward

and backward linkages may lead to intended and unintended spillovers of technologies,

skills, various forms of knowledge and know-how from foreign to domestic firms

(Blomstro

m and Kokko, 2001; Giroud and Scott-Kennel, 2009) (Figure 1).

Linkages between foreign and domestic firms are thus an important precondition for

vertical spillovers to occur (Blomstro

m and Kokko, 1998; UNCTAD, 2001; Go

rg and

Strobl, 2005; Scott-Kennel, 2007; Santangelo, 2009). The impact of linkages on

domestic firms could be both positive and negative, depending on what Cohen and

Levinthal (1989) called a firm’s ‘learning’ or ‘absorptive’ capacity (see also Cohen and

Levinthal, 1990; Girma, 2005). Absorptive capacity refers to the ability of firms to

‘identify, assimilate and exploit knowledge from the environment’ (Cohen and

Levinthal, 1989, 569). It also includes the ability of firms to identify and exploit new

scientific and technological knowledge generated by public research centers and

universities (Cohen and Levinthal, 1989). As such, absorptive capacity depends

particularly on R&D capabilities of firms (Cohen and Levinthal, 1989; Sturgeon et al.,

2010) and it is enhanced by their R&D investment. Firms that conduct their own R&D

are better at using and imitating external knowledge than firms without their own

R&D, including better abilities to imitate externally available process or product

innovations generated by other firms (Cohen and Levinthal, 1989, 1990). Domestic

firms that are able to absorb foreign technology and improve their overall competi-

tiveness can benefit from their integration into GPNs through increased production,

sales and employment (Scott-Kennel, 2004; Ivarsson and Alvstam, 2005). Such firms

can also gradually improve their position in GPNs and GVCs through improved

capabilities and functional upgrading (Humphrey and Schmitz, 2002). Absorptive

capacity is thus considered to be crucial for the ability of domestic firms to benefit from

FDI (Ernst and Kim, 2002; Kohli, 2004; Meyer, 2004) and upgrade their production

and products or services to meet buyers’ requirements (Dunning and Lundan, 2008).

Low technological and organizational capabilities of domestic firms may prevent them

from absorbing foreign technology and from benefitting from the presence of foreign

firms. This may result in negative consequences for domestic firms caused by FDI, such

as crowding out effects, leading to the loss of competitiveness, downgrading and closure

(Blomstro

m and Kokko, 1998; De Backer and Sleuwaegen, 2003; Go

rg and

Greenaway, 2004; Oetzel and Doh, 2009). Generally, the absorptive capacity of

domestic firms as well as the number and intensity of linkages tend to increase with the

overall level of development of host economies (Dunning and Lundan, 2008; Meyer and

Sinani, 2009). However, large differences exist between different industries and different

regions in the degree of linkages, especially in less-developed economies (UNCTAD,

2012).

The increasing integration of developing country suppliers into GPNs and GVCs,

which are mostly organized by developed country lead firms, has not necessarily lead to

the formation of strong linkages between foreign subsidiaries and domestic firms (e.g.

Belderbos et al., 2001; Pavlı

nek, 2004; Giuliani et al., 2005). The experience of weak

linkages between foreign and domestic firms has also been the case of peripheral regions

Linkages and spillovers in global production networks

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in developed countries (e.g. Schackmann-Fallis, 1989; Crone, 2002; Hewitt-Dundas

et al., 2005; Tavares and Young, 2006). Especially small domestic firms face high-entry

barriers to GPNs and GVCs (Hatani, 2009; Nolan and Zhang, 2002).

It has long been recognized by economic geographers and economists that

(technology) spillovers are innately geographical (e.g. Jaffe et al., 1993) because the

geographic proximity of economic actors increases the chances for spillovers by

facilitating the flow of information, especially among firms with linkages within

regional production systems (e.g. Florida, 1996). In addition to localized patterns of

codified knowledge, geographic proximity facilitates face-to-face contacts and the

exchange of highly localized tacit knowledge (Gertler, 2003; Howells, 1996, 2002;

Storper and Venables, 2004). The exchange of information and interactions of firms

within clusters may increase firms’ capabilities through processes of localized learning

(Maskell and Malmberg, 1999, 2007; Bathelt et al., 2004). The clustering of suppliers

around assembly plants as well as the clustering of automotive R&D is typical for the

contemporary automotive industry and has been well documented (e.g. Carrincazeaux

et al., 2001; Frigant and Lung, 2002; Lung, 2004; Sturgeon et al., 2008). Our previous

research has identified such clustering of suppliers and R&D in the Czech automotive

industry (Pavlı

nek and Jana

k, 2007; Pavlı

nek, 2012b). Figures 2–3 suggest the

importance of clustering in the Czech automotive industry around large passenger

car assembly plants, in and around large cities, especially Prague, Pilsen and Brno, and

along highways connecting Prague with Liberec through Mlada

Boleslav (the main

Figure 1. The classification of spillovers.

Source: The authors.

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koda Auto production complex) and with Pilsen and Germany. Both foreign and

domestic firms are located in these clusters. Based on the previous research, we can thus

assume that the clustering and agglomeration of automotive suppliers facilitate the

development of spillovers between foreign and domestic firms in the Czech automotive

industry.

3. Internationalization of the automotive supplier industry and its

consequences for domestic suppliers in less developed countries

Before turning to the empirical analysis of linkages between foreign and domestic firms

and spillovers in the Czech automotive industry, we will first investigate the position of

domestic firms in automotive GPNs and review the general effects of FDI in the Czech

automotive industry. In this section, we briefly demonstrate how the increasing

globalization of the automotive industry has undermined the position of domestic

suppliers in automotive GPNs. Consequently, the potential for linkages and vertical

spillovers from foreign to domestic firms has been diminished.

The contemporary automotive industry represents a typical example of quasi-

hierarchical (captive) value chains in which powerful lead firms organize and regulate

vertical production networks of component suppliers (Humphrey and Schmitz, 2004;

Gereffi et al., 2005). Large assemblers (lead firms) set the basic parameters of

automotive GPNs by wielding their corporate and market power. Lead firms define the

koda Auto

Toyota Peugeot Citroën

Hyundai

Škoda Auto

Tatra (heavy trucks)

Avia (trucks)

Iveco (buses)

SOR (buses)

TEDOM (buses)

Škoda Auto

0100km

First tier supplier

Second tier supplier

Third tier supplier

Assembly

est

ic ow

ship

n o

rship

Divided highway

Figure 2. The 2009 spatial distribution of foreign and domestic automotive firms in Czechia

based on their position in the supplier hierarchy.

Source: Authors.

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architecture of the final product and of its crucial parts, select suppliers of modules and

the most important components, set the schedule of their deliveries, and develop quality

control mechanisms to be employed throughout the production network (Humphrey

and Schmitz, 2002, 2004; Coe et al., 2004). During the 1990s and 2000s, the largest core-

based automakers invested heavily in new assembly plants located in the less developed

‘emerging’ economies (Humphrey, 2000; Sturgeon and Lester, 2004). They were

attracted by the profit-making potential of export-oriented low-cost production in

peripheral regions such as Mexico and East-Central Europe, which are located close to

automotive core markets and within regional trade agreements, and by potentially very

large domestic markets in rapidly growing economies such as China and India

(Humphrey et al., 2000; Pavlı

nek, 2002c; Liu and Dicken, 2006; Liu and Yeung, 2008;

Van Biesebroeck and Sturgeon, 2010).

