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Globalization, Growth, and Trade. Lectures 11-12 Foreign direct investment, models, types, and growth. Globalization and productivity growth. Solow growth model emphasizes importance of productivity growth in a hypothetical closed economy Open-economy Solow: (i) intermediate inputs - PowerPoint PPT Presentation

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  • Lectures 11-12Foreign direct investment, models, types, and growth*

  • Globalization and productivity growthSolow growth model emphasizes importance of productivity growth in a hypothetical closed economy

    Open-economy Solow: (i) intermediate inputsOriginal aggregate production function: Y = A(K, L) With intermediate inputs (N): assume Y = A(K,L)N ==> More N more output and more productive K & L==> If intermediates are dominated by imports, then lowering costs of importing N has positive effects on economic growth

    Example: demand for N = ND = PN-1, so Y = A(K,L)/PNThen Y/PN has an effect proportional to Y/A; lowering the domestic cost of N raises TFP.

    *

  • Globalization and intl capital transferOpen-economy Solow: (ii) imported capital (= FDI)Original capital growth equation: k = s(k) (d + n)k Savings in closed econ: S = I; s = I/Y.

    In open econ: S = I + FDI, s = (I + FDI)/Y ==> Imported capital (FDI) also adds to capital stock==> Lowering the cost of importing capital is equivalent to raising the domestic savings rate, which increases economic growth

    FDI may also interact with other factors (human capital, productivity) as discussed in previous class.*

  • *Focus on FDIAugments capital stocks in poor economies- alters comp. advantageMay be bundled with tech. transfers, sourcing and sales networks, etc. By moving factors across borders, acts as a substitute for trade in goodsIntroduces distinction between GDP and GNIGross national income (GNI) = GDP +/- factor earnings from/to abroad

  • *r1

    r1A

    r*

    01 KA K*MPPK1MPPK2 MPPKj = marginal product of capital; rj = price, in j K exporter reads from right, K importer from left FDI = intl flow equal to qty KAK*, equalizes r at r*abcde

  • *r1

    r1A

    r*

    01 KA K*MPPK1MPPK2abcdeabd = rise in 1s GNI; bcd = rise in 2s GNIr1 falls and r2 rises, but what about w1 and w2?

  • Why does capital move? DetailsTransfer of KAK* from country 2 to country 1:GDP in 1 rises by KAadK*, cost of capital falls to r*GDP in 2 falls by KAcdK* but repatriated profit on investment pays KAbdK*Net gain = acd: abd = rise in 1s GNI bcd = rise in 2s GNIThis theory says that world welfare is raised by capital flows: more efficient use of scarce resourcesCost of capital falls in importing country, rises in exporting country. What do we expect happens to wages in each country? *

  • *M XpW FDI in M sector shifts its prodn function upward (left panel) This moves PPF out asymmetrically Why does X sector output fall? (n.b.: pW unchanged) By how much does aggregate income grow? Consumer welfare?

    L

  • *Me fpW At const. pw, X output falls from b to a as cd labor reallocated to M Aggregate income increases by less than the rise in the value of production ef (some profits are repatriated)La bc d

  • *Types of international capital flowsFDI: acquisition of managerial control over productive assets. Tradable but typically illiquid (not easily moved) assets. Spillovers to rest of economy?

    Equity portfolio investment: acquisition of shares in listed companies. Tradable and liquid

    Bond finance: private or public issues with future payments (like loans) similar to portfolio investment, may include govt bonds

    Commercial bank (or non-bank) lending: non-tradable assets; liquidity varies (e.g. with term of loan)

  • The big picture on magnitudesFDI most important foreign capital flow for developing countries in past 20 yearsRemittances from migrants is the most dynamic source in past decadeBoth of these were somewhat jeopardized in 2008-9 crisis, for somewhat different reasons.A look at the numbers on FDI internationally.*

  • *International capital flows

  • *Mostly ODA until recently, with some FDI

  • *Mostly ODA and FDI, like Sub-Saharan Africa until 2006.

  • *FDI is the dominant source since mid-1990sNote also that FDI in Latin America is 10x larger than other regions above.

  • *FDI also dominates foreign capital flows in E Asia and is greater than ROW.

  • *China is single largest recipient of FDI; levels that rival all of LA or EAP

  • Why do private companies invest abroad?Efficiency rationale (seeking access to abundant endowments, cheap labor, human capital, lower transport costs, etc.)

