FDI Promotion:Why and How?

Beata Smarzynska JavorcikUniversity of Oxford

beata.javorcik@economics.ox.ac.uk

Is FDI really good for growth?

“One dollar of FDI is worth no more (and no less) than a dollar of any kind of investment” (D. Rodrik)

Yet, 59 out of 108 countries surveyed in the World Bank’s census of investment promotion agencies offered FDI incentives in 2004

Outline1. Why should we expect FDI to stimulate

growth in host countries?

2. Evidence on knowledge transfer to FDI recipients

3. Effect of FDI on other firms within the industry

4. Effect of FDI on firms in the supplying industries

5. Is FDI promotion effective?

6. Does IPI quality matter?

Technology transfer through FDI => economic growth

MNCs are responsible for most of the world’s R&D

700 multinational corporations accounted for 46% of the world’s total R&D expenditure and 69% of the world’s business R&D in 2002 (UNCTAD 2005)

R&D budgets of large multinationals may exceed R&D spending of some countries

R&D budgets of some MNCs exceed R&D spending of transition countries (2003)

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CIS figure includes: Russia, Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Tajikistan, Ukraine, Uzbekistan.New EU member states figure includes: Czech Rep, Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Rep, Slovenia.

Outline1. Why should we expect FDI to stimulate

growth in host countries?

2. Evidence on knowledge transfer to FDI recipients

3. Effect of FDI on other firms within the industry

4. Effect of FDI on firms in the supplying industries

5. Is FDI promotion effective?

6. Does IPI quality matter?

Effect of FDI on recipient firms

Key question: Is the superior performance of foreign affiliates due to some intrinsic advantage of foreign ownership or are foreign investors simply good at picking acquisition targets?

Arnold and Javorcik (2009)

Examine this question using plant-level information on 400 new FDI recipients in Indonesia (1983-2001)

Compare the differences in the paths of development between FDI recipients and the control group

Control group: plants with similar observable characteristics before a foreign acquisition, operating in the same industry/year

1/n 1 to n[(ProductivityFDI recipient, post-FDI - ProductivityFDI recipient, pre-

FDI)

- (Productivitycontrol, post-FDI - Productivitycontrol, pre-FDI)]

Foreign ownership improves performance

Total factor productivity (in logs)

Pre-acquisitionYear

Acquisitionyear

One year later

Two years later

FDI recipients 0.864 1.079 1.142 1.215

Control group 0.867 0.976 1.022 1.083

Difference 0.106*** 0.122*** 0.135***(0.034) (0.045) (0.051)

Foreign ownership improves performance

While best performers tend to receive FDI, foreign ownership also leads to increased productivity

FDI recipients exhibit a 13.5% higher productivity growth by the end of the 3rd year under foreign ownership

Foreign ownership improves performance

Labor productivity (in logs)

Pre-acquisitionYear

Acquisitionyear

One year later

Two years later

FDI recipients 4.28 4.50 4.60 4.62

Control group 4.20 4.14 4.06 4.05

Difference 0.280*** 0.459*** 0.489***

(0.072) (0.074) (0.088)

FDI induces rapid changes(d) Employment

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(e) Average wage

7.607.808.008.208.408.608.809.00

t-1 t0 t+1 t+2

(c) Output

10.0010.2010.4010.6010.8011.0011.2011.40

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FDI leads to higher investment

(f) Investment

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(g) Investment in machinery

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FDI facilitates integration into global markets

(h) Export share

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(i) Import input share

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Outline1. Why should we expect FDI to stimulate

growth in host countries?

2. Evidence on knowledge transfer to FDI recipients

3. Effect of FDI on other firms within the industry

4. Effect of FDI on firms in the supplying industries

5. Is FDI promotion effective?

6. Does IPI quality matter?

FDI affects domestic firms through multiple channels (Czech Rep.)

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Competitors and non-competitors as sources of knowledge

From multinationals in the same sector which are % of Czech firms reporting competitors non-competitors learning about new technologies 26% 22% learning about new marketing techniques 12% 11%

benefiting from knowledge of employees trained by multinationals

5% 2%

Relative magnitudes of the effects differ by country

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Latvia

Outline1. Why should we expect FDI to stimulate

growth in host countries?

2. Evidence on knowledge transfer to FDI recipients

3. Effect of FDI on other firms within the industry

4. Effect of FDI on firms in the supplying industries

5. Is FDI promotion effective?

6. Does IPI quality matter?

Effect of FDI on firms in the supplying industries While MNCs have an incentive to prevent

leakage of knowledge to their competitors, they may want to promote knowledge transfer to local suppliers

FDI boosts productivity in the supplying industries

Evidence from Lithuania (Javorcik 2004) Evidence from Indonesia (Gertler and Blalock

2007)

MNCs’ requirements vis a vis potential suppliers

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Improvequality

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Acquire ISO9000

Improvetimeliness of

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Use newtechnology

Purchasenew

equipment

Improve theproduct

Assistance received by Czech firms from MNCs

0% 5% 10% 15% 20% 25% 30% 35% 40%

Suppliers reporting a particular type of assistance

Any type of assistance

Personnel training

Advance payment

Leasing of machinery

Provision of inputs

Help with organizing production lines

Help with quality assurance

Assistance with technology

Help with finding export opportunities

Provision of patented technologies

Equipment repairs

MNC suppliers Different from other firms: larger, with higher

capital-labor ratio, paying higher wages and more productive

High productivity firms are more likely to become suppliers

Suppliers learn from their relationships with MNCs

Javorcik and Spatareanu (2009)

Outline1. Why should we expect FDI to stimulate

growth in host countries?

