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Trade, Foreign Direct Investment, Trade, Foreign Direct Investment, and International Technology and International Technology

Transfer: A SurveyTransfer: A Survey

Kamal SaggiKamal SaggiThe World Bank Development Research The World Bank Development Research

Group Group TradeTrade

May 2000May 2000Presented by Group 1Presented by Group 1

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IntroductionIntroductionEconomic growth results:Economic growth results:

– Accumulation of factors of production (Traditional trade Accumulation of factors of production (Traditional trade growth)growth)

– Improvement from technologyImprovement from technology

– Both Both

Technologies resulted from R&D spread throughout Technologies resulted from R&D spread throughout the world:the world:– International trade in technologyInternational trade in technology

– Indirect channels (trade in goods and international Indirect channels (trade in goods and international movement of factors of products)movement of factors of products)

– Foreign direct investmentForeign direct investment

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Knowledge spillovers through tradeKnowledge spillovers through trade• Traditional growth theory sought the explanation of economic growth in Traditional growth theory sought the explanation of economic growth in

terms of accumulation of capitalterms of accumulation of capital

• Neoclassical growth models assume costless technology transfer by Neoclassical growth models assume costless technology transfer by positing a common production function across countriespositing a common production function across countries

• Parente and Precoscott(1994):Parente and Precoscott(1994):– Emphasized barriers to technology adoption: legal, regulatory, political and Emphasized barriers to technology adoption: legal, regulatory, political and

social factorssocial factors– Suggested that trade may affect growth by lowering barriers to technology Suggested that trade may affect growth by lowering barriers to technology

adoptionadoption

• The new growth theory emphasizes endogenous technological change and The new growth theory emphasizes endogenous technological change and human capitalhuman capital– It is R&D based models of economic growthIt is R&D based models of economic growth– Two widely used strands of R&D based endogenous growth models are:Two widely used strands of R&D based endogenous growth models are:– ‘‘varieties only model’varieties only model’– ‘‘quality ladder model’quality ladder model’

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‘Variety model’ assumes:–Growth is sustained in a closed economy–The creation of new products expands the knowledge stock–Then lowers the cost of innovation (increased competition)

‘Quality ladders model’ assumes:–Open economy growth model–Consumers are willing to pay for higher quality of products–Firms always have incentives to improve the quality of products–Every successful innovation allows all firms to study the attributes of the product and improve upon it–Patent rights restrict a firm producing a product invented by some other firm but not form using the knowledge–Knowledge spillovers ensure that anyone can try to invent a higher quality version of the same product–Trade in goods can help transmit knowledge internationally

Knowledge spillovers through trade Knowledge spillovers through trade ctd..ctd..

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• There are two strands of multi-country models of There are two strands of multi-country models of endogenous growth:endogenous growth:– Those that study trade between identical countries North-Those that study trade between identical countries North-

North), andNorth), and– Those that have a North-South structureThose that have a North-South structure

• North-South emphasize on the product cycle nature North-South emphasize on the product cycle nature of tradeof trade– New products are invented in the NorthNew products are invented in the North– Firms in the south can successfully undercut Northern Firms in the south can successfully undercut Northern

producer once they succeed in imitating Northern productsproducer once they succeed in imitating Northern products– Post imitation all products are imported by the NorthPost imitation all products are imported by the North– These models capture technology driven and have been These models capture technology driven and have been

generalized to consider technology transfer more explicitlygeneralized to consider technology transfer more explicitly

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Scope of knowledge spillovers:Scope of knowledge spillovers:– National or internationalNational or international– Primarily localPrimarily local– R &D based models:R &D based models:

• Knowledge spillover substantially to other countriesKnowledge spillover substantially to other countries

• Trade is an important channel of such spilloversTrade is an important channel of such spillovers

• Knowledge spillover shouldn’t be limited to Knowledge spillover shouldn’t be limited to geographical location and geographical location and

• the role of innovator to controlling technology the role of innovator to controlling technology spreadingspreading

• the potential buyers and imitators shouldthe potential buyers and imitators should

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Explaining FDI: Location and Mode Explaining FDI: Location and Mode of productionof production

Two distinct questions that a firm seeking to serve foreign market:

– Location of productiona. Produce at home country and exportb. If Produce abroad (issue of technology transfer)