    Secure access to raw materials such as minerals or oil (resource and strategic rent rationale)

    Access to local markets (non-tradables or inside trade barriers)

    Other reasons?--> Various types of FDI in developing countries*

  • Benefits of FDIIncreased output (higher GDP)Higher labor productivity; more jobs; maybe higher wagesMore exports & foreign exchangeValue of addl exports should exceed earnings by foreign capital owners, so net gain to host countryScale economies, technological, managerial and skill spilloversFDI may create competition and undermine domestic monopolies (e.g. in telecoms, air travel)

    *

  • Why might FDI be bad for development?Market-access type FDI may create monopoly Technology and factor use intensity may be mismatched with local econ.Transfer pricing: intra-firm price manipulation to avoid taxesRent capture and market concentration; policy and institutional distortions (corruption)Limited spill-in of technologyLoss of control over domestic policyE.g. large MNCs in small economiesAre such constraints on policy always bad?

    *

  • Impacts of FDI on PovertyPoverty effects depend directly on whether returns to factor endowments of low-income households are enhanced by FDI and/or if prices (quality) of key consumer goods are reduced (improved)Incomes of poor households: mostly labor

    Which FDI types are most likely to reduce poverty?Returns to labor are critical impact of FDI, so efficiency rationale perhaps best for reducing poverty.FDI for resources if ownership is broadly distributed or well regulated, but that probably lowers incentive for FDI (rents)FDI for market access most likely to have positive price/quality impacts if under competitive conditions.*

  • Does FDI alleviate poverty?In most dev. countries, substantial FDI inflows are a recent phenomenonDoes FDI follow economic success, rather than the other way around?Globally, poorest countries receive least FDIClaimed benefits via tech transfer, etc increase labor productivity for FDI in labor-intensive activitiesSectoral targets for FDI are critical:Mining & other extractive industries, vs. labor-intensive or technology-intensiveRegulatory, policy & institutional settings in host countries are critical Financial development (monetization) is good indicator*

  • Does FDI alleviate poverty?To fully understand this, we also need to know something about labor mobility.Well return to this at end of todays class.*

  • FDI & GrowthBack to the Solow Model and what drives growth?Y = A(K, S, L)Where does FDI enter into this conception?Increase in K, which drives growthWhat about A?What about S?3 links to assess capital stock, technology, and human capital. Lets discuss each.*

  • FDI and Capital Stock - 1Link between FDI and capital stock seems clear from model presented earlier. Increases capital availability for investment which raises production and wages.Is this always true?What if the FDI is capital that is raised locally (via loans)?What if it involves joint venture investments?Simple point may not be 1:1 increase in domestic capital?Over time, what if FDI leads to profit drain out of country?When is this more likely to be the case?Still, seems as if FDI should add to domestic capital stock in most cases.*

  • FDI and Capital Stock - 2Does it matter what type of FDI occurs?Efficiency-seeking vs Market Access vs Resource-seeking?Solow model does not distinguish between types of capital or sectors of the economy.What issues might arise in terms of growth effects of different types of FDI?Which type seems most likely to contribute to growth? Why?Concerns with market access FDI?- Market power, restrict outputConcerns with resource-seeking FDI?- Same as market access plus resource rents are in play.*

  • SourceChina Statistical Yearbook, own presentation.

    Chart2

    1.95613.4661925961

    2.2448.8463766589

    2.31411.5832637805

    3.19411.2805836504

    3.3934.0632032186

    3.4873.8390249382

    4.3669.178936699

    11.00814.2407063564

    27.51513.9643146603

    33.76713.080681834

    37.52110.9249803261

    41.72610.0085234493

    45.2579.297033756

    45.4637.8333468618

    40.3197.6198357217

    40.7158.4312794503

    46.8788.3003175914

    52.7439.0820679696

    53.50510.0253787615

    60.6310.0850398745

    60.32510.4327566054

    63.02111.6

    74.76811.9

    FDI

    GDP Growth

    FDI (Billion USD)

    GDP Growth (%)

    FDI Inflow and GDP Growth in China, 1985-2007

    Sheet1

    FDIGDP Growth

    19851.9613.5

    19862.248.8

    19872.3111.6

    19883.1911.3

    19893.394.1

    19903.493.8

    19914.379.2

    199211.0114.2

    199327.5214.0

    199433.7713.1

    199537.5210.9

    199641.7310.0

    199745.269.3

    199845.467.8

    199940.327.6

    200040.728.4

    200146.888.3

    200252.749.1

    200353.5110.0

    200460.6310.1

    200560.3310.4

    200663.0211.6

    200774.7711.9

    Sheet1

    FDI

    GDP Growth

    FDI (Bill.USD)

    GDP Growth (%)

    FDI and GDF Growth in China, 1985-2007

    Sheet2

    Sheet3

  • Hong Kong has traditionally been the most important source of FDI into China.

    Sources of FDI in China, 2000-2007

    (in %

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