Discussion Paper Series
#9606 Foreign Direct Investments and Technology Transfers in Development: A Perspective on Recent Literature Nagesh Kumar August 1996
United Nations University, Institute for New Technologies, Keizer Karelplein 19, 6211 TC Maastricht, The Netherlands Tel: (31) (43) 350 6300, Fax: (31) (43) 350 6399, e-mail:
[email protected], URL: http://www.intech.unu.edu
Foreign Direct Investments and Technology Transfers in Development: A Perspective on Recent Literature
1. Introduction Technology is a critical input in the industrialisation and is to be sourced quite substantially from abroad at least in the initial phases of development of a country. In that context, foreign direct investment (FDI) flows which bring together with technology, other scarce and critical developmental resources such as entrepreneurship and capital, are seen as catalysts of development. Most developing countries, therefore, seek to attract FDI flows with different policy instruments. Since the mid-1980s a considerably more emphasis has been placed on FDI in the current scenario of drying up of soft credits and accumulation of huge external debt by developing countries which has affected the flow of commercial credit to them. FDI inflows received by developing countries have risen steadily from an annual average of US $13 billion during the first half of the 1980s to $ 30 billion in the second half of the 1980s and to $ 80 billion in 1994. The trend of rapid rise in magnitude of FDI inflows in developing countries tends to be a cause of optimism among them of prospects of receiving greater volumes of FDI inflows and associated multiple benefits such as technology transfer, market access and organisational skills as FDI is perceived as transfer of a package of capital and these resources. The trend of rising importance of arm’s length licensing as an alternative channel of technology transfer has also been reversed since the mid-1980s and FDI has emerged as the principal channel of technology transfer again [Kumar, 1995b]. Multilateral financing agencies have generally included liberalisation of policy towards FDI among the conditionalities attached with structural adjustment financing support provided by them to developing countries. A large number of developing countries have liberalized their foreign investment codes since the mid-1980s, offered various incentives, and have actively competed among themselves to attract greater flows of FDI. Among the other factors contributing to the rising importance of FDI in national economies is the trend of governments pulling out of productive activities the world over and leaving these activities for private enterprises including foreign owned ones.
In that context, research on the role and determinants of FDI and other forms of technology transfer and their developmental impact assumes importance as it could be of considerable value as policy inputs. A large volume of literature has addressed itself to different aspects of the phenomenon of FDI and other modes of technology transfers analyzing their determinants, and their impact on various parameters of development. The growth of the literature on the subject has been so rapid that no review of literature can
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claim to be exhaustive. This paper provides a selective review of this growing body of literature with a view to derive policy lessons and delineate an agenda for further research.
The rest of the paper is organised as follows. Section 2 summarises the theoretical and empirical literature on determinants of FDI and technology licensing and its implications. Section 3 reviews the evidence on FDI’s interface with growth and other macroeconomic parameters in the host countries. Section 4 considers the impact of FDI on host country market structures and performance. Section 5 examines the nature of the interface between technology imports and local technological capability and also reviews the evidence on knowledge spillovers from technology imports. Section 6 examines the literature on the role of FDI in expansion of manufactured exports from their host countries. Section 7 summarises the literature on the choice of technique and employment related issues. Section 8 looks at the direct and indirect cost of technology imports. Finally, the concluding section summarises the policy implications of this rather vast stream of literature and points out directions for further research brought out by this survey.
2. Determinants of FDI and Technology Licensing: Theory and Empirical Evidence 2.1. Theory of International Operations of Firms FDI is generally associated with large corporations with international operations called transnational or multinational enterprises (henceforth MNEs). The economic theory has dealt with FDI (and licensing) as a part of explaining the internationalization of firms. In fact exporting, FDI and licensing are treated in the theory as alternative means of operating abroad.
Hymer (1960, published 1976) made a first systematic attempt to explain internationalization of firms. Before that FDI flows were treated like any other international flows of resources such as portfolio investments and were thought to be driven by international factor price differentials. Since Hymer’s contribution the theory has evolved with the contributions of Vernon (1966), Kindleberger (1969), Caves (1971, 1974a, 1982), Buckley and Casson (1976), Dunning (1979, 1981), Rugman (1981), Teece (1981, 1983), Williamson (1981), and Hennart (1982) among others. Dunning has drawn upon different approaches in his 'eclectic theory' in an attempt to provide a comprehensive and general explanation of different types of international operations. The extent and mode of overseas expansion of a firm is determined by the three factors in the eclectic theory viz., ownership advantages, locational advantages, and internalization incentives. A firm wishing to operate abroad must possess advantages adequate enough to more than offset the handicaps faced in an alien atmosphere and to cover the greater risks [Hymer (1976), Kindleberger (1969), Caves (1971)]. 3
These advantages emanate from the ownership of proprietary intangible assets possessed by firms which can be productively employed abroad. These assets could include among others brand goodwill, technology (patented and otherwise), managerial and marketing skills, access to cheaper sources of capital and raw materials. Initially (in the first phase of the product cycle, à la Vernon), these advantages are exploited abroad through exports from the home base of the firm. In the subsequent stages production is moved closer to export markets with FDI, because locational advantages, which make it more profitable than exports, begin to emerge. These advantages arise from factors, such as tariffs and quantitative restrictions imposed on imports by host countries, communication and transport costs, and inter-country differences in input/ factor prices and productivity.
Due to imperfections in the market for knowledge and other intangible assets, ownership and locational advantages usually provided sufficient conditions for FDI flows during the early post-war period. In the period following the late 1960s, however, the standardization of a wide variety of technologies, and hence, increasing competition coupled with the improved bargaining position of host country governments, provided arm's length licensing of intangible assets as an alternative to FDI [Dunning (1983)]. Mere ownership of intangible assets and the presence of locational advantages were no longer sufficient, though still necessary, conditions for FDI. These advantages needed to be complemented by some incentives for internalisation of the markets of intangible assets and hence undertake their transfer on intra-firm basis or through FDI [Buckley and Casson (1976), Dunning (1979), Rugman (1981), Williamson (1981), Caves (1982), Hennart (1982)]. The internalisation incentives could arise because of market failures and information asymmetry involved in their transfer. The (external) markets for intangible assets are often inefficient channels of their transfer because of a number of infirmities which emanate from the characteristics of the intangible assets. First, because of their 'public goods' like nature, the marginal cost of their use elsewhere is close to zero. Hence, they are inefficiently priced. Second, a severe information asymmetry exists which results from the inability of the seller to make a convincing disclosure about the intangible asset. This is particularly applicable in the case of unpatented process know-how. Third, the unaffiliated firms abroad may fail to recognize the productive potential of technological developments taking place in a country. Fourth, there may be buyer's uncertainty about the claims of the supplier regarding the potential value of the intangible asset. Fifth, there may be problems with codification of knowledge. Certain kinds of knowledge may be embodied in the skills of personnel or may have a high tacit component. Hence their transfer will not be complete without physical transfer of personnel. Finally, the arm's length market may fail to ensure uniform quality standards which are important, particularly in the case of the transfer of goodwill assets like brand names.
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These infirmities lead to a high cost of market transactions (transaction or governance costs) of intangible assets. Firms tend to avoid these costs by internalizing the transactions of the intangible assets or by undertaking FDI. However, there may be certain costs associated with internalization itself. Co-ordination of manufacturing units located in geographical areas separated by national boundaries entails certain information costs. Further, the host country government may discriminate against enterprises under foreign control and hence there may be certain political costs. In addition, there are administration costs of internal markets depending upon the degree of professionalization of management. Therefore, firms weigh the economies arising from the internalization of transaction and the costs associated with it. Firm prefer to internalize the transaction (or undertake FDI) if the transaction cost economies outweigh the additional costs of internalization. Otherwise the intangible assets are licensed to unaffiliated firms abroad through markets. Thus presence of the internalization incentives provides the final requirement for explanation of FDI.
Besides the characteristics of intangible assets or technology to be transferred as predicted by theory, a number of other factors may affect the choice between FDI and licensing in practice. For instance, licensing is preferred when FDI is not profitable or possible. This could be because of the small size of the market or government restrictions on FDI. Licensing is encouraged when the licenser lacks experience in managing manufacturing plants abroad. Licensing may also be preferred when industry’s technology is changing rapidly because the lead time required to license an established producer usually is less than that required to start a subsidiary from scratch [Caves (1996: 168-71), Davidson and McFetridge (1985)].
The implications of the theory are that exporting and foreign production through either licensing or FDI are alternative modes of overseas operations. In the absence of any restrictions on imports and factor price differences, firms wishing to serve a particular market will rely on exports. Seen this way, excessive trade liberalization may erode the locational advantage of the country as a location of production for the local market and lead to deindustrialization. MNEs may prefer to export to the country from some other plants and their local operations may be reduced to assembling, packaging, marketing and after-sales service type operations. A number of empirical studies have confirmed the interdependence of exporting and FDI (or foreign production) [see for instance, Baldwin (1979), Lall (1980a), Buckley and Pearce (1981)]. The choice of the mode of foreign production is determined by the transaction costs involved in market transfer which would be determined by the nature of intangible assets. Process technologies which are covered by intellectual property rights such as patents and which can be codified in the form of designs and drawings can be transferred easily on licensing basis. Transfer of product technologies especially the 5
branded ones and process technologies not covered by patents, or those with high content of idiosyncratic inputs are subject to greater transaction costs. Hence, FDI generally will be a predominant mode for transfer in these cases.
2.2. Empirical Analyses of Determinants of FDI The determinants of FDI have been analysed at either intercountry, interindustry, or intertemporal levels. The intercountry studies explain the pattern of FDI inflows across countries in terms of country characteristics. Basically these studies analyze the locational factors in determining the country choice in FDI decision making of MNEs. These studies may be useful in formulation of FDI promotion policy. The interindustry studies analyse variation in the intensity of FDI outflows across industries from a particular country or interindustry variation in the intensity of FDI inflows in a particular country. These studies help in understanding the characteristics of industries that could attract FDI and or licensed technologies. Finally, intertemporal studies explain variations in FDI inflows in a country overtime in terms of policy changes and macroeconomic performance variables. These studies may help in evaluation of efficacy of particular set of policies and for formulating strategies to promote FDI inflows.
In view of the fact that the empirical studies of determinants of FDI have been extensively surveyed recently by UNCTC (1992a), Dunning (1993, chap. 6), and Caves (1996), we confine ourselves to a rather selective and brief review of findings of a few recent studies.
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2.2.1. Intercountry Studies Among the intercountry studies, Root and Ahmed (1979), Kudrle (1984), Schneider and Frey (1985), Contractor (1990), Balasubramanyam and Salisu (1991), Agarwal et al. (1991), Koechlin (1992), Wheeler and Mody (1992), and Moore (1993) have analyzed the determinants of FDI flows from a particular country or from all OECD countries to different samples of countries. Despite the divergent samples, measurements of variables, and methodologies used by these studies, there is a broad convergence in their findings. Among the factors that favoured FDI inflows are the level of prosperity as measured by the per capita income, market size in terms of national income, growth rates, extent of industrialization and urbanization and quality of infrastructure available. The high rates of inflation, current account deficits and political instability adversely affected the prospects for FDI inflow. In addition, man-days lost in strikes etc. representing quality of industrial relations was found to have a significant negative impact in the case of FDI in the Asian and Pacific developing countries by Rana (1988) who found the credit rating of the country also to be a significant positive determinant of FDI inflows. Geographical distance, language, economic-political and/military dependence of a potential host on the source country, labour cost and business environment risk index were also found to be significant factors in determining US FDI flows between 1966-85 by Koechlin.
