Chapter 6:

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Introduction
 What makes a developing country attractive to
multinational enterprises (MNEs) as a potential
destination for international production in the form of
contracting or FDI?
 We know that location advantages matter for MNE
choices
 So we can rephrase our question in terms of what types
of location advantages matter for developing countries to
be able to attract international production
 Domestic or adjacent markets for market seeking FDI
 Particular types of resources for resource seeking FDI
Patterns of FDI in Developing
Countries
 Natural resource or resource-based FDI
 The MNE wants access to the resource and the host country
government needs to manage this so as to share in the income
for the benefit of the country
 Domestic market serving FDI and export processing
 Institutional quality can matter, including democracy, good
governance and lack of corruption
 Intellectual property protection can matter in order for MNEs to
avoid dissemination risk
 Bilateral investment treaties (BITs) and regional investment
treaties (RITs) can also help facilitate FDI inflows
 BITs have grown rapidly over time, from approximately 400 in
1990 to approximately 2600 in 2008
Benefits and Costs

 It is helpful to have a sense of the potential benefits and

costs of hosting MNEs
 Table 6.1 gives a sense of these, for each of the ges
k a
following dimensions lin ,
r d y io n
 Employment and wages a in g b at
w l l m
 Competition a ck d fi he orm
b an n t s f t n d
r /
b ard ten al al a
 Education and training s te on
fo ati ps” nd pa nic nci
 Technology
c an rdin ga , sta nd ech ina
v t oo o n m , a ( t g f
 Balance of payments i g g
Go ith c mat the stin inin idin ’ .
 Health and the environment w for hing te tra rov rms
 Culture “in atc rials on, & p ll fi
m ate trati ial) ma
m gis ger or s
r e a n a or t f
m pp
su
Table 6.1: The Benefits and Costs
of Inward FDI
Item Benefits Costs

Employment Generate direct and indirect Transfer jobs from home to foreign
and Wages increases in employment. Might firms.
offer higher wages.

Competition Promote competition by increasing Retard competition in cases where

the number of firms in an industry. the foreign firm has a large amount of
market power.

Education Improve the education and training Restrict education and training to
and Training of host country workers. expatriate employees. Discriminate
against host-country workers.

Technology Transfer technology from developed Technology employed might not be

to developing countries. appropriate for the host country
economy.

Sources: Adapted from Dunning and Lundan (2008) and Hill (2009)
Table 6.1: The Benefits and Costs
of Inward FDI
Item Benefits Costs
Balance of Improve the import and export Worsen the import component
Payments components of the current account. of the current account. Worsen
Improve the direct investment the net factor receipt
component of the capital/financial component of the
account. capital/financial account.

Health and Employ new technology that is more Increase the amount of
the environmentally sound. Increase pollution and subject workers
Environment incomes and thereby make more to unsafe workplaces.
resources available for the
enforcement of existing environmental
regulations.
Culture Introduce progressive aspect of Increase dominance of urban
business culture in the areas of and Western culture over rural
organizational development and human and non-Western culture.
resource management.

Sources: Adapted from Dunning and Lundan (2008) and Hill (2009)
 ctors
Policy Stances quire me n t
ud e d f r
s: excl in amount
& limit
o m ce r

requi
t ain se

r e me
on t r o
nts: c or of the
beha
v i
ls the reign
fo

n e rs hip Re a n c e
Ow rm
Perfo
 Given the information in Table
firm
6.1, it is natural to
consider how to minimize the costs and maximize
the benefits of the FDI
 Attempts to achieve this are usually made through policy
stances towards the MNE that can be grouped into
ownership requirements and performance requirements
 Ownership requirements may be absolute as in the case of
foreign firms being excluded from certain sectors on national
security grounds, or they may simply limit foreign ownership to a
maximum specified amount
 Performance requirements place controls on the behavior of the
foreign firm in a number of areas, including local content
requirements, training, technology transfer, exports, local
research and development, and the hiring of local managers
Trade-Related Investment Measures
(TRIMs)
 The Marrakesh Agreement on Trade in Goods included
an Agreement on TRIMs, which prohibits some types of
TRIMs in the case of goods (Table 6.3)
 These include domestic content, trade balancing, foreign
exchange balancing, and domestic sales requirements
 Export performance requirements were not prohibited
 Investment related policies in services are covered under
the General Agreement on Trade in Services (GATS)
 Controversially, Some international economic policy
experts are now calling for policies that would go beyond
TRIMs to require the abandonment of all policies that
discriminate between domestic and foreign firms
Table 6.3: Types of Trade-Related
Investment Measures
Measure Explanation Comment
Local content Requires that a certain amount of local input be used in Prohibited by TRIMs
requirement production.

