Download w - Agricultural & Applied Economics

Lectures 11-12
Foreign direct investment, models, types, and growth
0
Globalization and productivity growth
 Solow growth model emphasizes importance of productivity
growth – in a hypothetical closed economy
 Open-economy Solow: (i) intermediate inputs
 Original aggregate production function:
Y = A ƒ(K, L)
•
 With intermediate inputs (N): assume
Y = A ƒ(K,L) N
•
•
==> More N  more output and more productive K & L
==> If intermediates are dominated by imports, then lowering costs
of importing N has positive effects on economic growth
Example: demand for N = ND = PN-1, so Y = A ƒ(K,L)/PN
Then –∂Y/∂PN has an effect proportional to ∂Y/∂A; lowering the
domestic cost of N raises TFP.
•
1
Globalization and int’l capital transfer
 Open-economy Solow: (ii) imported capital (= FDI)
 Original capital growth equation:
Δk = s ƒ(k) – (d + n) k
•
•
 Savings in closed econ:
 In open econ:
S = I; s = I/Y.
S = I + FDI, s = (I + FDI)/Y
==> Imported capital (FDI) also adds to capital stock
==> Lowering the cost of importing capital is equivalent to
raising the domestic savings rate, which increases
economic growth
 FDI may also interact with other factors (human
capital, productivity) as discussed in previous class.
2
Focus on FDI
 Augments capital stocks in poor economies- alters
comp. advantage
 May be “bundled” with tech. transfers, sourcing
and sales networks, etc.
 By moving factors across borders, acts as a
substitute for trade in goods
 Introduces distinction between GDP and GNI
 Gross national income (GNI) = GDP +/- factor earnings
from/to abroad
3
Why does capital move across borders?
r1
MPPK1
b
c
01
r2
a
r 1A
r*
MPPK2
KA
d
e
r 2A
02
K*
• MPPKj = marginal product of capital; rj = price, in j
• K exporter reads from right, K importer from left
• FDI = int’l flow equal to qty KAK*, equalizes r at r*
4
Net gain = area triangle acd
r1
MPPK1
b
c
01
r2
a
r 1A
r*
MPPK2
KA
d
e
r 2A
K*
02
abd = rise in 1’s GNI; bcd = rise in 2’s GNI
r1 falls and r2 rises, but what about w1 and w2?
5
Why does capital move? Details
 Transfer of KAK* from country 2 to country 1:
 GDP in 1 rises by KAadK*, cost of capital falls to r*
 GDP in 2 falls by KAcdK* but repatriated profit on investment pays
KAbdK*
 Net gain = acd:
abd = rise in 1’s GNI
bcd = rise in 2’s GNI
 This theory says that world welfare is raised by capital flows: more
efficient use of scarce resources
 Cost of capital falls in importing country, rises in exporting
country. What do we expect happens to wages in each country?
6
Effects of FDI in one sector
M
pW
L
•
•
•
•
X
FDI in M sector shifts its prod’n function upward (left panel)
This moves PPF out asymmetrically
Why does X sector output fall? (n.b.: pW unchanged)
By how much does aggregate income grow? Consumer welfare?
7
Effects of FDI in one sector
M
pW
L
c
d
a b
e
f
• At const. pw, X output falls from b to a as cd labor reallocated to M
• Aggregate income increases by less than the rise in the
value of production ef (some profits are repatriated)
8
Types of international capital flows
 FDI: acquisition of managerial control over productive
assets. Tradable but typically illiquid (not easily moved)
assets. Spillovers to rest of economy?
 Equity portfolio investment: acquisition of shares in listed
companies. Tradable and liquid
 Bond finance: private or public issues with future payments
(like loans) similar to portfolio investment, may include
gov’t bonds
 Commercial bank (or non-bank) lending: non-tradable
assets; liquidity varies (e.g. with term of loan)
9
The big picture on magnitudes
 FDI most important foreign capital flow for
developing countries in past 20 years
 Remittances from migrants is the most dynamic
source in past decade
 Both of these were somewhat jeopardized in 2008-9
crisis, for somewhat different reasons.
 A look at the numbers on FDI internationally….
10
International capital flows
11
Million $US
Sub-Saharan Africa
Mostly ODA until recently, with some FDI
12
Million $US
South Asia
Mostly ODA and FDI, like Sub-Saharan Africa – until 2006.
13
Million $US
Latin America & Caribbean
FDI is the dominant source since mid-1990s
Note also that FDI in Latin America is 10x larger than other regions above.14
Million $US
East Asia and Pacific
FDI also dominates foreign capital flows in E Asia and is greater than ROW.
