FDI Flows and Technology Transfer
WT/WGTI/W/105 26 June 2001
Working Group on the Relationship between Trade and Investment (01-3171)
The following communication, dated 13 June 2001, has been received from the Permanent Mission of India.
FDI FLOWS AND TECHNOLOGY TRANSFER
- The possible role that foreign investment could play in aiding countries to achieve the goal of increased income, employment and output is now universally recognised. Almost every country is engaged in autonomously liberalizing their foreign investment regimes with a view to facilitating smooth flow of investment to their respective territories. However, there has been a general reluctance among countries to leave the scene completely open to foreign investors. While a large number of countries maintain formal screening procedures to regulate investment inflow, the reluctance to surrender all discretionary authority as regards entry and establishment is near universal. This is largely because of the strong perception that investment inflows are not unmixed blessings and that investors cannot be expected to automatically fulfil their obligations diligently. When some of the Members of WTO discussed the issue of a multilateral agreement on investment outside WTO, in OECD, this concern came out clearly in the open with the participating Members coming out with requests for exemptions one after another. In fact, the nature and extent of exemptions sought by the participants led to the very abandonment of the negotiations. The participants in the OECD process were all countries that had reached a certain level of development whose economic problems and concerns had largely transcended those of the large majority of the WTO Membership who are developing countries and LDCs. It would, therefore, be naïve to expect the latter group of countries to be unconcerned about the implications of any efforts that are aimed at eventual curbs on their ability to influence investment inflows into their territories.
- Foreign investment inflows are not homogeneous. The economic effects of foreign direct investment (FDI), for example, differ substantially from those of portfolio investment. The ripple effects created and the imprints left behind by FDI on the host economies differ substantially from those by portfolio investment. Low income countries with very limited technological capabilities and complementary production factors like skilled labour and managerial skills would be most comfortable with imported products that are ready for consumption. However, imports have to be paid for. This means these countries have to earn foreign exchange to pay for such imports. Besides, there is the need for building domestic capabilities in areas of their potential comparative advantage so that these countries could eventually participate effectively in the global market place. Developing countries, therefore, naturally seek FDI, in preference to other types of investment, which brings with it a bundle of production factors in the form of capital, technology, skilled manpower and managerial skills; these are expected to help ease constraints on their industrialization and development, imposed by scarcities of capital, foreign exchange, technology, organizational and entrepreneurial resources. Technology is perhaps the most crucial of them all from the point of view of development.
- The last decade has seen a veritable explosion in the total FDI flows, both in the absolute volume of the global flows and also as a share of the global output. World FDI flows today are more than thrice the level of what they were in 1990, and some seven/eightfold their level in 1980. Going by the recent trends, especially manifested after the Asian crisis of 1997, the predominant channel of transferring the FDI funds has been through the merger and acquisition (M&A) mode, rather than in the form of greenfield investments. Data from the World Investment Report (2000) indicates that the M&As today constitute about 85% of the total FDI flows the world over.
- Studies have confirmed the general apprehension that FDI inflows in the form of mergers and acquisitions (M&As) are in general of poorer quality as compared to greenfield FDI inflows, in terms of their domestic capital augmenting potential, spillover benefits, competition and efficiency. This is because M&As do not always augment the stock of productive physical capital in the host country which would contribute to further growth. It is to be noted that greenfield investment, by virtue of new entry, increases competition, while M&As most often lead to increases in economic concentration by reducing the number of active enterprises in the market.
- Even a successful M&A bid and its efficient implementation from the investors’ point of view need not necessarily have a favourable impact on the economic development of the host country. The main reason for this is that the objectives of the concerned multinational corporations (MNCs) and those of the host economies do not necessarily coincide. The effects of the M&As, either directly or through linkages and spillovers, also depend on whether the investment is natural-resource-seeking, market-seeking, efficiency-seeking or created-asset-seeking. In case the initial investment decision related to a merger or acquisition is taken on purely financial profitability considerations, without due regard for the economic benefits likely to accrue to the host country, the effects of such M&As cannot be expected to be beneficial for the host economy. Chia Siow Yue et al note that the “driving forces behind this M&A surge include increased corporate competition as a result of liberalisation in many host country regimes, and the need to consolidate international business in the face of falling corporate profit margins. Recent declines in commodity prices and global over-capacity across a spectrum of industries have exacerbated this business consolidation trend”. The motive-factor would also have an important bearing on the type and quality of the technology transferred. It is important for the developing countries, therefore, to not only see “whether” technology is being transferred, but also the “nature” of such transfer. The quality of the technology acquired cannot be ignored if one has to keep in mind the dynamic long-term development interests of the developing countries.