Trade balancing Requires that import be a certain proportion of exports. Prohibited by TRIMs
requirement
Foreign exchange Requires that use of foreign exchange for importing be a Prohibited by TRIMs
balancing certain proportion of exports and the foreign exchange
requirement brought into the host country by the firm.

Domestic sales Requires that a proportion of output be sold locally. Prohibited by TRIMs
requirement
Manufacturing Requires that certain products be manufactured locally.
requirement

Manufacturing Prohibits the manufacturing of certain products in the host

restriction country.

Sources: Low and Subramanian (1996) and UNCTAD (2003)

Table 6.3: Types of Trade-Related
Investment Measures
Measure Explanation Comment

Export performance Requires that a certain share of output be exported. Prohibited or

requirement discouraged by many
BITs and RITs
Exchange restriction Limits a firm’s access to foreign exchange.

Technology transfer Requires that certain technologies be transferred or Prohibited or

requirement that certain R&D functions be performed locally. discouraged by many
BITs and RITs
Licensing Requires that the foreign firm license certain
requirement technologies to local firms.
Remittance Limits the right of the foreign firm to repatriate profits.
restriction
Local equity Restricts the amount of a firm’s equity that can be held Prohibited or
requirement by local investors. discouraged by many
BITs and RITs

Sources: Low and Subramanian (1996) and UNCTAD (2003)

 osting
ards h
stan ce tow
Export Processing Zones Policy
MNEs wnership R equiremen
• O
m
eq
a n ce r
u i re m ents
ts

r fo r
• Pe
• EPZ
 Another policy stance towards hosting MNEs is to set
up an export processing zone or EPZ
 An EPZ is an area of the host country in which MNEs
can locate and in which they enjoy, in return for exporting
most or the whole of their output, favorable treatment in
the areas of infrastructure, taxation, tariffs on imported
intermediate goods, and labor cost
 Table 6.4 gives a sense of the number and extent of
EPZs, with 3,000 of them in existence in 2006
 In most cases, EPZs involve relatively labor-intensive,
“light” manufacturing such as textiles, clothing,
footwear, and electronics
Table 6.4: Export Processing
Zones
1975 1986 1997 2002 2006
Number of 25 47 93 116 130
countries with
EPZs
Number of 79 176 845 3,000 3,000
EPZs
Employment NA NA 23 43 66
(millions)
Employment NA NA 18 30 40
accounted for
by China
(millions)

Source: Singa Boyenge (2007)

Export Processing Zones

 A number of studies have tried to assess EPZs from the

benefit and cost framework
 These studies show that in many (but not all) cases, the
benefits do outweigh the costs
 Some studies have shown that EPZs are an important
source of employment
 In some cases, infrastructure costs of setting up the
EPZ were too high for a net positive benefit
 In some cases, EPZs were helpful in diversifying the
industrial structure of the country and attracting FDI
Promoting Linkages
 It is possible for MNEs to leave some parts of the
upstream components to other firms, but chose to buy
from local firms in the country in which it is located
 This is known as backward linkages to domestic
suppliers
 Historically, backward linkages have been weak
 The increased role of MNEs in an economy without
significant backward linkages results in what are termed
enclaves with little connection to the rest of the
economy and little contribution beyond direct
employment effects
Promoting Linkages: Traditional
and New Approaches
 Traditionally, the means to avoid enclave FDI was via
the local content requirements discussed in the
previous section, but these are no longer allowed for
WTO members
 New thinking in the area of facilitating backward
linkages suggests that local content requirements should
be replaced by efforts to support local suppliers in
their efforts to secure contracts with foreign MNEs
 If a foreign MNE can be induced to source inputs locally
rather than by importing them, the host country can gain
a number of important benefits
Promoting Linkages: Potential
Benefits
 The potential benefits of promoting backward linkages
from MNEs to domestic firms include
 Employment can increase since the sourced inputs are new
production
 The balance of payments can improve since the inputs will no
longer be imported
 Production technologies can be better adapted to local
conditions
 Tangible and intangible assets can be, to some degree at least,
passed from the foreign MNE to the local, host-country suppliers,
and local suppliers can coalesce into a spatial cluster that
supports innovation and upgrading
Promoting Linkages: How To Do It

 The key policy question for developing countries is how

to foster backward linkages between foreign MNEs and
potential local suppliers
 The role government is one of coordination, attempting
to bridge the “information gaps” among the players
 The government can do this in a number of ways
 Provide a matching service between MNEs and local suppliers
 Provide support in standards formation, materials testing, and
patent registration
 Provide technical training and managerial training
 Remove small firms’ obstacles to access to financial resources