15
China is single largest recipient of FDI; levels that rival all of LA or EAP16
Why do private companies invest abroad?
 Efficiency rationale (seeking access to abundant
endowments, cheap labor, human capital, lower transport
costs, etc.)
 Secure access to raw materials such as minerals or oil
(resource and strategic rent rationale)
 Access to local markets (non-tradables or inside trade
barriers)
 Other reasons?
--> Various “types” of FDI in developing countries
17
Benefits of FDI
 Increased output (higher GDP)
 Higher labor productivity; more jobs; maybe
higher wages
 More exports & foreign exchange
 Value of add’l exports should exceed earnings by foreign
capital owners, so net gain to host country
 Scale economies, technological, managerial and
skill spillovers
 FDI may create competition and undermine
domestic monopolies (e.g. in telecoms, air travel)
18
Why might FDI be bad for development?
 Market-access type FDI may create monopoly
 Technology and factor use intensity may be
mismatched with local econ.
 Transfer pricing: intra-firm price manipulation to
avoid taxes
 Rent capture and market concentration; policy and
institutional distortions (corruption)
 Limited spill-in of technology
 Loss of control over domestic policy
 E.g. large MNCs in small economies
 Are such constraints on policy always bad?
19
Impacts of FDI on Poverty
 Poverty effects depend directly on whether returns to factor
endowments of low-income households are enhanced by
FDI and/or if prices (quality) of key consumer goods are
reduced (improved)
 Incomes of poor households: mostly labor
 Which FDI types are most likely to reduce poverty?
 Returns to labor are critical impact of FDI, so efficiency rationale
perhaps best for reducing poverty.
 FDI for resources if ownership is broadly distributed or well
regulated, but that probably lowers incentive for FDI (rents)
 FDI for market access most likely to have positive price/quality
impacts if under “competitive” conditions.
20
Does FDI alleviate poverty?
 In most dev. countries, substantial FDI inflows are a recent
phenomenon
 Does FDI follow economic success, rather than the other way
around?
 Globally, poorest countries receive least FDI
 Claimed benefits via tech transfer, etc increase labor
productivity for FDI in labor-intensive activities
 Sectoral targets for FDI are critical:
 Mining & other extractive industries, vs. labor-intensive or
technology-intensive
 Regulatory, policy & institutional settings in host countries
are critical
 “Financial development” (monetization) is good indicator
21
Does FDI alleviate poverty?
 To fully understand this, we also need to know
something about labor mobility.
 We’ll return to this at end of today’s class.
22
FDI & Growth
 Back to the Solow Model and what drives growth?
 Y = Aƒ(K, S, L)
 Where does FDI enter into this conception?
 Increase in K, which drives growth
 What about A?
 What about S?
 3 links to assess – capital stock, technology, and
human capital. Let’s discuss each.
23
FDI and Capital Stock - 1
 Link between FDI and capital stock seems clear from
model presented earlier. Increases capital availability for
investment which raises production and wages.
 Is this always true?
 What if the FDI is capital that is raised locally (via loans)?
 What if it involves joint venture investments?
 Simple point – may not be 1:1 increase in domestic capital?
 Over time, what if FDI leads to profit drain out of country?
 When is this more likely to be the case?
 Still, seems as if FDI should ‘add’ to domestic capital stock
in most cases.
24
FDI and Capital Stock - 2
 Does it matter what ‘type’ of FDI occurs?
- Efficiency-seeking vs Market Access vs Resource-seeking?
- Solow model does not distinguish between types of capital or sectors
of the economy.
- What issues might arise in terms of growth effects of different types of
FDI?
 Which type seems most likely to contribute to growth? Why?
 Concerns with market access FDI?
- Market power, restrict output
 Concerns with resource-seeking FDI?
- Same as market access plus ‘resource rents’ are in play.
25
80
16
70
14
60
12
50
10
40
8
30
6
20
GDP
Growth
10
4
2
Source：China Statistical Yearbook, own presentation.
0
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
0
GDP Growth (%)
FDI (Billion USD)
FDI Inflow and GDP Growth in China, 1985-2007