The geographic expansion of assembly operations and the contemporaneous

development of modular design and production (Baldwin and Clark, 1997; Frigant

and Talbot, 2005) compelled lead firms to increasingly demand global (follow) sourcing

of certain components. Leading Tier 1 suppliers (sometimes referred to as Tier 0.5

suppliers) met this demand by rapidly internationalizing their operations through a

wave of mergers, acquisitions and joint ventures in order to quickly develop their ability

to supply lead firms wherever they assemble vehicles (Sturgeon and Lester, 2004). These

‘global’ suppliers have also become increasingly specialized in particular technologies

and the production of distinct modules (Sadler, 1999), and they significantly enhanced

their R&D capabilities. As the differences in capabilities among suppliers increased, the

0 100 km

Škoda Auto

Toyota Peugeot Citroën

Hyundai

Škoda Auto

Tatra (heavy trucks)

Avia (trucks)

Iveco (buses)

SOR (buses)

TEDOM (buses)

Škoda Auto

wne

Less than 50

50 - 249

More than 249

Dom

c owne

ship

Num

Divided highway

Figure 3. The 2009 spatial distribution of foreign and domestic automotive firms in Czechia

based on their number of employees.

Source: Authors.

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entire supplier industry has been reorganized into distinct tiers (e.g. Humphrey and

Memedovic, 2003; Pavlı

nek and Jana

k, 2007). Tier 1 suppliers are the most

internationalized and supply modules and the most sophisticated components, which

they co-design with lead firms. Tier 2 suppliers are less internationalized and supply

lead firms and Tier 1 suppliers with less sophisticated and lower value-added

components. Tier 3 suppliers are the least internationalized and supply low value-

added, simple, standardized and slow-changing components in the entire GPN.

The internationalization and geographic expansion of leading suppliers and the

restructuring of the supplier industry have had important consequences for domestic

automotive suppliers in less developed countries. The widespread follow sourcing and

the importance of long-term supplier relationships, based upon reputation and trust,

favor existing core-based suppliers who are now required to supply lead firms in foreign

locations wherever their high-volume final assembly takes place (Humphrey, 2003;

Ivarsson and Alvstam, 2005). Domestic firms are typically ill positioned to compete

with established foreign suppliers, which are often controlled by large TNCs and are

experienced in delivering high quality components in a just-in-time regime in multiple

foreign locations (Humphrey and Memedovic, 2003; Meyer, 2004). Experienced foreign

suppliers also already possess management and quality expertise required by lead firms

and capital to grow rapidly in foreign locations (Humphrey, 2000). As a result, foreign

lead firms often develop supplier networks through follow sourcing in less developed

host countries consisting almost exclusively of their established foreign suppliers,

including Tier 2 and Tier 3 suppliers. Because of high entry barriers, domestic firms find

it almost impossible to enter such ‘closed’ supplier networks, and if they do, they

play only a marginal role in them by delivering simple low value-added components

(2009–2011 interviews; Barnes and Kaplinsky, 2000). This situation prevents the

development of supplier linkages between foreign and domestic firms and consequently

prevents the development of vertical spillovers. In the context of the Czech automotive

industry, this has been the case of Japanese and South Korean automotive lead firms,

which relied on follow sourcing and almost totally excluded domestic companies from

their production networks (2009–2011 interviews; see also Sturgeon and Lester, 2004).

Hatani (2009) has conceptualized such a situation as ‘spillover interception’ in which

spillovers from foreign to domestic firms fail to materialize in middle-income economies

despite high levels of FDI, and which has been supported by empirical evidence found

in numerous studies (Meyer and Sinani, 2009). Therefore, although FDI and linkages

between foreign and domestic firms are a necessary precondition for vertical spillovers

to develop, they do not guarantee that spillovers will occur (Saliola and Zanfei, 2009).

Restructuring of the supplier industry has significantly reduced the number of

suppliers (Sadler, 1999). Domestic suppliers who survived the restructuring and

consolidation of the supplier industry have become predominantly concentrated in the

lowest tiers of the supplier hierarchy (Barnes and Kaplinsky, 2000; Sturgeon and Lester,

2004). Typically, there are only very few Tier 1 domestic suppliers, if any at all, in less

developed countries (Pavlı

nek and Jana

k, 2007). The number of domestic Tier 2

suppliers has also diminished as these were often taken over by foreign firms during

their internationalization drive (Humphrey, 2000, 2003; Sturgeon and Lester, 2004).

Although the performance of domestic suppliers tends to improve with their integration

into GPNs (UNCTAD, 2001), they usually lack the necessary size and resources to

engage in product and process innovation at the scale required by lead firms (Aller

et al., 1999; Pavlı

nek, 2012b). Therefore, they tend to specialize in the supply of simple

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standardized components. Their incorporation into automotive GPNs is based mainly

on their low-production costs. In such cases, there may be little or no knowledge

transfer from foreign to domestic firms even if the domestic firms supply large volumes

of components and materials to foreign firms (Saliola and Zanfei, 2009). In many less

developed countries, domestic suppliers lack basic capabilities, such as process and

project management capabilities or know-how and engineering capabilities that limit

their integration into automotive supplier networks (Lockstrom et al., 2011). In such a

situation, even a long-term presence of foreign firms in host countries may not lead to

the increase in linkages with domestic firms (Saliola and Zanfei, 2009).

The continuous cost-cutting pressure and the emphasis on product quality through-

out automotive GPNs stimulate process and product upgrading among suppliers

(Humphrey and Schmitz, 2002, 2004). As long as domestic suppliers participate in

GPNs, these cost-cutting and quality demands are favorable for the development of

vertical spillovers since foreign firms might be willing to help their domestic suppliers

achieve desired quality and price of supplied components through sharing some of their

broadly defined technology. Spillovers may improve the position of domestic firms in

automotive GPNs. More capable and competitive domestic firms could help decrease

the dependence of the automotive industry on foreign capital in less developed

countries. They can also increase their value creation, enhancement, and capture that

are crucial for regional development (Henderson et al., 2002; Coe et al., 2004).

Ultimately, this may help enhance the competitive position of the entire economy in the

international division of labor. However, the increasing globalization of the automotive

industry has led to a decreasing role of domestic suppliers in automotive production

networks (Barnes and Kaplinsky, 2000; Humphrey and Salerno, 2000; Humphrey,

2000, 2003; Humphrey and Memedovic, 2003). Consequently, the potential for vertical

spillovers has tended to diminish in host economies.

Still, it is difficult to make any general conclusions about automotive suppliers in less

developed countries since the nature of the automotive industry and the related

opportunities for domestic suppliers depend on a number of different factors, including

market size, institutional factors and the distance from developed country markets

(Sturgeon and Van Biesebroeck, 2011). However, we think it is safe to conclude that the

recent changes in the organization and functioning of automotive GPNs have been

unfavorable for the integration of domestic suppliers into these networks. Domestic

suppliers tended to be increasingly excluded from the existing GPNs or were unable to

integrate in cases of newly developed supplier networks. Such a situation tends to

weaken backward linkages between foreign firms and domestic suppliers and

undermines the potential for spillovers. On a more general level, it has been argued

that changes in the sourcing strategies of automotive TNCs tended to undermine

engineering and design capabilities of less-developed countries (Humphrey, 2000, 2003).

To investigate these issues in a specific context, we will turn to the analysis of FDI,

linkages and spillovers in the Czech automotive industry.

4. FDI effects in the Czech automotive industry

In this section, we argue that large inflows of FDI into the Czech automotive industry

in the 1990s and 2000s resulted in strong productivity spillovers but not necessarily in

technology spillovers from foreign to domestic firms. We contend that the position of

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firms in automotive GVCs and GPNs affects the development of spillovers from foreign

to domestic firms.