The policy factors such as degree of openness of the economy, incentives, tax rates etc. have generally not proved significant determinants of FDI inflows. Contractor (1990) in his empirical study of 46 countries did not find liberalisation to be an important factor in influencing the pattern of FDI flows. The foreign investors’ response was found to be strongly influenced by the size and growth of the host economy rather than by changes in the government’s FDI policies. Wheeler and Mody (1992) in their study covering 42 countries for the period 1982 and 1988 emphasised the importance of the quality of infrastructure, level of industrialisation and market size in attracting US FDI. The open market policies or incentives, such as tax breaks were found to be of limited value in determining the investment decisions of US MNEs. Loree and Guisinger (1995) in a recent paper found some support for the incentives in influencing the intercountry pattern of US FDI outflows. Yet they find no evidence to suggest that 'a dollar spent on incentives has a higher return, in the form of investment attracted, than a dollar spent on infrastructure'. Agarwal et al. (1991:128) finding the irrelevance of specific incentives and attractions offered to foreign investors concluded that what is good policy for domestic investors - for instance, a stable and favourable general framework for investment - is also good for foreign investors. The role of intellectual property protection in influencing FDI flows has also been debated. Frischtak (1989) and Bosworth (1980) did not find a significant role of intellectual property rights (IPRs) in influencing the pattern of FDI and technology transfers respectively. Ferrantino (1993) found no 7
discernible impact of a country's adherence to IPR agreements on arm's length exports or subsidiary sales (i.e. FDI) of US firms. But subsidiaries in countries adhering to IPRs had a greater chance of sourcing more components from the US than from the host countries. The affiliates in countries belonging to Paris Convention are also likely to have higher payments of royalties and licence fees than others. The greater dependence on parents for sourcing components also creates greater potential for transfer pricing. Since the 'U.S. is generally a low tax regime compared to LDCs, this suggests that strong international IPRs may indirectly cause a diversion of tax revenue from LDCs to the US treasury' (p.329). Kondo (1994) in a Harvard University PhD dissertation found no consistently significant relationship between the strength of patent laws in terms of four alternative indicators and the levels of and changes in US FDI in a sample of 33 countries over a 15 year period. Mansfield (1994), on the other hand, cites some tentative unpublished results of Lee which suggest that weakness of intellectual property protection as perceived by firms to be adversely affecting the US capital outflow in a sample of 16 countries if size of the country was held constant and Japan was excluded and Mexico was separated with a dummy variable. These results, however, are at best conjectural because of specification errors, subjective bias in measurement of IPRs, and a small sample of countries. Mansfield himself cautions about inferring too much from these. Kumar (1996b) found the strength of IPR regime of host countries unable to explain R&D investments of US MNEs while analyzing their determinants across countries. However, the strength of IPRs could influence the nature or direction of R&D investments. Clearly, there is need for more rigorous analysis of the role of IPRs in influencing the magnitudes and composition of FDI.
Finally, Kumar (1994a) has found export-oriented FDIs to be a special type of FDIs even more unevenly concentrated than local market oriented FDIs. Apparently MNEs are more selective while choosing a location for export-oriented production. These investments have depended on the availability of low cost labour and natural resources as expected, but also on industrial capability and presence of export processing zones giving them freedom from trade regimes of the host countries. The other aspects of host country policies and overall international orientation of the economy were found to be insignificant factors in explaining the attractiveness of a country to such investments. The implications of the body of literature on determinants of FDI inflows as reviewed above is that low income, agrarian economies with relatively poor availability of infrastructure such as India, have limited scope of attracting FDI inflows. The liberalization of policy regimes, investment incentives and strengthening of intellectual property rights may be of limited help if at all. It is clear from the recent trends of declining shares of low income countries such as those in South Asia and Sub Saharan Africa in global inflows of FDI despite liberalization of their investment and trade regimes. The bulk of FDI inflows to developing countries continue to be concentrated in a handful of middle income countries in East and 8
Southeast Asia and Latin America. China has been highly successful in attracting large magnitudes of FDI in recent years despite its low per capita income. But FDI in China is of a very special type. The bulk of FDI in China is by non-resident Chinese based in Hong Kong, Taiwan, Macau, Singapore and not by Western MNEs which are targeted by most developing countries. Finally, competition for attracting export-oriented FDIs is even keener among developing countries and MNEs pick up winners.
2.2.2. Inter-industry Studies The inter-industry studies have either explained variation across industries in the outward FDIs from a home country or shares of inward FDIs in a host country. Pugel (1978), Lall (1980a), Bergsten et al. (1978), Denekamp (1995) explained interindustry variation of the US outward FDI, and Swedenborg (1979), of Swedish outward FDI. Caves (1974a), Caves et al (1980), Saunders (1982), Owen (1982) have explained variation in foreign shares across Canadian industries and Lall and Mohammed (1983a) and Kumar (1987c) in Indian industries. Most of the studies have ignored the possibility of arm's length licensing as an alternative and have concentrated on FDI. The main findings of these studies include FDI intensity varying positively with advertisement intensity, skill intensity, R&D intensity and capital requirement intensity of the industry among other factors. Kumar (1987c) considered the FDI vs licensing choice and analyzed determinants of their intensity across 49 Indian manufacturing industries for 1980-81. He found FDI to be concentrated in advertising and human skill intensive industries while licensing in industries where know how could be embodied in plant and machinery or those with less complex machinery. Neither FDI nor licensing was concentrated in the large capital requiring industries apparently because of development of local capital markets and term lending institutions. The import substitution industrialization strategy prompted erstwhile exporters to the country to set up manufacturing plants in the country. Kumar (1990d) found the US MNEs to be preferring FDI for transfer of product technologies, and licensing, for transferring process technologies. Kumar (1995a) has highlighted the fact that the selective policy that the Indian government followed over the 1970s and early 1980s favoured licensing as a mode of local production in India and affected the balance between FDI and licensing in the country.
The implication of the above literature is that in the absence of any policy factors the choice between FDI and licensing will be determined by the transaction costs. Since transaction costs are quite significant for branded consumer goods, much of the FDI will be concentrated in those industries. Thus liberalization of policy should make the effect of intangible assets and internalization incentives to be more pronounced. This is a hypothesis for future research.
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2.2.3. Intertemporal Studies The intertemporal studies have explained variations in FDI inflows in a country over time in terms of policy changes and macroeconomic performance variables. The examples of this stream of literature include Riedel (1975) and Tsai (1991) for Taiwan, Agarwal (1990) for 8 Pacific Rim countries; Lucas (1993) in East and Southeast Asian countries; and UNCTAD (1993) for different regions. Of these Lucas's study is most interesting from the policy perspective as he attempted to capture the effect of prices and wages on FDI inflows and is singled out for a comment. He estimates a model of derived demand for foreign capital for a profit maximising multiple product monopolist for seven countries in South and East Asia viz. Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand for the period 1961-87. FDI inflow at constant prices (deflated by deflator for fixed capital formation) and net of depreciation is found to be responsive to cost and prices for all countries with the exception of Japan. FDI inflows are less elastic to a rise in capital costs than to a rise in wages. Domestic investment affects foreign inflow favourably in Korea, Malaysia, Singapore and Philippines (a weak relationship); inversely in Indonesia, and has no clear relationship in Taiwan and Thailand. A higher risk of currency depreciation captured in terms of months of imports covered by foreign exchange reserves discourages FDI inflows. Greater incidence of industrial disputes also deters FDI. Enhanced size of domestic and export markets (the later represented by the GDP of major export markets) favours FDI inflows. The elasticity with respect to export markets is greater than that for domestic market size. Lucas infers from this that inward orientation may not be a necessary condition for attracting FDI. This finding, however, could not be generalised because the sample comprises countries that have all pursued export-oriented strategy. It remains to be seen if the same holds good for an economy with a large domestic market such as India. Finally, the study brings out the role of influential episodes in a country's history in affecting the FDI inflows: Asian games in Korea, Aquino's succession in Philippines, US build up in Thailand brought in more FDI while Sukarno's rule in Indonesia, Park's assassination in Korea and Marcos martial law reduced it.
3. FDI, Host Country Growth and Other Macroeconomic Effects 3.1. FDI and growth: which comes first Given the fact that per capita income and growth rates in the host countries appeared to be important determinants of FDI inflows, the examination of impact of FDI inflow on national development is fraught with a simultaneity problem. The direction of causality needs to be determined. A few studies have addressed themselves to determining the direction of causation. Singh (1988) found a support for exogeneity of FDI penetration variable and found it to have a little or no consequence for economic or industrial growth in a sample of 73 developing countries. These findings were corroborated by Hein (1992) for a sample of 41 developing countries where he reported an insignificant effect of FDI inflows on 10
medium term economic growth of per capita income. The available evidence, therefore, suggests that the direction of causality runs more often from growth to FDI than the other way round.
3.2. Macroeconomic Analysis of FDI's Impact A number of studies have developed methodologies for evaluating the impact of FDI on the macroeconomic parameters. An early attempts in this direction was by Bos et al. (1974). They developed a two sector dynamic macroeconomic model of a developing host country where the two sectors were the FDI (PFI in their terminology) and rest of the economy. The model could be used to compute cumulative (viz. between 0 and t) or marginal (between t and t+1) effects of FDI on income, balance of payments (bop), private savings and government savings and could also be extended to compute employment effect. They used the method to evaluate the effects of FDI in India, the Philippines, Ghana, Guatemala, Argentina and Zaire in the 1960s. Their general conclusions from the empirical country studies were that FDI played a minor role with respect to increase of income. In most cases the overall income effect was less than the direct effect of FDI on income suggesting that it had negative indirect effects on income e.g. on account of absorption of financial resources otherwise available for investment in the rest of the economy. FDI tended to pose a heavy burden on bop of the country. FDI seemed to affect public savings favourably although with some exceptions and to varying degrees.
