FDI, MNCs, and

host country policy

What’s special about MNCs?

Effects of FDI
FDI policy
Why worry about FDI?
 Sales of foreign affiliates larger than total
world exports
 MNCs account for 2/3 of world trade
 FDI is growing faster than world production or
world trade
= Capital, jobs, technology, exports?

Expansion driven by international trade

liberalization, regional integration, technical
progress
Ari Kokko
Why do FDI and MNCs exist?
 Understanding what is special about
MNCs helps understand their behavior
and predict their effects

 Older explanations
– market disequilibrium and distortions
 Newer explanations
– market failures and market imperfections

Ari Kokko
Market disequilibrium and
distortions as motives for FDI
 Temporary disequilibria in markets
– Differential rates of return
– Cost differentials
– Valuation of currencies
 Government imposed distortions
– Trade barriers
– Tax rules
– Investment incentives
Ari Kokko
Market imperfections
as motives for FDI
 External effects and scale economies
could mean that doing A makes you
better at B.
– If R&D makes you a more efficient
producer, then you should expand through
FDI.
– Licensing will not be a good alternative,
because other firms (with no R&D) will
never be as efficient as you can be.
Ari Kokko
Market failures
as motives for FDI
 Markets for intangible assets -
technology, trade marks, marketing -
often fail.
 The transactions costs for finding a
price that satisfies both seller and buyer
are very high.
 Firms based on intangible assets tend
to expand through FDI rather than
licensing.
Ari Kokko
Conclusions:
motives for FDI and MNCs
 Many different types of FDI
 Older explanations are not sufficient,
because FDI continues when
disequilibria and distortions disappear
 New theories suggest that intangible
assets - technology, trade marks,
marketing skills - are central to MNCs.

Ari Kokko
Host country effects of FDI

 Resource transfer effects: capital and

technology
 Trade and balance-of-payments effects
 Competitive and anti-competitive effects
 Sovereignty and autonomy effects

Ari Kokko
FDI as a source of capital
 Arguments:
– MNCs have plenty of capital and access to
international capital markets
– MNCs may help mobilize local savings
– MNCs may stimulate aid flows
 Objections:
– not much capital transfer going on, most of
investments financed locally
– FDI is an expensive source of funds
– profits are repatriated
Ari Kokko
FDI as a source of technology
 Arguments:
– most commercial technology owned by
MNCs
– few countries can afford comprehensive
R&D programs on their own
– benefits possible even if MNCs keep
ownership of technology: spillovers
 Objections:
– MNC technology may be too expensive
– MNC technology may not be appropriate
Ari Kokko
Spillovers
 When locals benefit from the presence
of MNCs without paying the full price.
 Several possible channels:
– Demonstration effects, ”copying” MNCs
– Training of employees who may leave the
MNCs for jobs in local firms
– Forward and backward linkages
– Local firms are forced to work harder
because of tougher competition

Ari Kokko
Evidence on spillovers
 Lots of case studies showing that locals
learn from MNCs
 Spillovers are not automatic. Effects are
determined by the local environment:
– Technological capability and labor skills
– Level of competition
– Trade policy

Ari Kokko
Balance-of-payments effects
 Arguments:
– shortage of forex for imports of investment
goods a common development problem
– both export-oriented and import-
substituting FDI should improve BoP
 Objections:
– MNCs import a lot. Import-substituting
MNCs, in particular, may create import
dependence
– MNCs repatriatiate profits
Ari Kokko
 Competitive and
anti-competitive effects
 Arguments:
– MNC entry may stimulate competition,
efficiency, and development
– MNCs often enter industries where entry
barriers for local firms are high
 Objections:
– MNCs are stronger and may outcompete
local firms. Risk for foreign oligopolies and
monopolies
Ari Kokko
Sovereignty and autonomy effects
 Arguments:
– Foreign ownership always carries a cost.
Foreign MNCs may push for policies that
are good for them but not necessarily for
the host country
 Objections:
– Who cares if the Americans own our
factories, as long as we get jobs and tax
revenue

Ari Kokko
Other effects
 Negative externalities from FDI, e.g. on
the environment?
 Cultural imperialism?
 Inappropriate consumption patterns -
Camel, Heineken, and Yves St. Laurent
in poor countries?
 FDI may create dependence on foreign
capital

Ari Kokko
FDI policies
 What do host countries want from FDI
and foreign MNCs?
 What policy measures are available to
host country governments?
 How effective are FDI policies?

Ari Kokko
Host country objectives
 To acquire
– capital and jobs
– technology, production, and R&D skills
– organizational and managerial skills
– marketing and exporting skills

 To retain national control over strategíc

industries and strategic decisions

Ari Kokko
Policy measures

 Investment promotion - to attract foreign

MNCs
 Market access restrictions - to retain
national control
 Regulation of MNC operations - to make
the foreign MNCs behave in the right
way

Ari Kokko
Investment promotion
 Information
– Consumer preferences, markets, production
factors, rules and regulations
 Incentives
– Investment and profit repatriation guarantees
– Beneficial tax rules - tax holidays, reduced rates,
investment allowances, and other fiscal incentives
– Tariff protection
– Subsidies and grants
– Provison of infrastructure - industry parks and
export processing zones
Ari Kokko
FDI incentives
 Used by almost all countries
 Financial incentives in OECD - fiscal incentives
in developing countries
 Probably becoming more important for
corporate decision making…
– WTO membership makes other policies more
similar across countries
 …but also risk for excessive subsidization
– politically attractive
– competition between host countries
– uncertainty about spillover benefits

Ari Kokko
Market access restrictions
 Licensing requirements (where
applications are individually screened)
 Outright prohibitions
– military industries
– mass media
– air and land transports

– banking and finance

– telecommunications
Ari Kokko
Regulation of MNC operations
 Performance requirements
– technology transfer
– exports
– employment
– local content
 Requirements for joint ventures
– to secure transfer of technology to local
industry

Ari Kokko
Are FDI policies efficient?
 Prohibitions work
 Performance requirements not very efficient -
easy to get around
– and increasingly in conflict with WTO rules
 Investment incentives increasingly important,
but mainly because everyone else is offering
them
– fundamentals like political stability, market size,
and growth rate more important
– risk for ”bidding wars” between host countries
– better to focus on industrial policy?

Ari Kokko
Example:
Objectives of FDI policy in India
 technology transfer  avoid concentration
 technology diffusion  diversification
 limitations on foreign  local content
ownership  export promotion
 save foreign  advancement of
exchange Indians
 national  local R&D
independence  regional development
 priority sectors
 capacity utilization
 employment creation
Ari Kokko
Consequences of
Indian FDI policies
 Very little FDI until early 1990s
 Major MNCs left because of regulations
 Reform recommendations in late 1980s
– liberalize and simplify bureaucracy
– focus on employment creation and labor-intensive
industry
– allow foreign majority ownership
 Reforms and somewhat increased inflows of
FDI from early 1990s
– but still only a fraction of that directed to China
Ari Kokko