Agglomeration, foreign firms and firm exit in regions under transition: the increasing importance of related variety in Hungary

Related variety of economic activities is widely recognized to induce regional development; however, it is not clear how this mechanism takes place in regions that go through major structural and institutional transformation. Furthermore, foreign direct investment (FDI) is typically a major source of structural change in these areas; and we still need a better understanding on how foreign-owned (foreign) firms affect the dynamics of domestic-owned (domestic) companies. For these reasons we analyse firm-level exit in Hungarian city regions between 1996 and 2011, over the late post-socialist transition in manufacturing industries, focusing on the difference between foreign and domestic firms. Introducing ownership into the related variety calculation, we estimate the probability of firm exit with the region-level related variety calculated separately for foreign and domestic firms. Our results suggest that related variety of foreign firms decreases the probability of domestic firm exit earlier during the economic transition compared to the related variety of domestic firms. This finding supports the idea that FDI plays a formative role in regions under transition, and shows that domestic firms benefit from being in agglomerations where foreign firms are technologically related to each other.