In a more recent attempt to examine macroeconomic effects of FDI, Fry (1992) estimated a macroeconometric model with three-stage least squares for a pooled time series cross section of 16 developing countries and 1966-88 period using IMF's International Financial Statistics. The 16 countries included in the sample are Argentina, Brazil, Chile, Egypt, India, Mexico, Nigeria, Pakistan, Sri Lanka, Turkey, Venezuela, and 5 Pacific basin countries viz. Indonesia, Korea, Malaysia, Philippines, Thailand. For his sample as a whole he reaches the inferences that a) FDI (expressed as a ratio of net FDI inflow to GNP) neither increases domestic investment nor does it provide additional balance-of-payments financing suggesting that FDI appears to have been used in large part as substitutes for other types of foreign flows; b) an increase in FDI reduces national savings; c) FDI does not exert a significantly different effect from domestically financed investment on the rate of economic growth; d) FDI exerts both direct and indirect effects on the current account, the latter appears to be a substantial negative effect. Hence, FDI appears to have been immiserizing. However, these effects vary across countries to some extent and the 5 Pacific basin countries differ from the rest in terms of the nature of these effects. For these countries FDI has not been a close substitute for other types of foreign capital flows. FDI appears to be autonomous and matched by increased capital formation and is consistent with that reached by Rana and Dowling (1990) and Hussain and Jun (1992) for these countries. However, FDI even in this case is just as productive as 11
domestically financed investment and does not exert a significantly different effect on the rate of economic growth. Finally, Fry finds evidence that financial repression as measured by real deposit rate of interest and trade distortions as measured by the black market exchange rate can cause FDI to be immiserizing. The outward orientation of the Pacific basin developing countries ensures that relative prices cannot diverge too far from world market prices. Because of the favourable investment climate prevailing, these countries could attract FDI without offering 'discriminatory incentives provided in the mistaken belief that FDI brings externalities' (p24-5).
Ramstetter (1993a) develops a macroeconometric model analyzing macroeconomic effects of FDI in Thailand. This type of models allow simulations of effects of policy changes on enterprises under different ownerships and could be useful in policy analysis. However, the data requirements for meaningful specifications are rather demanding. Chen et al. (1995) have developed a macroeconomic model to examine the role of FDI in China’s economic development in the post-1978 period. They find a positive relationship between FDI and economic growth although the relationship was not as strong as in the case of domestic savings. The effect of FDI on domestic savings was not significant. Tsai (1995) examines the relationship between FDI and income inequality in the host countries and finds some evidence that income distribution worsened in the East and Southeast Asian countries in the 1970s because of FDI holding other determinants of income inequality.
Some studies have made use of social cost benefit analysis to evaluate the net social benefits of individual FDI projects [Lall and Streeten, 1977; Lal, 1975; Kumar, 1984]. These studies found that a large proportion of FDI projects were not viable in terms of net internal rate of return to the society but had been made profitable to their owners by government incentives e.g. protection in the case of import substituting projects and export subsidies in the case of export-oriented projects. Other research has also shown that government incentives could be quite costly in terms of welfare implications especially when they apply to FDI only. Social cost benefit analysis could be a useful tool for screening of individual project proposals. However, it is of limited value in policy analysis as it is often not possible to generalize about the impact of FDI from individual project evaluations.
To sum up, therefore, the literature shows a rather marginal macroeconomic impact of FDI. For some countries, FDI crowds out local investments but in others it complements it with consequent implications for its impact. Apparently the government policy determines the direction of the impact. More research, both in intercountry framework as Fry or individual country case studies on the lines of Bos and Ramstetter, is clearly indicated. 12
4. FDI and Market Structure, Conduct and Performance The studies analysing the impact of MNEs or FDI on host country market structures, conduct and performance have confined themselves to an examination of relationships between FDI and level of concentration, advertisement and R&D intensities or performance in terms of profitability.
4.1. Univariate Comparisons The market structure can be affected by the relative scale of operation of enterprises. A number of studies have provided evidence on larger scale of operations of foreign enterprises than that of their local counterparts, for instance, Newfarmer and Mueller (1975) for Mexico and Brazil; Lall and Streeten (1977) for India, Colombia and Malaysia. Radhu (1973) in Pakistan, Willmore (1976) in Guatemala, Newfarmer and Mueller (1975) in Mexico and Brazil have observed significant correlation between the degree of presence of MNEs and seller concentration. Evans (1977) and Willmore (1989) for Brazil, Lall (1979) for Malaysia, and Blomstrom (1986) for Mexico found the positive influence of foreign ownership on industry concentration even after controlling for the entry barriers.
The conduct has been compared in terms of advertising and R&D behaviour. Caves et al. (1980), and Gupta (1983) found the foreign share in industry sales to have a significant positive influence in explaining the proportion of advertising expenditure in Canadian manufacturing industries. This could be due to two reasons: one, the foreign subsidiaries spend a relatively higher proportion of their income on advertising so that the industry average of advertising expenditure rises in proportion to their presence; and two, foreign subsidiaries induce the industry to pursue non-price rivalry, and both foreign and local firms spend a higher proportion of income on advertising. Which of the two effects is dominant, however, is not clear from the two studies. Willmore (1986) found foreign enterprises to spend a higher proportion of sales on advertising than their local counterparts in Brazil even after controlling for firm size and industry. Fairchild and Sosin (1986) in Latin American countries and Kumar (1987b) reported that local firms had a greater inclination to do in-house R&D activity than their foreign controlled counterparts. Lall (1985, ch.7) found a positive relationship between foreign ownership and R&D in the Indian engineering industry but a negative one in the chemical industry, thus allowing no generalization.
MNE affiliates or foreign owned firms can be expected to enjoy higher profitability than their local counterparts because of their monopolistic ownership of intangible assets and the prices charged by them may include monopoly rents for goodwill and other intangible assets held. The evidence from the literature 13
gives the impression that MNE affiliates fare better than local firms in terms of profitability. However, the observed differences did not prevail when extraneous factors were controlled for. The examples are, Lall (1976) for Colombia and India, Gershenberg and Ryan (1978) for Uganda, and Fairchild and Sosin (1986) for the Latin American countries. Subrahmanian (1972), Fairchild (1977), Newfarmer and Marsh (1981), Ahiakpor (1986a) also did not find any significant differences between profitability of MNE affiliates and their local counterparts in Indian, Mexican, Brazilian, and Ghanian case studies respectively. The reported profits, however, need not necessarily reflect the true profits, since they are subject to possible manipulations such as transfer pricing.
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4.2. Towards a framework for Comparisons: Rivalry and Strategic Groups The above findings on behavioural differences between MNE affiliates and their local counterparts, however, had not been woven into a coherent framework. Furthermore, the extraneous factors have very seldom been controlled for as most of these studies have been made in univariate frameworks. Kumar (1990a, ch. 4) noted the findings for univariate and multivariate tests of comparisons of foreign and local firms in India to be quite different. Kumar (1991) attempted to provide a framework explaining behavioural differences between foreign and local enterprises in a country. He contends that the basic difference between MNE affiliates and local firms is that of their mode of competitive rivalry. MNE affiliates enjoy a dowry of intangible assets such as internationally recognised brand names, captive access to technology and reservoirs of technical, managerial and organisational skills. In order to maximise the revenue productivity of these assets, MNE affiliates are more likely to pursue non-price modes of rivalry than their local counterparts. The choice of the mode of rivalry gets reflected on different aspects of firm's conduct and performance.
Non-price modes of rivalry are generally accompanied by extensive advertising and marketing campaigns to disseminate the differentiating features of their products among potential customers. Hence, MNE affiliates are expected to have a higher advertising intensity than their local counterparts. MNE affiliates were considered to be favouring larger scales of operations intending to serve the national markets because of significant scale economies involved in advertisement activity. MNE affiliates are also expected to have a greater degree of vertical integration to avoid the risk of losing trade secrets in the course of transfer of component designs and specifications to subcontractors and because of reduced scope of subcontracting due to product specificity. MNE affiliates are expected to employ proportionately more highly skilled personnel and managers than local firms because product rivalry involves skill intensive activities such as advertising, specialised marketing, quality control and product development. Besides brand names and advertising, the product is often differentiated by superiority of the overall package offered in terms of generous credit terms, superior after-sales service and so on. MNE can be expected to have a greater degree of liquidity in order to be able to extend manufacturer's credits to dealers/buyers. Finally, the monopolistic environment that MNE affiliates create by product differentiation may allow them to earn super normal profits. Hence, profit margins of MNEs may be higher than local firms.
The empirical findings of Kumar (1991) relating to a comparison of the behaviour of the two groups of firms in 49 Indian industries in the framework of both univariate as well as multivariate discriminant techniques were in tune with the above predictions, namely, that the MNE affiliates operate at relatively larger scales, enjoy higher profit margins, are more vertically integrated, fund flush firms that employ more 15
skilled personnel. With regard to advertising and R&D, they also benefit from the global expenditures of their associates. The tendency of MNE affiliates to opt for non-price modes of rivalry has important implications for the market structure and competitive situation in the host developing countries. MNE affiliates' preference to operate at a larger scale, depend more heavily on marketing, advertising and R&D activity to differentiate their products, raises barriers to entry of new firms. These ‘contrived barriers’ to entry perhaps explain the continued domination by MNE affiliates of several brand sensitive consumer goods industries despite instruments of the Indian government's policy which sought to curb monopolies [Kumar (1990a, chap. 2)].
If MNE affiliates and local firms do follow different modes of rivalry, they perhaps could be constituting different strategic groups within the same industries of the type that Porter (1979) described. If that were so then MNE affiliates would be protected by ‘mobility barriers’ from not only potential entrants to the industry but also from other existing industry firms. Kumar (1990b) argued that MNE affiliates and local firms in India belonged to different strategic groups in view of the observed differences in their conduct as reported earlier. The empirical verification of this contention was made by examining the determinants of profit margins of MNE affiliates and local firms in 43 Indian manufacturing industries. In the empirical tests, while the variables capturing technology and skill intensity entry or mobility barriers turned out with positive and statistically significant coefficients in the case of MNE affiliates, they had coefficients not significantly different from zero in the case of local firms. The covariance analysis further confirmed the statistical significance of the differences in the slopes of profit functions of the two groups of firms.
Thus the empirical analysis finds support for the proposition that MNE affiliates and local firms constitute different strategic groups within specific industries and that the former as a group enjoy greater protection from mobility barriers. MNEs appear to enjoy persistent advantage over their local counterparts especially in knowledge (both technology and human skill) intensive industries. This is because in such industries the overall technological strength and reputation of an enterprise and the width of product and service range plays a crucial role in market transactions. Being part of the global enterprises, MNE affiliates enjoy a formidable edge over local enterprises in these respects. The two groups of firms seem to be serving different market segments. MNE affiliates concentrate on the upper end of the market consisting of discriminating consumers who can accept higher prices, and local enterprises, on usually more price competitive lower end [Kumar, 1990a].
Findings of a few other studies tend to corroborate the above propositions. Singh (1990) in a study of Indian pharmaceutical industry found that the size of multinational parent exercised an independent 16
favourable influence on profitability of MNE affiliates in India. This finding tends to uphold the proposition that the affiliation with a global enterprise lends a formidable edge to MNE affiliates. Keshari and Thomas (1994) in a study of banking industry in India found no significant differences between technical efficiency of foreign and domestic banks using stochastic production function. But foreign banks enjoyed higher profitability which was attributed to their greater focus on upmarket segment in the banking sector.
5. FDI, Technology Imports and Local Technological Capability The issue of impact of technology imports whether in the form of technology licensing contracts or as a part of package of FDI on local technological capability is a complex one. It has been approached by two strands of literature. One strand of literature has looked at the nature of interface between technology imports and local R&D. The second group of studies have examined the diffusion of imported technology in the rest of the economy through knowledge and productivity spillovers and vertical inter-firm linkages and employee mobility. These spillovers could constitute an important externality for the host economy of technology imports.