Our previous work on FDI in the Czech automotive industry, and in East–Central

Europe as a whole, highlighted the crucial role of FDI in its post-1990 restructuring

(e.g. Pavlı

nek, 2002a, 2002b, 2002c) and upgrading (Pavlı

nek et al., 2009; Pavlı

nek and

enka, 2011; Pavlı

nek, 2012b). As of 2012, foreign investors invested more than EUR 8

billion in the narrowly defined Czech automotive industry (NACE 29) making it,

together with the real estate sector, the third largest recipient of FDI in Czechia after

the banking industry and the wholesale–retail industry (CNB, 2012). By 2008, there

were 225 foreign automotive firms employing 135,827 workers in the broadly defined

automotive industry.

Foreign firms dominate the sector, accounting for more than

90% of turnover, value-added, profit, income taxes, tangible assets and R&D

expenditures (Table 1).

The post 1990 economic liberalization and subsequent FDI exposed domestic firms

to foreign competition, which introduced much higher standards for the quality of

supplied components, quality-management practices, and the timing of delivery

(Pavlı

nek, 2002b, 2003). To quickly achieve new standards, Volkswagen (VW)

organized the restructuring of the supplier base of its newly acquired Czech assembler

koda Auto through follow sourcing and upgrading its domestic suppliers in the early

1990s. S

koda Auto actively encouraged foreign takeovers of its pre-1991 domestic

suppliers to transfer foreign technology from foreign (mostly VW’s) suppliers. By 2005,

94 joint ventures had been established between S

koda Auto’s domestic and foreign

suppliers in Czechia and Slovakia (the vast majority of them in Czechia) and foreign

suppliers built 58 new factories to supply S

koda Auto (Pavlı

nek, 2008). Mergers,

acquisitions and newly built foreign factories were not limited to S

koda Auto suppliers

but affected the entire Czech automotive components industry. In the process, the most

capable domestic suppliers were taken over by foreign firms. For VW, foreign

acquisitions and joint ventures represented the fastest and most efficient way of

transferring foreign technology to the Czech automotive industry. At the same time,

koda Auto educated its domestic suppliers who remained in domestic hands about the

ways of achieving new standards. All its suppliers had to undergo a quality system

certification process and pass S

koda Auto’s regular quality audits in order to continue

supplying. Automotive suppliers have to continuously upgrade their production

through better technology, more efficient work organization and management practices

in order to survive. Especially lower tier suppliers who supply simple low value-added

standardized components can be relatively easily replaced if they are unable to keep up

with the relentless competitive pressure in the automotive industry and the ongoing

price squeeze by lead firms (Ernst and Kim, 2002). Those S

koda suppliers who could

not upgrade quickly were replaced by foreign suppliers (see also De Backer and

Sleuwaegen, 2003; Pavlı

nek, 2003). About two-thirds of original pre-1989 S

koda

suppliers stopped supplying S

koda Auto in the 1990s (Pavlı

nek, 2008).

Although horizontal spillovers were especially negative for the domestic firms that

were forced to exit the automotive industry, the exit of uncompetitive domestic firms

1 In addition to NACE 29 firms, the broadly defined automotive industry includes firms from other

industrial sectors that are involved in the automotive value chain, such as suppliers from the plastic

industry, rubber industry, electrical equipment, and iron and steel industry.

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was a necessary part of the restructuring and upgrading of the domestic automotive

industry that increased its overall competitiveness and without which it could not have

survived in the long run. Crowding out effects of FDI in the Czech automotive industry

also need to be understood in the context of changes in the global automotive industry

that tended to marginalize domestic suppliers in automotive GPNs (Barnes and

Kaplinsky, 2000; Humphrey, 2000, 2003). Those few domestic suppliers in the narrowly

defined automotive industry, who survived strong crowding out effects of FDI in the

1990s, benefitted from the rapidly growing automotive production in Czechia and also

from exports. In addition to the crowding out of domestic firms, FDI thus strongly

encouraged process and product upgrading of those who survived through productivity

spillovers (Pavlı

nek and Z

enka, 2011) and indirect spillovers in the form of increased

requirements and competition from foreign firms. However, it does not necessarily

mean that technological knowledge has been transferred along with the productivity

spillovers (Hatani, 2009). We will address this issue in the empirical analysis of

spillovers in the Czech automotive industry.

During the 2008–2009 economic crisis, lower-tier suppliers (both domestic and for-

eign) were further squeezed by assemblers and forced to lower their prices by 10–20%

(interview 8 July 2011). Consequently, 15 suppliers went bankrupt or closed their

automotive plants in Czechia and four plants were relocated abroad during, and

immediately after, the economic crisis (Pavlı

nek, 2012a). These enormous price

pressures contribute to process upgrading but make it extremely difficult for

automotive suppliers to engage in functional upgrading (Pavlı

nek and Z

enka, 2011).

The economic crisis thus contributed to the further marginalization of domestic

suppliers in the automotive supply chain.

These crowding out effects of FDI need to be understood in the context of trade and

FDI liberalization and institutional changes related to the political–economic

transformation of the 1990s (see Pavlı

nek, 2002b; Drahokoupil, 2009). Government

policies affected potential spillovers from foreign to domestic firms especially in the

early 1990s. During the negotiations of the terms of joint venture between S

koda and

VW in 1991, the government openly supported the development of linkages between

foreign and domestic firms by securing the temporary protection of S

koda’s domestic

Table 1. Basic indicators of the domestic and foreign firms in the broadly defined Czech automotive

industry, 2008

Domestic Foreign Domestic (%) Foreign (%)

Number of firms 250 225 52.6 47.4

Employment 37,125 135,827 21.5 78.5

Turnover (billion CZK) 62.3 730.0 7.9 92.1

Value-added (billion CZK) 15.4 144.8 9.6 90.4

Profit (billion CZK) 0.7 22.8 3.0 97.0

Wages (billion CZK) 8.7 60.1 12.7 87.3

Income taxes (billion CZK) 0.8 7.4 9.2 90.8

Tangible assets (billion CZK) 16.3 193.2 7.8 92.2

R&D expenditures (billion CZK)

0.6 9.0 6.1 93.9

Notes: Includes firms with more than 20 employees, financial indicators are in constant prices,

2007 data.

Source: Authors’ calculations based on various databases.

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suppliers. After S

koda’s takeover, existing domestic suppliers were granted a transition

period during which they continued to supply S

koda but had to gradually achieve VW’s

quality standards (Pavlı

nek, 2008). Between 1992 and 1998, however, the government

failed to openly support the development of linkages between foreign and domestic

firms. In the absence of an explicit industrial policy, the government FDI policies were

either completely absent (1992–1997) or limited to the indiscriminate attraction of FDI

(1998–2001) (Pavlı

nek and Z

enka, 2011). After 2000, the government began promoting

linkages between foreign and domestic firms and links between firms (both domestic

and foreign) and universities. Since 1999, CzechInvest, the state investment promotion

agency, has operated the ‘Supplier Development Program’ in order to foster links

between foreign and domestic firms and attract more foreign investors in the Czech

automotive industry. It consists of the provision of a database of Czech-based (both

domestic and foreign) automotive suppliers, including a list of their products and

capabilities; the arrangement of links between Czech-based suppliers and incoming

foreign investors; and the identification of potential domestic firms suitable for mergers

and acquisition (CzechInvest, 2014). Between 2002 and 2013, the government together

with the EU spent EUR 42.5m to support the formation and operation of about 60

regional cluster organizations in various industries. These clusters had to have at least

15 members, 60% of them small- and medium-size enterprises, and had to include a

university and/or research institute. The Moravia-Silesia automotive cluster is the only

cluster formed in the automotive industry. It supports innovation activities, competi-

tiveness and export capabilities of its 62 members (domestic and foreign firms,

engineering service providers, universities, technical high schools and a regional

development association of producers), through inter-firm cooperation and close links

to state and regional institutions (MIT and CzechInvest, 2013). Our survey of 274

automotive firms revealed that only 29% of them were actively involved in some form

of cooperation with other stakeholders, such as organized partnerships or clusters. The

poor participation of automotive firms has thus limited the potential benefits of these

programs in the Czech automotive industry.

