FDI policy and industrial growth in a globalizing world

1. September 3, 2012 FDI policy and industrial growth in a globalizing world Rajneesh Narula Professor of international business regulation

2. Main points! FDI per se ? economic development If FDI results in technology transfer, and if domestic firms internalise the spillovers, and if domestic non-firm sector support learning, there will be economic development Converting appropriate types of FDI to support economic development requires us to move away from passive view of economy Host economy is inextricably linked to global economy, MNE linked to other MNEs and other locations FDI is often either mainly capital, or un-transferable skills. Or simply technology which the domestic sector is able to efficiently absorb given its stage of development Globalization and liberalization have changed the principles of FDI-assisted development Development needs to be seen in a much broader sense than we currently do – not only about creating aggregate economic growth, but also about income disparities, and what are defined as human development. This is what Sen has been saying for years – that development makes freedom of choice possible. There are a number of intervening factors between the two – it is not entirely clear whether FDI causes ED, or whether it can simply be attributed to it. Development needs to be seen in a much broader sense than we currently do – not only about creating aggregate economic growth, but also about income disparities, and what are defined as human development. This is what Sen has been saying for years – that development makes freedom of choice possible. There are a number of intervening factors between the two – it is not entirely clear whether FDI causes ED, or whether it can simply be attributed to it. Too much ha sbeen made of a few countries success with FDI. Not to take an extreme post modern view that each FDI project is different, and that each counrties capacity is different; there are lessons to be learnt. However, these lessons mean much less now, because eteh global mileu in which their policies worked has changed. Different types of FDI- rules have changed – rationalise dFDI, networked MNEs. Different types of subsidiaries, different types of MNEs. Development needs to be seen in a much broader sense than we currently do – not only about creating aggregate economic growth, but also about income disparities, and what are defined as human development. This is what Sen has been saying for years – that development makes freedom of choice possible. There are a number of intervening factors between the two – it is not entirely clear whether FDI causes ED, or whether it can simply be attributed to it. Development needs to be seen in a much broader sense than we currently do – not only about creating aggregate economic growth, but also about income disparities, and what are defined as human development. This is what Sen has been saying for years – that development makes freedom of choice possible. There are a number of intervening factors between the two – it is not entirely clear whether FDI causes ED, or whether it can simply be attributed to it. Too much ha sbeen made of a few countries success with FDI. Not to take an extreme post modern view that each FDI project is different, and that each counrties capacity is different; there are lessons to be learnt. However, these lessons mean much less now, because eteh global mileu in which their policies worked has changed. Different types of FDI- rules have changed – rationalise dFDI, networked MNEs. Different types of subsidiaries, different types of MNEs.

3. Transition economies driven by dual need to create/sustain domestic system and to attract FDI “Compared to countries with a similar per-capita income, Romanian labour force is more educated (see WB, World Development Indicators), and the country presents a lower labour cost within industrial and service sectors. However, the country is not exporting products intensive in high-skills: on the contrary, it is specialising in exports of products with a higher content of low-skills labour. “ This gap calls for an intervention by the government, in order to lead the country to exploit its real competitive advantages