5.1. Technology Imports and in-house R&D The nature of relationship between technology imports and local in-house R&D has been a subject of increasing debate in the recent development literature. One school of thought has tended to view technology imports to be substituting the local R&D activities. Therefore, excessive technology imports could be inimical to building up of local technological capabilities. On the other hand, an importer of technology generally needs to supplement it by in-house technological effort to absorb and adapt the purchased knowledge. Therefore, technology imports and local technological efforts are considered as complementary to each other according to the other view.
Blumenthal (1979) argued the technological level of a country to be a function of indigenous R&D, technology imports, and the relation between the two. She found the relationship to be a complex one depending upon, among other things, nature of R&D, the degree of risk aversion of private firms, the role played by government in high-risk projects, relative expenditure on basic as opposed to applied research, availability of foreign technology and government policy towards it, the institutional framework for adaptation of technology, and the industry structure. Consequently, Blumenthal's empirical exercise for six countries namely, Australia, France, West Germany, Italy, Japan, and Sweden led to no firm conclusion. For three countries, i.e. Australia, Japan, and France, there is an evidence of complementarity between
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imported technology and local R&D while no significant relationship was found in the case of the other three countries.
A number of studies have investigated the relationship between technology imports and in-house R&D in India using firm and industry level observations. Desai (1980) and Lall (1983) maintained that Indian R&D is basically adaptive and consequently import of technology would encourage in-house R&D. A number of empirical exercises including Lall (1983), Katrak (1985, 1989), Siddharthan (1988, 1992), among others, generally confirmed the complementary relationship between imported technology and local R&D. Alam (1985) in a survey of technology imports by Indian firms found that most (i.e. 157 of 211 firms) technology importers reported some R&D activity. The most important motivation for R&D activity was adaptations of imported technology (in 66 per cent cases). The second most important motivation was indigenization of production. Therefore, the relationship would appear to be of complementary nature. However, he also came across cases where Indian firms undertook R&D as technology could not be imported because of government regulations or the negotiations with a foreign technology suppliers broke down. In these cases therefore, local R&D substituted for technology imports. Desai (1980:85; 1985:2086) had also observed that many Indian firms stepped up their R&D outlays after their technology import agreements expired and government approval of their extension was difficult to get; some others after their technology suppliers failed to help them.
Kumar (1987b) argued that the nature of relationship between imported technology and local R&D is also influenced by the mode of technology import, in addition to other factors. Firms importing technology internally i.e. under the package of foreign direct investment (FDI) may not be induced to invest in R&D because of their continued captive access to the centralised research laboratories of MNEs. On the other hand, the unaffiliated licensees may be prompted to invest in R&D not only by the lack of access to the parent's laboratories but also by the anxiety to absorb technology during the life of the licensing agreement. Therefore, technology imported through FDI may not be followed up by local R&D while licensing imports may be complemented by further technological effort. Hence, FDI mode may be characterised by a substitution and licensing by complementarity. MNEs also tend to centralize their R&D activity near their headquarters and may discourage their affiliates in developing countries from undertaking in-house R&D activity. This proposition was put to test in an inter-industry study. He estimated an R&D function for a cross section of 43 Indian industries (at three digit level of disaggregation) for the years 1978-81. Two technology import variables were included in this study viz., the share of foreign controlled enterprises in industry sales representing importance of FDI and proportion of royalty and technical fees remitted abroad. Both these variables turned out significant in explaining 18
variation in R&D intensity, foreign share with a negative and royalty payments, with a positive sign. These results upheld the contention that technology import through FDI may not be followed by in-house R&D and could have a depressing effect on the levels of local R&D spending while the unaffiliated licensees may be more willing to absorb, assimilate and master imported technologies.
In view of the trends in the Indian industry under changing policies in the 1980s, Subrahmanian (1991) noted that firms develop their technological capability under protectionism and regulation differently than under economic liberalism. In the former, firms supplement their technology imports by internal R&D effort and strengthen their manufacturing capability although building up of design capability needed for continuous updation is neglected because of protection. Under liberal economic environment firms will build up technological capability through continued reliance on technology imports. In other words, the technology imports may not be complemented by internal R&D in the liberal policy environment.
Deolalikar and Evenson (1989) made use of an industry level data set for 50 Indian industries over a 1960-70 period and estimated an input demand system based on a generalised quadratic cost function where R&D (measured in terms of patents taken out by Indian industry) and technology purchase are treated as jointly determined by characteristics of Indian industries, prices, and supply of purchasable foreign technology. They find some evidence of complementarity of purchased technology and inventive activity. Foreign and state ownership did not have a significant relationship with domestic patenting in the country except for the chemical industry. In the chemical industry, domestic patenting was positively related with the state ownership and negatively with foreign ownership. They explained the latter on account of the tendency of MNEs in drug industry to use their parent companies’ inventions in India and avoid doing R&D in India. The state ownerships sign was positive in view of avowed objective of public sector entry in the drugs sector to reduce the dependence of the country on foreign technology and on drug MNEs by undertaking substantial R&D.
Braga and Willmore (1991) in a study covering 4342 establishments in Brazil analyzed the probability of a firm doing in-house R&D, among others variables, in terms of ownership and technology import variables in the framework of a logit model. The empirical results reveal that firms importing technology were more likely to undertake R&D than others. Firm size, diversification and export-orientation also favoured R&D significantly while foreign or state ownership, profitability, protection and market concentration did not have any significant influence.
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Kumar and Saqib (1994) examined the effect of technology imports on the probability and intensity of inhouse R&D activity for a sample of 291 firms included in the RBI survey of foreign collaborations in the framework of Probit and Tobit models. In the empirical exercise neither a variable capturing technology imports nor that distinguishing controlling foreign ownership achieved statistical significance. This implied that the relationship between technology imports and local R&D varied across firms and neither complementarity nor substitution dominated the relationship.
Fikkert (1993) argued that most studies of technology import and in-house R&D interaction suffered from a problem of simultaneity in that they treat one of the two as an exogenous variable and from sampling biases. He treated R&D and foreign technology purchase as jointly determined by including crossequation and exclusionary restrictions in the model in his study covering 305 Indian private sector firms for the 1974-75 to 1977-78. His empirical results showed that i) technology imports and R&D have a significant negative relationship; ii) firms having foreign equity participation have an insignificant direct effect on R&D but they tend to depend significantly more on foreign technology purchases which in turn tend to reduce R&D; and iii) trade restrictions have induced adaptive R&D. In view of these findings, he concludes that ‘India’s closed technology policies with respect to foreign direct investment and technology licensing had the desired effect of promoting indigenous R&D, the usual measure of technological self-reliance’. Furthermore, in view of the evidence of Indian R&D absorbing considerable foreign R&D spillovers, he suggested that a ‘weak patent regime may allow spillovers simultaneously to promote R&D and to have a positive direct effect on productivity’ and implied that adoption of a ‘stronger patent regime may not be optimal from either the short- or long-run perspectives’. To some extent, Fikkert’s results corroborate those of Kumar (1987b) where he found an adverse effect of FDI on R&D. In the light of his results, Fikkert also feels, very much like Kumar (1990c), that a tax on technology imports could be host country welfare improving.
These results, therefore, tend to highlight Blumenthal's assertion about the complexity of the relationship depending upon many factors [Dahlman (1984:329) observes the complex and varied nature of the relationship with a number of Brazilian case studies]. There are some technology imports that are followed by local R&D and there are others which eliminate the need to do R&D. One of the factors that turns out important in determining the nature of the relationship is the mode of technology imports. In the internal or FDI mode of technology imports, the technology supplier retains the controlling stake in the enterprise. Bulk of FDIs world-wide are undertaken by multinational enterprises. The technology recipient enterprise becomes a link in the global chain of affiliates subject to centralised decision making. The location of R&D as of production and sourcing is generally subject to centralised decision making owing to its strategic 20
importance to the global operations. Hence, the affiliate in a developing country undertakes local R&D only if it fits in the global strategy of the enterprise. Though over the years MNEs have shown a tendency to decentralise their R&D activity geographically, it is still concentrated largely in the industrialised countries. A marginal proportion of R&D of MNEs that takes place in developing countries is concentrated in those countries that are able to offer them cheaper technological resources and infrastructure [Kumar, 1996b]. At the same time licensing only creates necessary but not the sufficient conditions for further technological effort. It may or may not be followed up by further technological effort depending upon the management’s outlook. The complexity of the relationship suggests that much is also to be learnt from more detailed and often more qualitative case studies of industries and firms over time that could capture the role of finer enterprise and management characteristics, market structure, policy environment and other factors in shaping the relationship. A number of case studies have appeared recently e.g. Chaudhuri (1995) for Indian electronics industry, Chugan (1995) for Indian automotive components industry, Brunner (1995) of Indian computer industry, Mani (1992) for Indian public sector enterprises, Lall (1987) for case studies of assimilation of technology by leading Indian enterprises. More attempts in that direction would be desirable.
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5.2. Diffusion of Imported Knowledge in the Host Economies An important indirect consequence of FDI and technology licensing contracts on host economies could be in the form of spillovers of knowledge to locally owned firms that are either foreign firms’ or foreign technology licensers' competitors, suppliers or customers. These may include exposure to new production of management technologies employed by foreign firms and spillovers of knowledge through employee mobility. In certain cases the demonstration effect from foreign firms may be speeding up the diffusion of new technologies. Yet another source of spillovers could be through the increased competition with the foreign entry which forces local firms to become more efficient users of existing technologies or to explore new technologies. These spillovers could constitute important positive externality of FDI on the host economies.
The empirical literature has captured these different sources of spillovers from MNEs in their host countries in two strands of literature. The first group includes studies that attempted to quantitatively analyse the impact of foreign entry or presence on productivity or efficiency of local firms. Some of these studies used multiple regression analysis to detect the effect of technology imports on productivity of nonimporting firms. The other set attempted to analyse the knowledge spillovers from R&D and technology imports with the help of production functions. The second group of studies includes those examining the backward and forward linkage generation by MNE affiliates and training and employee mobility which are also sources of knowledge spillovers. These studies have generally applied a case study approach.
5.2.1. Knowledge Spillovers and Productivity Improvements Caves (1974b) attempted to evaluate the presence of these spillovers in Australian manufacturing by examining the effect of foreign share in an industry on labour productivity of locally owned firms which was found to be positive. Globerman (1979) found a weaker evidence of the presence of technical efficiency spillovers in Canadian industry using Caves' methodology. Blomstrom (1989, ch.4) found a strong positive association between labour productivity of owned enterprises and foreign share in employment in 1970 in 215 four digit Mexican manufacturing industries. However, the foreign entry (defined in terms of change in foreign share between 1970 and 1975) was not found related with changes in the technological frontier nor changes in labour productivity of least efficient plants. Blomstrom and Wolff (1989) in a further work on 20 two digit Mexican industries for the period 1965-1984 found increasing convergence of productivity levels of locally owned firms to that of foreign owned firms. The rate of productivity growth of local firms was found to be positively related to the degree of foreign ownership of an industry. Furthermore, they found evidence of convergence of productivity levels between Mexican and US industries over the period and the rate of convergence was related with the 22
extent of foreign ownership in the industries. One should keep in mind, however, an important limitation of the sector level studies that there may be potential overestimation of the positive impact of foreign presence on domestic firm productivity if FDI is concentrated in more productive industries.
