FDI and Development: Quantity vs. Quality

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