4. WE ARE NOT ALWAYS CLEAR AS TO WHAT WE WANT FROM FDI – CANNOT HAVE ALL. M&A not a bad choice, but M&A is often undertaken to achieve rationalisation within the MNE on a global basis, so local operations may be reduced in size, or sometimes done to acquire customer base. We do not always think about the net effects. Ar ether actually increases in capital formation, or are we simply moving and revaluing the same assets? In the case of rationalised investment, exports may increase, but is there an increase in the imports of intermediate goods? Will not argue about the cost benefit analysis of FDI, because we need to examine consumer surplus, etc. But, if the goal is to build up a domestic sector, or to promote competitiveness of firms located in the domestic sector, perhaps we need to more closely examine whether in fact FDI is the most appropriate mode of technology transfer, or may be that we need to see FDi as being complementary to other (more direct) forms of TT.WE ARE NOT ALWAYS CLEAR AS TO WHAT WE WANT FROM FDI – CANNOT HAVE ALL. M&A not a bad choice, but M&A is often undertaken to achieve rationalisation within the MNE on a global basis, so local operations may be reduced in size, or sometimes done to acquire customer base. We do not always think about the net effects. Ar ether actually increases in capital formation, or are we simply moving and revaluing the same assets? In the case of rationalised investment, exports may increase, but is there an increase in the imports of intermediate goods? Will not argue about the cost benefit analysis of FDI, because we need to examine consumer surplus, etc. But, if the goal is to build up a domestic sector, or to promote competitiveness of firms located in the domestic sector, perhaps we need to more closely examine whether in fact FDI is the most appropriate mode of technology transfer, or may be that we need to see FDi as being complementary to other (more direct) forms of TT.

5. MNE activities and economic development FDI can promote growth as they can be a source for capital and technology Three conditions for positive externalities: Does the kinds of FDI being attracted generate significant spillovers? Does the domestic sector have the capacity to absorb these spillovers? It is perhaps worth adding (in the case of LDCs particularly) that there needs to be a domestic sector. Is the FDI that is being attracted a substitute or complementary to domestic industry?

6. Globalisation has changed things… It has changed the nature of MNE activities… Different motives for FDI Asset-seeking FDI & rationalised FDI Portfolio investment masquerading as FDI (private equity firms) Foreign owned is not the same thing as foreign managed! Growth in FDI in services aspect of FDI Changing configuration of MNE’s spatial distribution Scope and competence levels have changes Growing intra-MNE aspect of FDI Use of existing MNE networks for intermediate goods, rather than local suppliers Change in bargaining power of MNE Vs. Host MNEs have truncated their operations to utilise cross-border differences in comparative advantage, and to achieve economies of common governance, and economies of scale. Truncation of MNE affiliates scope of operations. Increased truncation of scope not necessarily complementary with increased competence levels of operations. Transaction-type O advantages associated with services are much harder to absorb and transfer.MNEs have truncated their operations to utilise cross-border differences in comparative advantage, and to achieve economies of common governance, and economies of scale. Truncation of MNE affiliates scope of operations. Increased truncation of scope not necessarily complementary with increased competence levels of operations. Transaction-type O advantages associated with services are much harder to absorb and transfer.

7. Attitudes have not changed.. But reality has Fundamental difference: MNEs are seeking efficiency and profits. Governments seek to control the process of economic growth in order to increase economic welfare of the nation. Attitudes and informal institutions still largely reflect the old economic order pre-globalization and pre-EU membership Competition for FDI and markets is not simply –intra-EU, but global. Returns to EU membership are not the same as they were for Spain. globalization has created “economic equity” in the sense that the challenges of transition and developing countries are increasingly similar to those of developed countries.

8. Being overly dependent on FDIor domestic firms does not result in sustainable growth Trying to achieve domestically driven industrial upgrading is an increasingly unviable option Most transition economies have promoted domestic capitalists State has vested interest in promoting the domestic accumulation of capital. In some economies local political class has created opaque institutional environment which deter FDI FDI-driven growth alone only leads to initial growth, not necessarily long term growth. Only coupling and integrating foreign and domestic industry leads to sustainable growth But connecting the two is difficult because of network failures/market failures, and alignment of resources. Integrating the two in the same innovation system is a challenge for policy makers