Haddad and Harrison (1993) examined the impact of FDI on productivity of firms in Morocco's manufacturing sector using a firm level panel data set for 1985-1989 which allowed controlling for firm specific influences such as firm size. They found that after controlling for firm size, foreign firms do not exhibit higher levels of labour productivity or a greater outward orientation for most sectors, although they do continue to pay higher real wages than domestically-owned firms pay. Foreign firms achieved on average a higher level of total factor productivity than local firms but the growth rate of their productivity was not higher. They find the evidence that sectors with high levels of FDI have a lower dispersion of productivity levels across firms, moving domestic firms closer to the efficiency frontier. However, no significant relationship was found between higher productivity growth in domestic firms and greater foreign presence in a sector. The faster productivity growth of domestic firms could not be attributed to a higher foreign share.
Aitken and Harrison (1993) made a similar exercise for a panel data on 4000 Venezuelan firms for 19751989. In Venezuela, foreign owned firms on average exhibited higher labour productivity, higher propensity to import as well as export and paid higher wages than their domestic counterparts even after controlling for size and capital intensity etc. Foreign ownership is found to affect the productivity of domestically owned plants in Venezuela. The negative effects are large and robust. These results suggest that benefits of FDI are limited to direct effects on the productivity improvements from technology acquired by enterprises receiving foreign participation. Spillovers to other local enterprises are negligible and do not justify the incentives granted by host governments to foreign investors.
Kokko (1994) by examining Mexican data found no evidence of spillovers in industries where the foreign affiliates have much higher productivity and larger market shares than local firms. In other industries, there appeared to be a positive relationship between foreign presence and local productivity. This result suggests that spillovers from foreign enterprises are dependent upon the local capability in the industry. If local firms are too weak they will not be able to absorb spillovers and might vanish in the face of competition from foreign firms as Cantwell (1989) has observed in a study of the impact of entry of US firms in European markets between 1955 and 1975. He found that the entry of US affiliates provided a highly beneficial competitive spur in the industries where local firms had some traditional technological
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strength, whereas local firms in other industries were forced out of business or pushed to market segments neglected by MNEs.
The quantification of direct and indirect effects of technology imports on productivity has started only recently in India. Goldar (1994) attempted to explain the total factor productivity growth attained by 330 large Indian enterprises belonging to six major Industries over the period 1987-88 to 1989-90 in terms of their own R&D expenditures and technology imports over the same period among other factors. His specification, however, turned out to be with rather poor explanatory power with none of the technology variables explaining the growth in the dependent variable in an expected manner. Goldar explained his results to suggest that Indian firms do not import technology to improve productivity but to fulfil other objectives such as diversification and expansion. However, an important reason behind neither R&D nor technology imports coming up to expectations could be the fact that both technology generation and imports are activities involving significant lags in their returns to investors. Current expenditures on R&D and technology imports could contribute to productivity improvements in the subsequent period. Therefore, one needs to pose this question with data for a longer time series with lagged measurements of technology inputs.
A few studies have used the production function approach to estimate the marginal products of R&D, technology imports and their spillovers to other firms following the tradition of studies made for the US and Canada [see Griliches (1995) for a recent survey]. Basant and Fikkert (1993) in a study covering a panel data for 787 large Indian private sector firms for the period 1974-75 to 1982-83 estimate the impact of in-house R&D, expenditures on foreign technology purchase and spillovers of foreign and domestic R&D on productivity. They controlled for firm level heterogeneity through fixed effects estimation. They found quite high rates of return to both R&D and technology purchase expenditures. While the private returns to technology imports ranged between 124 to 165 per cent depending upon the specification, the returns to own R&D varied between 19-80 per cent and were highly sensitive to the specification. The R&D activity of other domestic firms tended to have a significant positive impact on output, while foreign R&D activity significantly raised the marginal productivity of in-house R&D. In view of the fact that local R&D, especially of the type that is conducted at rather modest levels and geared to specific product and process adaptations by developing country enterprises, is known to have rather high returns, a rather small and highly unstable estimate compared to that for technology imports is rather surprising. Furthermore, this exercise could not capture the spillovers of technology imports which could be significant.
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In a more recent study, Haksar (1995) estimated marginal products of R&D and technology imports -both embodied in capital good imports disembodied- and their spillover effects of other firms’ productivity using the Reserve Bank of India data for 642 Indian firms distributed across 65 industries for 1975-1990 period. His estimates indicate a 141 per cent rate of return on own R&D, nearly 30 per cent return on disembodied technology import expenditures and 9 per cent on embodied technology imports. Both local R&D and disembodied technology imports had positive spillovers which made their social rates of return higher than their private returns viz. 145 and 45 per cent respectively. Therefore, although (disembodied) technology imports had a much smaller rate of return to the importer than similar investments in R&D, the spillovers to other firms were quite substantial. Haksar estimated these rates for specific sectors also and found them to be even larger for the scientific industries but broadly bearing the same pattern. For the pharmaceutical industry the rate of return both private and social to R&D was by far the highest at 173 and 198 per cent respectively. Haksar explains it on account of the highly successful adaptive R&D effort of Indian pharmaceutical firms directed at development of alternative processes of known drugs, made possible by the weak patent laws which did not allow patents on pharmaceutical products. Incidentally, technology imports had rather poor rates of return in this industry at 22 per cent and hardly any spillovers. Haksar’s results are more reasonable and interesting than those of the earlier study although both use very similar data sets and methodologies.
Mixed evidence on knowledge spillovers from FDI from different countries again suggest that impact of FDI varies a great deal across countries. Some countries seem to have been able to harness the positive externalities of FDI more than others. What factors or policies explain the nature of FDI's impact remains to be an fruitful topic of research.
5.2.2. Vertical Interfirm Linkages with Domestic Economy The vertical inter-firm linkages created by foreign enterprises could be an important externality for the host economy and could also be sources of diffusion of knowledge from them. For instance, Katz (1969) who noted that the inflow of FDI into the Argentine manufacturing sector in the 1950s had a significant impact on the technologies used by local firms. The technical progress did not only take place in the MNE’s own industries, but also in other sectors, because the foreign affiliates forced domestic firms to modernize by imposing on them minimum standards of quality, delivery schedules, prices etc. in their supplies of parts and raw materials (p.154). The volume of vertical backward linkages generated is determined by two decisions concerning the sourcing of raw materials and intermediate products of the firm: 'import or procure locally' and 'make or buy'.
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A number of studies have compared the dependence of foreign and local firms on imported raw materials in order to get an idea of the extent of linkages generated in the domestic economy as local content in production is an indicator of the strength of local linkages. Foreign affiliates can be expected to import a higher proportion of their raw materials and other inputs than local firms, because of their familiarity with foreign suppliers and the alleged inadequacies of local producers, and sometimes to provide markets for products of their associates elsewhere. Cohen (1975) in the case of South Korea, Taiwan, and Singapore, and Riedel (1975) in the case of Taiwan have found export-oriented foreign firms importing a greater proportion of their inputs than their local counterparts. Even foreign firms producing producing predominantly for domestic markets have been found to depend more on imports than their local counterparts in studies by Kelkar (1977) and Subrahmanian and Pillai (1979) for India; McAleese and McDonald (1978) for Ireland; Jo (1980) for South Korea; and Newfarmer and Marsh (1981) for the Brazilian electrical industry. Lall and Streeten (1977) in a study of six countries including India, however, did not find any significant difference between the import dependence of foreign and local firms. Kumar (1990a, ch. 4) also did not find a statistically significant difference between import dependence of foreign and local firms across 43 branches of Indian manufacturing. Siddharthan and Safarian (1994) in a study of 640 large Indian corporations for the period of 1987-88 to 1989-90 that imports of disembodied technology are accompanied by greater imports of embodied technology in the form of capital goods.
The make or buy decision actually relates to the degree of vertical integration. The latter is inversely related to subcontracting parts of the production run to unassociated vendors. In countries like India, which have evolved a strict trade and exchange control regime that restricts the freedom of firms to import, subcontracting may be an important aspect of a firm's decision making concerning the sourcing of intermediates and raw materials. A number of market failures may tempt the firm to internalize the manufacture of intermediate inputs, such as the certainty of delivery schedules and quality standards [Williamson (1975); Jansson (1982)]. A certain monopoly rent may also be associated with vertical integration. On the other hand, firms can internalize part of the scale economies in the manufacture of intermediates and can escape problems of industrial relations by subcontracting their production to other firms. Cohen (1975) found that among the export oriented enterprises in Taiwan, South Korea and Singapore, local firms had a greater degree of vertical integration. Newfarmer and Marsh (1981), and Willmore (1986) found a reverse pattern in the case of Brazil. Lall (1980c) could not find any significant difference between the extent of subcontracting of a foreign subsidiary and a local company in India both producing trucks. Kumar (1990a, ch. 4) found foreign controlled firms to be having a greater extent of vertical integration than their local counterparts in 43 Indian manufacturing industries even after controlling for firm size, profitability and financial variables in the framework of multivariate analysis. 26
Pangetsu (1991) found that export-oriented FDIs in Indonesia to have little creation of domestic linkages and diffusion of know how.
The literature on generation of vertical interfirm linkages by MNE affiliates relative to their local counterparts, therefore, is mixed affording no generalization. Furthermore, studies have yet to examine the effectiveness of these linkages in diffusion of knowledge brought in by MNEs in the host economy.
5.2.3. Training and Employee Mobility Some studies have documented the spillovers from FDI to local economies in the form of on- the-job training imparted by MNE affiliates to their personnel and through mobility of trained personnel. Gerschenberg (1987) examined detailed career data for 72 top and middle level managers in 41 manufacturing firms and concluded that MNE affiliates offer more training to their managers than local private firms although the mobility seemed to be lower for managers employed by MNEs than for those in private local firms. Chen (1983) also reported significantly higher training expenditures on the part of MNE affiliates in Hongkong than for local firms in three of the four industries sampled.
Therefore, the limited evidence that is available suggests that while MNE affiliates may invest more in human resource development, the diffusion of these resources within the host economies may be insignificant. 6. FDI and Expansion of Host Countries’ Manufactured Exports MNEs dominate markets in the industrialised countries and are equipped with captive global information and marketing networks. Therefore, a strong plea is often made that association with MNEs could provide to their developing host countries access to new markets and help in expansion of manufactured exports. MNEs also rationalize their production across the world in order to take advantage of international differences in factor prices. A number of countries in East and Southeast Asia have been able to expand their manufactured exports by serving as hosts to export platform production for MNEs.
