Foreign Direct Investment and Competitiveness

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Foreign Direct Investment and Competitiveness

• Foreign Direct Investment (FDI) occurs when a
  multinational builds a plant or establishes a
  subsidiary in a foreign country
• FDI is not PORTFOLIO investmentthat is a
  financial investment like buying a foreign stock
  or bond
• It represents a real investment in plant,
  buildings, equipment and people by a
  multinational firm
• FDI has grown very rapidly in recent times with a
  very strong boom in the late 90s

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Some facts

• FDI since 1980 has grown twice as fast as trade
• The bulk of FDI has been between the industrial
  countries
• Developing country FDI has picked up recently
  particularly into Asia, Latin America and East
  Europe
• FDI is either a) so that a global company can
  serve the local market (eg. McDonalds) or b)
  builds a plant for export to other markets (eg.
  Sonys plants in South East Asia)

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The competition for global investment by countries

• Countries compete for FDI in the sense that most
  countries would like to attract FDI investmentit
  creates jobs, transfers technology and leads to
  more trade
• On the other hand when a large domestic firm
  invests abroad this leads to charges that the
  firm is exporting jobs (see Lou Dobbs CNN show)
• Foreign outsourcing is when a particular job that
  was previously done domestically is transferred
  abroad--in some cases through FDI or in some
  cases by contracting out the service to a foreign
  firm

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Outsourcing Debate in Large Industrial Countries

• Outsourcing debate very hot in the US
• Eg. Call centresfirms that once used US based
  labour to answer calls about software for eg.
  Have transferred these jobs to India and Canada!!
• The fear is that outsourcing will lead to reduced
  jobs in the US for white collar labour
• Thus far numbers are fairly small but will
  probably grow
• Outsourcing, FDI export of jobs, and import
  competition threatening jobs all related phenomena

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Competitiveness and Attracting FDI

• Lots of countries would like to attract FDIhow
  do they do that?
• Countries like companies can compete with each
  other
• One way to compete is on the direct COST of doing
  businessnational governments can try to have
  lower costs thus hoping to attract FDI

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Cost based locational competition strategies

• Examples of cost based factors which might
  attract FDI
• Lower taxes
• Lower wages
• A low exchange rate (cheap currency)
• Few regulations for eg. on the enviornment
• Direct subsidies to certain business costs (eg.
  Low electricity costs, or subsdized job training)

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Consequences of cost based locational competition

• Lots of examples of thisrecent moves by Ontario
  and BC governments to increase tax credits for
  movie productions
• When locations compete on cost with each other
  they tend on average to drive down the after-tax
  costs to the firm making an FDI decision
• This process is often called The Race to the
  Bottom
• Why? Because lower taxes, lower wages, fewer
  environmental regs may be good for the Global
  corporation but may not be good for a high wage
  high cost economy
• Low wage economies have huge advantage in cost
  based locational competitions (The Giant Sucking
  Sound)

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Other factors in locational competition

• Cost however is NOT the only factor which drives
  FDI locational choices
• Quality of the labour force in the local market
  is very important (high tech firms need highly
  skilled labour)very important for eg. In
  explaining Irish success
• Overall productivity of operations in certain
  locations as affected by transport links,
  communications links, reputation of regulatory
  system (eg. Very important in financial services)
  

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The Agglomeration Factor

• Another factor which is enormously important is
  the clustering or agglomeration of similar firms
  and activitiesFDI by one firm is strongly
  attracted the presence of other firms in the same
  activity
• Eg. Movies in Vancouver, semiconductor firms in
  Taiwan, oil service companies in Houston and
  Calgary, etc. etc.
• Why agglomerations or clusters occur in some
  locations is not fully understoodoften
  historical accident but can be quite important in
  some industries

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Other factors on the quality side

• Open marketsif you are looking at an FDI
  decision for export you want to make sure
  importing and exporting is free from interference
• Good legal system and protection of intellectual
  property
• Honest and efficient government (want to avoid
  making bribes and being ripped off)

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So how to compete for FDI?

• Policy makers in countries have to balance the
  above set of cost and quality factors
• Lower costs are one factor but not the only one
• High productivity, high quality business
  enviorment with skilled labour another
• Which is more important? Evidence is that both
  matter. Very few instances of a clear race to
  the bottom although it does happen
• Generally the smaller the country the closer
  attention the government must pay to this issue

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National Competitiveness Indicators

• There are a number of organizations which publish
  national competitiveness indicators ranking
  countries on these type of factors
• One of the most famous is published each year by
  World Economic Forum with detailed rankings of
  countries on a number of these factors
• The WEF breaks it down into a general economic
  growth index (overall quality of the national
  economic polices toward growth such as education
  and support for RD) and a business
  competitiveness index (which focuses specifically
  on policies of interest to global business)

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Growth and Business Competitiveness factors
appear to be closely related

• The implication of these type of studies which
  all tend to come to similar conclusions is that
  cost is important but on average quality of the
  overall business enviornment more important
• Global competition between locations for
  investment is just as likely to improve quality
  and productivity of an economy as it is to lower
  wages or cut taxes
• This is not to say the latter is never
  importantif wages become too high relative to
  productivity or taxes too high relative to
  similar jurisdictions business will move