FDI HAS LITTLE SPILLOVER EFFECTS ON LOCAL FIRMS

11:18 AM Jan 29, 1997

FDI HAS LITTLE SPILLOVER EFFECTS ON LOCAL FIRMS
Geneva, 29 Jan (Chakravarthi Raghavan) -- Higher levels of foreign investment in a developing country seems to lead to higher wages and productivity, but only in the foreign firm, and has little or no spillover effects, and casts doubt on the current orthodox view that Transnational Corporations and their foreign investment in a country enable it to 'catch up' via knowledge and ideas.

The lack of spillover effects, in higher wages and productivity, of local firms, is a conclusion, drawn in an article published in the Journal of International Economics by three authors -- Brian Aitken, Ann Harrison and Robert Lipsey. It is based on data from Mexico, Venezuela and the United States.

The United States is a major source of FDI for Mexico and Venezuela. The US gets FDI from a number of sources, but mainly from Europe and Japan.

Aitken is on the IMF staff. Harrison and Lipsey are US academics.

Their conclusions bear out anecdotal experiences in many developing countries that FDI and TNC, while creating modern high-productivity sectors, remain 'enclave units', with little forward and backward linkages to the domestic economy, and with little diffusion of technology (brought in by the TNC) across the economy.

The authors conclude that higher levels of foreign investment are associated with higher wages, but in Mexico and Venezuela, FDI is associated with higher wages only in foreign-owned firms. There is no evidence of wage spill-overs leading to higher wages in domestic firms.

In the United States, where there is strong evidence of wage spill-overs, wage differentials between foreign and domestic firms are much smaller, and a large part of the differential seems to disappear after taking into account the fact that foreign-owned enterprises are larger and more capital intensive than their domestic counterparts.

It is generally accepted that TNCs, the foreign investors, go to a country and invest, competing with domestic firms, because of their ability to translate their intangible assets (technological know-how, marketing and managerial skills, export contacts, relations with suppliers and customers and reputation) into profitable returns.

The assets are transferred more easily, and cheaper, to a subsidiary, with greater returns to the parent, than by licensing the assets to host country firms.

A number of studies also suggest that foreign investors can facilitate spread of productive knowledge, and even improve performance of domestic firms through buyer-seller linkages and improved access to technology, management and marketing practices.

However, the authors note, empirical evidence about the overall impact of foreign firms in diffusion of knowledge locally remains mixed.

In Mexico, some studies suggest that domestic firms in sectors with greater foreign ownership were more productive, while in Venezuela this relationship disappeared, when account is made for fact that FDI is concentrate in more productive sectors.

This result, the authors say is consistent with a 1970 OECD study of 65 subsidiaries in 12 developing countries which found little evidence of spill-overs.

That OECD attributed the lack of spillover effects to the fact that the foreign subsidiary limited hiring of higher-level domestic employees, there was little labour mobility between foreign and domestic firms, limited domestic subcontracting and few incentives to the TNCs to diffuse knowledge to local competitors.

An Aitken-Harrison study of 1993 found that in Venezuela while foreign investment raised productivity overall, the gains were internalized (i.e. within the subsidiary) or captured by other foreign firms, while productivity in domestic firms actually declined.

Both in Mexico and Venezuela, a higher share of foreign investment in a firm raised overall wages for both skilled and unskilled workers, but there were no spill-over effects on wages in domestically-owned firms.

In the United States in contrast, larger share of foreign firms in employment is associated with both higher average wages and higher wages in domestic establishment.

The authors suggest that one explanation for the lack of spillover effects on wages in domestic enterprises in Venezuela and Mexico could be that foreign and domestic firms operate in different labour markets.

According to the authors, the evidence in all the three countries, suggest that while wage spillovers are generally associated with higher productivity in domestic plants, their absence appears to accompany persistent productivity differentials.

And while in all the three, foreign investment seems to result in higher levels of labour and total factor productivity, the evidence on growth of productivity is more mixed.

FDI seems to be associated with higher productivity for the enterprises that receive the FDI, but with lower productivity in other firms. From the evidence of Venezuela and Mexico, it would appear that gains from foreign investment, both in higher productivity and higher wages, were internalized by the foreign owned firms.

The productivity data and wage data for the US suggest spillovers from foreign-owned to domestically owned establishments -- something not visible in Mexico or Venezuela.

Do the geographical location of the foreign owned industry (such as foreign firms being located in high-wage states or regions within a given industry) account for the wage differentials?

The authors find that while in the US, the foreign investor in manufacturing tends to locate in low-wage states within each industry, Mexican data suggest that foreign enterprises are more likely to locate in higher wage regions, and the tendency is even stronger in Venezuela.