5. Backward linkages between foreign firms and domestic suppliers

Our analysis of spillovers in the Czech automotive industry is based on detailed firm-

level data collected through personal interviews with senior managers of selected

automotive firms and a survey of Czech-based automotive firms. We have drawn on a

database of 490 Czech-based automotive firms with 20 or more employees in the

broadly defined automotive industry (CSO, 2009) to conduct a survey in 2009, which

yielded a response rate of 65% (317 firms). The survey provided firm-level data about

linkages between domestic and foreign suppliers in Czechia. The interviews with 100

foreign and domestic automotive firms were carried out by the authors between

December 2009 and August 2011 (Table 2). The interviews, in which foreign and

domestic firms were targeted with different questions, collected more detailed

information about spillovers than the survey and are, therefore, the main source of

data for our analysis presented here. A large number of surveyed and interviewed firms

at different positions of the automotive value chain yielded a highly representative

sample. In-depth interviews allowed us to investigate factors behind spillovers and

mechanisms through which they occur. Therefore, in addition to the identification of

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different types of spillovers, our qualitative data allowed us to examine their

consequences for technological, organizational and strategic competences of domestic

suppliers and explain why only certain domestic suppliers have been able to benefit

from spillovers. We have classified Czech-based suppliers into tiers based on the

sophistication and value-added of supplied components while ignoring their degree of

internationalization and their size as criteria for their classification. As opposed to some

recent studies (e.g. Giroud et al., 2012), we differentiate between Czech-based foreign

firms and domestic firms and analyze their supplier linkages to evaluate the effects of

FDI on domestic firms. This distinction is very important since, as we have already

shown, foreign firms and domestic firms play very different roles in contemporary

automotive supplier networks because of the widespread use of follow sourcing by lead

firms.

We have argued that the development of vertical spillovers depends on the existence

and intensity of linkages between foreign and domestic firms. Therefore, the starting

point of our empirical analysis is the evaluation of linkages between foreign and

domestic firms. Czech-based foreign firms were asked during interviews to estimate to

what extent they source components and materials from domestic firms, other Czech-

based foreign firms and from abroad. We want to emphasize that these figures are

based on qualified estimates of respondents rather than the precise data. In most cases,

firms do not differentiate among Czech-based suppliers according to their ownership

structure. Still, we believe that these qualified estimates are an important source of

information about the extent of linkages between domestic and foreign firms. The

results, which are summarized in Table 3, show a low share of parts and components

sourced from domestic suppliers (13.5%) and a high share sourced from abroad

(76.0%). Overall, Czech-based foreign firms sourced 86.5% of their total supplies from

other foreign firms supplying both from abroad and from Czechia. This relatively low

share of domestic suppliers of the total supplies to Czech-based foreign firms is also

supported by the survey data. Out of 146 surveyed foreign firms, 98 (67.1%) reported

Table 2. Basic characteristics of the interviewed and surveyed firms compared to the

total database

Interviewed firms Surveyed firms Total database

Total number of firms 100 317 490

Domestic firms 38 162 228

Foreign firms 62 155 262

Assemblers 6 7 8

Tier 1 19 42 52

Tier 2 32 102 149

Tier 3 43 166 281

Small size 8 41 51

Medium size 33 143 233

Large size 59 133 206

Average size 1,056 488 364

Note: Size categories of firms: small firms less than 50 employees, medium-size firms

50–250 employees, large firms more than 250 employees.

Source: Authors’ 2009 survey and 2009–2011 interviews, CSO (2009).

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the share of supplies from domestic firms to be less than 25%. Only 21 foreign firms

(14.4%) estimated that more than 50% of their total supplies were sourced from

domestic suppliers, while almost two-thirds (94 firms) were sourcing more than 50% of

their total supplies from abroad (Table 4).

However, 40% (25) of interviewed foreign firms, all of them greenfield investors,

reported that the share of domestic suppliers in their total supplies increased since their

investment, and 35% (22) reported an increase in supplies from Czech-based foreign

firms. This would support the arguments about the gradual development of linkages

between foreign and domestic firms and the increasing embeddedness of foreign

investors in host economies with time (e.g. Dunning and Lundan, 2008; Dicken, 2011).

At the same time, however, seven large formerly domestic firms that were taken over by

foreign investors, including assemblers such as S

koda Auto, Avia and Tatra, reported a

significant decrease in the share of domestic suppliers of their total volume of supplies.

This decrease reflects their integration into GPNs after their foreign takeovers and the

importance of centralized sourcing strategies of TNCs. In the process, many traditional

domestic suppliers were replaced with the established foreign suppliers of their new

foreign owners. In some cases, production increases following the foreign takeover

required increases in supplies that undercapitalized small- and medium-sized domestic

suppliers were unable to meet. Consequently, their overall share of supplies decreased,

or they were replaced by foreign suppliers.

The share of domestic suppliers also

decreased because many of them were taken over by foreign firms and, with the change

of ownership, became foreign suppliers.

According to our data, foreign Tier 3 suppliers account for 44% of all foreign

automotive suppliers located in Czechia. A low share of supplies sourced by foreign

Tier 3 firms from domestic suppliers underscores the fact that their assembly operations

of simple standardized components were most often set up to exploit lower-labor costs

in Czechia, rather than to tap into the local manufacturing expertise. Since simple

standardized components are not usually supplied in a just-in-time regime, the

Table 3. The average share of the total volume of automotive supplies sourced by

Czech-based foreign firms (in %)

Number of firms Per cent share of total supplies from

Domestic firms Czech-based

foreign firms

Abroad

Total 62 12.6 10.9 76.5

Tier 1 14 13.7 10.8 75.5

Tier 2 21 15.4 7.7 76.9

Tier 3 22 7.0 7.9 85.1

Assemblers 5 20.0 32.0 48.0

Source: Authors’ 2009–2011 interviews.

2 13.5% of the interviewed domestic firms lost their former domestic customers after these were taken over

by foreign firms (2009–2011 interviews).

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proximity of Tier 3 suppliers to assembly operations in Western Europe is less

important than low-production costs (Frigant and Lung, 2002; Pavlı

nek and Jana

2007; Klier and Rubenstein, 2008). The majority of parts and components for foreign

Tier 3 suppliers are now supplied from low-cost countries, particularly China and India,

where production costs are significantly lower than in Czechia. As a result, foreign Tier

3 suppliers tend to have only tenuous, if any, linkages with domestic automotive firms

(Table 3). At the same time, the main reason behind a low share of domestic suppliers in

supplying Tier 1 foreign firms is the relative lack of domestic firms capable of supplying

more sophisticated, high-quality components at the price and quantity required by Tier

1 firms (2009–2011 interviews). A small average size of domestic automotive firms (149

workers) compared to foreign firms (604 workers) in 2008 (Table 1) makes it difficult

for domestic suppliers to produce components and parts in volumes required by high-

volume assemblers and Tier 1 suppliers. As a result, the majority of these components

are also supplied from abroad and by Czech-based foreign suppliers (Table 3). At least

theoretically, therefore, domestic firms should be in the best position to supply foreign

Tier 2 suppliers. However, even in this case, domestic suppliers do not account for a

significantly higher share of supplies of foreign firms as they have had increasing

difficulties to compete with imports from both lower-cost and more developed

countries. A director of a Tier 2 domestic supplier argued in 2011:

Our prices always keep on going down. What cost 10 euros ten years ago costs 4 euros now.

However, the greatest decrease was in the past three years during the economic crisis when we

got really squeezed by assemblers. More or less, we were included in global sourcing together

with the Chinese and Indians, and assemblers squeezed everything out of us that was left

(interview, July 8, 2011).

