Benefiting Foreign Direct Investment

Nguyen, Thanh Hoang, PhD

IR, USSH

Learning outcomes
p Getting knowledge about:
n Benefits of FDI
n Channels to transfer FDI benefits to the host country
n Factors need to absorb FDI benefits.
Contents
p Benefits of FDI and its spillover effect
p Position to absorb FDI
p The path of spillovers
p Factors need to absorb FDI s benefits.

Benefits of FDI
p FDI is thought of as a composite bundle of capital stocks,
knowhow, and technology,
p FDI is an important vehicle for transfers of advanced technology to
developing countries; FDI triggers technology spillovers,
incorporated technologies,
p FDI assists human capital formation, enhancing levels of human
capital in host countries,
p Possibilities to gain managerial and labor skills.
Benefits of FDI
p Higher incomes and economic development,
p FDI supports finance development, infrastructure, health,
education,
p FDI contributes to international trade integration, helps create
a more competitive business environment and enhances
enterprise development,
p cleaner technologies transferred by FDI might lead to
improvement of environmental and social conditions in host
countries.

Benefits of FDI

6
FDI spillover effect to Host Countries
p MNEs are the most productive firms in their home
countries

p MNEs, most of the time, are more productive than firms

in host countries, especially compared to those in
developing countries

p Most MNEs are skill intensive, knowledge intensive, and

heavy in R&D investment

p Host countries want to attract FDI because they may

benefit from MNE’s presence, through spillover effect

Allocate/
Combine
More Efficient use Immobile resources/assets
Mobile assets of TNCs
Mobile assets of TNCs of host countries
Make

p Capital p Natural resources

p Technology p Land
p Know-how p Labour
p Skills p Skills
p Infrastructure (transport, power,
p Innovatory capabilities telecom)
p Management p Institutions/policies
p Brand names p Research institutions and innovatory
p Access to TNCs (Transnational capabilities
Corporation)/MNCs p Local enterprises incl. SMEs (potential
(Multinational Corporation) suppliers to TNCs/MNCs)
markets p Free access to large international
markets
Discussion
p FDI naturally contains some benefits, whether host countries
can get all those benefits?
p Whether absorption is more essential than attractiveness?

Rain on leaf Water drops on duck

1 4 7

Which foods do you want to eat

to make your health better?
2 5 8

3 6 9
 FDI spillover effect to Host Countries
Positive Neutral or even Negative
Personnel
trained at MNEs, more skilled, and later
they may open their firms, or work in
other domestic firms
Technology Technology
may leak to domestic firms, through MNEs’ incentives to protect
domestic firms’ interactions with MNEs technology from leaking so to maintain
their lead in innovation put a brake on
technology transfer

Competitiveness
MNE’s entry into domestic industry may
out-compete domestic firms,
sometimes forcing them to shut down
or switch to other industries
11

The Impact of FDI on Host Countries

p FDI can only enhance the growth in higher income
countries. This indicates that not all host countries are,
as yet, far enough advanced, in terms of critical mass
status, to be able to benefit from FDI.
p Blomstrom, Lipsey, and Zejan (1994) study FDI effects on
technology gap of the host country: FDI only enhanced
the growth in the higher income countries group.
FDI absorption
p Absorption in FDI context means assimilation of FDI in a
given host economy.

p Absorptive capacity (ABC) denotes maximum amounts of

FDI that host economies can assimilate or integrate into
their economies in a meaningful manner.

Position of Absorption in FDI inflow

After animated FDI promotion campaign?

Bottleneck?
How to transfer benefits from FDI?

Position of Absorption in FDI inflow

How to transfer FDI benefits to host national benefits?
Position of Absorption in FDI inflow

Home Host
side side

FDI
Call for FDI FDI entry Performance
establishment

Incentive
y
ABC in Capital ABC in converting
Policy Disbursement FDI benefits

Clean land, infrastructure, Domestic firms’ capacities

available labors/ materials, technology, labors,
suppliers, financial system, financial system,
supportive policies… supportive policies…

Năng lực cần có để tiếp nhận lợi ích từ FDI

Yếu kém về thể chế, kết cấu hạ tầng và nguồn nhân lực có kỹ năng đang là những “nút
thắt cổ chai” đối với việc triển khai nhanh và có hiệu quả các dự án FDI. Mặt khác, do ta
cũng chạy theo thành tích, quá mê những đại dự án mà không xem kỹ thực lực của nhà
đầu tư (TS Phan Hữu Thắng, nguyên Cục trưởng Cục Đầu tư nước ngoài (Bộ Kế hoạch
- Đầu tư).

18
 The Path of Spillovers

Absorptive Process

FDI Benefits per se

Channels for FDI benefits transfer

Absorptive Capacity

FDI spillovers

Host country
Growth

Channels for FDI benefits transfer

p Macro-economic (national) level:
n Technological learning can take place through competition, imitation,
foreign linkages, and by doing business between foreign and local
firms.
n Training, learning by doing, and accumulating experience.

p Micro-economic (firms) level:

n Domestic firms are seen as main channels for receiving FDI benefits
involving horizontal and vertical spillovers effects, training effects,
skills acquisition, knowledge transfers, and labor turnover.
Micro-level channels
From parent firms à local (foreign) affiliates à domestic firms
p Technology/ Innovation:
n R&D and other forms of innovation,
n demonstration - imitation effects,
n competition effects,
n foreign linkage/cooperation effects.
p Knowledge/ know-how:
n qualified of labor,
n training effects,
n knowledge transfer through supply chains, skilled labor turnovers, hiring
workers who were previously trained by multinational corporations,
n advanced practices and experiences in innovation management effects.

