Direct Foreign Investment and Migration
V.N.Balasubramanyam
Department of Economics
Lancaster University
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Last year The University Of Lancaster conferred an honorary degree on Professor
Bhagwati. To mark the occasion my colleagues and I organised a mini seminar.
Whilst working on my contribution, a paper on “Diaspora and Development”, I
realised that Professor Bhagwati had said most of what I had to say and pithily stated
the conclusions of my paper
in a brief paragraph in one of his articles on
international migration published some three decades ago! His response was “ never
mind, if something is worth saying it is worth saying again and again”. Most of what
I have to say on FDI at this celebration of my mentor’s 70th birthday is also a
repetition of what he has said on the subject, but I do so in the belief that it is worth
saying again.
Bhagwati’s work on FDI and international labour flows is memorable for its
theoretical insights and policy implications. Amongst other contributions it includes
analysis of capital inflows in the presence of tariffs, quid pro quo FDI, impact of
trade policy on the volume and efficiency of FDI, and analysis of the costs and
benefits of skilled labour migration, which is well known for the brain drain tax
proposal or the eponymous Bhagwati tax. This paper provides a brief account of my
work in the area of FDI and labour flows inspired by Bhagwati’s vast output.
Technology Inflows in the Presence of Tariffs and Immiserizing Growth
Bhagwati’s pioneering analysis of immiserizing growth has been extended by
himself and others to show that, within the framework of the 2 country 2 good and 2
factor trade model, capital inflows in the presence of a tariff on the importable good
could be immiserizing. ( Bhagwati, 1973, Brecher and Alejandro 1977). Whilst the
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capital inflows induce growth at constant tariff inclusive domestic prices, the tariff
imposes the familiar production and consumption costs and the rewards accruing to
foreign capital must also be reckoned as a cost. Is it likely that imports of technology,
unaccompanied by capital inflows as in the case of technology licensing agreements,
in the presence of a tariff on the importable good could also be immiserizing? My
early work on India’s technology licensing agreements during the decade of the
sixties and the early seventies suggested as much ( Balasubramanyam, 1973). The
FDI regime in place during the sixties and the seventies in India favoured technology
licensing agreements as opposed to FDI in the belief that the former would allow for
the importation of technical know how free of foreign control over operations This
attempt of the Indian government at having it both ways largely failed both because
of the lack of resources to restructure and adapt the imported technologies to suit
local factor and product market conditions and the absence of incentives to do so.
The import substituting industrialisation strategy in place at that time coupled with
domestic industrial licensing policies had effectively sealed off competition from both
international and domestic sources. As Bhagwati and Desai remarked in their seminal
work on India’s industrialisation at the time “Indian industrial and import policies
may have prevented the competitive process from penalising inefficient Indian firms,
thus making inefficiency in the importation of technology both feasible and likely”
(Bhagwati and Desai, 1970).
The inefficiencies in the importation of technology resulted in misallocation of
resources in favour of the protected capital intensive importables, imposed the
familiar tariff induced consumption loss and there were also payments to foreign
exporters of technology in the form of royalties and lump sum technical fees which
too should be counted as a cost. My analysis of the productive efficiency of firms
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which had imported technology showed that their productive efficiency on most
indicators of efficiency was lower than that of
both comparable Indian firms
operating with indigenous technology and foreign owned firms. They were also
relatively capital intensive in their operations. Imports of technology in the presence
of a tariff could be immiserizing in much the same fashion as imports of capital in the
presence of a tariff.
Could technology licensing agreements be superior to FDI as vehicles for the
importation of technology in the absence of policy induced distortions, especially so
in the age of information technology? India now possess the absorptive capacity
required for restructuring imported technologies, due to long years of investments in
science and engineering education, she is well endowed with IT resources including
software and the trade regime now is much more liberal than in the past. Foreign
firms may also find it less expensive in terms of managerial time and resources to
exploit the rents inherent in the technology they own through licensing agreements
rather than FDI. Their preference for FDI is attributed to the public good nature of
technology. The risks of imitation, replication and resale of technology sold through
the open markets tends to be high . Foreign firms, therefore, prefer to internalise the
market for knowledge, i.e. undertake FDI, rather than enter into licensing agreements
as a vehicle for maximising the rents inherent in the knowledge they own (Hymer
1960, Markusen 1995). The alternative explanation for the preference of foreign firms
for FDI over licensing agreements is that the transaction costs involved in the sale of
knowledge through the market may be much too high and hence their desire to
internalise operations in the form of FDI (Kogut 2005). If this is the case, the tools of
information technology can be of immense value in reducing transaction costs
involved in international transfers of technology. The sort of information, data and
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instructions required to absorb technology by the technology importing firms can be
easily transmitted via the net and communication between the licensor and licensee
firms could be effective and costless. It is tempting to argue that Hymer’s proposition
that FDI rather than licensing is the preferred mode of transactions by foreign firms
may have to be stood on its head in the age of information technology. And India’s
policy makers may be doing the wrong thing at the right time or the right thing at the
wrong time – they preferred licensing to FDI in the pre information technology age
and now, since the nineties, they seem to have a preference for FDI though they have
not entirely forsaken licensing agreements.
