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FDI and Development: Quantity vs. Quality

This article examines the relationship between FDI and development, focusing on the quality of FDI and its impact on domestic investments. It analyzes the crowding-in and crowding-out effects of FDI on domestic investment and discusses the role of host government policies in improving the quality of FDI. The article also provides evidence on the effectiveness of policy measures such as performance requirements in attracting high-quality FDI.

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FDI and Development: Quantity vs. Quality

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  1. FDI and Development: Quantity vs. Quality Nagesh Kumar RIS, New Delhi CTDS

  2. Background • 1990s: renewed emphasis on FDI • Implicit assumption: FDI is more productive than domestic investment because of its potential to generate favourable externalities • Magnitudes of FDI inflows even seen as a yardstick of performance of governments • Governments wooing FDI with policies such as • Liberalization of policies • Incentives • Promotional measures CTDS

  3. Wide variations in quality of FDI • FDI projects differ in many respects; generation of externalities varies • Entry mode: M&As vs. greenfield investments • Low technology vs. high technology investments • Shallow manufacturing vs. deeper manufacturing • Vertically integrated vs. enclave productions • Export-oriented versus domestic market-oriented • Joint ventures vs. sole ventures • Implications for the developmental impact • Crowd-in vs. crowd-out of domestic investments CTDS

  4. FDI,growth and Domestic Investments: evidence • Analysis for 81 countries over 1980-1999 examining the direction of causality: • FDI led to growth only in 12 countries • Growth pulled FDI in 11 countries • Relationship was indeterminate in rest of the countries • FDI and domestic investment: complements or substitutes • Empirical analysis of the relationship in a dynamic setting • 29 countries experienced FDI crowding-out domestic investment in net terms • 23 countries experienced FDI crowding-in domestic investments • Latin America: crowding-out more prominent; Asia and Africa; crowding-in more prominent • FDI can reduce welfare by crowding-out domestic investment CTDS

  5. Host Government Policy and FDI Quality • Host government policies employed to improve the quality of FDI • Trade Policy • Selective FDI Policies • Performance Requirements • Investment Incentives • Competition Policy CTDS

  6. Commonly employed PRs • Local content requirements (LCRs) in different forms • Export performance requirements in different forms • Indirect export performance requirements in the form of trade balancing or dividend balancing, or foreign exchange neutrality requirements • Requirement to establish a joint venture with domestic participation or for minimum level of domestic equity participation • Employment performance requirements • Requirement to transfer technology, production processes or other proprietary knowledge • R&D requirements CTDS

  7. Use of PRs by Developed Countries • US: extensive restrictions on foreign investors in the nineteenth century when it was a importer of capital; • currently imposes PRs under Exon-Florio Amendment • Canada: extensive set of undertakings under FIRA to ensure ‘substantial benefit’ is reaped by it • UK and Germany: Use of PRs and exchange controls in post-WWII period • France: extensive PRs imposed on foreign investors depending upon nationality of investor, effect on growth, employment, regional balance, R&D and competition to French enterprises CTDS

  8. Use of PRs by Developed Countries • Australia: 50% domestic ownership requirements in natural resources industry; offsets programme 30% local activity; 85% local content on auto until 1989 • Japan: extensive use of PRs depending on technology development, export or import substitution, competition to Japanese industry; required 50% ownership and President to be a Japanese • LCRs in auto industry in developed countries: Italy (75% on Pajero), US (75% on Toyota Camry), UK (90% on Nissan Primera), Australia (85% on all autos) CTDS

  9. Changing Form of PRs in Developed Countries • In 1980s and 1990s use of grey area measures to achieve the same objectives • VERs: US on Japanese cars, c.1981, EU on Japanese electronics • Screw drivers regulations: EU to deepen the local content of Japanese consumer electronics • Anti-dumping: EU (cars and other imports) and US: ‘substantially equivalent competitive opportunities’ • Buy American Act: price preferences for 51% local content • Stringent Rules of Origin under RTAs such as NAFTA, EU CTDS

  10. Evidence on effectiveness • Theoretical studies showing the relevance of • LCRs: (Davidson et al 1985, Balasubramanyam 1991, Richardson 1993, Lahiri & Ono 1998, Yu and Chao 1998); • EPRs: (Rodrik (1987), Greenaway (1992) • Cross-country studies: • Kumar/UNU-Intech (1998, 2000, 2002):finds evidence of the effectiveness of LCRs and EPRs for a sample of 74 host countries, 2 home countries, 7 branches of industry and 3 points of time • Belderboss et al (2001): LCRs effective in case of Japanese electronics MNEs in 24 countries CTDS

  11. Case Study Evidence • Mexico and Brazil: LCRs and EPRs led to export focused auto industry + externalities world scale plants and best practice technology (Moran 1998) • Taiwan’s emergence as a major autoparts supplier (Gee 1997) • China’s evolution as a manufactured exports hub • Share of MNEs in China’s manufactured exports rises to 45 % and to 80 % of high technology exports (Rosen 1997) • Thailand’s emergence as Southeast Asia’s Auto hub • LCRs during 1970s: local capacities but no exports • EPRs since mid-1980s to hook up to global production networks • 2001: export of 170,000 vehicles; third largest auto exporter in Asia; sourcing hub for Honda City for Japan, global production base for Toyota pick-up trucks; Export worth 200 billion baht (~US$ 4 billion) (Moran 1998) • Recent success of India in building an internationally competitive auto industry (Kumar, 2003) CTDS

  12. Concluding Remarks • Quality of FDI is an important consideration for developing countries • Selective policies and PRs can be effective tools of development policy • Developed countries have used them effectively in their process of development • It is now the turn of developing countries to use them • Need to preserve this policy space for development: NO to international rules on investment • Review of TRIMs Agreement to seek flexibilities for developing countries to impose PRs that are phased out CTDS

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