Foreign Direct Investment

The central theme of this book is that the behaviour of multinational corporations (MNCs) and their affiliates, and the impact of inward foreign direct investment (FDI) on the host economy, will vary between industries and countries. Multinationals decide their strategies depending on the characteristics of their technologies and products as well as the characteristics and policies of the host countries. The MNCs’ strategic decisions then determine how FDI affects the host economy. We know that some host country governments try simultaneously to influence the behaviour of the foreign MNCs operating in their territory, either directly — through regulations — or indirectly, by affecting the environment in which the MNCs operate. To the extent that these interventions affect the behaviour of the foreign MNCs, they also determine the effects on the host economy. This intricate interplay between firm and host country strategies is that FDI may contribute significantly to growth and development in some circumstances, but may also have insignificant or even negative effects on the local economy in others. Our research agenda since the late 1980s has largely been devoted to attempts to understand this interplay. This volume summarizes the results of these efforts.

The role of technical progress as a key to economic growth is widely recognized today. New technologies can be developed domestically through investments in research and development (R&D), they can be imported in various ways from abroad, or generated through some combination of the two. Since R&D activities are normally very costly, many countries rely heavily on imports of modern technology from abroad. In most cases they must turn to multinational corporations, who have become the most important actors in the generation of technology.

Over the years, we have witnessed an increasing desire in a number of developing countries to exercise greater control over the activities of multinational corporations. Many countries have started to frame the environment within which these firms operate and have introduced various performance requirements for their behaviour. Special attention has been given to policies regarding the transfer of technology. A number of measures intended to encourage multinational firms to transfer more technology have been introduced over the years, including requirements for a certain degree of local participation in the ownership of the MNCs’ affiliates. By forcing the multinationals to ‘unbundle the package’ of inputs they bring to the host country, it is believed that a host country can enable local firms to obtain access to these inputs without the traditional direct investment.

Multinational firms may initiate affiliate activities abroad in two different ways; either by building a new establishment (greenfield investment) or by taking over an already existing firm (acquisition).The two methods can be expected to yield different costs and benefits for the host economy. Some argue, for example, that acquisitions have few positive effects on productive capacity, employment or market concentration, and that foreign purchases of local firms should therefore be prevented. Others are less pessimistic and point to possible long- run effects on the host economy, such as improvements in technology and management practices.

The fact that multinational companies do not undertake all their research and development activities at home has become a matter of recent concern, both in the home and host countries of these companies. Some empirical work has been done on the question of why MNCs decentralize their R&D activities (see Mansfield et al, 1979; Lall, 1979a; Håkansson, 1980; and Hirschey and Caves, 1981).¹ The study by Håkansson (1980) is one of the few that deal with the determinants of the R&D intensity of MNC affiliates, but it is confined to subsidiaries that carry out R&D, while foreign affiliates that do not are excluded.² Furthermore, the analysis does not take into account the characteristics of the MNC to which the affiliates belong.

International trade has always been an important aspect of economic development and there has been an increasing emphasis on trade as a mechanism for promoting economic growth. In almost every year since the end of the 1940s, the volume of international trade has grown faster than the volume of world production and, as a result, the degree of interdependence of the world economy has increased markedly. A large share of this rapid growth of international trade has been accomplished under the control of multinational corporations, and a good proportion of the MNCs’ exports and imports consist of intra-firm or intra-corporate trade.