2. Evidence on knowledge transfer to FDI recipients

3. Effect of FDI on other firms within the industry

4. Effect of FDI on firms in the supplying industries

5. Is FDI promotion effective?

6. Does IPI quality matter?

Why do investment promotion? Knowledge externalities as justification for

policy intervention

Information asymmetries between host countries and potential foreign investors are significant obstacles to investment flows across international borders

What can aspiring FDI destinations do to reduce such barriers?

Is investment promotion the answer?

Almost all countries are engaged in FDI promotion

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1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

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IPAs in developing countries

IPAs in developed countries

Harding and Javorcik (2011)

Conducted a Census of IPIs on behalf of the World Bank

Point of departure Sector targeting considered best practice in investment promotion

Information on sector targeting Standardized list of targeted sectors with dates when the policy was in place

Data on FDI from the U.S. by country, sector and year (124 countries, 15 sectors, 1990-2004)

Did FDI inflows to targeted sectors increase during targeting?

(relative to non-targeted sectors)

Which sectors are targeted?

No. of countries targeting in 2004

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Developed countries

Developing countries

Estimation results

Investment promotion generates higher FDI flows to developing countries and emerging markets:

Targeting increases FDI by 155%

Additional $17 mn dollars of FDI

Investment promotion is more effective in countries…

where information asymmetries are large

with burdensome bureaucratic procedures

IP: an inexpensive way of overcoming information asymmetries

Crude back-of-the-envelope cost-benefit exercises: Costs

$90,000 spent on average per sector targeted

Benefits Additional $17 mn of FDI in typical sector

=> $1 spent on investment promotion => $189 of FDI

Additional 1,159 jobs in foreign affiliates

=> cost of $78 per job created

Outline1. Why should we expect FDI to stimulate

growth in host countries?

2. Evidence on knowledge transfer to FDI recipients

3. Effect of FDI on other firms within the industry

4. Effect of FDI on firms in the supplying industries

5. Is FDI promotion effective?

6. Does IPI quality matter?

Measuring IPI qualityGlobal Investment Promotion Benchmarking (GIPB) assesses two aspects of IPIs:

Web site quality: content, architecture, design and promotional effectiveness relevant, clear and credible information presented in an

attractive and user-friendly way

Mystery shopper: handling of direct project inquiries from investor competence and responsiveness of the agency’s staff timeliness, quality and credibility of informational content

Quality of IPIs varies widely across countries

90% or above

80-89% 70-79% 60-69% 50-59% 40-49% 30-39% 20-29% 1-19% 0%0

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Web site Inquiry handling

GIPB 2006-2012 scores by region

Unconditional scatter plot: ln FDI flows and IPI quality

AGO

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All countriesFDI inflow and IPI quality

Unconditional scatter plot: ln FDI flows and Inquiry handling quality

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All countriesFDI inflow and Inquiry handling quality

Unconditional scatter plot: ln FDI flows and Website quality

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All countriesFDI inflow and Website quality

Does IPI quality matter?Empirical approach

Cross section analysis, 156 countries: Average IPI quality (GIPB06, GIPB09 and GIPB12) Average FDI inflows from all countries 2000-10 (IFS)

Controlling for: GDP per capita GDP growth Population size Inflation Political stability in host country

Findings

A one unit increase in the GIPB score associated with a 1.5% increase in FDI inflows

Going from Sub-Saharan Africa to Latin America in GIPB performance => 35-40% more FDI

(Harding and Javorcik 2013)

Results are robust to…

1. Focusing on developing countries only

2. Controlling for various aspects of the business climate

3. Using sector-specific information

4. Instrumenting for the quality of IPIs

Policy conclusions Evidence on knowledge externalities associated with FDI provides

justification for public support of IPIs

Successful investment promotion requires Professionalism, competence, effort and commitment to customer

service Up-to-date, attractive and user-friendly web site Providing relevant and useful information in the site selection

process makes a difference

The GIPB initiative and results: valuable guiding-tool for IPIs The GIPB criteria specify what high quality of inquiry handling and Web

sites mean Its assessment process can provides useful feedback on areas in need of

improvement

Thank you

ReferencesArnold, Jens and Beata S. Javorcik (2009). Gifted Kids or Pushy Parents? Foreign Acquisitions

and Firm Performance in Indonesia. Journal of International Economics 79(1)

Blalock, Garrick and Paul J. Gertler (2008). “Welfare Gains from Foreign Direct Investment through Technology Transfer to Local Suppliers” Journal of International Economics 74(2): 402-421

Harding, Torfinn and Beata Javorcik (2011). “Roll out the Red Carpet and They Will Come: Investment Promotion and FDI Inflows” Economic Journal 121(557)

Harding, Torfinn and Beata Javorcik (2013). “Investment Promotion and FDI Inflows: Quality Matters” CESifo Economic Studies forthcoming

Javorcik, Beata (2004). Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers through Backward Linkages. American Economic Review 94(3): 605-627

Javorcik, Beata and Mariana Spatareanu (2009)."Tough Love: Do Czech Suppliers Learn from Their Relationships with Multinationals?“ Scandinavian Journal of Economics 111(4)

UNCTAD (2005). World Investment Report: Transnational Corporations and the Internalization of R&D. New York and Geneva: United Nations