Hong Kong has traditionally been the most important source of FDI
into China.
Sources of FDI in China, 2000-2007
(in % of total)
2008
2000
100
100
Hong Kong, China
37.05
38.07
Korea
Japan
Singapore
United States
4.92
4.80
4.26
3.50
3.66
7.16
5.34
10.77
Taiwan, China
2.37
5.64
other
43.10
29.37
Total
Source：China Statistical Yearbook

The largest portion of FDI is for manufacturing, which took up
almost 55 percent of total FDI. Next is real estate at 23%.
Sectoral Distribution of FDI in China
(in % total, 2007 )
Manufacturing
Real Estate
Leasing and Business Services
Wholesale and Retail Trades
Transport, Storage and Post
other
Source：China Statistical Yearbook, own presentation.
China & FDI (Is Vietnam similar?)
 FDI predominantly in manufacturing, some real estate
but lots of ‘investment’ there.
 Almost nothing in natural resources – very little
struggle over ‘resource rents’
 Lots from elsewhere in Asia, linked to higher tech
goods through assembly first and then moving to more
sophisticated stages of manufacturing
 Diversified national origin (not dominated by US FDI,
as in Mexico).
FDI and Technological Change
 Solow Model: A is technological change :
 Does it increase with FDI?
 Why would it?
 What would we want to assume about the spread or spillover
of FDI in the economy?
 What factors would make that spillover more likely?
 Does type of FDI matter again?
 What local or domestic factors might make spread more
likely?
 Does the form of FDI (e.g., joint venture) matter? Why or why
not?
30
FDI and Technological Change - 2
 What would enhance the potential for FDI or other forms




of absorption of foreign technology?
Active R&D support/infrastructure in country for both
capacity and resource.
Coordination among firms encouraged by state and other
institutions. How can that be done? Incentives (+ and -).
State sponsorship of training of workers and managers,
such as here at university.
FDI and other foreign contracts tied to tech transfer, again
like the UW-Madison working with the Hanoi University of
Agriculture.
31
China consumer electronics & auto parts
 Rodrik develops this example:
 FDI key role in technology transfer
 Lots of joint ventures and domestic capacity built

“interactions with domestic companies” have been important
sources of productivity growth
 China has taken advantage of good “fundamentals” (e.g.
macroeconomic stability) and a determined government
effort to acquire capacity and build domestic industry.
FDI and TFP: Rodrik’s conclusions
 China unusual export profile, rapid movement to higher