– Extremes: wholly owned subsidiaries to licensing

Export vs. production• Two approaches of explaining foreign markets:

a. Theoretical models (Economics literature)b. Empirical models

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• Economic literatureEconomic literature – the choice between export and FDI are substitutesthe choice between export and FDI are substitutes

• Empirical literatureEmpirical literature uncovers the complementary relationship uncovers the complementary relationship between exports and foreign affiliate sales( at industry and between exports and foreign affiliate sales( at industry and micro levels)micro levels)

• Blonigen(1999) using a study of product data:Blonigen(1999) using a study of product data:– Complementary trade between intermediate goods and affiliate salesComplementary trade between intermediate goods and affiliate sales– The substitutability of export of final goods and FDIThe substitutability of export of final goods and FDI

• Existing theoretical models strategic consideration for choice Existing theoretical models strategic consideration for choice between exports and FDI as:between exports and FDI as:– A tariff jumping motive for FDIA tariff jumping motive for FDI– Interdependence of decision making between multinational firmsInterdependence of decision making between multinational firms– Are well developed to make static decision between export and Are well developed to make static decision between export and

productionproduction

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In exploring optional strategies empirical studies:In exploring optional strategies empirical studies:– The dynamic problem and exporters behaviorThe dynamic problem and exporters behavior– Prior exporting experience( the role of sunk costs)Prior exporting experience( the role of sunk costs)– Saggi(1997): Two period models in the face of demand uncertainty Saggi(1997): Two period models in the face of demand uncertainty

(If a significant portion of the fixed cost of FDI is sunk, it is optimal (If a significant portion of the fixed cost of FDI is sunk, it is optimal for a firm to export)for a firm to export)

Lessons from the success and failure of others,Lessons from the success and failure of others,– Lack of prior experienceLack of prior experience– Complexity surrounding FDI (operational conditions like: labor Complexity surrounding FDI (operational conditions like: labor

market literacy and productivity of the labor force timely availability market literacy and productivity of the labor force timely availability as well as quality of inputs) as well as quality of inputs)

– Information is gathered either through one’s own experience or Information is gathered either through one’s own experience or through the experience of othersthrough the experience of others

While the degree of fixed/sunk costs may play a role inWhile the degree of fixed/sunk costs may play a role in determining the choice between licensing ,joint ventures, anddetermining the choice between licensing ,joint ventures, and FDI other considerations are probably more importantFDI other considerations are probably more important

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Mode of Operation: Licensing, Joint Mode of Operation: Licensing, Joint Venture and FDIVenture and FDI

Knowledge-capital model:–Knowledge is a public good–Any innovation applied at multiple plants all over the world.–Internalization: the incentive to prevent dissipation of knowledge based assets multinationals transfer technologies via direct investment

Empirical paper: focuses on intra-trade differences in R&D intensity as a determinant mode of entry chosen by the firms

–Protecting technology of high tech industries–Low technology sectors for joint venture

Horstmann and Markusen’s(1996) model:Potential local firms (licensee) have better information about local demandSuch agency costs can be utilized to explain the dynamics of optimal entry modesTherefore foreign firms initially licensing and later on terminate licensing agreement to avoid agency cost if there is demandLicensing is a method of information acquisition on the part of foreign firm about uncertainly demand

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FDI;TECHNOLOGY TRANSFER & FDI;TECHNOLOGY TRANSFER & SPILLOVERSSPILLOVERS

• Dominance of FDI as a channel of technology Dominance of FDI as a channel of technology transfertransfer

• FDI as a vehicle of spillovers in LDCsFDI as a vehicle of spillovers in LDCs

• Channels of Spillovers;Channels of Spillovers;

– Demonstration EffectsDemonstration Effects

– Labour TurnoverLabour Turnover

– Vertical LinkagesVertical Linkages

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FACILITATION OF TECHNOLOGY FACILITATION OF TECHNOLOGY ADOPTION ADOPTION (Demonstration Effect)(Demonstration Effect)

• demonstration effect argument states that demonstration effect argument states that exposure to the superior technology of exposure to the superior technology of multinational firms may lead local firms multinational firms may lead local firms to update their own production methods.to update their own production methods.– FDI may expand the set of technologies FDI may expand the set of technologies

available to local firmsavailable to local firms

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• More attention given to direct imitation and More attention given to direct imitation and reverse engineering as channels of inter-firm reverse engineering as channels of inter-firm technology diffusion, technology diffusion, – the role of labor turnover has been rather the role of labor turnover has been rather

neglected.neglected.

