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Mr. Massimo M Beber Fellow in Economics Sidney Sussex College Cambridge CB2 3HU [email protected] http://people.pwf.cam.ac.uk/mb65/mpes European Economics Lecture 4 INVESTMENT, INNOVATION AND CORPORATE CONTROL (Provisional Version: last updated 28th October 2007) M.Phil. in Contemporary European Studies 2007/8 ©Massimo M Beber 2007 Lecture Outline • A “European Economy” implies integrated production: the combination of labour and capital inputs on a EU, rather than national, scale through FDI • The efficiency capital in European production depends on several crucial dimensions, to be examined in turn: – Investment and capital accumulation – Technical change, innovation, diffusion – Competition policy I: Accumulation and Innovation • Without technical change, investment is subject to diminishing returns; capital therefore should flow to where it is scarce (from rich to poor countries/regions) and lead to convergence. • Technical change can delay/prevent diminishing returns: a virtuous circle (high investment, successful innovation, higher savings, higher investment) can lead to divergence, or at least to convergence clubs. • Integrated production is therefore crucial not only to the aggregate performance of the European Economy, but also to its cohesion. Basic Definitions • MNE (multi-national enterprise): business including permanent establishments producing value added in more than one jurisdiction • FDI (foreign direct investment): expenditure resulting in substantial control of such a permanent establishment abroad through one of the following: – Greenfield investment – Brownfield investment – M&A (mergers and acquisitions) Basic Explanations – the OLI Model • Cross-border expansion: FDI vs exports, licensing, franchising • FDI the preferred strategy in the presence of advantages such as – Owner-specificity: reputation, tacit knowledge… – Localization: different factor endowments, infrastructure, business/tax culture, political stability… – Internalisation: predictability through vertical integration, avoidance of incentive problems (adverse selection, moral hazard), tax planning… Basic Statistics EU15 % World FDI, 1998 Inward Stock, % GDP Inflows Outflows 1980 1997 36 60 6 15 USA 50 21 3 8 Japan 1 4 .3 .6 Source: Hansen (2001). Memorandum: MNE’s intra-company trade accounts for 40% of world trade The Historical Background • Capital mobility one of the “four freedoms” • But little progress in the 1950’s and 1960’s – General commitment to the “mixed economy” (direct production of services; nationalised industries); – “commanding heights” (timing of investment; control over the destination of industrial subsidies); – Residual protection provided a painless way to subsidize “national champions” “Old” Industrial Policy • Discriminates between different economic activities • Impacts upon the economy’s allocation of resources • Uses a variety of instruments – – – – – Subsidies to investment Privileged access to credit Protection and government procurement Acceptance or promotion of restrictive practices Nationalisation • Sees tension between competition and competitiveness The Rise of Integrated Production • National protection undermined by the shocks of the 1970’s • Business demands for integration build up from Davignon’s “Round Table” to the 1985 White Paper • Trade integration in principle an alternative to production integration (Kindleberger’s “investment creation/diversion” classification) • In practice, both have been stimulated by “1992” “New” Industrial Policy • Also known as “Industrial and Competitiveness Policy” • Broadly defined to include “acts and policies of the state designed to improve a country’s economic performance” • “Horizontal” or non-discriminatory amongst sectors • Reflecting the neo-liberal twist in the philosophy and ambitions of economic policy since the 1970’s The Single Market and FDI • “Investment creation” explains the increase in inward FDI from the rest of the world; • “Investment diversion”, however, is inconsistent with the observed rise in intra-EU FDI • Economies of scale inside the Single Market less important than – – – – – – Vertical segmentation Preservation of market power Retrenching to core functions Reduction in sales uncertainty by closer presence in export markets Transport costs Strategic motivations (e.g. perceived first-mover advantages Country Distribution of FDI • Significant variations over time, both across sectors and countries • Overall, strengthened position of the smaller member states as host countries to inward FDI (Finland, Sweden, Denmark, Ireland; the CEEC), especially when FDI measured as a share of total domestic investment • When measured as share of total FDI, core countries