In the backwash of the debt financing of the 1970s and the world-wide recession of the early 1980s, many developing countries, particularly in Latin America, ran into serious debt-servicing difficulties. To cope with this debt crisis, radical policy changes were introduced. These ‘structural adjustment programmes’ generally included deregulation and privatization of the economies, and opening them to external markets and competition.¹ The shift from inward to outward orientation has involved shifting production from domestic to export markets. In this study, we examine the extent to which a number of heavily-indebted Latin American countries have redirected their sales of manufactured goods to world markets and the role of multinational corporations in this shift. We are particularly interested in investigating whether affiliates of multinational firms are better equipped to redirect their sales than local firms in developing countries.²

The operations of multinational corporations continue to stir strong emotions, both in the home countries and abroad. In the major home countries, the debate on foreign direct investment has ranged from worries that outward FDI may substitute for domestic investment and erode technology leadership, to the argument that firms must invest abroad in order to stay competitive in an increasingly international environment. The attitudes towards MNCs have also been mixed in the host countries, although the proponents of FDI seem to have gained the upper hand since the late 1980s. Most host countries have liberalized their FDI regulations since the early 1980s — many are now actively trying to encourage foreign firms to invest — and the benefits of inward FDI on capital formation, employment, exports and technology are generally considered to dominate the costs of foreign ownership of local factors of production.

Since the 1960s the developing countries have had very different experiences regarding income and productivity growth, and the extent to which they have converged on developed countries. Some, such as the Asian newly-industrialized countries (NICs), clearly are in a process of rapid convergence, whereas others, such as most countries in Africa, show no sign of convergence. This indicates that the realization of the potentiality for productivity catch-up simply because of backwardness depends strongly on another set of causes, some of which are internal and others external to the countries themselves (see Abramovitz, 1986).

There are numerous case studies to suggest that technology spillovers from foreign direct investment may provide important benefits for the host countries of multinational corporations (MNCs) (see Chapter 8). The technology and productivity of local firms may improve as foreign firms enter the market and demonstrate new technologies, provide technical assistance to their local suppliers and customers, and train workers and managers who may later be employed by local firms. The competitive pressure exerted by the foreign affiliates may also force the local firms to operate more efficiently and introduce new technologies earlier than would otherwise have been the case.

The predominant view in the literature on foreign direct investment is that various types of spillover may provide important benefits for the countries that host foreign multinational corporations. For example, numerous case studies have shown that the technology and productivity of local firms may improve as foreign firms enter the market and demonstrate new products and technologies, provide technical assistance to their local suppliers and customers, and train workers and managers who are later employed by local firms. There are also reports that the competitive pressure exerted by foreign affiliates has forced local firms to operate more efficiently and introduce new technologies earlier than would otherwise have been the case (see Chapter 8 for a review of the literature).

In the debate on the role of multinational corporations in international technology transfer, it has often been suggested that a large share of the host countries’ benefits from foreign direct investment may come in the form of external effects or ‘spillovers’. MNCs may, for example, introduce new technologies that are imitated by local producers, or train workers whose specific skills spill over when they set up their own firms or are hired by existing local firms. These benefits can be characterized as effects of contagion and demonstration. Other effects are related to competition, and occur when local firms are forced to become more productive — by introducing new technologies or increasing X-efficiency — in order to survive in markets where foreign affiliates are present.

The debate on the role of government policies for economic performance has, in recent years, turned from discussing the choice between free markets and government intervention to asking what types of intervention are good or bad. One reason is that almost all governments, irrespective of their political orientation, have chosen to play an active role in their economy (see, for example, Bardhan, 1990). However, the definition of successful intervention is still disputed, although an important lesson from the recent experience of several Asian economies seems to be that governments should make use of market forces in their efforts to influence the direction and character of economic growth: markets and competition need to be retained to discourage wasteful use of resources and to encourage learning and technical advances.

In Chapter 13, we examined aggregated data on the technology imports of US affiliates in thirty-three host countries, and found some weak support for the hypotheses proposed by Wang and Blomström (1992). Our results showed that the affiliates’ technology imports were positively related to the income level of the host country and (crude proxies for) the competitive pressure in the host economy, but negatively related to the level of distortions and various host country performance requirements. In this chapter, we use more detailed data from a single host country, Mexico, to analyze how the technology imports of foreign firms are related to various industry characteristics. We are particularly interested in the hypotheses that market rivalry and availability of skilled labour may encourage the multinationals to bring more technology to their foreign operations.¹