A number of studies have examined the role of MNEs or FDI in export expansion of developing countries by comparing the relative export performance of foreign owned and locally owned enterprises in different countries. The findings of these studies have been mixed. A study of export-oriented firms in South Korea, Taiwan, and Singapore by Cohen (1975) concluded that local firms were more likely to export than foreign firms, while that by Riedel (1975) found no significant difference in export performance of the two groups of firms in Taiwan except for electronics. Some studies compared the proportion of exports in sales of firms predominantly producing for domestic markets, and found foreign controlled firms 27
performing more poorly than local firms. The examples include, Lall and Streeten (1977), and Subrahmanian and Pillai (1979) for India; Jenkins (1979) for Mexico; Kirim (1986) for the Turkish pharmaceutical industry. Morgenstern and Mueller (1976) for 10 Latin American countries; Newfarmer and Marsh (1981) for the Brazilian electric industry; and Fairchild and Sosin (1986) also for Latin American countries did not find a significant difference between export performance of foreign controlled and local enterprises. Reza et al. (1986) in Bangladesh’s industrial sector found foreign firms to be performing better than local firms in terms of exports but also highly dependent on imports from parents and other affiliated firms.
Lall and Mohammed (1983b) found a positive, though weak, influence of the degree of foreign ownership on industry's export performance in India. But that did not necessarily imply a superior export performance of MNE affiliates compared to their local counterparts. Lall and Kumar (1981) for a sample of 100 Indian engineering firms and Lall (1986) which had an additional sample of 45 Indian chemical industry firms found foreign share to be having an insignificant effect in the case of engineering firms sample and a weak positive effect for the chemical firms only in the absence of technology licences variable with which it was collinear. Kumar (1990a, chap 4) in a study of 43 Indian industries did not find a statistically significant difference in the average or weighted export performance of foreign and local enterprises. A further analysis of the determinants of export performance across 43 industries did not bring out any significant differences between industry characteristics of exports of foreign and local enterprises [Kumar, op. cit. chap.6; 1987a].
Willmore (1992) using data for a cross section of 17053 Brazilian industrial firms reported that foreign ownership has a large positive effect on both export performance and import propensities independently of other determinants of trade such as firm size, skill intensity, advertising. Kumar and Siddharthan (1994) in a more recent firm level analysis of the export performance of Indian enterprises in 13 Indian industries found foreign controlled firms to be performing no better than other firms in all except non-electrical machinery industry. Pant (1995) in a study covering 218 chemical and 202 engineering firms in India found no significant difference between export-orientation of MNE affiliates and local firms except for pharmaceutical industry where local firms actually performed better than foreign firms. Athukorala, Jayasuriya and Oczkowski (1995) in a Probit estimation for a sample of 111 manufacturing firms in 1981 found the probability of affiliates of developed country MNEs to be an exporter no significantly greater than that for local firms, while affiliates of developing country MNEs did reveal a significantly greater probability of being an exporter.
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The mixed findings pertaining to export performance of foreign and local firms across countries may suggest that some countries may have been more successful in harnessing the potential of MNEs in expanding manufactured exports. In certain countries, such as Mexico, Taiwan, Hong Kong, Singapore and Malaysia, MNEs have apparently played an important role in expanding manufactured exports from their host countries [Nayyar (1978), Blomstrom (1990)]. Tambunlertchai and Ramstetter (1991) found a significant role played by foreign firms in export growth of Thailand. In contrast, in India for instance, foreign firms have played a relatively minor role in expansion of exports with a share of between 5-7 per cent in India’s exports [Rao, 1994]. What factors explain the divergent performance of MNEs across countries in terms of export orientation? The success of these countries in expanding manufactured exports through MNEs is in fact due to the their ability to attract export-oriented FDI. The latter represents investments made by MNEs to relocate their production away from home countries or other industrialised countries in response to rising wage costs. In Malaysia and Indonesia, for instance, about 70 per cent of projects involving FDI have been export-oriented. In China, the share of foreign owned firms soared from a negligible 0.3 per cent in 1984 to 5 per cent in 1988 to 30 per cent by 1993 [Chen et al. (1995)]. Thus only export-oriented FDI and not FDI as such may help in export promotion in host countries.
The export-oriented FDI arises in the process of relocation of production by MNEs abroad in order to maintain their international competitiveness in the face of rising wages and other costs, currency appreciations and increasing costs of pollution abatement in their home countries. The relocation of production is attempted sometimes through subcontracting to unaffiliated enterprises and sometimes by affiliates set up abroad to undertake production meant for exports. Arm’s length international subcontracting and export-oriented FDI are, therefore, two principal alternative means of expanding manufactured exports for developing countries. Subcontracting of production abroad entails transfer of knowledge, designs, drawings, specifications and quality control. Because of this the relative importance of arm’s length subcontracting and export-oriented FDI varies a great deal across industrial sectors depending upon the governance or transaction costs involved. In the cases where the transaction costs are high, for instance, because of a closely held novel technology or knowledge, the subcontractor may prefer overseas production by means of a subsidiary (i.e. FDI) rather than arm’s length subcontracting (subcontracting) to avoid the risk of losing a trade secret, e.g. in microchip fabrication. In a more standardised product such as leather goods or textiles, contracts are generally fairly easy to govern. Hence, subcontracting to unaffiliated parties is fairly common for these products. In an econometric analysis, Siddharthan and Kumar (1990) found intra-firm trade between US MNEs and their affiliates abroad to be predominating R&D and skill intensive 29
industries. In these knowledge or technology intensive industries, therefore, export-oriented FDI would be a principal mean of tapping the market access of MNEs by developing countries.
There is an intense competition among countries to attract export-oriented or export platform production from MNEs by offering various incentives and attractions. A large number of export processing zones have been set up in different parts of the world to attract export platform investments from MNEs. Kumar (1994a) in an empirical analysis of intercountry pattern of export-oriented investments made by US MNEs across 40 countries found the extent of export-oriented investment attracted by a country to be determined by wage levels, industrial capability, infrastructure and the presence of export processing zones. The government policy towards FDI (e.g., incentives and performance obligations) or the overall international orientation of the economy did not affect it significantly. In an analysis of export-oriented FDI made by US and Japanese enterprises abroad, Kumar (1996a) has observed a stagnation in these flows in the recent period because of evolution of new manufacturing and organizational techniques. This, however, does not diminish the prospects for attracting these investments for developing countries which have been unsuccessful in attracting them so far. This is because of the footloose nature of these investments as revealed by their changing geographical pattern. Southeast Asian countries such as Malaysia, Indonesia, Thailand and China have successfully replaced East Asian newly industrializing economies viz., Hong Kong, Korea, Taiwan and Singapore as the most important hosts of export-oriented FDI in Asia. South Asian countries have failed to attract any significant volume of exportoriented FDIs despite abundance of cheap labour and skills. It also finds that preferential access to home country market and partnerships in regional economic and trading co-operation schemes is becoming an increasingly important attraction for these FDIs.
6.1. Indirect Effects on Export Performance It has been pointed out in the literature that firms that penetrate export markets reduce the costs of entry into export markets of other potential exporters through spillovers of information on export potential and potential markets, by demonstration effect. Therefore, substantial spillovers of information may flow from entry of export-oriented foreign affiliates into the country. Aitken et al. (1994) examine the hypothesis that MNEs act as export catalysts for a panel data on 2113 Mexican manufacturing plants for the period 1986-1990. The logit estimations show that controlling for factor costs, output prices, and other variables which affect the export decision, MNEs were roughly twice as likely as domestic plants to export. They also found that locating near a MNE exporter significantly raises the probability of exporting for an individual firm. This effect is not observed from a higher concentration of export activity in general. This, however, remains to be a solitary evidence on market access spillovers from FDI so far. 30
7. Choice of Technique and Employment 7.1. Choice of Technique The issue of choice of technique by foreign firms has perhaps been the most controversial. The a priori reasoning has been that technologies of MNE affiliates are appropriate to the factor endowments of their home countries, which are typically capital abundant. Reuber et al. (1973, ch.6) found that in over 70 per cent of the cases, MNEs transferred process technologies to developing countries without any adaptations. Courtney and Leipziger (1975), and Leipziger (1976), however, found that MNE subsidiaries in developing countries employed different techniques, in most cases more labour intensive than their counterparts in industrialised countries. Among the several factors that might discourage adaptation of imported technology to make it more appropriate to the factor proportions of developing countries is the possibility of technological rigidity. Marsh et al. (1983) find a close association between capital intensity and technological rigidity that limits the scope for influencing technological choice.
Several studies that compared factor proportions have noted a higher capital intensity of operations in foreign firms compared to local ones. The examples are, Forsyth and Solomon (1977) in the case of Ghana; Gershenberg and Ryan (1978) for Uganda; Newfarmer and Marsh (1981) for the Brazilian electrical equipment industry; Biersteker (1978) for Nigeria; Radhu (1973) for Pakistan; Wells (1973) for Indonesia; Agarwal (1976) for India; Jo (1980) for South Korea; Chen (1983) for Indonesia and Thailand; Balasubramanyam (1984) in Indonesia; Meller and Mizala (1982) for six Latin American countries; and Willmore (1986) in Brazil. Athukorala and Jayasuriya (1988) in a study covering data on 132 Sri Lankan manufacturing firms found that firms affiliated with developed country MNEs employed significantly more capital intensive technology than either local private firms or those affiliated with developing country based MNEs only in textiles and wearing apparel industries. In chemicals and metal product industries the differences in capital intensity were not statistically significant. Mahmood and Hussain (1991) on the basis of comparisons across 32 matched pairs of foreign and local firms in 25 manufacturing industries in Pakistan in 1981 found that foreign firms used more capital intensive and skill intensive techniques and enjoyed a higher labour productivity than local firms even after controlling for their higher capital and skill intensity.
On the other hand, Cohen (1975) in the case of Taiwan, South Korea and Singapore; Riedel (1975) for Taiwan, and Jo (1980) for South Korea found that export oriented foreign subsidiaries did not employ a significantly different technology from that of the local export oriented firms. Chung and Lee (1980) in the case of Korea; Mason (1973) in the case of Mexico and Philippines; and Chen (1983) in the case of Hong 31
Kong, Malaysia, and Taiwan, also could not find any significant difference in capital intensities, possibly due to the export-oriented nature of these economies. Kirim (1986) for Turkey and Ahiakpor (1986b) for Ghana did not find any significant difference in capital intensity on the basis of nationality after controlling for size and degree of vertical integration factors. ILO (1984), on the basis of studies in a number of developing countries noted that MNE affiliates tended to be more capital intensive but that their capital intensity was explained in terms of other characteristics, such as size rather than by multinationality. Comparisons on the basis of capital employed as a proportion of total wage bill in the absence of information on number of employees did not yield any significant differences in Kumar (1990a). Ramstetter (1993b) found for a large sample of Thai manufacturing firms in 1990 that in general foreign firms seemed to be having higher capital intensity and labour productivity but these differences were statistically significant only in one third of the industries. Chen and Tang (1986, 1987) examined the capital intensity and technical efficiency of 184 MNE firms in Taiwan’s electronics industry in 1980 and found that export-oriented MNE affiliates tended to be more labour intensive and employing a larger proportion of unskilled production workers than local market oriented ones. They were also found to be more efficient and closer to the production frontier than the import-substitution-oriented firms.
