FDI, MNCs, and host country policy

1
FDI, MNCs, and host country policy

• Whats special about MNCs?
• Effects of FDI
• FDI policy

2
Why worry about FDI?

• Sales of foreign affiliates larger than total
  world exports
• MNCs account for 2/3 of world trade
• FDI is growing faster than world production or
  world trade
• Capital, jobs, technology, exports?
• Expansion driven by international trade
  liberalization, regional integration, technical
  progress

3
Why do FDI and MNCs exist?

• Understanding what is special about MNCs helps
  understand their behavior and predict their
  effects
• Older explanations
• market disequilibrium and distortions
• Newer explanations
• market failures and market imperfections

4
Market disequilibrium and distortions as motives
for FDI

• Temporary disequilibria in markets
• Differential rates of return
• Cost differentials
• Valuation of currencies
• Government imposed distortions
• Trade barriers
• Tax rules
• Investment incentives

5
Market imperfections as motives for FDI

• External effects and scale economies could mean
  that doing A makes you better at B.
• If RD makes you a more efficient producer, then
  you should expand through FDI.
• Licensing will not be a good alternative, because
  other firms (with no RD) will never be as
  efficient as you can be.

6
Market failures as motives for FDI

• Markets for intangible assets - technology, trade
  marks, marketing - often fail.
• The transactions costs for finding a price that
  satisfies both seller and buyer are very high.
• Firms based on intangible assets tend to expand
  through FDI rather than licensing.

7
Conclusions motives for FDI and MNCs

• Many different types of FDI
• Older explanations are not sufficient, because
  FDI continues when disequilibria and distortions
  disappear
• New theories suggest that intangible assets -
  technology, trade marks, marketing skills - are
  central to MNCs.

8
Host country effects of FDI

• Resource transfer effects capital and technology
• Trade and balance-of-payments effects
• Competitive and anti-competitive effects
• Sovereignty and autonomy effects

9
FDI as a source of capital

• Arguments
• MNCs have plenty of capital and access to
  international capital markets
• MNCs may help mobilize local savings
• MNCs may stimulate aid flows
• Objections
• not much capital transfer going on, most of
  investments financed locally
• FDI is an expensive source of funds
• profits are repatriated

10
FDI as a source of technology

• Arguments
• most commercial technology owned by MNCs
• few countries can afford comprehensive RD
  programs on their own
• benefits possible even if MNCs keep ownership of
  technology spillovers
• Objections
• MNC technology may be too expensive
• MNC technology may not be appropriate

11
Spillovers

• When locals benefit from the presence of MNCs
  without paying the full price.
• Several possible channels
• Demonstration effects, copying MNCs
• Training of employees who may leave the MNCs for
  jobs in local firms
• Forward and backward linkages
• Local firms are forced to work harder because of
  tougher competition

12
Evidence on spillovers

• Lots of case studies showing that locals learn
  from MNCs
• Spillovers are not automatic. Effects are
  determined by the local environment
• Technological capability and labor skills
• Level of competition
• Trade policy

13
Balance-of-payments effects

• Arguments
• shortage of forex for imports of investment goods
  a common development problem
• both export-oriented and import-substituting FDI
  should improve BoP
• Objections
• MNCs import a lot. Import-substituting MNCs, in
  particular, may create import dependence
• MNCs repatriatiate profits

14
Competitive and anti-competitive effects

• Arguments
• MNC entry may stimulate competition, efficiency,
  and development
• MNCs often enter industries where entry barriers
  for local firms are high
• Objections
• MNCs are stronger and may outcompete local firms.
  Risk for foreign oligopolies and monopolies

15
Sovereignty and autonomy effects

• Arguments
• Foreign ownership always carries a cost. Foreign
  MNCs may push for policies that are good for them
  but not necessarily for the host country
• Objections
• Who cares if the Americans own our factories, as
  long as we get jobs and tax revenue

16
Other effects

• Negative externalities from FDI, e.g. on the
  environment?
• Cultural imperialism?
• Inappropriate consumption patterns - Camel,
  Heineken, and Yves St. Laurent in poor countries?
• FDI may create dependence on foreign capital

17
FDI policies

• What do host countries want from FDI and foreign
  MNCs?
• What policy measures are available to host
  country governments?
• How effective are FDI policies?

18
Host country objectives

• To acquire
• capital and jobs
• technology, production, and RD skills
• organizational and managerial skills
• marketing and exporting skills
• To retain national control over strategíc
  industries and strategic decisions

19
Policy measures

• Investment promotion - to attract foreign MNCs
• Market access restrictions - to retain national
  control
• Regulation of MNC operations - to make the
  foreign MNCs behave in the right way

20
Investment promotion

• Information
• Consumer preferences, markets, production
  factors, rules and regulations
• Incentives
• Investment and profit repatriation guarantees
• Beneficial tax rules - tax holidays, reduced
  rates, investment allowances, and other fiscal
  incentives
• Tariff protection
• Subsidies and grants
• Provison of infrastructure - industry parks and
  export processing zones

21
FDI incentives

• Used by almost all countries
• Financial incentives in OECD - fiscal incentives
  in developing countries
• Probably becoming more important for corporate
  decision making
• WTO membership makes other policies more similar
  across countries
• but also risk for excessive subsidization
• politically attractive
• competition between host countries
• uncertainty about spillover benefits

22
Market access restrictions

• Licensing requirements (where applications are
  individually screened)
• Outright prohibitions
• military industries
• mass media
• air and land transports
• banking and finance
• telecommunications

23
Regulation of MNC operations

• Performance requirements
• technology transfer
• exports
• employment
• local content
• Requirements for joint ventures
• to secure transfer of technology to local industry

24
Are FDI policies efficient?

• Prohibitions work
• Performance requirements not very efficient -
  easy to get around
• and increasingly in conflict with WTO rules
• Investment incentives increasingly important, but
  mainly because everyone else is offering them
• fundamentals like political stability, market
  size, and growth rate more important
• risk for bidding wars between host countries
• better to focus on industrial policy?

25
Example Objectives of FDI policy in India

• technology transfer
• technology diffusion
• limitations on foreign ownership
• save foreign exchange
• national independence
• priority sectors
• employment creation

• avoid concentration
• diversification
• local content
• export promotion
• advancement of Indians
• local RD
• regional development
• capacity utilization

26
Consequences of Indian FDI policies

• Very little FDI until early 1990s
• Major MNCs left because of regulations
• Reform recommendations in late 1980s
• liberalize and simplify bureaucracy
• focus on employment creation and labor-intensive
  industry
• allow foreign majority ownership
• Reforms and somewhat increased inflows of FDI
  from early 1990s
• but still only a fraction of that directed to
  China