중동부유럽

I. Introduction

When many countries started to liberalize capital accounts in 1980s, foreign direct investment (FDI) is welcomed by emerging and developed economies alike. FDI complements domestic savings as a stable financial source from foreign saving and contributes to increasing productive capacity in host countries. It is thus no surprise that domestic regulations have been revised to treat foreign investors as equals to domestic businesses, removing any obstacles and discrimination against them with a view to attract more foreign investment.

However, developing countries have a variety of levels in economic development; and a “one-size-fits all” type of generic and simple FDI attraction policy may no more be sufficient in addressing the conditions of all host developing economies. It is interesting to note that at policy level many developing countries are not aware of a need to customize FDI policies in order to reap maximum benefits. 

In this note, I discuss some selected types of FDI policies which can address the needs of developing countries with different levels of development with a view to benefit most from FDI inflows.

II. FDI: Benefits vs Costs

The literature on the net benefits (ie., possible benefits net of possible costs) of FDI is not conclusive. Generally, empirical studies concentrate on estimating various types of benefits, (e.g., technological, or managerial) as well as whether they are inter- or within industry. Possible economic costs of FDI to host countries are generally absent in the research literature.   

However, like all economic phenomenon, there are benefits as well as costs of FDI. OECD (2003) for example provides a balanced articulation of benefits and costs of FDI: 

“A preponderance of studies shows that FDI triggers technology spillovers, assists human capital formation, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise development.” FDI may help improve environmental and social conditions in the host country by, for example, transferring “cleaner” technologies and leading to more socially responsible corporate policies.

Potential drawbacks include a deterioration of the balance of payments as profits are repatriated  albeit often offset by incoming FDI), a lack of positive linkages with local communities, the potentially harmful environmental impact of FDI, especially in the extractive and heavy industries, social disruptions of accelerated commercialisation in less developed countries, and the effects on competition in national markets. Moreover, some host country authorities perceive an increasing dependence on internationally operating enterprises as representing a loss of political sovereignty. Even some expected benefits may prove elusive if, for example, the host economy, in its current state of economic development, is not able to take advantage of the technologies or know-how transferred through FDI.

In the least developed economies, FDI seems to have a somewhat smaller effect on growth, which has been attributed to the presence of “threshold externalities”. Apparently, developing countries need to have reached a certain level of development in education, technology, infrastructure and health before being able to benefit from a foreign presence in their markets. Imperfect and underdeveloped financial markets may also prevent a country from reaping the full benefits of FDI.”

All the more, this account may overlook other types of costs of FDI to host economies. One such cost could be the appreciation pressure arising from continued inflow of capital to an economy. Such pressures are likely to distance local exchange rate away from its “fundamental” level possibly leading to protracted periods of deterioration of the trade balance.

In any case, the premise that there may be benefits as well as costs of FDI call host countries to develop more refined policies to extract maximum net benefits from FDI.

III. Smart FDI Policies 

Varying degrees of development in host countries may require a different look at various types of FDI; not all types of FDI may bring all kinds of benefits to all types of host developing economies. This section discusses a selected list of categorization of determinants of a ‘smart investment policy’ for host country as following:

Attracting FDI to increase low-skilled employment opportunities

For social purposes, increasing employment is a very critical objective especially in the earlier stages of economic development when constraints on domestic capital accumulation, saving capacity and entrepreneurship lead to limited domestically driven job opportunities. For example, in Singapore during period covering the second half of 1950s until 1970s, the primary objective in attracting FDI was to produce employment opportunities.

Employment opportunities created by inward FDI in relatively less developed would involve low skilled jobs and thus be characterized by relatively low value added. However, even low skilled jobs present a significant value in countries in which supply of high value added labor is constrained.

Attracting FDI to increase high-skilled employment opportunities

More developed host economies could target FDI that seeks high-skilled labor. In such countries, FDI seeking low skilled labor may even create negative externalities as it would create wrong incentives for skill accumulation by labor force and value generation by businesses.

It could be argued that incentives involved in the process are actually bi-directional. Existence of skilled labor in the host country invites higher value added FDI; and higher value added FDI presents incentives for skill accumulation. For example, it has been argued that post Second World War industrial development of Sweden owed to vocational training policies that assisted industries’ access to skilled labor  and thus an attractive environment for higher value added FDI.

If that argument is correct, two further arguments can be built on that. Firstly, a host country with a stock of low skilled labor and receiving FDI looking for such labor may fall into a vicious circle where total employment may increase due to FDI but income (and productivity) levels may stagnate. Secondly, and consequently, host developing countries should implement educational and vocational training policies that could help attract FDI demanding higher skilled labor with a view to escape from that vicious circle. At the same time, these countries should target FDI seeking high skilled labor.

The real world experience confirms the above in that FDI naturally going to developing countries are mostly those seeking low skilled/low wage labor. Moreover, OECD (2003; 10) argues that “in the least developed economies, FDI seems to have a somewhat smaller effect on growth, which has been attributed to the presence of “threshold externalities.” Apparently, developing countries need to have reached a certain level of development in education, technology, infrastructure and health before being able to benefit from a foreign presence in their markets. Imperfect and underdeveloped financial markets may also prevent a country from reaping the full benefits of FDI.”

Attracting FDI on a sector-based approach

In more developed stages of development, host countries could target benefits from FDI beyond creation of employment opportunities whether low or high-skilled.