• Labour turnover differs from these channels Labour turnover differs from these channels because knowledge embodied in workers because knowledge embodied in workers moves across firms only through the physical moves across firms only through the physical movement of workers.movement of workers.

FACILITATION OF TECHNOLOGY FACILITATION OF TECHNOLOGY ADOPTION ADOPTION (Labour Turnover)(Labour Turnover)

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• multinationals have an incentive to limit multinationals have an incentive to limit diffusion of their technology to local rivalsdiffusion of their technology to local rivals

• Local competition policy may also affect labor Local competition policy may also affect labor turnoverturnover

• Labor turnover rates may vary at the industry Labor turnover rates may vary at the industry level as welllevel as well

FACILITATION OF TECHNOLOGY FACILITATION OF TECHNOLOGY ADOPTION ADOPTION (Labour Turnover)(Labour Turnover)

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• multinationals may benefit the host economy multinationals may benefit the host economy via the backward and forward linkages that via the backward and forward linkages that they generatethey generate

FACILITATION OF TECHNOLOGY FACILITATION OF TECHNOLOGY ADOPTION ADOPTION

(Vertical Linkages& Technology Transfer)(Vertical Linkages& Technology Transfer)

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SPILLOVERS FROM FDI:SPILLOVERS FROM FDI:(A RECAPITULATION)(A RECAPITULATION)

• Regarding technology spillovers from FDI, how can they ever be in the interest of the multinational firms?

• entry of multinationals may indeed be beneficial for host countries even though it fails to result in much in the way of spillovers for local firms.

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FDI & GROWTHFDI & GROWTH• FDI is attracted to countries that are expected FDI is attracted to countries that are expected

to grow faster simply because it yields higher to grow faster simply because it yields higher returns therereturns there

• An optimistic view of FDI would then look to An optimistic view of FDI would then look to technology transfer and/or spillovers as the technology transfer and/or spillovers as the mechanism through which FDI may affect mechanism through which FDI may affect growth.growth.

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ROLE OF POLICYROLE OF POLICYTRADE POLICY:• interaction between protection and technology transfer

has not received significant attention• temporary protection (i.e. protection that is removed

upon successful adoption by the domestic firm) actually delays the date of technology adoption.

FDI POLICIES:• No simple way of describing policy environment

facing multinationals• FDI was either completely prohibited or multinational

firms had to operate under severe restrictions

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INTELLECTUAL PROPERTY RIGHTS (IPR):INTELLECTUAL PROPERTY RIGHTS (IPR):• if any policy variable should affect international

technology transfer, it ought to be the host country's intellectual property rights (IPRs) regime.

ROLE OF POLICYROLE OF POLICY

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CONCLUSIONSCONCLUSIONS• Role of trade in encouraging growth hinges Role of trade in encouraging growth hinges

critically on the geographical scope (national critically on the geographical scope (national versus international) of knowledge spilloverversus international) of knowledge spillover

• Little is known about the relative role of trade and Little is known about the relative role of trade and FDI as mechanisms of technology transferFDI as mechanisms of technology transfer

• A well-developed paradigm seeks to explain the A well-developed paradigm seeks to explain the emergence of multinational firms, givenemergence of multinational firms, given

the existence of viable alternatives such as exports, the existence of viable alternatives such as exports, licensing, and joint ventures.licensing, and joint ventures.

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• Local policy frequently makes pure FDI Local policy frequently makes pure FDI infeasible forcing foreign firms to opt for infeasible forcing foreign firms to opt for licensing or joint venturelicensing or joint venture

• Policies designed to lure in FDI have Policies designed to lure in FDI have proliferated in recent years.proliferated in recent years.

• Several studies (both theoretical and Several studies (both theoretical and empirical) indicate that absorptive capacity in empirical) indicate that absorptive capacity in the host country is crucial for obtaining the host country is crucial for obtaining significant benefits from FDIsignificant benefits from FDI

CONCLUSIONSCONCLUSIONS

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Discussions & Discussions & Questions ? Questions ?