Trade Policy and the Efficacy of FDI
Analogous to Bhagwati’s analysis of the welfare costs of tariff jumping FDI is his
analysis of the relationship between trade regimes and the volume and efficacy of
FDI. The well known proposition he enunciated in this context reads “ with due
adjustments for differences among countries for their economic size, political
attitudes towards DFI and stability, both the magnitude of DFI flows and their
efficacy in promoting economic growth will be greater over the long haul in countries
pursuing the export promotion (EP) strategy than in countries pursuing the import
substitution (IS) strategy” (Bhagwati 1978, 1985). The EP strategy is defined as one,
which equates the average effective exchange rate on exports to the average effective
exchange rate on imports.1 Thus defined, an EP strategy is neutral and is biased
neither towards import substitution activities nor export activities. In contrast the IS
strategy is one where the effective exchange rate on imports exceeds the effective rate
1
The effective exchange rate on exports (EERX) and the effective exchange rate on imports (EERM)
are defined as:
EERx=n(1+s) and EERm= n (1+t), where n= the nominal exchange rate, t= average tariff rate on
imports, s= average rate of subsidies on exports. Note that t includes policy instruments, including
tariffs and quotas which bias policy incentives in favour of imports and s includes all policy
instruments which favour exports.
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on exports and is biased in favour of import substitution activities. The underlying
logic of these two propositions is that a distortion free market environment promotes
both increased volumes of FDI and its efficiency. The neutral EP regime does just
that. It is free of artificial and transient policy induced incentives and foreign firms
allocate resources between sectors on the basis of the innate comparative advantage
of the sectors. FDI in the EP countries is not restricted by the size of the domestic
markets as is the case in IS countries, it has wider horizons including both the
domestic and export markets.
My colleagues and I tested the twin propositions relating to the volume and efficacy
of FDI enunciated by Bhagwati and the results of the econometric tests provided
substantial support for both the propositions. The first of these tests related the
volume of FDI in a cross section of forty six developing countries to the usually
identified determinants of FDI including market size, labour costs and an openness
variable designed to capture the argument that the EP countries attract larger volumes
of FDI than IS countries. We encountered several data problems and were unable to
estimate effective exchange rates for exports and imports for a large enough sample
of developing countries. Nevertheless, in the time-honoured tradition of
econometricians, we estimated several proxy variables for the type of trade regimes
various countries had in place in the years 1967 and 1978. Our principal conclusion
based on the results of the statistical exercises was “ for the year 1978 FDI as a
percentage of GDP was high in countries pursuing the EP strategy (Singapore, Hong
Kong, Taiwan, Malaysia and Kenya) compared to that in countries pursuing the IS
strategy in the recent past (India, Brazil, Ghana, Argentina). Much more significantly
in the case of most countries pursuing the EP strategy the stock of FDI as a
percentage of GDP increased substantially over the period 1967-78. In a majority of
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the countries pursuing the IS strategy however, this ratio of FDI to GDP declined
appreciably”(Balasubramanyam and Salisu, 1984).
The test of the relative efficacy of FDI in the EP and IS countries also
supported Bhagwati’s hypothesis (Balasubramanyam, Sapsford and Salisu, 1996). We
classified a sample of forty-six countries into EP and IS countries based on various
measures of openness and types of trade regimes. Econometric tests relating growth
rates of these two sets of countries to the volume of FDI and other relevant variables
substantiated Bhagwati’s proposition. In brief the conclusion of the tests was that “
the elasticity of output with respect to FDI in EP countries is significantly greater than
that for IS countries. These results indicate that FDI is a potent driving force in the
growth process in EP counties (with the relevant elasticity being of the order of 1.83)
it exerts no significant influence upon growth in IS countries. These results provide
strong support for Bhagwati’s hypothesis”
The superior efficiency of FDI in the EP countries is due both to the efficient
allocation of resources, which the regime promotes, and the diffusion of technology
and know how from the foreign owned firms to the locally owned firms it facilitates.
The channels through which diffusion of technology and skills occur include subcontracting arrangements between foreign firms and local suppliers of components,
learning by doing and learning by watching foreign firms. (Wang and Blomstrom,
1992, Blomstrom, Kokko and Zejan 1994). One important prerequisite for the
diffusion of technology is a distortion free appropriate economic environment, which
fosters competition. As Bhagwati(1988) remarks “ it would be foolish to assume that
learning automatically follows from doing, rather learning is a function of doing
within an appropriate environment. An appropriate economic environment is one
which is not only free of policy induced distortions but also one which facilitates
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transfers of skills through adequate investments in human capital, infrastructure
facilities and one which provides for macroeconomic stability. In the absence of these
prerequisites diffusion of technology from FDI to the local economy may be limited
or absent. (Gorg and Greenaway 2004). Foreign firms build upon the endowments of
human capital and capabilities of the local economy in their bid to maximise the rents
from the advantages they possess. Put differently FDI does not initiate development
but it builds upon that which already exists, it is a catalyst of growth not its prime
mover. Indeed, it is suggested that the catalyst is most effective in countries , which
have a threshold level of growth or possess a threshold level of human capital
(Blomstrom,1986, Blomstrom and Kokko 1998, Borensztein, Gregario and Lee
1998).