Additional reasons for a low share of domestic supplies to foreign firms are suggested in

Table 5. According to foreign suppliers, the most important advantages of domestic

suppliers include their geographic proximity, flexibility and low prices. At the same

time, the lower quality of their products, together with their smaller size, lower

reliability and less competitive prices compared to foreign suppliers are considered to be

their most important disadvantages. Suppliers from more developed countries often

supply higher quality components at competitive prices despite higher labor costs

Table 4. The distribution of the total volume of automotive supplies sourced by Czech-based foreign firms

Share of supplies Domestic firms Czech-based foreign firms Foreign firms

(%) Number of firms (%) Number of firms (%) Number of firms (%)

0 22 15.1 49 33.6 13 8.9

1–24 76 52.1 54 37.0 17 11.6

25–49 27 18.5 28 19.2 22 15.1

50–74 17 11.6 10 6.8 40 27.4

75–99 2 1.4 3 2.1 49 33.6

100 2 1.4 2 1.4 5 3.4

Total 146 100.0 146 100.0 146 100.0

Source: Authors’ 2009 survey.

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because of their use of advanced technologies and more efficient, less labor intensive

production processes compared to domestic firms.

According to Czech-based foreign firms, the two most important reasons for a low

share of supplies sourced from domestic suppliers are the unavailability of particular

parts, components and materials in Czechia and the centralized sourcing by foreign lead

firms (Table 6). This means that Czech-based foreign firms have no or very limited

influence on where their most important supplies are sourced from. When they have a

choice, they choose suppliers that meet their price, quality and quantity requirements.

The majority of interviewed managers argued that whether suppliers were foreign or

domestic was not an important selection criterion. Tier 3 foreign firms are most affected

by centralized sourcing and, therefore, have the weakest linkages with domestic firms

(compare with Table 3). Even if domestic suppliers are competitive, because of their

small or medium size, they are often unable to meet the requirement of centralized

sourcing to supply the entire production network of a particular foreign firm. For Tier 1

suppliers, the most important reason for sourcing supplies abroad is their unavailability

in Czechia. Examples include electronic components or parts made of advanced plastic

materials.

Technology spillovers from foreign to domestic firms should potentially contribute to

process and product upgrading of domestic firms which, over time, should be reflected

in the gradually increasing quality and sophistication of supplied components by

domestic firms. How did linkages between foreign and domestic firms influence

domestic firms from the point of view of foreign firms? More than two-thirds of foreign

firms argued that their requirements on domestic suppliers were higher than the Czech-

industry standards at the beginning of their supplier relationship, especially in terms of

quality of supplied parts and components. In 60% of the cases, domestic suppliers were

asked to meet specific requirements before they could start supplying foreign firms,

especially to undergo technology audits and obtain quality certificates (Table 7).

Approximately half of the respondents argued that both the quality (25 responses) and

the sophistication (29 responses) of parts and components supplied by domestic

suppliers increased over years in response to the increased quality and sophistication

requirements of their customers. This empirical evidence points to strong productivity

Table 5. Strengths and weaknesses of domestic firms according to Czech-based foreign firms

Strengths No. of firms (%) Weaknesses No. of firms (%)

Geographic proximity 25 59.5 Product quality 16 39.0

Flexibility 20 47.6 Size 8 19.5

Product prices 12 28.6 Reliability 8 19.5

Communication 5 11.9 Product prices 8 19.5

Transportation costs 3 7.1 Instability 4 9.8

Product quality, know-how 3 7.1 Managerial skills 3 7.3

Technology 3 7.3

Financial resources 2 4.9

Productivity 2 4.9

Notes: 42 foreign firms listed at least one strength and 41 foreign firms listed at least one weakness of

domestic firms. Each firm could list more than one strength and weakness of domestic firms.

Source: 2009–2011 interviews.

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spillovers especially at the beginning of supplier relationships between foreign and

domestic firms. However, according to foreign firms, no domestic suppliers have

upgraded to the extent that would allow them to improve their position in the supplier

hierarchy. Not surprisingly, 59% of foreign firms argued that foreign suppliers supply

more sophisticated and complex products than domestic suppliers.

The analysis of foreign firms has revealed their limited linkages with domestic firms.

While these data suggest that domestic firms only play a marginal role in supplying

Czech-based foreign firms, it does not mean that most domestic automotive firms do

not supply foreign firms. The low share of domestic suppliers in supplying Czech-based

foreign firms corresponds with their low share of the total turnover, value-added and

Table 7. Requirements on domestic suppliers by Czech-based foreign firms

Yes No

(%) (%)

Higher requirements on domestic suppliers than was the domestic

industry standard at the beginning of the supply relationship

in terms of:

38 67.9 18 32.1

Quality of parts/components 29 51.8

Production technology 15 26.8

Timing of delivery 8 14.3

Domestic suppliers asked to meet specific requirements before they

could start supplying

35 60.3 23 39.7

Quality certificate 19 32.8

Technology audit 18 31.0

Increase in parts/components quality 14 24.1

New production technologies 6 10.3

New machinery 2 3.4

Notes: a: only at the beginning of investment. These were standard requirements in the automotive industry

abroad. Each firm could list more than one from the list of requirements.

Source: 2009–2011 interviews.

Table 6. Reasons for sourcing supplies from abroad by Czech-based foreign firms

Centralized sourcing Unavailability in Czechia Low quality in Czechia Total firms

(%) (%) (%)

Total 40 64.5 40 64.5 25 40.3 62

Assemblers 4 80.0 4 80.0 2 40.0 5

Tier 1 8 57.1 11 78.6 5 35.7 14

Tier 2 11 52.4 12 57.1 9 42.9 21

Tier 3 17 77.3 13 59.1 9 40.9 22

Note: Each firm could list more than one reason for sourcing supplies from abroad.

Source: 2009–2011 interviews.

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other financial indicators of the Czech automotive industry (Table 1). Both the survey

and company interviews show that the vast majority of domestic automotive firms are

involved in supplier linkages with foreign firms. 92% of the interviewed domestic

companies supply foreign firms. Therefore, we need to turn to domestic firms for a

better understanding of the nature of linkages between foreign and domestic firms and

their consequences for spillovers.

6. Spillovers and FDI effects on domestic firms

In the next step, we have analyzed interviews with 37 domestic firms about their

linkages with foreign firms and spillovers. Our sample included 20 firms that existed

during the centrally planned economy before 1990 and 17 firms that were established

after 1990. Five firms were small (less than 50 employees), 20 were medium-sized (50–

250 employees), and 12 were large (more than 250 employees). More than half (21 firms,

57%) where classified as Tier 3 suppliers, 11 (30%) were Tier 2 firms, 4 (11%) were Tier

1 firms and there was also one small assembler of buses. Generally, higher-tier suppliers

are in a better position to benefit from linkages than lower-tier suppliers (UNCTAD,

2001). Our interview questions were designed to identify horizontal and vertical

spillovers based on direct and indirect relationships between foreign and domestic firms.

Overall, 49% of interviewed domestic firms argued that they were positively affected

by the entry and operation of foreign firms in the Czech automotive industry, while

19% believed that they were affected negatively and 38% of firms believed that the

entry of foreign firms had no effect on them at all. Increased sales, because of new

customers among Czech-based foreign firms, was by far the most important positive

effect of foreign firms on domestic firms, cited by 70% of domestic firms. In several

cases, domestic firms were established to take advantage of the increased demand for

parts and components generated by the entry of foreign firms. The increased

competition for workers in the local labor market was the most important negative

effect of foreign firms on domestic firms cited by 46% of interviewed domestic firms.

Only about one-third of domestic firms were negatively affected by product competition

from Czech-based foreign firms (Table 8).

