Foreign Investment and Spillovers

The assumption that foreign direct investment (FDI) will automatically bring benefits to the host country in the form of valuable spillovers is false. One reason why many governments have reversed their old hostility towards FDI is that they see that multinational enterprises (MNEs) can raise the level of training of the national workforce. But three economists, Andrea Fosfuri of the Universidad Carlos III, Madrid, Massimo Motta of the European University Institute, Florence, and Thomas Rønde, of Universität Mannheim expose ways in which this might not work. Writing in a discussion paper published by the Centre for Economic Policy Research, they say, ‘attracting FDI into a country does not necessarily imply that local firms will benefit from the diffusion of the superior technology introduced by the MNEs’ affiliates’. 

This is because multinationals will often give specific training, thus making the workers valuable only to their MNE employer. In such circumstances there can be positive effects, such as the phenomenon the authors call pecuniary spillover, which reflects the higher wages paid to such workers. But the technological spillover would be limited. If workers are given general rather than specific training, labour mobility will improve. The authors develop this familiar concept by establishing that the degree of product market competition affects labour mobility. If, say, two firms (one foreign and one local) do not compete fiercely in the host country marketplace and on-the-job training is general, technological spillovers will be high, especially if the absorptive capacity of the local firm is high.

The authors also note occasions when MNEs have refused to invest abroad precisely in order to prevent technological spillovers. Thus the German chemical firm, IG Farben, decided to export to Japan after World War I rather than invest there or permit licensed production which could assist the burgeoning local chemical industry. When Japanese firms adopted a similar approach towards the European Community for a time, ‘the European Commission replied by threatening to use anti-dumping duties and safeguard clauses to discourage exports, promote investments, and create technological spillovers’. (The Uruguay Round had made it impossible by this time simply to raise tariffs.) MNEs might also be quite reluctant to invest abroad in some circumstances because of the extra cost they could incur through having to pay their employees excess wages in order to discourage them from taking their training with them to a local firm.

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The Authors:

Massimo Motta is Professor of Economics at the European University Institute, San Domenico di Fiesole, Italy and a Research Fellow in CEPR’s International Trade and Industrial Organization research programmes. Andrea Fosfuri is Assistant Professor at Universidad Carlos III, Madrid, Spain and a Research Affiliate in CEPR’s International Trade research programme. Thomas Rønde is based at Universität Mannheim, Germany.