The evidence, therefore, suggests that the nature of technology employed by MNEs or foreign owned firms has to do with their market orientation. Although there are exceptions, the evidence in general indicates that domestic market oriented foreign firms employ technology that is relatively more capital intensive compared to that used by local firms. The export-oriented foreign enterprises, however, appear to employ technology not significantly different from that employed by their local counterparts.
7.2. Employee Compensation Behaviour MNE affiliates have been expected to pay higher wages and salaries than their local counterparts in developing countries because of their grooming in an environment of labour scarcity and higher wages. A number of studies seem to support this expectation, for instance, Markensten (1972) for Swedish MNEs in India; Gershenberg and Ryan (1978) for Uganda; Mason (1973) for the Philippines and Mexico; Possas (1979) for Brazil and ILO (1976). Chen (1983:147) reported that while there was a significant difference between wage payments by foreign and local firms to managerial and skilled workers, no significant difference was observed in the case of unskilled workers. Cohen (1975) did not find any clear pattern in the relative employee compensation behaviour of foreign firms in the case of export-oriented firms in South Korea, Singapore, and Taiwan. Lim (1977) while examining the determinants of average hourly wages in West Malaysian manufacturing industries, inferred that the higher wages paid by foreign firms were largely due to greater capital intensity and productivity of their production processes. Similar 32
conclusions were reached by Dunning and Morgan (1980) in a six country study where they observed that, normalizing for industry and country differences, MNEs do in general pay higher wages than indigenous firms but the margin of difference is not as great as is sometimes alleged. Balasubramanyam (1984) in the case of Indonesia, and Willmore (1986) in the case of Brazil find the average wages paid by MNE affiliates to be significantly higher than their local counterparts, but they attribute them to differences in the quality of human capital. Kumar (1986) found foreign controlled enterprises in Indian manufacturing to be paying higher than their local counterparts. However, in a further analysis this was explained in terms of their tendency to employ qualitatively superior personnel than their local counterparts [Kumar, 1990a, chap. 4].
Thus the existing evidence does not affirm any pervasive differences strictly due to the foreign ownership. Furthermore, a part of the higher wages paid by MNE affiliates may be on account of possible differences in skills seldom controlled for in these studies.
8. Direct and Indirect Cost of Technology Imports A number of studies have computed direct and or indirect effect of FDI and technology imports under contractual modes on host country’s balance of payments. Since FDI and other technology imports involve transfer of capital and other resources, the receiving economy owes their servicing burden. Hence, the balance of payment effect of FDI is expected to be negative except for primarily export-oriented FDI projects where export earnings outweigh the servicing remittances. Furthermore, since bulk of the trade of MNE affiliates is conducted by MNE affiliates is with related firms viz. either parents or other associated firms, the transactions are not governed by markets and leave scope of transfer of resources abroad through manipulation of transfer pricing. A number of studies have reported evidence of transfer pricing from case studies. The evidence on the direct balance of payments effect and transfer pricing has been extensively reviewed by us elsewhere, although somewhat dated by now, [see Kumar (1985)] and hence is not reproduced here.
The other aspect of the cost of technology imports for the host country arises from certain restrictive clauses often included in technology transfer contracts such as those restricting the sources of raw materials, components or capital goods; restricting the exports of technology importing firm, or prohibiting sublicensing and modifications in the products or processes supplied [e.g. RBI (1985) for evidence of their incidence. Khanna (1984), Ram (1990) report their incidence in Indian petrochemical industry. Cooper (1985) reports that many times there are also unwritten clauses besides those included explicitly in the agreements]. These clauses could imply certain costs for the importing firm and country in 33
terms of lost opportunities of exports or raw material substitution and technology indigenisation. It has been shown that indirect costs of technology imports such as those resulting from these channels and others through their direct and indirect impact on trade performance, market structures, choice of techniques, local technological capability etc. in the host countries may be several times more valuable than their direct costs [Kumar (1985) and reference cited therein].
The Indian government’s restrictions on maximum royalty rates payable and other regulations appear to have had their desirable effect of reducing the royalty remittances and reducing the dependence of importing firms on technology suppliers over the years according to a number of observers [Desai (1985), Subrahmanian (1991)]. However, some studies have indicated that these regulations might have also affected the quality of technology and knowledge content of transfer [Bell and Scott-Kemis (1985)] or might have affected the payment pattern in favour of lump sum fees than royalties [Desai (1990)]. With respect to the cost of technology imports what is interesting to examine is under what conditions, the transfer is most cost effective. Although the evidence from the literature reviewed in Kumar (1985) tended to show that licensing may be a cheaper mode of technology imports under certain conditions in terms of overall costs, comparative assessment of cost in specific cases is rare to find. Khanna (1984) in a detailed study of technology transfer in Indian petrochemical industry found that a public sector company was able to substantially reduce the direct cost of technology acquisition compared to similar plants set up by MNE affiliates in the country by unbundling the package of technology by licensing processes, engaging a local consultancy organisation and fabricating some equipment indigenously. However, significant absorption and diffusion of know how imported was constrained by the restrictive clauses included in the technology transfer agreements concluded by MNE affiliates or public sector companies. In that background detailed case studies examining alternative mechanisms of technology import and their relative direct and indirect costs through several effects discussed above, would be highly desirable.
9. Concluding Remarks The research on the determinants and impact of FDI and contractual transfers of technology in developing countries has assumed a renewed emphasis in view of the increasing importance of FDI as resource flows to developing countries in the context of stagnation in the flows of soft credits and development aid and hence an intense rivalry among developing countries to attract FDI. This review of rather large developmental literature on the MNEs’ activity in the host country economies has brought out several policy implications as well as gaps in current state of knowledge which provide pointers for further work. The following paragraphs briefly recapitulate major implications for policy and further work to conclude the paper. 34
9.1. Implications for Policy The implications arising from the above review relate to different spheres of economic policy in the host countries. These include foreign direct investment and technology imports policy, macroeconomic policy, competition policy, technology policy and exports promotion policy. These broad groupings of policies, however, are mutually overlapping and interactive as would become clear from the following discussion.
9.1.1. Foreign Direct Investment and Technology Imports Policy The internationalization theory posits exporting and local production in the host market by either FDI or arm’s length licensing as alternative means of doing business abroad. Host country policies such as protection granted to local industry determine the choice between exporting and local production by MNEs as a mode of serving the local market, the policies also affect the balance between FDI and licensing as a mode for local production. The excessive trade liberalization may prompt MNEs to export rather than produce locally. Liberalization of investment restrictions may change the balance between FDI and licensing in favour of the former as a mode of local production. While a wide range of process technologies especially those protected by intellectual property protection are generally available easily on licensing basis, technology owners are often wary of providing product technologies especially those involving use of brand names of suppliers unaccompanied by ownership stake and greater control over the management. The intercountry analyses of FDI inflows reveal that FDI inflows in large part are determined by structural factors such as per capita income, market size and its growth rate, extent of industrialization, urbanization, hormonious industrial relations and the quality of infrastructure available and adversely by economic and political uncertainty. The host country policy factors such as investment incentives and liberalization of policies have a limited role to play in expanding FDI inflows in relatively low income agrarian economies with low levels of urbanization and poor infrastructure. The recent expansion in the magnitude of FDI inflows in developing countries has benefited a handful of relatively more industrialised economies in East, Southeast and Latin America and low income countries in South Asia and Sub Saharan Africa continue to receive marginal amounts of FDI despite policy liberalizations. The competition for export-oriented FDI flows is even keener and MNEs pick up winners.
9.1.2. Macroeconomic Policy The direction of causation in the relationship between FDI inflows and growth of host economies appears to run from growth to FDI inflow rather than the other way round for the most developing countries. Several other studies have reported rather marginal effect of FDI on host country growth. There is some evidence to suggest that FDI crowds out other types of foreign flows and domestic investments in some 35
countries, is no more productive than domestic investments [evidence for some countries at least suggests that it is less productive than domestic investments], has adverse effect on the host country’s current account and could contribute to worsening of income distribution. In the export-oriented economies or in countries that push FDI to export-oriented manufacturing, FDI may have more positive consequences than in those where FDI is primarily serving local markets. This is because export-orientation does not leave much scope for divergence between international and domestic prices.
9.1.3. Competition Policy FDI tends to affect host country market structures directly with the tendency of multinational affiliates to operate at a larger scales than other firms and indirectly by their tendency to compete through non-price rivalry including advertising and product differentiation and thus raising ‘contrived’ barriers to entry of other firms. The non-price competitive strategy helps them to earn higher profit margins on sales than firms not following such strategy. MNE affiliates enjoy a persistent advantage over local firms especially in knowledge and brand name sensitive industries because they take advantage of the global technological strength and reputation of the enterprise and their internationally renowned brand names. The competition policies of the host countries may take into account these findings and take steps to create conditions for a level playing field between foreign and local firms. The competition policies, for instance, could encourage national champions to build their own brands by initially protecting them in certain manner or restricting the use of international brand names for domestic sales by MNE affiliates and licensees. A number of countries discourage take-overs of their national champions by foreign enterprises as a means of preventing excessive accumulation of monopolistic advantages by MNE entrants.
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9.1.4. Technological and Industrial Competence Policy FDI and technology licensing could have differential impact on the tendency to do further technological effort that is an important channel of local learning and hence of local technological capability building. In the case of FDI, the location of R&D is determined by the headquarters of MNEs and is governed by global corporate strategic considerations and very seldom by the intention to make a particular subsidiary or affiliate technologically independent. The evidence on spillovers of knowledge from FDI to other firms is also mixed. It appears that local firms that have some technological strength alone are able to absorb these spillovers. On the other hand, in the case of technology licensing unaccompanied by ownership of technology supplier, the licenser can decide to selectively delink and build up technological capability with further technological effort in trying to absorb, assimilate and adapt the knowledge once imported. The limited duration of technology transfer contracts may also encourage them to absorb as much knowledge as possible within the life of the agreement. A lesson to be taken from the experiences of Japan and South Korea in building technological capability is about delinking technology imports and capital imports to retain freedom of decision making for doing local R&D. It is evident that both these East Asian countries imported a large volume of technology but bulk of the technology has been imported under contractual modes, outright licensing or through capital goods imports. These technology imports were followed up by further technological effort locally to absorb it through the process of reverse engineering. Thus the first generation of manufacturing plants in these countries were built by foreign capital goods exporters and technology licensers. The second generation of plants were built locally with the knowledge absorbed through reverse engineering. The next generation of plants were not only built locally but had been suitably updated and incorporated cost saving improvements [see Westphal et al 1979; Kim, 1988; Amsden, 1989, among others]. This would not have been possible had Japan and South Korea imported technology under package of FDI. The Japanese and Korean enterprises would have continued to have remained ‘subsidiaries’ of Western corporations for ever in that case and would not have been able to graduate to their current status of international corporations in their own right. An important prerequisite for licensing to contribute to the building up of local capabilities, however, is the presence of certain absorptive capacity and technological entrepreneurship within the country. In the absence of adequate skills for absorption of knowledge and build upon it, this strategy will be of limited value.