Spillover and Its Relation to Type of FDIs

Technology is transferred through horizontal and vertical

spillover effects
n Horizontal spillovers – related to horizontal FDI
n Spillover from MNEs to domestic firms within the same industry

p Vertical spillovers – related to vertical FDI

n Backward linkage
p spillover from downstream firms to upstream firms
p e.g., spillover from foreign firms to their domestic suppliers
n Forward linkage
p spillover from upstream firms to downstream firms
p e.g., foreign circuit board producer and domestic PC maker .

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Vertical vs. Horizontal spillovers
q direct knowledge transfer from foreign firms to local firms;
q indirect knowledge transfer through movement of labor;
q higher requirements regarding product quality and on-time delivery
introduced by multinationals, which provide incentive to domestic
firms to upgrade their production management or technology;
q increased demand for intermediate products due to multinational
entry, which allows local suppliers to reap the benefits of scale
economies;
q competition effect - multinationals acquiring domestic firms may
choose to source intermediates abroad thus breaking existing
supplier-customer relationships and increasing competition in the
intermediate products. 23

How to absorb benefits from FDI?

 FDI Photosynthesis
Absorptive Capacity

FDI absorptive capacity

To absorb new knowledge and optimally utilize FDI benefits,
host countries need to have a certain degree of
development of related knowledge and capacities.
The absorptive capacity of nation including:
(1) Domestic firms,
(2) Technological level,
(3) Human capacity,
(4) Financial development, and
(5) Institutional development
FDI absorptive capacity
p Technology factors at both national and
domestic firm levels: the most important
capacity, proxies for technological gaps between
host and home countries FDI.
p The larger the technological gap, the smaller is
the impact of FDI on economic growth.

Global Skills Index

https://www.coursera.org/gsi
FDI absorptive capacity
p Human capital - Labor forces: essential factor for
absorbing and adapting foreign technology, and
to generate sustainable long-run growth,
described in terms of and education.
p Low-cost unskilled labour remains a source of
competitive advantages for countries, and can
still attract FDI, but its importance is diminishing.

FDI absorptive capacity

p R&D: firms' ability to exploit external knowledge.
FDI absorptive capacity
p Financial system: A better developed financial
system positively contributes to the process of
technological diffusion associated with FDI.

FDI absorptive capacity

p Institutional development: an investment-
friendly policy and administrative framework, the
regulation of business, the protection of property
rights and anti-corruption measures as
institutional indices.
Absorptive capacity factors
Author Cohen & Chen Keller De Mello Blomstrom Borenzstei
Levital et al. n et al.

Year (1990) (1994) (1995) (1997) (1996) (1998)

Level firm nation nation nation review nation
Technology
Human
Capital
R&D
Financial
System
Physical
Infrastructure
Institutional
development

Absorptive capacity factors

Author Kalotay Narula Hermes & Blomstrom Gorg & Nunnemk
Lensink et al Greenaway amp
Year (2000) (2003) (2003) (2003) (2004) (2004)
Level nation nation nation nation review nation
Technology
Human Capital

R&D
Financial
System
Physical
Infrastructure
Institutional
development
Absorptive capacity factors
Author Durham Alfaro Chundnovsky Girma Krogstup Fu Yi
et al et al & Matar
Year (2004) (2004) (2004) (2005) (2005) (2008) (2008)
Level nation nation nation firm nation region nation
Technology
Human Capital

R&D
Financial
System
Physical
Infrastructure
Institutional
development

Propositions P.2. Human capital

P.3. Financial sys

P.1. Domestic firm

P.6. Institution

P.5. Technology
P.4. Infrastructure
 Propositions

Proposition 1: To absorb FDI spillovers for national economic growth,

host country should develop its capacity in educated and skilled labor force

Proposition 2: To absorb FDI spillovers for national economic growth,

host country should improve local firm absorptive capacity

Proposition 3: To absorb FDI spillovers for national economic growth, host

country should progress its capacity in financial system

Proposition 4: To absorb FDI spillovers for national economic growth, host

country should have adequately in physical infrastructure

Proposition 5: To absorb FDI spillovers for national economic growth, host

country should advance its capacity in technology and R&D

Proposition 6: To absorb FDI spillovers for national economic growth, host

country should improve its capacity in institutional development

Benefitting FDI
p Many developing countries seek to attract and enlarge their
FDI placements, but do not recognize that certain initial
conditions or FDI host country critical mass must be in
place to absorb FDI benefits.

p Nunnenkamp (2004) argues that countries should obtain a

minimum level of economic development before they are
capable of benefiting from FDI. If not, they should not expect
FDI investors to respond.
Benefitting FDI
p FDI per se can bring important benefits, such as capital,
advanced technology and improved managerial skills to a
destination.
p However, those benefits do not automatically convert
convert to host
country spillovers.
p These benefits need to go through a conversion
conversion process
process before
becoming host countries spillovers.
p This process requires host countries to have sufficient
absorptive capabilities
capabilities.
p FDI absorptive capacity directly and decisively influences
economic growth
growth. In turn, the absorptive capacity will enhance
the attractiveness of quantity and quality of FDI inflows.

Discussion
p Using FDI to build supply chains in middle-skilled
manufacturing
n Costa Rica Case
n Malaysia
n Morocco
n Czech Republic