7. FDI & Economic Agglomeration Flashcards
What are FDI spillovers?
Newman et al. (2020)
The promise of Foreign Direct Investment is the creation of jobs and bringing foreign capital, bringing superior know-how, managerial skills, and tech that can diffuse in the domestic sector (spillovers)
Spillovers- happen indirectly usually
Linkages- usually formed through contractual agreements
FDI spillovers can be:
- horizontal (intra-sector): knowledge/tech used by multinationals is ‘transferred’ to competing local domestic firms in the same sector
MNEs usually tend to prevent such spillovers but it’s not really possible due to worker mobility, copying the business’s activities, or through informal networks
- vertical (inter-sector): transfers of intangible assets through the supply chain from foreign intermediate suppliers to domestic producers (forward spillovers) or from MNEs to domestic input suppliers (backward spillovers)
Backward linkages (or upstream linkages) can be desirable if they lead to deliberate knowledge transfer, higher requirements for product quality, and on-time delivery introduced by MNEs -> domestic suppliers are incentivized to upgrade their production
Forward linkages can lead to a “lock-in” because domestic firms have to use the inputs purchased by the MNEs
Can we see beneficial spillovers from FDI to domestic firms?
Newman et al. (2020)
Estimates of the impact of FDI spillovers are context-specific. They say that the effect of FDI spillovers can be measured by looking at linkages between foreign and domestic firms
They argue that when direct FDI linkages are present in the case of SSA, they raise the likelihood of direct knowledge tech transfers from MNEs to domestic firms. In Asia, competition erodes the possibilities for direct spillovers.
They find no evidence that direct knowledge or tech transfers are more likely to occur through FDI than trade.
In the absence of sufficient economic complexity (that would ensure indirect spillovers) in SSA, establishing direct linkages between foreign and domestic firms through binding contractual agreements could be an effective policy to ensure tech spillovers.
Newman et al. (2015)
!!! They look if there is evidence for FDI spillovers on the productivity of domestic firms by looking if change in FDI impacts change in productivity.
Overall, the results suggest that spillovers are more likely through vertical than through horizontal linkages
Policy implication: continue supporting FDI, but also couple it with improved conditions for the direct transfer of knowledge between firms
Moran (2007) says that developing countries’ requirements for joint ventures is to ensure that there are backward linkages into their economy.
What is the difference between direct and indirect linkages?
Direct linkages occur when “intermediaries provided by foreign-invested firms embody new, more advanced technologies from which domestic firms can learn” (Newman et al. 2015). They can also occur when the inputs supplied by foreign firms are accompanied by services or other forms of support that impact the productivity of domestic firms.
Indirect spillovers can happen when an increase in FDI in upstream sectors increases competitive pressures on input suppliers to eliminate inefficiencies in their production process -> downstream sectors then benefit from a more efficient use of inputs in the upstream sectors
What is FDI?
FDI happens when a multinational enterprise invests in the construction of new production facilities (“greenfield” investments) or the acquisition of existing firms (“brownfield” investments or mergers and acquisitions).
Pros (theoretically):
- assist human capital formation, contribute to international trade integration, create better business environment, lead to tech adoption and spillovers
Cons (theoretically):
- balance of payments problems as profits are repatriated
- lack of linkages to the local community
- harmful environmental impact and labour standards
- damaging impact on competition
Most FDI goes into mining, car industry and heavy industry - which don’t create a lot of spillovers.
Types of FDI:
- market seeking (China)
- resource seeking (Africa)
- efficiency seeking (EU)
How to investigate the impact of FDI spillovers on development?
Moran (2007):
He argues that in order to investigate the impact of FDI in manufacturing on development it is important to use multiple techniques to reinforce or refute each other.
Common ways:
- Cost-benefit analysis (early assessment show a positive effect of FDI on national income); in this case, the key determinant is the extent of effective protection granted to the investors
- study individual FDI projects and industries (provides more depth to how MNEs alter their strategies in response to international competition and domestic protection)
- parent-affiliate relationships -> fragmentation vs integration (the relationship between the parent and affiliate are becoming more fragmented within the import substitution framework, but it is more integrated when the parent relies on the affiliate to secure its position in international markets)
- management interviews and firm surveys (in short, positive FDI spillovers when companies are able to control their affiliates themselves with less domestic intervention and restriction from the host government)
The case of Korea and Taiwan are kind of exceptions because of national policy focused on “learning by doing” -> requiring domestic production of inputs and creating ‘national champion’ companies through government funding. They entered the global market gradually as original equipment manufacturers (OEMs) and developed relationships with foreign-owned affiliates
How to search for externalities and spillovers?
Moran (2007):
Positive externalities are free spillovers from FDI that benefit the host economy.
- executives, managers, engineers and workers leaving foreign-owned plants after having acquired skills and expertise
- non-related firms observing and adopting MNE strategies, replicating their production or management practices
- foreign investors may provide advice, designs, direct production assistance or marketing contacts to suppliers
Horizontal externalities
- look if MNEs try to avoid leakage of technology to potential rivals (for instance patents), but as other texts suggest this type of spillover can’t really be avoided
Is econometrics a good methodology to measure externalities or spillovers?
Moran (2007)
Econometrics can’t really capture the full picture. For example, when a foreign firm comes in, 2 contradictory effects happen:
- domestic firms experience increased performance due to horizontal spillovers
- they also experience a damage to performance because the foreign firms take part of their market share
Econometric models need to find a way to control for both levels of competition and labor movement and technology movement (include vertical externalities and labor market externalities)
He recommends mixed-methods basically: surveys + interviews + econometric data
Should governments support FDI?
Moran (2007)
Hard to tell because it’s not so easy to say which FDI will produce which spillovers. Governments need to be selective of which sectors would benefit the most from FDI.
Policy implications:
- there is no one single relationship between manufacturing FDI and host country development which means that there is no one solution fits all
- positive externalities seem to be derived from FDI when governments loosen their controls and ownership of FDIs and engage in joint ventures
- tax breaks and direct subsidies are tricky -> if the host countries refuses to provide these, the MNE will find them somewhere else
- need for an international agreement to roll back locational incentives to make countries possibilities of attracting FDIs more equal
Why do MNEs want to invest abroad?
Traditional Answer:
Cost-of-capital theory: MNEs, because of their size or structure, have access to lower-cost funds not available to locals).This view suggests that MNEs are simply arbitragers moving capital from low-return countries to high-return ones.
Another view:
Presence of intangible assets (technologies, managerial skills) specific to the firm. Public goods - use of assets in one plant does not diminish use of the asset in other plants. BUT why FDI and not just multiple plants?
-> Localization: low-cost inputs or low-wage labor (or can allow the MNE to bypass tariffs)
-> Market/contract failure – internalizing market transactions.
Are workers more productive when they move to cities?
Duranton (2015):
yes, workers in larger cities are more productive because workers benefit from agglomeration economies through a variety of channels: resource sharing, quicker and better job matching, and more learning opportunities.
BUT this is true only at the start. Once these benefits are exploited, they no longer contribute to increased productivity -> meaning that the productive advantage of large cities is constantly eroded and must be sustained by new job creation, entrepreneurial activity, and innovation
Do all workers benefit equally from agglomeration benefits?
Duranton (2015): Agglomeration benefits do not apply equally to all workers in all cities.
There are 3 sources of heterogeneity:
- it varies from sector to sector (industry to industry): more tech advanced industries benefit more from urbanization economies
- agglomeration effects are stronger for more educated workers
- not all workers contribute equally to the agglomeration effects
