Foreign Direct Investment, Imports and
Innovations in the Service Industry
and ANDRE JUNGMITTAG
Fraunhofer Institute for Systems and Innovation Research, Breslauer Strabe, Karlsruhe;
Economics Department, University of Kassel, Mora-Platiel Strabe 4, 34127 Kassel, Germany
Macroeconomic Theory and Policy, FB B, University of Wuppertal, Gaustrae 20, 42119
Abstract. The paper analyses for the ﬁrst time empirically the impact of foreign competition
due to inward foreign direct investment and imports on the innovation activities using data of
German service ﬁrms. Based on the hypothesis that foreign competition has a disciplining
eﬀect on domestic markets derived from the manufacturing sector, a positive impact can be
expected on innovation in the service sector, while other theoretical considerations do not
absolutely support this optimistic view. In the empirical analysis, variants of two probit
models are estimated for a sample of 2,019 service ﬁrms to explain their product and process
innovation activities. The results show that both foreign direct investment and imports have
highly signiﬁcant positive eﬀects on product and process innovations. Vice versa, the export
and foreign production activities of domestic ﬁrms support innovations, too.
Key words: Foreign direct investment, foreign trade, innovation, market structure, probit
JEL Classiﬁcations: C25, F14, F21, L11, L80, O31.
In traditional foreign trade theory, services count as tradable only to a very
limited extent, because transactions of services in most cases require the
spatial and temporal proximity of buyers and sellers simultaneously. Today,
in the age of the Internet and telecommunications, however, the barriers to
mobility have fallen for a number of services. Due to decreasing communi-
cation costs, it is no longer necessary for customers and suppliers to be in the
same place in order to guarantee the simultaneous temporal coincidence of
service production and consumption (Harris, 1998). In particular, an increase
in trade with business services over great distances is thus facilitated.
Author for correspondence: Tel: +49-202-439-3176; Fax: +49-202-439-3177; E-mail:
Review of Industrial Organization 25: 205–227, 2004.
Ó 2004 Kluwer Academic Publishers. Printed in the Netherlands.