Less than half of the interviewed domestic firms were affected by technology

spillovers (Table 9). The most important technology spillovers included learning about

new technology, new methods of quality management and new organizational and

management methods. Domestic firms could experience these spillovers either directly

or indirectly. Direct effects refer to the direct active help of foreign firms to domestic

firms. Examples include a foreign firm providing production technology to a domestic

firm or training managers of domestic firms in quality management. Indirect

(demonstration) effects refer to a situation in which domestic firms learned about

new technology indirectly from foreign firms, for example, through observation during

visits of foreign firms. Indirect spillovers, especially in the form of demonstration

effects, played much more important role than direct effects. Technology transfer

through workers previously employed by foreign firms affected only 16% of the

interviewed domestic firms (Table 9).

Overall, one-third of the interviewed domestic firms experienced some direct

spillovers from foreign firms, suggesting the limited significance of direct spillovers

for domestic firms (Table 10). Direct spillovers took place especially in those cases when

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Table 10. Direct spillovers from foreign to domestic firms in the Czech automotive industry

No. of firms (%)

Quality certificates advise 5 13.5

Management training 4 10.8

Provision of technology (license, sale, etc.) 4 10.8

Blue-collar workers training 3 8.1

Production organization advise 3 8.1

Production inputs 2 5.4

Suppliers connections 2 5.4

Domestic firms with direct spillovers 12 32.4

Note: N ¼ 37.

Source: 2009–2011 interviews.

Table 8. General effects of the entry and operation of foreign firms in the Czech automotive industry on

domestic firms according to domestic firms

General FDI effects Yes (%) No (%)

New customers among foreign firms 26 70.3 11 29.7

Increased competition in the labor market 17 45.9 16 43.2

Increased direct (product) competition 12 32.4 25 67.6

Decreased share of the domestic market 6 16.2 25 67.6

Note: N ¼ 37. Not all interviewed firms answered all questions.

Source: 2009–2011 interviews.

Table 9. Technology spillovers from foreign to domestic firms in the Czech automotive industry

No. of

firms

(%) Indirect

effect

(%) Direct

effect

(%)

Learning about new technology 16 43.2 15 40.5 4 10.8

Learning about new quality management

systems

14 37.8 12 32.4 2 5.4

Learning about new organizational and

management methods

12 32.4 10 27.0 4 10.8

Access to new components/parts 10 27.0 9 24.3 2 5.4

Technology transfer through workers

previously employed by foreign firms

6 16.2

Learning about new marketing methods 2 5.4 1 2.7 1 2.7

Firms affected by technology spillovers 17 45.9

Note: N ¼ 37. Each firm could be affected by both indirect and direct effects.

Source: 2009–2011 interviews.

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foreign firms were interested in sourcing components and parts from domestic firms

and domestic firms needed help to achieve the required quality and efficiency of

production. These requirements significantly affected domestic firms because 62% of

the interviewed domestic firms had to meet such specific requirements before they could

start supplying foreign firms. These prerequisites were important especially in the early

and mid-1990s when the linkages between domestic and foreign firms began to form

and when domestic firms had no prior experience with supplying foreign firms. The

most frequent requirement of foreign firms, before entering into the supply relationship

with domestic firms, was the possession of an international quality certificate and

technological audits (30% of domestic firms). Other requirements, together listed by

32% of domestic firms, included demands to improve the quality of particular parts or

components, timing of deliveries and lowering their prices.

The most important negative spillovers experienced by domestic firms were related to

increased competition on the local labor market because of the entry of foreign firms.

These include the loss of workers because of poaching by foreign firms (40.5% of the

interviewed domestic firms), followed by the necessity to increase wages in order to keep

up with foreign firms and stay competitive in the labor market (24.3%). These negative

spillovers are place specific and are strongly affected by the distance decay effect

within particular clusters of automotive production. Additionally, 13.5% of the

interviewed domestic firms were negatively affected by the loss of supplier contracts

due to the takeover of former Czech customers by foreign firms. No domestic firm

reported a worsened access to credit because of the presence of foreign firms, and 27%

of the interviewed domestic firms did not experience any negative spillovers from

foreign firms.

6.1. Absorptive capacity of domestic firms

How can we explain the limited significance of technology and direct spillovers from

foreign to domestic firms in the Czech automotive industry? One possible explanation is

the low absorptive capacity of domestic firms (Carrillo et al., 2004). Although

absorptive capacity is a ‘fuzzy concept’ which cannot be empirically measured directly,

we use R&D employment of domestic firms and their cooperation with universities and

public research institutes as proxy measures to evaluate their absorptive capacity

(Humphrey and Oeter, 2000). The R&D employment in domestic automotive firms

increased from 292 in 1997 to 585 in 2007 and their R&D expenditures grew by 158%,

suggesting an increasing absorptive capacity of domestic automotive firms (CSO, 2009).

However, a closer look at the data reveals that out of 250 domestic firms in the broadly

defined automotive industry only 69 (28%) employed any R&D workers, 38 (15%)

employed more than 3 R&D workers and 14 (6%) employed more than 10 in 2007

(CSO, 2009). The fact that almost three-fourths (72%) of domestic automotive firms

employed no R&D workers suggests their low absorptive capacity (see also Pavlı

nek,

2012b).

Out of 37 interviewed domestic firms, 18 (49%) employed R&D workers and an

additional 6 (16%) reported workers in design and engineering, 14 (38%) employed

three or more R&D workers and 7 (19%) employed 10 or more. The fact, that 35% of

the interviewed domestic firms did not employ any R&D workers and an additional

27% employed only one or two suggests a low-absorptive capacity of the majority of

domestic firms. The information collected during interviews also revealed that a

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majority of the domestic firms had no links with universities and public research

institutes. Ten of the 37 interviewed domestic firms (27%) cooperated with Czech

universities on R&D activities in the form of joint R&D projects, product testing and

measurements, and by supporting selected university students in an effort to recruit

them. Only one interviewed domestic supplier cooperated with a public research

institute on joint research projects supported by national R&D programs. The interview

data were further supported by the information collected by the survey according to

which 19% (31 of 163) surveyed domestic automotive firms were engaged in some form

of R&D cooperation with universities. We argue that the low-absorptive capacity of the

majority of domestic firms contributes to limited spillovers from foreign to domestic

firms and that differences in absorptive capacity contribute to differences in abilities of

domestic firms to benefit from potential spillovers from foreign firms.

6.2. Classification of domestic suppliers based on spillovers

In our approach, we combine both the experience of foreign firms with domestic

suppliers and the experience of domestic suppliers with foreign firms to investigate

spillovers from foreign to domestic firms. Our field work suggests that domestic

suppliers are a highly variegated group of firms with different capabilities and a

different absorptive capacity whose relationships with foreign firms vary as well as their

abilities to benefit from potential spillovers (see also Kohli, 2004; Sturgeon and Van

Biesebroeck, 2009; Klier and Rubenstein, 2010). During our interviews, we could clearly

see that some suppliers have been able to benefit from spillovers while others have not.

Therefore, treating domestic automotive firms as a homogeneous group obscures the

complex reality and may lead to generalizations that do not necessarily apply to a

significant number of domestic firms. To address this problem, we have categorized

domestic firms into four distinct groups based on our interview data about spillovers

from foreign firms. These four categories are related to the type of product, the firm’s

position in the GPN, production and R&D capabilities, and spillover effects (Table 11).