- One major reason why FDI is sought by countries, especially developing countries, is that FDI generally brings with it the much needed state-of-the-art technology that developing countries lack. However, available facts and figures do not vindicate this expectation of developing countries. An analysis of the trends in global technology transfers indicates that the annual technology transfer payments are not growing at expected levels. It is estimated that the technology transfer payments rose from US$ 6.8 billion in 1976 to an estimated US$ 64.4 billion in 1995. Providing for the OECD countries not reporting the technology receipts, especially Switzerland’s, and emerging newly industrialising economies in Asia, the global magnitude of technology-related fees crossing national borders could well be to the tune of US$ 68 billion. Comparatively, annual global FDI flows rose from US$ 22 billion to US$ 315 billion over the same period. However, what is significant is that the growth rates recorded by FDI flows have been more impressive than those by technology transfer payments over the whole or any sub-period.
- These observations together suggest that the recent spurt in FDI inflows may not have been accompanied by technology transfers in the same proportion. Further, and more striking, particularly for the developing countries, is the fact that while their share of FDI inflows has gone up, their share in global technology transfers has come down. Dahlman et al have also noted the relative slowdown in technology transfers to developing countries. This is an alarming trend from the point of view of developing countries. While it can be argued that the subsidiaries payments for the technology transferred from the parent companies is expected to be lesser in the case of M&As than in the case of greenfield investments, even then this trend definitely does not augur well for the developing countries who are generally dependent on the technology brought in by the foreign investors to give a boost to their economic activities.
- In this regard, Sanjaya Lall makes a distinction between the “know-how” and “know-why” of technology transfer. He first stresses that technology import is not a substitute for indigenous capability development; the efficacy with which imported technologies are used depend on the local efforts. However, not all modes of technology import are conducive to indigenous learning. Much depends on how the technology is packaged with complementary factors. In general it has been observed that technology transfers within a MNC are very efficient for transferring know-how, but less so for transferring know-why. In this, licensing or arm’s length transactions are deemed to be more effective for generating local know-why, though they are more expensive in the short-term for accessing know-how. Thus the type of investment that comes in would be of the type that supports ‘assembly-led-growth’ and skill formation among workers. With reference to Korea it has been noted that labour intensive investment that came in textile, clothing and footwear sectors saw a rise in the export and also the manufacturing value-added by the labourers. On the other hand, in the assembly-led investment in manufacturing units like telecommunications, furniture, pottery and other non-metallic mineral products, etc., exports and manufacturing value-added had, in fact, declined. Therefore, as noted by Hattori, “although Korean companies accumulated a very high level of technology to operate new machines, they could not acquire technology and skill required for developing new machines. Thus, while Korean engineers design new machines, the know-how required to produce high quality parts at low prices in the domestic market is not available for the production of these machines”. It has been noticed that M&A type FDI accompanying MNCs has transferred a high level of ‘operating and organisational’ technology, which is very different from a high level of ‘production technology’. In the former case, the goods produced will have weak competitiveness except for price.
- As underlined in the UNCTAD series Paper on issues in International Investment Agreement, a clear distinction needs to be made between the learning of operational technology and the creation of new technology. “FDI may be a very effective way of transferring new operating know-how but not necessarily of the innovation process that underlies the generation and upgrading of the technology. It is widely accepted that TNCs tend to transfer the results of the innovation but not the innovative capabilities themselves, at least to most developing countries: the re-location of their research functions abroad is overwhelmingly to other developed countries. This can lead to a “truncating” of the process of technology transfer and to a relegation of developing host countries to lower levels of technological activity (even when their industrial capabilities have reached a level at which, as in many newly industrialised economies, they are able efficiently to undertake advanced research-and-development work”. The above, therefore, makes it very clear that transfer of technology is not automatic. Developing countries will need to retain policy discretion to persuade foreign investors to effectively transfer technology, even though it might involve ‘higher cost’ to these countries.