There is also evidence that Japanese, Korean and even Indian enterprises were able to take advantage of soft patent regimes to harness local technological capability through reverse engineering and adaptations. The recent trend of strengthening and harmonization of intellectual property regimes world-wide imposes certain constraints on possibility of building local technological capability through reverse engineering especially in chemical and allied industries. 37
Finally, the nature of technology imports policy itself may have some implications for the nature of relationship between technology imports and local R&D. A too restrictive policy regime towards technology imports may create a situation of virtual monopoly for the existing firms leaving hardly any compulsion for product improvements or cost savings thus choking any technological dynamism on their part. On the other hand, a too liberal policy for technology imports may discourage local R&D because of its several monopolistic attractions over local technologies [Kumar, 1990c]. Therefore, technology import policies of developing countries have to strike a delicate balance between protection of local technological effort as well as sustaining a constant pressure to innovate. This balance has to take into account the level of existing technological capabilities in the country. Stewart (1984:84) also finds selectivity of technology imports policy an important prerequisite for building local technological capability in developing countries.
In view of the need of protection of local learning and technology generation, Paulsson (1985), Kumar (1990c) and Fikkert (1993) feel a tax on technology imports could be host country welfare improving by providing protection to local technology generation. Technology import policies generally need to be complemented by policies supporting further technological effort of enterprises on absorption, adaptation and updation of technologies acquired as well as further generation of technology and skills. Developing countries can learn, in this respect, from industrialised countries as well as newly industrialising countries which encourage technological effort of enterprises by several institutional means. These include provision of technological infrastructure, subsidisation of enterprise R&D, protection and support to innovative enterprises, design engineering and consultancy organisations and national champions. In the current scenario of liberalization of national economies, protection of these national enterprises from threats of take-over by foreign enterprises or groups could also constitute an aspect of the technological competence policy.
9.1.5. Export Promotion Policy The wide divergence in the country experiences with respect to the role that MNEs have played in export expansion of host countries is explained in terms of their relative success in attracting export-oriented FDIs or international subcontracting deals with MNEs. Only export-oriented FDI inflows and not all FDI inflows help in expansion of exports from the host countries. Export-oriented FDIs are special types of FDIs and are determined by different factors than domestic market oriented FDI inflows. Hence, a specific targeting of them is desirable.
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9.2. An Agenda for Further Research The research summarised above suggests that developmental literature on MNEs and technology transfer is extensive. It has also pointed out several gaps which provide directions for further work.
9.2.1. The relative importance of FDI over licensing across industries may be different in a more liberal policy framework than that obtaining in a restrictive regime as structural determinants viz. internalization incentives may turn out more prominently in the absence of any restriction on the choice of the mode of technology import. In that context, it may be interesting to examine changes in the determinants of FDI and arm’s length licensing across industries with liberalization of policy.
9.2.2. Although foreign controlled enterprises account for a substantial share of industrial output in many developing countries, only a few attempts have been made to build macroeconomic models which disaggregate the domestic industry according to ownership and control characteristics. More attempts in this direction would be useful for the examination of impact of FDI on different parameters of development and simulation of effects of policy changes on enterprises under different ownership groups.
9.2.3. The quantitative analysis of impact of FDI on host country market structures needs to be complemented by case studies of MNE entry in different sectors. Also different modes of entry e.g. greenfield entry versus a takeover may have different impact on market structures. These case studies might be able to bring out conditions under which foreign entry could have a more favourable impact on the host country market structures and competitive situation. Furthermore, the comparative static framework of analysis that has been adopted by most studies analysing the behavioural differences between foreign and local enterprises does not bring out the dynamic influences of foreign entry on different aspects of conduct of local firms [Kumar, 1994b:118]. Because firms in any industry interact mutually, the behaviour of local firms could be affected by the very presence of foreign rivals. Finally, very little information is available on a number of the aspects of behaviour of foreign controlled and local enterprises in terms of cost structures, relative pricing, investment strategies, marketing practices, diversification policy, capacity utilization, relative dependence on foreign and local sources of technology, working conditions and training, creation of forward linkages etc. In view of the fact that company annual reports and financial statements do not provide data on these characteristics, these have to be captured in detailed case studies that are able to gather primary data.
9.2.4. More case studies of industries and firms that examine the role played by technology imports in building up local technological capability by examining the evolution of the nature of interface between 39
technology imports and local technological effort over time and the nature and extent of knowledge spillovers would be desirable. These case studies would be able to bring out the potential role of factors such as firm size, nature of operations, ownership characteristics, dynamism of entrepreneurship and policy factors besides the mode of import in shaping the nature of the interface.
9.2.5. The export-oriented FDIs may have different implications on parameters of development than the local market-oriented ones. Similarly, FDIs originating in different countries e.g. US, Europe, Japan and developing countries may reveal different tendencies with respect to export-orientation, local linkage generation, employment and choice of techniques, transfer of technology, ownership patterns and so on. Similarly, one doesn’t know whether different organizational forms of foreign participation e.g. a sole venture and a joint venture, or majority and minority foreign ownership have any implications on the enterprise performance and their developmental impact. Here again detailed case studies may help to capture these differences. Also detailed case studies of the cost effectiveness of alternative mechanisms of technology transfer from the host country point of view would be useful for policy purposes. Furthermore, it may also be useful to analyze relative terms of technology transferred by small and medium enterprises vis-à-vis large MNEs from the host country’s point of view.
9.2.6. FDI and technology transfers hardly flow in one direction. As developing country enterprises accord a greater importance to their overseas markets and acquire global ambitions, their investments in subsidiaries and other affiliates are bound to grow. Since 1970s, a number of developing country enterprises have already set up affiliates abroad which have been subjects of a number of studies [see for instance, Wells, 1983; Lall et al., 1983]. Enterprises are known to use FDI abroad some times as a market defensive tool, some times to support their exporting activity and at times, or to explicitly gain international competitiveness by relocating in a location that may give either a cost advantage or a preferential access to the markets, for instance, use by certain enterprises of Lome convention countries to take advantage of their preferential access to the European Union member states. The competitiveness and other macroeconomic implications of the overseas investment activity of developing country enterprise should constitute an interesting topic of research in the coming years.
9.2.7. Finally, the overall impression emerging from a great variety of experiences across countries in terms of the impact of FDI on different parameters of development is that FDI promises more than it delivers. The diverging experiences of countries with respect to host country gains from MNE entry could probably result from different policy packages adopted by different countries. In that the determination of
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an optimal package of FDI, technology imports, trade, competition and related policies that help to maximise the host country gains is itself a fruitful area of research.
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10. An Extended Bibliography [Not all the references in this bibliography have been cited in the text]
Agarwal, J.P. (1976) ‘Factor Proportions in Foreign and Domestic Owned Firms in Indian Manufacturing’, Economic Journal, 86, 529-95. Agarwal, J.P.(1979) ‘Productivity Comparisons in Foreign and Indian Manufacturing’, Weltwirtschaftliches Archiv, 115, 116-27. Agarwal, J.P. (1990) ‘Determinants of FDI in Pacific-RIM Developing Countries’, Asian Economic Review, 83-100. Agarwal, J.P., Andrea Gubitz and Peter Nunnenkamp (1991) Foreign Direct Investment in Developing Countries: The Case of Germany, Kieler Studien 238, Tübingen: JCB Mohr. Agarwal, J.P. (1985) Pros and Cons of Third World Multinationals, Tübingen: JCB Mohr Ahiakpor, James C.W. (1986a) ‘The Profits of Foreign Firms in a Less Developed Country: Ghana’, Journal of Development Economics, 20, 321-35 Ahiakpor, James C.W. (1986b) ‘The Capital Intensity of Foreign, Private Local and State Owned Firms in a Less Developed Country’, Journal of Developed Economics, 20, 145-62. Aitken, Brian, Gordon H. Hanson and Ann E. Harrison (1994) Spillovers, Foreign Investment and Export Behaviour, NBER Working Paper # 4967, Cambridge, MA: NBER. Aitken, Brian and Ann Harrison (1993) Do Domestic Firms Benefit from Foreign Direct Investment? Evidence from Panel Data, Working Paper 1248. Alam, Ghayur (1985) ‘India’s Technology Policy and Its Influence on Technology Imports and Technology Development’, Economic and Political Weekly, Vol XX, Nos 45, 46 and 47, Special Number, 20732080. Amsden, Alice (1989) Asia’s Next Giant: South Korea and Late Industrialization, New York: Oxford University Press. Athukorala, Premchandra and S.K. Jayasuriya (1988) ‘Parentage and Factor Proportions: A Comparative Study of Third World Multinationals in Sri Lankan Manufacturing’, Oxford Bulletin of Economics and Statistics, 50(4), 409-23. Athukorala, Premchandra, Sisira Jaisuriya and Edward Oczkowski (1995) ‘Multinational Firms and Export Performance in Developing Countries: Some Analytical Issues and New Empirical Evidence’, Journal of Development Economics, 46, 109-122. Bagchi, Amiya Kumar (1987) Public Intervention and Industrial Restructuring in China, India and Republic of Korea, New Delhi: ILO-ARTEP. Balasubramanyam, V.N. (1974) International Transfer of Technology to India, New York: Praeger. Balasubramanyam, V.N. (1984) ‘Factor Proportions and Productive Efficiency of Foreign Owned firms in the Indonesian Manufacturing Sector’, Bulletin of Indonesian Economic Studies, 70-94. Balasubramanyam, V.N. and M.A. Salisu (1991) ‘Export Promotion, Import Substitution and Direct Foreign Investment in Less Developed Countries’, in Koekkoek, A. and L.B.M. Mennes (eds.) International Trade and Global Development, Essays in Honour of Jagdish Bhagwati, London, Routledge. Baldwin, Robert E. (1979) ‘Determinants of Trade and Foreign Investment: Further Evidence’, Review of Economics and Statistics, 61, 40-48. Basant, Rakesh and Brian Fikkert (1993) Impact of R&D, Foreign Technology and Technology Spillovers on Indian Industrial Productivity, Working Paper No.11, Maastricht: UNU/INTECH. Bell, Martin and Don-Scott-Kemmis (1985) ‘Technology Import Policy: Have the Problems Changed?, Economical and Political Weekly, Vol XX, Nos 45,46 and 47, Special Number, 1975-1990. Bergsten, C.Fred, Thomas Horst, and Theodore Moran (1978) American Multinationals and American Interests, Washington DC: Brookings Institution. Biersteker, T.J. (1978) Distortion or Development: Contending Perspectives on the Multinational Corporation, Cambridge, Mass.: MIT Press. Blomström, Magnus (1986) ‘Multinational and Market Structure in Mexico’, World Development, 14, 52330. Blomström, Magnus (1989) Foreign Investment and Spillovers: A Study of Technology Transfer to Mexico, London: Routledge.
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