The table suggests that there are only a few (11%) domestic Tier 2 and Tier 1

innovation-oriented and relatively highly capable suppliers (Category 3), including

domestic engineering service providers. These firms have a high-absorptive capacity and

are, therefore, able to benefit from spillovers. All domestic firms classified in this

category were affected by horizontal spillovers, especially through demonstration effects

in terms of learning about new management systems and new technology, access to new

technology, and through increased market opportunities provided by Czech-based

foreign subsidiaries and through exports. Supplier linkages played an important role in

transferring information and knowledge from foreign firms about quality requirements

and new delivery systems. The majority of these domestic firms have begun to

internationalize their production by setting up subsidiaries abroad. For example,

according to the director of a large domestic supplier (2300 workers) of door and cockpit

systems, R&D is its most important source of competitiveness. In 2011, it employed 150

R&D workers. Since the early 1990s, the company has learned ‘everything’ from foreign

firms through supplier linkages, although it did not receive any direct technical,

management, financial or procurement assistance from foreign firms. Its turnover

increased ten times between 1990 and 2011. Today, it supplies all of the major assemblers

with the exception of Nissan and Hyundai/Kia. It is one of the very few domestic

suppliers that have tentatively begun to internationalize by setting up small subsidiaries

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Table 11. Categorization of domestic firms based on spillover effects in the Czech automotive industry

Category 1 (N ¼ 10, 27%) Category 2 (N ¼ 21, 56.8%) Category 3 (N ¼ 4, 10.8%) Category 4 (N ¼ 2, 5.4%)

Type of product Standardized, simple, low value-

added parts based on detailed

customer specifications (e.g. cast-

ings), products designed by

customers

Higher value-added and more

complex products/components

that may be partly based on in-

house development (e.g. bearings,

engine components, bus and truck

chassis)

Final parts/components based on

in house know-how and R&D

Final parts/ components that

may be based on in-house

know-how and R&D

Position in GPN Captive Tier 3 suppliers Tier 3 and Tier 2 suppliers Tier 2 and Tier 1 suppliers Tier 2 and Tier 3 suppliers

R&D activities and

absorptive capacity

None or only technical support of

production and/or simple tech-

nical construction

Mostly technical development and

engineering focused on incremen-

tal process and product

development

Development of new products,

material development, engineer-

ing, process innovation

Product development, produc-

tion process development

Firms with R&D workers: 20% Firms with R&D workers: 48% Firms with R&D workers: 100% Firms with R&D workers:

50%

College-educated workers: 5.2% College-educated workers: 16.0% College-educated workers: 21.9% College-educated workers:

10.7%

Capabilities Operational Duplicative Adaptive and innovative Duplicative

 Basic manufacturing skills

 Quality control

 Maintenance and procure-

ment capacity

 Expansion of production

through investment

 Purchase and use of external

technologies

 Adaptation and improvement

of external technologies

 Development of new tech-

nical, engineering and design

skills

 New products and processes

developed through formal

R&D activities

 Expansion of production

through investment

 Purchase and use of ex-

ternal technologies

(continued)

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Table 11. Continued

Category 1 (N ¼ 10, 27%) Category 2 (N ¼ 21, 56.8%) Category 3 (N ¼ 4, 10.8%) Category 4 (N ¼ 2, 5.4%)

Spillover effects Passing by Enhancement Interactive Negative

Only a potential for spillovers

through:

Mixture of different spillovers

through:

Prevalence of demonstration/

indirect spillovers through:

Predominantly negative direct

spillovers through:

 Demonstration effects:

access to new technology

and quality control

 Direct effects through

purchasing/leasing

technology

 Demonstration effects: access

to new technology,

organizational, management

and marketing methods;

references

 Direct effects: management

training, support in search

for new suppliers

 Pressure put on quality,

delivery and in-house

development

 Co-design with customers

 Direct competition

 Employee poaching

Complementarity and coupling

between the supplier and oppor-

tunities provided by links with

foreign investors and the integra-

tion into GPNs

Missing endogenous competencies

and absorptive capacity to fully

benefit from the inclusion in

GPNs. Supplier assets and cap-

abilities do not match the needs of

TNCs.

Source: The authors

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in Russia, China and South Africa. It is also one of the very few domestic companies

that, according to its director, improved its position in the supplier hierarchy from Tier 3

to Tier 2 in the past 20 years (interviews on 24 June 2005 and 8 August 2011).

A small group of capable domestic firms (5%; Category 4) has been strongly affected

by negative direct horizontal spillovers, especially in terms of employee poaching and

direct product competition. Still, these firms have survived FDI’s crowding out effects

by switching to new products and new markets. For example, a domestic supplier of

fuel injectors for diesel engines has been negatively affected by a foreign Tier 1 firm that

set up three subsidiaries to produce fuel injection systems in the same town in order to

tap into the domestic firm’s skilled labor force and low-labor costs in the 1990s. Its

three subsidiaries were generously supported by government investment incentives for

every newly created job and by tax holidays. They actively recruited workers of the

domestic firm by offering higher wages and openly preferring them to other job

applicants. By 2005, they were employing about 5000 workers in the region. Out of

these, about 3000 workers were trained by and formerly worked at the domestic firm.

The domestic firm lost its most qualified and skilled workers despite substantially

increasing wages. It also lost its market share to its foreign competitor and was forced

to completely abandon supplying the automotive industry. In order to survive, it has

specialized in the production of injection pumps and fuel injection systems for

agricultural and construction machinery. Its employment dropped from 6000 workers

in 1989 to 1900 in 2011 and the number of R&D workers declined from 92 to 25

between 1995 and 2011. R&D capabilities and the related absorptive capacity of the

domestic firm were crucial in switching to new products and new markets (interviews on

11 July 2005 and 11 April 2011).

About one-fourth (27%) of the interviewed domestic suppliers (Category 1) is unable

to benefit from direct vertical spillovers because of their low capabilities and low

capacity to effectively absorb knowledge from foreign firms (Ernst and Kim, 2002).

These Tier 3 suppliers have low competencies that are limited to simple manufacturing

and assembly operations and they supply standardized, simple, low value-added parts

and components based on detailed customer specifications. The absence of R&D

functions in 80% of these firms and a low share of college educated workers are

important indicators of their low-absorptive capacity (Cohen and Levinthal, 1990;

Giroud et al., 2012). The low-absorptive capacity of these domestic firms prevents them

from exploiting potential direct spillovers from foreign firms which, in turn, prevents

them from narrowing their gap behind foreign firms. As a result, these domestic

suppliers experience the ‘spillover interception’ (Hatani, 2009). For example, a Czech-

based subsidiary of a foreign Tier 1 firm (AB) outsourced the low-volume production of

its older spare parts to a medium-size domestic firm which was established in 2000 and

employed 60 workers at the time of the interview. AB also helped the domestic firm to

launch the production of these spare parts by providing its old production line, helping

to organize the production, assisting with achieving the quality certificate, and by

providing the administrative support. It also helped the domestic firm to establish links

with its existing suppliers. In other words, the domestic firm benefited from the direct

knowledge transfer from AB in the form of technical assistance, the provision of various

information and administrative assistance (see Giroud et al., 2012). Consequently, its

number of employees increased 12 times, its revenues 13 times, but its value added only

2.7 times between 2000 and 2010. At the same time, however, despite this help, the

domestic supplier has failed to develop its own know-how, it has been unable to fully

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absorb the technology provided by AB and has remained strongly dependent on AB,

which buys more than 90% of its output. AB taught its domestic supplier how to use its

technology to produce spare parts but since it is too advanced for the domestic firm, it

does not fully understand its know-how and it does not engage in any R&D activities on

its own. In other words, technology has been transferred, which significantly increased

AB’s productivity (productivity spillovers), but technological knowledge has not,

indicating the absence of technology spillovers. Although the domestic firm has learned

a lot through its cooperation with AB and it has been growing, it remains a typical

captive Tier 3 supplier producing simple standardized low value-added spare parts and

remains highly dependent on AB, its key customer (interview on 25 March 2011) (see

also Gereffi et al., 2005).

