Movement of Capital: Multinational Corporations and Foreign Direct

Investment (FDI)

EC 378November 30, December 5, 2006

Motivation

• Factor movements and trade:

o Over one quarter of world trade is intra-firmo Firm relocation may displace trade: produce locally rather than

exporto Firms that vertically integrate internationally generate trade

• Foreign investment has grown faster than world trade or world output over the last 15 years

Motivation, cont.

• Multinational Corporations (MNCs)

o Are catalysts of technology transfero Provide employment opportunitieso Contribute to growth and development in LDCso Benefit local firms through demonstration effectso Benefit local firms through forward and backward linkageso Benefit domestic workers through training and education

Motivation, cont.

• Multinational Corporations (MNCs)

o Exploit local workers by paying them lower wageso Drive indigenous firms out of the marketo Drain local coffers by getting tax breaks and other incentiveso Produce under sweatshop conditionso Contribute to a “race to the bottom” in labor standardso Contribute to a “race to the bottom” in environmental standardso Contribute to the global harmonization of cultureo Are a threat to national security

Overview

• Defining FDI

• Some Numbers

• Empirical Evidence

What is Foreign Direct Investment? • Formal definition: Ownership of assets in one country by residents of

another for purposes of controlling the use of those assets

• Control:What share of ownership brings with it actual control: 10% in the U.S., 20 percent in many other countries

• A firm that engages in FDI is a multinational enterprise

• Measurement:Changes in FDI: FDI flows Existing FDI: FDI stock

• Alternatively: Value of assets in foreign-owned firms; employment in foreign-owned firms; sales by foreign-owned firms

Terminology and Data Sources• Source (home) country: Where MNC is headquartered

• Host country: Hosting a foreign affiliate

• Bureau of Economic Analysis (BEA at www.bea.gov):U.S. Direct Investment Abroad (outward FDI)Foreign Direct Investment in the U.S. (inward FDI)

• BEA data: confidentiality issues

Forms of FDI

• Greenfield investment

• Joint ventures

• Acquisition of local firms(cross-border mergers& acquisitions, M&A)

• Portfolio investment isnot direct investment

• Produce the same good in different locations: horizontal investment

• Organize an international production chain, where each stage is located where best suited: vertical investment

E.g.: labor-intensive assembly in low-wage countries,capital- and skilled-labor intensive R&D at home

FDI to All Countries

• UNCTAD: good source for international FDI data

Resource Flows to Developing Countries

Growth rates of FDI, GDP, Trade worldwide

9.453.68.7Exports

6.81.35.2GDP

11.4817.39.5FDI Stocks

-15.8539.721.2FDI Flows

2001-041996-20001991-95

Effects of FDI

• Home country effects of outward FDIo FDI and employmento FDI and exports

• Host country effects of inward FDIo Host country wageso Host country productivityo Host country growtho Host country exports/imports/trade balanceo Public finance effects (subsidies, other expenditures)o Technology transfers

Some select evidence: Outward FDI and employment at home

• Matt Slaughter (Dartmouth, currently on CEA):

MNCs create 2 jobs in the U.S. for every job they create abroad

• Why?

• Lower costs abroad lead to increase in scale and scope of operation

Local Effects of FDI, U.S.

• David Figlio and Bruce A. Blonigen investigate FDI in South Carolina

• They find that foreign investment raises local real wages much more than does domestic investment – Reasons?

• They find that foreign investment lowers per capita county-government expenditures and redistributes money away from public school expendituresWhy?

Technology and FDI, U.S.

• Lee Branstetter investigates technology spillovers (transfers of technological knowledge) from the presence of Japanese firms in the U.S.

• He finds that there are spillovers both from and to the investing Japanese firm

FDI and Wages: Evidence from Aitken, Harrison, Lipsey for Mexico, Venezuela, and the U.S.

• Does foreign ownership lead to higher wages?

o Do higher wages spillover into non-foreign owned firms?

• Find that higher FDI is associated with higher wages in all countries.

• In Venezuela and Mexico higher wages are only realized in foreign owned firms: no spillovers into domestic firms;in fact, possibly negative effect on wages in dom. firms

Possible Explanations

• At least for Venezuela: Higher foreign equity participation is strongly correlated with higher plant productivity. (Aitken and Harrison 1993)

• Higher productivity may be due to higher capital intensity or different skill mix

• This suggests controlling for capital intensity and skill

Model• Hypothesis: foreign-owned firms raise the overall marginal

productivity of labor.

• Y = A(DFI)f(X,L)o DFI = share of labor in the market employed by foreign firms. o L = labor employed by the industryo X = all other factors of production

Model

• W = PRICE*MPL = PRICE*[A(DFI)f1(X,L(W))]W= wageL(W) = the labor supply curve

• Ln W = C + α1DFI + α2ln PRICE + α3ln X– α4(v ln W)

• Ln W = C´ + [α1/(1 + α4)]DFI + [α2/(1+ α4v)]ln PRICE +[α3/(1 + α4v)]ln X

Model, continued

• Ln Wsk = α0 + α1DFI +α2ln PRICE +α3ROYALTYα4KSTOCK + LOC + SIC + e

• Ln Wusk = β0 + β1DFI +β2ln PRICE +β3ROYALTYβ4KSTOCK + LOC + SIC + e

SIC = industry dummyLOC = region dummy

Data

• Plant-level dataMexico: domestic and foreign sales, equity ownership positions by country of origin, price indices on inputs and outputs. Venezuela: foreign ownership, assets, employment, cost information, location and product destination.

• Data aggregated to industry-level

• US data did not begin until 1987. Used only in cross-sectional form

Results

Results

Interpreting the Results

• Clearly, foreign plants are more productive and thus pay higher wages

• Results are consistent with “poaching” of workers by foreign enterprises

• Moreover, could reflect efficiency wages paid

Results for the U.S.

Note the different controls: data limitations

Survives Numerous Robustness Checks

• Re-estimated results using plant-level instead of industry level data.

• Incorporated the impact of plant age on wages.• Impact of plant size. • Issue of endogeneity of foreign investment and wages.

Summary

• Evidence on many positive effects of MNCs

• Evidence on some negative effects (local school expenditures, domestic firms, the poorest countries, environmental regulations?!)

• Much more detailed study with detailed micro-level cross-country data needed:

A fertile field of study!