Multinational Corporations in the Global Economy

1. 1 Multinational Corporations in the Global Economy

2. 2 Lecture 2 Lecture 2 � Friday 9 May 2008 This lecture discusses the impact that foreign direct investors have on host economies. Different theories and empirical evidence will be considered. We will also discuss why Governments are very active in attracting foreign multinationals and what are the expected benefits of foreign direct investment. Reading: Lipsey R.E. (2002) Home and host country effects of FDI, NBER Working Paper 9293.

3. 3 Goverments attitudes towards FDI

4. 4 Goverments attitudes towards FDI

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7. 7 Effects on the host country Governments spend part of their budgets in attracting FDI because they believe that FDI will generate positive effects on their country What happens when multinational companies invest in a host country? How does it contribute to the country�s economic growth and prosperity? Important for host countries that are poor or in an industrialisation phase How can we measure the effects Economic effects Other effects on society and environment (Lecture 3)

8. 8 Economics effects Operations and behaviour of the subsidiary Higher Wages Higher efficiency Higher exports Effects of the subsidiary on domestic firms Wage Spillovers Productivity & Knowledge Spillovers Export Spillovers Start up of new industries

9. 9 Wages MNC typically pay higher wages than local firms � esp. in developing countries In 1931 a study documented that ��Colombian labor�is better remunerated and granted more sanitary living quarters by foreigners than by natives, but the foreigners probably extract more systematic and strenuous effort� Initial studies did not take into account: The quality of workers employed The size of the firms The sophistication of the activities

10. 10 Wages More recent studies take these dimensions into account and find that: MNC pay +25% in Mexico (1970) MNC pay + 70% in Marocco (+30% if controlled by size) MNC pay +50% in Indondesia (1990s) Some studies find that MNC pay higher prices for people with higher education (higher quality), while for blue collar differences are minimal

11. 11 Wages Why would a firm pay more wages than its competitors in the host country? Host country regulations or home country pressures To maintain �good public relations� with local government and host environment It pays a premium for reducing turn-over To attract better workers

12. 12 Wage Spillovers Wage spillovers = when the higher wages of MNC produce an effect on the wages of employees in domestic firms

13. 13 Wage spillovers When they occur, why do they occur? By raising the demand of labour (+) By skill upgrading (+) By substracting the better workers to domestic firms (-)

14. 14 Productivity Productivity indicates how efficient is the production process � i.e. how much output a firm produces given its inputs E.g. n� pair of shoes/hour; value added per worker� Economists generally assume that MNC have higher productivity than domestic firms, especially in developing countries E.g. MNC have access to superior technologies Several studies document this in a number of developing countries (Uruguay, Moroc, Indonesia, Mexico, etc.)

15. 15 Productivity Spillovers �Theories of the effect of direct investment on host countries have generally taken it for granted that foreign-owned firms possessed superior technology and that some of that technological knowledge spills over to the host country economy� (Lipsey, 2002, p.41)

16. 16 Productivity Spillovers The benefits to the host countries, if they exist, stem mainly from the superior efficiency of the foreign- owned operations Economists look at whether MNC superior productivity spills over to locally- owned firms in their industries, or their industries within their regions, or related industries.

17. 17 Productivity Spillovers Positive: When the increase of FDI in an industry leads to an increase in productivity of domestic firms in the same industry (horizontal spillovers) or in industries that are vertically connected (vertical spillovers) Negative: When the increase of FDI in an industry leads to an decrease in productivity of domestic firms in the same industry (horizontal spillovers) or in industries that are vertically connected (vertical spillovers)

18. 18 Positive Productivity Spillovers Locally- owned firms might increase their efficiency by: Copying the operations of the foreign- owned firms; Being forced by competition from foreign- owned firms to raise their efficiency to survive Qualify and improve the skills of local human resources The transfer of knowledge through backward linkages with domestic suppliers

19. 19 Negative Productivity Spillovers

20. 20 What are the effects on domestic firms?

21. 21 Why in some cases there are effects and in other not? What do you think are the factors that limit/favour the transfer of technologies in developing countries?

22. 22 The capabilities of domestic firms Even to adopt, adapt and imitate countries and firms need a minimum of absorptive capacity (Cohen, Levinthal, 1990) Human resources (training, education) Investment in experimentation, R&D

23. 23 What do you think it is the % R&D/GDP of�. US? UK? Italy? China? Brazil? Other developing countries???

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25. 25 Science & Technology Indicators

26. 26 2. Behaviour of MNC subsidiaries Economists almost always conceive MNC subsidiaries as having �advanced� skills/ technologies with respect to domestic firms Economists also assume that R&D is centralised in the Headquarters and that subsidiaries are just a �passive� local branch of the MNC

27. 27 In other terms, economists conventional model is: Very hierarchical. But, how much technology will they be able to transfer if nothing happens in their subsidiaries?6Very hierarchical. But, how much technology will they be able to transfer if nothing happens in their subsidiaries?6

28. 28 But from Lecture 1 we know� Subsidiaries are different: some are more innovative than others Local adaptor: limited mandate, only minor adaptation at the local level International adaptor: more creative local laboratories, eg. To adapt technologies for a continent (Latin America, Asia) not just a country International creator: Internationally interdependent laboratories which provide inputs into a centrally coordinated R&D program Which do you think have a higher potential for positive productivity spillovers?

29. 29 3. National Policies Is there a need for governments to promote actively the creation and deepening of linkages? �Markets may fail to create efficient linkages, raising the cost to both parties of entering into long-term supply relationships and reducing the ability of domestic firms to become competitive suppliers (UNCTAD, World Investment Report, 2001) Rules of origin/Local content requirements: preferential treatments based on the level of value added or local content Example: the entry of Suzuki in Hungary was done to enjoy duty-free access for car exports to the EU, and it was subject to the creation of local linkages

30. 30 Exports and new industries MNC can have two further effects: Export Spillovers: Because they on average export more than local firms, they generate export spillovers on domestic firms Generation of new industries: The case of Ireland and Costa Rica and the generation of new high tech industries

31. 31 FDI and the creation of a new industry: the case of Costa Rica ��Costa Rica represents an outstanding success story of a small economy being able to increase and diversify its exports and attracting significant FDI inflows into its economy.� (OECD, 2004; p. 68)

32. 32 Costa Rica: structural change 1984: beginning of the Export Processing Zones policies 1990: boom of Foreign Direct Investments (FDI) in high tech industries Electronics, microprocessors, medical devices Costa Rica strength Relatively skilled human resources Proximity to USA Macroeconomic and political stability

33. 33 Evolution of main export sectors� shares (2-digit SITC Rev 1)