Tier 3 and Tier 2 suppliers who supply various automotive parts and components

that are partly based on their in-house process and product development represent the

most numerous category of the interviewed domestic suppliers (57%; Category 2).

These suppliers have employed foreign technology and invested in the expansion of

production in order to tap into the increased demand for automotive components in

Czechia and abroad. Their higher absorptive capacity, which is also indicated by a

higher presence of R&D functions (in 48% of the firms in the category), allowed them

to benefit from various horizontal and mainly indirect vertical spillovers through

backward linkages with foreign firms and through demonstration effects. They gained a

valuable experience by supplying foreign firms which they used to win contracts to

supply other foreign firms both in Czechia and abroad. Overall, they have been able to

keep up with competition through process and product upgrading in their particular tier

but unable to improve their position in the supplier hierarchy. Some of these domestic

firms benefited from direct vertical spillovers from foreign firms. For example, a large

domestic supplier of metal castings (300 employees) received direct knowledge transfer

from foreign firms in order to meet their requirements after it was selected to supply

them. Prior to the start of the supplier relationship, foreign firms sent their experienced

process engineers to the domestic firm for up to one week to improve its production

processes in order to ensure 100% reliability of their future supplier. Although foreign

firms offered this help free of charge, any resulting savings were split between the

domestic firm and the foreign firm providing help. The domestic firm learned how to

improve the quality of its products, the reliability of its machinery and how to

streamline its production through supplier linkages with foreign firms. At the same

time, it has been actively upgrading its production processes and its products in order to

increase its competitiveness. The domestic firm designs its own machinery and it has

gradually shifted from the production of castings to work pieces and preassembled

simple modules that now account for 20% of its output (interview on 17 December

2009). However, it is important to note that such examples of direct knowledge transfer

from foreign to domestic firms have been mentioned very rarely during our interviews

(Table 10), suggesting that, overall, they do not play a very important role in the Czech

automotive industry.

7. Conclusion

Our analysis has identified diverse spillover effects from foreign to domestic firms in the

Czech automotive industry. Although econometric studies have mostly found either

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statistically insignificant or negative horizontal spillovers from foreign to domestic

firms in East–Central Europe (Djankov and Hoekman, 2000; Jarolı

m, 2000; Kinoshita,

2001; Konings, 2001; Go

rg et al., 2006), our firm-level qualitative data suggest that both

positive and negative horizontal spillovers have affected domestic firms. Negative

horizontal spillovers, especially in the form of increased competition and increased

quality requirements, led to strong crowding out effects that forced the majority of

domestic firms to be either acquired or form joint ventures with foreign firms or exit the

automotive industry in the 1990s. The domestic firms that survived these challenges

benefited from positive horizontal spillovers, especially from demonstration effects,

imitation and increased access to both domestic and international markets to upgrade

their products and processes and become integrated in automotive GPNs. This suggests

that negative horizontal spillovers played the most important role after the entry of FDI

but may only be temporary, although some negative horizontal spillovers, such as

employee poaching and increased labor market competition, continue to negatively

affect domestic firms. It also suggests that positive horizontal spillovers affected those

domestic firms that survived the original restructuring of the 1990s (see also Kosova

2010). Overall, at least in terms of the extent of impact, horizontal spillovers in the form

of increased product and labor market competition, quality requirements, demonstra-

tion effects and market access have played a more important role than vertical spillovers

in the Czech automotive industry after 1990 because they affected the vast majority of

domestic automotive firms. This finding challenges the conclusion of Gers

l (2008, 243),

who found vertical spillovers to be ‘much more important’ than horizontal spillovers in

the Czech manufacturing industry as a whole.

Vertical spillovers from foreign to domestic firms were more selective than horizontal

spillovers. Our analysis of linkages between foreign and domestic firms revealed that

Czech-based foreign firms source 86.5% of their total supplies from other foreign firms

both from abroad and from Czechia and only 13.5% from domestic suppliers. The most

important reasons for a low share of supplies from domestic firms include the

centralized sourcing by automotive TNCs, the unavailability of particular materials or

parts in Czechia and often a low quality of supplies by domestic suppliers. These

reasons tend to outweigh the advantages of geographic proximity, flexibility and often

lower prices of domestic firms. However, a low share of domestic suppliers does not

mean that linkages between foreign firms and domestic firms are weak because the low

share of domestic suppliers corresponds with their low share of the total output of the

Czech automotive industry. Almost all interviewed domestic firms were to a greater or

lesser extent integrated into automotive GPNs through their supplier linkages with

foreign firms, which is the basic precondition for the development of vertical spillovers.

Our data point to strong productivity spillovers from foreign to domestic firms

especially at the beginning of their supplier relationships. This is because, in most cases,

foreign firms imposed higher requirements on domestic firms with respect to quality

and sophistication of supplied parts and components than was the industry standard in

Czechia. However, despite the integration of domestic firms into GPNs and strong

supplier linkages between domestic and foreign firms, we have found that only less than

half of the interviewed domestic firms reported any technology spillovers from foreign

firms and only one-third experienced direct technology spillovers. In other words, while

linkages between foreign and domestic firms are an important precondition for vertical

spillovers to occur, there is no guarantee that vertical spillovers will actually develop in

the presence of these linkages. One plausible explanation of weak vertical spillovers

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from foreign to domestic firms is the low absorptive capacity of domestic firms, which is

suggested by a high share of domestic firms with no R&D capabilities and by the weak

links of domestic firms with universities and public research institutes.

We acknowledge the limitations of our analysis that has focused on the existing

domestic firms. A part of the explanation of weak direct vertical spillovers may lie in the

fact that the majority of most capable domestic suppliers were taken over by foreign

firms in the 1990s and 2000s. These former domestic firms benefited from direct

transfers of technology and know-how from their new foreign owners. At the same

time, we did not investigate domestic firms that did not survive and that might have

experienced strong negative spillovers from foreign firms. Our focus on the existing

domestic firms would thus tend to underestimate the real extent of both positive and

negative FDI effects on domestic firms.

Our research suggests that the failure to consider the heterogeneity of domestic firms

may lie behind many inconclusive results of various analyses about spillovers from

foreign to domestic firms as these effects can significantly differ among different firms

or groups of firms. Consequently, it makes it almost impossible to generalize the effects

of spillovers on technological, organizational and strategic competences of domestic

firms as a whole. Therefore, instead of treating domestic firms as a homogeneous group,

we classified them into four basic types. Our classification shows large differences in the

capabilities and absorptive capacity of domestic firms which significantly influence their

ability to benefit from spillovers.

Our research also shows how the particular nature of GPN influences the potential of

domestic firms to benefit from linkages and spillovers in the form of improving their

overall position in the value chain. In our case of the quasi-hierarchical value chain,

even direct positive spillovers did not help domestic firms improve their position in the

supplier hierarchy. As a result, the vast majority of domestic automotive firms remain

locked in subordinate positions as Tier 3 and Tier 2 suppliers in automotive GPNs

dominated by foreign lead firms. Consequently, despite high levels of FDI, domestic

firms continue to lag behind foreign firms (Peter et al., 2012) with limited chances to

significantly improve their position in the automotive value chain and become major

competitive players in the Czech and European automotive industry. Given this

inability to close the gap between themselves and foreign firms and given the

contemporary nature of the global automotive industry and limited technology

spillovers from foreign firms, the marginalized and vulnerable position of domestic

automotive suppliers of less developed countries in the automotive GPNs is likely to

persist in the foreseeable future.

Acknowledgements

The authors wish to thank the editor and four anonymous referees for their comments on an

earlier version of this article. We are grateful to Jan Z

enka for help with the administration of the

company survey and conducting company interviews. We also want to thank Karel Hostomsky´

for preparing the maps.

Funding

This work was supported by the Czech Science Foundation [Grant Number 13-16698S].

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