- There is also the debate regarding whether obtaining technology through the FDI route is preferable to licensing and other similar arrangements. As the UNCTAD paper cited above notes, Japan and Korea relied heavily on licensing and other forms of acquisition of technology from TNCs, while Singapore mainly relied on FDI, attracting it into specified industries. On the other hand, Taiwan made active use of both the routes.
- Gordon H. Hanson in a G-24 discussion paper notes that “multinational firms concentrate in high–productivity sectors and that domestic plants in these sectors, while having high relative levels of productivity, experience even or negative growth in productivity relative to plants in other sectors. Micro-level data, then, appears to undermine empirical support for positive net productivity spillovers from FDI, perhaps indicating that multinationals confine domestic firms to less profitable segments of industry”. In this connection, he quotes studies by Haddad and Harrison (1993) and Aitken and Harrison (1999). Haddad and Harrison, using data on Moroccan manufacturing plants for the period 1985-1989 found a weak correlation between plant total productivity growth and presence of foreign firms in the sector. Aitken and Harrison (1999), using data on Venezuelan manufacturing for the period 1979-1989, found that productivity growth in domestic plants is negatively correlated with foreign presence in the sector.
- Evidence from the newly developing South-East Asian Tigers’ experiences also indicates that the total productivity growth in these economies has been low in spite of the liberalization and significant inflows of FDI which ought to have brought in newer technologies. What this implies is that low technological capability might coexist with the capability to successfully use new technologies. It must therefore be remembered that the simple act of high-technology production in any country does not ensure that efficient learning has occurred, and the latter depends on a host of other factors other than technology transfer per se. Studies undertaken also reveal that developing countries attract only marginal shares of foreign affiliate research, and much of what they get relates to production, adaptation and technical support (i.e. know-how) rather than relating to innovation (know-why).
- The extent of technology and management of know-how transfer by the MNCs depend to a large extent on their corporate strategy; for example, firms desiring to have a longer-term relationship with the suppliers (rather than those simply using the host country as a marketing/export base) will be more inclined to effect transfer technology. As pointed out in the World Investment Report, 2000, MNCs may restrict the access of particular affiliates to technology in order to minimise inter-affiliate competition. It is noted that MNCs are more likely to licence older technologies from which they have already derived significant rents than newer technologies on which there are still relying for market leadership. Further, they may hold back the upgrading of the affiliate technology or invest insufficiently in host-country training and R&D in accordance with their global corporate strategies. Therefore, arguing that FDI inflows and economic liberalization automatically facilitates technology transfer is being extremely naïve.
- It is also important to underline that MNC presence through export-led FDI has mixed implications for the local technological activity in different economies. In industrially-advanced countries, MNC export activity can have significant inputs of indigenous content and design, and interact with and contribute to the local technological know-why base. In low-wage, less industrialized countries, MNC exports are driven mainly by cheap labour, and have low levels of local technological content. Between these two extremes, a number of combinations of MNC presence and technological activity are possible. Even in cases of MNC-driven assembly activity, there may be scope for creation of local technological capabilities, but the learning tends to be concentrated in operational capabilities rather than in the know-why. For this reason, even in the most liberalised countries, once allowed in, investors are induced to diffuse technologies locally. Singapore, for example, was also found to have used selectivity in a strong way to initially attract investors into targeted activities, and later to upgrade their technological content.
- The issue of technology is at the core of development debate. Development on a self-sustaining basis has, as its essential pre-condition, development of technological capabilities and the ability to attract and absorb state-of-the-art technology. Transformation from a stage of low technological development to this stage would not be possible except through transfer of technology. However, the evidence as cited above, does indicate that, left to market forces, transfer and diffusion of technology may not materialise, especially in the case of developing countries. This allows the inevitable conclusion that developing countries should preserve their right and ability to influence foreign direct investment flows into their territories with a view to ensuring that it is accompanied by appropriate technology and that there is a sincere effort on the part of the investors to effect technology transfer so that productivity levels are enhanced and export capabilities augmented, which alone could assist in the increased participation of developing countries in the global market place.