9. Modernisation trade offs (courtesy Radosevic) Foreign led Fast productivity improvements in production (operations) Significant expansion in volume Quick international market and production integration vs. Reduced strategic autonomy Limited functional / technological upgrading Unchanged subsidiary mandate Limited local networking Fast growth in short term but potential structural weakness in a long term Domestic led Broad strategic autonomy Full functional autonomy Local networking ‘Preserved’ NIS vs. Slow productivity improvements and low efficiency Slow expansion in volume Poor operational performance Limited international market and production integration Potentially high rent seeking costs and ‘waste’ Slow productivity growth in short term but structurally potentially more advantageous situation Foreign led: Driving principle: efficiency; short term focus on operational efficiency, costs of reallocation of unemployed engineers Domestic led: driving principle strategy; long – term focus is on growth; inefficient use of resource in short run; costs of learning engineers? Poor operational performance Example; Russian automotive industry Foreign led: Driving principle: efficiency; short term focus on operational efficiency, costs of reallocation of unemployed engineers Domestic led: driving principle strategy; long – term focus is on growth; inefficient use of resource in short run; costs of learning engineers? Poor operational performance Example; Russian automotive industry

10. Types of MNE subsidiaries varies Rationalisation means: Segmentation of value chain may reduce opportunities for useful spillovers and linkages Different types of ownership advantages Applies especially for service aspect of value chain These have more limited options for deepening of either scope or competence levels. In most transition economies subsidiaries of large MNEs are poorly integrated to domestic system, and tend to have limited R&D and innovation Example of service chain, think of call centres. Less global, smaller MNEs may actualy provide more opportunities! Different nationality of ownersprovide different opportunities. Eg Sa firms vs eu firmsExample of service chain, think of call centres. Less global, smaller MNEs may actualy provide more opportunities! Different nationality of ownersprovide different opportunities. Eg Sa firms vs eu firms

11. Value chain examples:garment and footwear

12. The centrality of the non-firm sector Provides appropriately educated people Provide quasi-public goods in the form of innovative output and capacity government policies are essential to promote interlinkages between the different elements of absorptive capacity, as well as to create the opportunities for economic actors to absorb and internalize spillovers efficient institutions contribute more to economic growth than location or trade. The role of governments as a market facilitator and provider of complementarily created, location-specific assets is critical

13. The growing need for specialised resources Although the amount of total FDI stock directed towards developing countries may well have increased, an increasing proportion of new investment is of a kind that requires the use of specialised created assets . On the one hand, MNEs seek more specialised inputs, and on the other, more countries offer generic inputs. Increasing number of countries offering ‘generic’ location advantages, and subsequent incentives war

15. globalisation has introduced a fourth dimension, that of International Institutions. This influences both sets of players, and in its turn influences FDI and development.

16. Does FDI matter? Yes! But not as much as making the conditions to learn from it, because the conditions for learning are the conditions for attracting higher quality FDI The ‘wrong’ FDI is little more than a capital infusion at a higher cost than capital markets there are diminishing returns on marginal increases in absorptive capacity as firms approach the frontier of knowledge If economic policy doesn’t look to build the institutions and conditions for learning, FDI policy will not matter. Attitudes towards FDI still date to the import-substituting era When attracting FDI that is largely rent-seeking, you need to fact in the costs of subsidies to the ‘MNE’ that will seek to Instead of be-moaning the end of traditional instruments used by NICs, a la ha joon chang, ook to see new instruments that can be used. Focus is more on attracting FDI, rather than embedding it, or creating linkages, in ways beyond LC requirementWhen attracting FDI that is largely rent-seeking, you need to fact in the costs of subsidies to the ‘MNE’ that will seek to Instead of be-moaning the end of traditional instruments used by NICs, a la ha joon chang, ook to see new instruments that can be used. Focus is more on attracting FDI, rather than embedding it, or creating linkages, in ways beyond LC requirement

17. Too much focus on attracting and establishment, not on new ways to embed. The conventional wisdom today points towards a balance between an interventionist role for governments where governments attempt to ‘pick winners’, and one which seeks to overcome market failures and imperfections with an intention to establish the appropriate milieu or ‘ecology’ for innovation overcoming market failure (promoting institutions, building up the non-firm sector) assumes that we don’t have government failure.