tech goods than predicted (see EXPY, yesterday’s class).
Critical contribution to faster economic growth.
Active industrial policy important to overcoming
uncertainty and technological and informational
“spillovers” associated with what will and won’t work.
Secret is not to “pick winners” but not keep on feeding
losers. Need to overcome externalities.
Implications for other countries? China is not a special
case (Japan, Korea, Singapore, Taiwan). Vietnam can learn
from China but recognize that it is smaller country and will
need to cultivate high tech profile.
FDI vs Licensing
 Pros of FDI:
 Investment, competition
 Pros of licensing
 More spillovers by design because licensing involves a
foreign firm transferring knowledge, equipment, and so
forth to domestic firms.
Strategic Perspective on
MNC FDI Decisions & Technology
 Consider multinational corporation with a technology facing a
market opportunity – e.g., China or Vietnam
 Opportunity? Consumer market, labor, and/or resources.
 Options?
 Export from home
 FDI – internalize via an owned subsidiary
 License to an existing firm in China
 What are the tradeoffs involved with each option?
What happens if the MNC licenses or
undertakes a joint venture?
 Advantages?
 Existing partner has better knowledge of local culture
 Marketing channels may be established
 Local management of workers
 Local knowledge of “adaptation” paths for new tech.
 Friendly government policies likely inc. subsidy, tax breaks, loans,
infrastructure, etc.
What happens if the MNC licenses or
undertakes a joint venture?
 Disadvantages?
 Creates strong competitors in longer run, especially if
the licensees directly or indirectly enhance local
research capacity.
 Knowledge spillovers via more complete transfer of
technology
 Contract that limit the future use of technology might
be difficult to enforce. Why?
Should the MNC use FDI instead?
 Advantages
 Protect technology ownership and knowledge
 Improve market presence and control quality
 More of profits via controlling tech dynamic option?
 Disadvantages
 Increase competition and lowers rents
 May not be a high profit area for them or have capacity
to make FDI work well.
 In practice: more FDI, less licenses but some
countries (Korea, China) push for joint ventures.
Preferred path for developing economies?
 If licensing is the fastest, most direct path to learning, then would
they not first encourage JVs and licensing over FDI?
 Japan, Korea, and Taiwan limited FDI but encouraged licensing.
 But, Singapore, Thailand, and Malaysia relied heavily on FDI,
though they were a host for lots of Japanese investment as well as
US and European.
 China has also relied lots on FDI but has played US vs European vs
other FDI efforts off on another (e.g., insurance university by
Chubb, Microsoft help develop Chinese software industry in
exchange for “entry”.) Why might China have bargaining position?
FDI and Human Capital (H)
 Solow Model: Y = AF(K, L,H). Does H increase with FDI?
 How might FDI and H have positive feedback effects?
 Does higher human capital attract FDI? Why?
 Does higher FDI improve H? Direct and indirect effects?


Direct effects: Learning about new technologies, markets,
organizational approaches, management practices and so on.
Indirect effects: FDI raises wages, or potential wages, attracting more
private and public investment in human capital.
 Potential source for successful endogenous growth
strategy especially in labor abundant regions with relatively
high levels of human capital? Why?
41
FDI, Human Capital, and Policy
 What can the state do?
 Education
 Technical training, and
 Support for private and public investment
 When are they more likely to do so?
 Growth, taxation, and industries and activities that use
human capital (manufacturing and services), but what
about ag/nat resource products?
 Does type of FDI matter again to public and private
investment? Should, because it may reward or not more
human capital.
42
Poverty impact of FDI depends on labor
mobility
 Why does labor migrate?
 What happens in each economy when it moves
between them?
 Gains/losses in GDP and GNI
 Wages in each economy
 Labor mobility need not be between national
economies
 China’s experience of internal migration restrictions
 Hukou acts like a tax on rural labor
43
Poverty impact of FDI depends on labor
mobility
 Analysis: (i) effects of FDI on labor demand; (ii)
response of the labor market (e.g. rural-urban
migration)
 Poverty is most widespread in rural areas
 Labor market may be “segmented”
 How will gains of FDI-led growth be distributed?
44
Migration and wages: standard model
w1
w10
w*
01
VMPL1
a
VMPL2
w2
b
d
c
e
w20
L*
02
LA
w*
• MPPL = marginal product of labor (demand), with K fixed in each sector
• Outmig. area reads from right, L importer from left
• Migration = flow equal to qty LAL* equalizes w. Notice w1 must fall to
achieve this-- unless MPPL2 rises for some reason
45
Labor effects of FDI with segmentation
w1
w1
01
0
VMPL2
VMPL1
w2
a
c
w20
LF
02
• No migration – labor fixed at LF, wages do not equalize
• FDI raises L demand in sector 1, what happens to wages in
1? To wages in 2? To poverty, assuming that’s in sector 2?
46
Review & questions
 What’s the difference between FDI and portfolio inv?
 Suppose capital productivity rises in one country – due
to technological change for example. What will
happen to FDI flows?
 How does uncertainty affect FDI flows?
 Macro instability (inflation/exchange rate)
 Risk of expropriation (nationalization) as in Venezuela?
47