still play a major role (Germany, France, UK, Italy) Sectoral Distribution of FDI • Negligible role of agriculture (until Eastern enlargement, net disinvestment); • Services accounting for over 2/3 of total FDI, and likely to increase further as public services reform “marketises” further services in health, education, utilities… • Anomalous pattern in manufacturing, with the bulk of FDI involving relatively low-tech sectors Cross-country patterns • Analysis of EU-15 cross-country FDI flows in the 1990’s did not support the basic neoclassical prediction, whereby capital (net FDI outflows) move to where it is scarce; • Rather, there is some evidence that countries of similar income levels have intense two-way (gross) FDI flows; • Also, gross FDI is higher where bilateral trade is more intense II: Science and Technology Policy (STP) • Why having a STP at all? – Uncertainty – Indivisibility – Inappropriability • Why fearing policy failure? – Public choice – Legitimacy and evaluation difficulties – Conflict with competition criterion, both internally and globally Historical Background • EEC Treaty: elements, but no framework: Euratom the main exception. • The poor precedent of the JNRC (Joint Nuclear Research Centre) • More independent collaborations since the 1960’s – Concorde – Airbus – ESA (the European Space Agency, launched in 1973) • January 1974: Council decision on launching a European STP overtaken by stagflation/Eurosclerosis One Market, One STP? • By the early 1980’s, business pressures for a single market also imply a co-ordinated approach to science and technology • In 1979, Davignon initiative for an industrialists’ “Ronnd Table” • ESPRIT (European Strategic Program of Research in Information Technologies) runs successfully in 1982-7 • In 1987, the SEA’s Title VI establishes the aims and structure of a EU STP: central role of the 5-year “Framework Programme” Legitimacy and Effectiveness • Evaluating STP raises a number of issues: – – – – Ambit Horizon Additionality Counterfactuality • Yet for STP to be sustainable at the EU level, its legitimacy must be based on demonstrable effectiveness – to an even greater extent than in the case of national STP’s; • In practice, EU STP – including both Framework Programme and ESA allocations – still accounts for less than 15% of total EU STP spending Unresolved Tension in EU STP • Pre-competitive research/applied research • Euro-networks/clusters vs. global IICAs (InterInstitutional Collaborative Agreements) • STP as a redistribution policy (resentment in rich, stagnant economies if STP disseminates their technological advantage to faster-growing new members) • The primacy of NSI’s (National Systems of Innovation) III: Competition Policy • Setting standards of conduct rather than achieving specific goals • Anchored in the principles of market capitalism • Direct Function: to guarantee the economic efficiency of integrated production within the European Economy • A “meta-policy” expanding (industrial and R&D) and informing (media, telecoms) EU competencies • Indirect Function: by preventing abuse of market power by business, to maintain and enhance public support for the integration process Historical Background • A core requirement from the start: the Spaak Report warned against – Market segmentation – Collusion to restrict output/technological change – Abuse of Dominant Position • A legalistic approach – Business Conduct: Art 81 (1) and (3), 82; – Market Structure: the 1989 Merger Control Regulation – Public Relationship with Industry: Art 86-88 A Competitiveness Renaissance • As late as the early 1990’s, “an afterthought” • a raft of big ticket cases raised the profile of EU competition policy – Nestle/Perrier (1993), Boeing/McDonnell Douglas (1997), GE/Honeywell (2001) – Microsoft, the Hoffman-La Roche vitamin cartel – EdF Current Issues in EU Competition Policy • Progressive move from legalistic to economic philosophy in assessing effective competition, reflecting both greater technical competence and a shift to “market optimism” • Modernisation and streamlining of decision-making, to keep pace with greater dynamism in market structures (M&A, Schumpeterian monopolies in new products) • Enforcement, especially of the 1999 Regulation on State Aid, in the face of persistent member state support of strategic/politically sensitive national firms and industries. Conclusions • Regionally integrated production is a relatively recent stage in European economic integration (post-SEA) • FDI decisions are complex, and the observed patterns generally do not fit a simple convergence scenario • EU-wide public governance - science and technology policy, and competition policy - have significantly expanded and changed in philosophy and practice as a result