The optimum level of FDI required to attain a given growth rate may differ between
countries depending upon their endowments of human capital and the quality of their
institutions. It may also depend on the structure and composition of the
manufacturing sectors of the host countries. It may be low in economies whose
manufacturing sectors consist of a relatively high proportion of high tech capitalintensive industries than in economies with a high proportion of low-tech industries.
High tech industries are by definition capital intensive or as Hirschman puts (1963 )
it, they are characterised by machine paced rather than operator paced operations as
is the case with labour intensive industries. And machine paced operations are less
intensive in their use of managerial time and effort than labour intensive low –tech
industries. Also economies with a high proportion of high tech capital-intensive
industries may possess the sort of technical and managerial skills required to
restructure and adapt imported technologies. An important caveat to these admittedly
untested propositions is that the high tech industries must be exposed to competition
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from both domestic and international sources, they should function in an EP
environment and not in a highly protected IS environment as was the case in India
until recently. It is tempting to speculate on the basis of these assumptions that one of
the reasons, though not the only reason, for the low volumes of FDI in India in the
post liberalisation era compared with the huge volumes of FDI in China may be the
differing structures of the manufacturing
sectors in the two countries and
the
differences in the type of institutions and human capital the two countries possess.
There are several other contributions of Bhagwati, principally his work on
international flows of skilled labour, which has provided inspiration for further work.
My work in progress on diaspora and development , argues that for some countries
such as India migration of skilled people may yield net benefits . This though is a
proposition, which Bhagwati identified in his work on the brain drain as early as
1977. But I soldier on in the belief that if something is worth saying it is worth saying
again and again, hopefully with some new insights.
References
Balasubramanyam V.N. (1973) International Transfer of Technology to India ( New
York, Praeger Publishers)
Balasubramanyam V. N. and Salisu, M. (1991),‘Export Promotion, Import
Substitution and Direct Foreign Investment in Less Developed Countries’ in
Koekkoek, A. and Mennes, L. (eds.) International Trade and Global Development
(London: Routledge).
Balasubramanyam, V N, Salisu M A and Sapsford, D (1996), 'Foreign
Direct Investment and Growth in EP and IS Countries'. The Economic
Journal, 106, no. 434, 92-105.
Bhagwati J. N. and Desai P (1970) India; Planning for Industrialisation
(London: Oxford University Press)
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Bhagwati JN. (1973) " The Theory of Immiserizing Growth : Further
Applications " in Swoboda and Connolly (ed) International Trade and
Money, (London , George Allen and Unwin)pp 45-54
Bhagwati J N (1977)" The Brain Drain: International Resource Flow
Accounting, Compensation, Taxation and Related Policy Proposals "
Prepared for the Division of Transfer of Technology, UNCTAD
Bhagwati, J. N. (1978) Anatomy and Consequences of Exchange Control Regimes,
Vol. 1, Studies in International Economic Relations, 10 (New York: National Bureau
of Economic Research).
Bhagwati J N ( 1985) Investing Abroad; Esmee Fairbain Lecture,
Lancaster University. Reprinted in V.N. Balasubramanyam (ed) J N
Bhagwati, Writings on International Economics ( 1997, Delhi, Oxford
University Press)
Bhagwati J N (1988) Protectionism; (Ohlin Lectures, Cambridge Mass,
MIT Press)
Blomstrom M, Lipsey R and Zejan M (1992) What Explains developing
Country Growth; NBER Working Paper no 4132
Blomstrom M, Kokko A and Zejan M (1994) Host Country Competition,
Labour
Skills
and
Technology
Transfers
by
Multinationals
“
Weltwirtschaftliches Archiv, 130 pp 521-33
Borensztein E, De Gregorio J and Lee J W (1998) “ How Does Foreign
Direct Investment Affect Growth ? “ Journal of International Economics,
vol 45 pp 115-135.
Brecher R and Carlos Diaz-Alejandro (1977) “Tariffs, Foreign Capital
and Immiserizing Growth “ Journal of International Economics, vol 7 pp
317-22
Gorg H and Greenaway D ( 2004) “ Much Ado About Nothing? Do
Domestic Firms Really Benefit From Foreign Direct Investment “ The
World Bank research Observer, vol 19 no 2
Hirschman A O (1963) The Strategy of Economic Development( New
Haven, Yale University Press)
Hymer
S
(1960) The International Operations
of National Firms;
Dissertation, MIT, published Cambridge, Mass, MIT Press, 1976
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Kogut B ( 2005) “ Learning, or the Importance of Being Inert; Country
Imprinting and International Competition” in Ghoshal S and Westney D E
(Ed) Organization Theory and the Multinational Corporation ( London,
Palgrave)
Markusen J R ( 1995) “The Boundaries of Multinational Enterprises
and the Theory of International Trade” Journal of Economic Perspectives,
vol 9 no 2
Wang J and Blomstrom M (1992) “Foreign Investment and Technology
Transfer; A Simple Model” European Economic Review , vol 36(1)
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