FDI and the Multinational Corporation Devising Appropriate Policies

FDI and the Multinational Corporation
Devising Appropriate Policies

A CEPR workshop on ‘Foreign Direct Investment and the Multinational Corporation’ was held in London on 27/28 November 1998. The workshop, which dealt with various policy issues concerning FDI, formed part of a research network funded by the TMR Programme of the European Commission, and was organized by Riccardo Faini (Università degli Studi di Brescia, IMF and CEPR) and Anthony Venables (LSE, World Bank and CEPR).

Andrea Fosfuri (Universitat Pompeu Fabra, Barcelona) presented ‘Foreign Direct Investments and Spillovers through Workers’ Mobility’, which was written with Massimo Motta and Thomas Rønde. The paper investigated the technological spillovers from FDI due to the movement of trained workers from a multinational subsidiary to a local firm. The authors showed that if industry profits were higher when both the multinational corporation (MNC) and local firms produced, as against when the MNC was a monopolist, then spillovers would arise. This was more likely to happen when the two firms were not close competitors, and when the knowledge acquired by the workers was broad rather than specific. Frank Barry (University College Dublin) pointed out that domestic labour, rather than the MNC, was normally observed to bear the costs of the training. Anthony Venables questioned the robustness of the product market with respect to changes in the number of MNC firms.

In ‘FDI, Soft Budget Constraints and Expropriation Incentives’, Klaus Wallner (Stockholm School of Economics) investigated the incentives for a host country to invite FDI under soft budget constraints and expropriation possibilities. FDI raised the social cost of domestic subsidies because part of the payments went to foreign owners. Thus foreign participation hardened the budget constraint, which favoured restructuring. In general, however, it was optimal to set binding upper limits on foreign ownership because of a negative externality.

In her paper on ‘Trade, FDI, and Unions’, which was written with David Collie, Hylke Vandenbussche (Universiteit Antwerpen, UFSIA, and CEPR) showed that trade and FDI were not substitutes when labour markets were unionized. Furthermore, when firms were footloose, the optimal domestic tariff was always lower than, or equal to, the tariff policy in the absence of relocation possibilities. The authors also showed that a tariff that deterred outward FDI, or induced inward FDI, could improve domestic welfare.

Niko Matouschek (LSE) presented ‘FDI and Quality Linkages’, which examined the impact on the host economy of a high-quality foreign investment project. On the one hand, the foreign investment induced local firms to downgrade their product quality owing to the intense competition. At the same time, however, the demand generated by the MNC might lead local input suppliers to invest in quality improvements. The local output firms would then benefit from better inputs which might induce them to improve their product quality. The model showed that local quality upgrading in the product market would occur only if the MNC used several independent input suppliers, thus generating a net increase in production of high-quality inputs. The MNC had an interest in the spillover which improved the firm’s bargaining position with the local input suppliers. Anthony Venables remarked that the model was useful in that it assisted understanding of the mechanisms leading to domestic quality upgrading following the entry of a multinational.

Through their empirical work on Ireland and Spain, Salvador Barrios (FEDEA, Universidad Complutense de Madrid, and Institut d’Etudes Politiques de Paris), Frank Barry (University College Dublin), and Eric Strobl (University College Dublin) attempted to study the impact of FDI on the structure of industry and employment in the EU periphery countries. Their paper, ‘FDI and the Convergence of Employment and Industry in the EU Periphery: The Cases of Ireland and Spain’, found that the peripheral countries had a weaker presence than the core countries in increasing-returns sectors, and that FDI flows into the periphery caused industrial structures to converge. The authors suggested that differences in industrial structure provided part of the explanation for asymmetries in the business cycles of core and periphery. If the periphery continued to receive greater FDI flows than the core, the scope for asymmetric shocks would be reduced. Irish data on the average length of jobs in indigenous and foreign industries suggested that shocks affecting FDI location decisions were less frequent and less pronounced than shocks affecting indigenous industry.

Giorgio Barba Navaretti (Università degli Studi di Milano) presented ‘Italian Multinationals and De-localisation of Production’, which was co-authored by Anna Falzoni (CESPRI, Università Bocconi, Milano, and Università degli Studi di Bergamo) and Alessandro Turrini (CESPRI, Università Bocconi, Milano, and CEPR). Using data from Italian MNCs in the textile and mechanics industries, the authors found that subsidiaries in LDCs were mostly of a vertical type, and that they were driven by the need to reduce production costs and exploit cheap resources in the host country. The subsidiaries were found to have a large share of intra-firm trade with their parent companies.

Helen Louri (Athens University of Economics and Business and IMOP) presented ‘FDI in the EU Periphery: A Multinomial Logit Analysis of Greek Firm Strategies’. This was an empirical paper on investments by Greek firms in the Balkan states, and it was written with John Lantouris and Marina Papanastassiou. The authors found that Greek firms that had a long- and medium-term borrowing capacity, and a solid market basis (as evidenced by larger relative firm size and greater growth rate of sales), were more likely to engage in FDI. In addition, the more intense the acquired familiarity of firms with foreign markets, the more likely it was that they would undertake FDI. Hylke Vandenbussche wondered how the framework could be used to answer interesting questions, such as the profitability of Greek MNCs in the Balkans as against domestic firms.

Jan Haaland (Norwegian School of Economics and Business Administration, Bergen, and CEPR) presented ‘International Competition for Multinational Investment’, which was written with Ian Wooton. The paper showed how linkages between the MNC and domestic input suppliers could give rise to gains from providing inducements to attract FDI. Agglomerating forces implied that MNCs had incentives to locate together, while pressure from rising wages in the labour market worked in the opposite direction. The incentives for host countries to use active policies, such as subsidizing production to attract MNCs, were particularly strong when the agglomerating forces dominated. Whether the policy competition between different host countries would result in subsidies that were so high that all net benefits for the countries would be dissipated, would depend on the parameters of the model.