In particular, prioritizing FDI on a sectoral base can provide additional benefits to the host country through positive externalities. Considering gross value added as a measure of economic value can be useful in that prioritization. GDP in a country is the sum of value added by businesses. Not all economic sectors have the same capacity of generating economic value. A country attracting FDI to sectors which produce higher gross value added is likely to command higher GDP and thus higher per capita GDP, ceteris paribus.

At a broader level, FDI can flow into services, agriculture or industry. There has been a marked difference in the composition of FDI inflows in the last two decades. Whereas services and industry received broadly similar shares in total (around 45 percent each) global FDI flows in 1990, now two-thirds of total FDI inflows is directed towards services against about one-quarter into the industrial sector (with agriculture having a share of less than 10 percent all along since 1990s).

Benefits obtained from industrial FDI are likely to be higher than those in services. This, is at least built on the case that manufacturing products make up the major part of the international trade and technological externalities are crucial for developing countries in manufacturing. Thus, positive (technological) externalities in manufacturing industries will provide much needed hard currency for developing countries. Moran (2005), citing Wasow (2003), Wells Jr (1986) reminds that the net effects of even manufacturing FDI to a host country may be negative. On the other hand, empirical studies have shown that manufacturing FDI is likely to create positive externalities in inter-industry basis rather than within-industry.

Thus, meaningful technological spillovers from FDI do not come for granted; host country policies are called for to extract maximum positive technological spillovers for the host country. It is interesting that in the case of Japan, during the high growth period, the general attitude of the government have been against FDI but pro-technology licensing. Blomström, Kokko and Zejan (2002) argues that competition environment and labor skills are positively related to the recorded technology imports of foreign owned affiliates especially in durable and capital goods industries and recommend that government policies aiming to improve competition and labor quality may promote inflows of modern technology.

Enhancing the Propagation Process of Technological Spillovers

Some of the possible technological spillovers from FDI would emerge and propagate naturally; but some may not. In order to catalyze general spillover propagation and to make use of more valuable components of them, host countries may need to devise specific carrot (if not stick) policies. A historical example argued by Prestovitz (1988: 34-35), among others, may be illustrious here: in 1960s Japanese government raised tariffs against IBM`s computers forcing IBM to conduct FDI and start manufacturing in Japan. MITI then refused to permit the FDI unless IBM licensed basic patents to fifteen Japanese companies.   Further, IBM had to follow instructions of MITI in terms of types and number of computers to produce in Japan until 1979.  

Green field vs acquisition FDI

In many developing countries, acquisition of existing businesses (whether in the form of privatizations or acquisitions of private businesses) has been a significant part of FDI inflows. Moreover, increasingly, acquisition FDI covers non-manufacturing sectors The literature does not include an adequate assessment of comparative net benefits to host countries of such acquisition FDIs in non-manufacturing sectors; but likely conclusion could be that such FDI could generate only managerial spillovers rather than hardcore technological ones. Moreover in FDI in services would generate very scarce export earnings to the country while profit repatriations would drain host country reserves. It is interesting to note that the in Korea, the Government did not allow much acquisition FDI from 1960s until 1997 during when the country displayed a spectacular development performance. 

Net export potential

It is important to recognize that net export potential from FDI may be critical in developing countries which need solid hard currency gains in order to further their development and finance imports. So a foreign investment that targets export markets clearly presents additional benefits over one that targets exclusively the domestic market.

IV. Conclusions

I discussed some of factors that could define components of a “smart FDI policy” by host countries that are classified as developing countries. The brief conclusion is that a ‘liberalization’ policy aiming only at attracting “any” kind of FDI may not effective in bringing about maximum developmental benefits from FDI. More “refined” policies are required to maximize net benefits from FDI.  

References

Alfaro, L. and Charlton, A. (2008). Growth and the quality of foreign direct investment: Is all fdi equal?. CEP Discussion Paper No. 830.

Blomström, M., Kokko, A. and Zejan, M. (1994). Host country competition, labor skills, and technology transfer by multinationals. Weltwirtschaftliches Archiv,130(3), 521-533.

UNEVOC (1995) The Role of Technical and Vocational Educationn in the Swedish Education System
Katzenstein, P. J. (1985). Small states in world markets: Industrial policy in Europe. Cornell University Press.

De Vylder, S. (1996). The rise and fall of the Swedish model. UNDP Occasional paper, 26.

Blomström, M. and Kokko, A. (2002). From Natural Resources to High-Tech Production: The Evolution of Industrial Competitiveness in Sweden and Finland (No. 139). The European Institute of Japanese Studies.

Lee J., Yoo, J., Choi’ N.’ Kim, J.D., Hyun, H., Kim, S., Suh, J., Yoon, D.R. Lee, H. and Song, Y. (2010) “International Economic Policy”, in SaKong, I. and Koh, Y. (Eds.). (2010). The Korean Economy: Six decades of growth and development. Korea Development Institute.

OECD (2003) Foreign Direct Investment and Development: Maximizing Benefits Minimizing Costs, OECD: Paris

Moran, T. H. (2005). How does FDI affect host country development? Using industry case studies to make reliable generalizations. Does foreign direct investment promote development, 281-313.

Prestowitz, C. V. (1988) Trading places: How we allowed Japan to take the lead. Basic Books.
 
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Yülek, M. (2014) “Kalkınma Tartışmalarında Japon Modelinin Yükselişi, Düşüşü ve Tekrar Yükselişi” in,  Akkemik, K. Ali; Ünay, Sadık (eds.), Doğu Asya Ekonomi Politiği: Kalkınma, Siyaset, Jeostrateji, İstanbul: Boğaziçi Üniversitesi Yayınları.