1. Ari Kokko HOME COUNTRY EFFECTS OF FDI Winners and losers Effects on home investments and exports Balance-of-payments effects R&D and technology effects Structural changes Literature: Dunning, chapter 12, 14, Blomström and Kokko (1994)

2. Ari Kokko Winners and losers How does FDI affect different actors in the home country? u Differential rates of return models: Big changes in relative factor prices. Immobile factor (labor) at home loses, mobile factor (capital) abroad loses. u Mundell (1957): No winners and losers - no long run changes in factor prices. u More realistic case: Some of adaptation to factor movements comes through trade. Smaller changes in relative factor prices.

3. Ari Kokko Winners and losers u Is there too much FDI because of divergence between private and social returns? –Investors don’t care that their new FDI lowers return on existing FDI stock. –Investors are indifferent between paying Home or Foreign taxes. Countries are not. u Changes in bargaining strength of labor and capital?

4. Ari Kokko Impact on home investment and exports The international debate has been dominated by two issues: u Investment substitution: Does FDI reduce the level of home investment? u Export substitution: Does FDI replace exports from the home country?

5. Ari Kokko Investment substitution: does FDI replace home investment? u Three theoretical possibilities: –Classical case: one-to-one substitution. –Reverse-classical case: fixed amount of investment opportunities, no substitution. –Anticlassical case:Differentiated products and separate markets, no change at home, net gain abroad. u Most studies suggest some investment substitution, for financial reasons or because of other supply restrictions in MNCs.

6. Ari Kokko Export substitution: does FDI replace home exports? u Key question: Why FDI instead of exports or license sales? Offensive or defensive strategies? Vertical or horizontal? u Offensive FDI: probably some substitution in the short run. u Defensive FDI: may be necessary for survival. u Trade in intermediate goods important determinant of total impact. Export structure changes whatever the impact on volume.

7. Ari Kokko Balance-of-payments effects Sum of capital transfers and impact on trade. u Simple case: initial capital outflow balanced by subsequent stream of repatriated profits. –Caveats: Capital often borrowed in foreign country. Profit is often reinvested. u More complicate case: capital flows influence consumption and terms-of-trade (exchange rates). May neutralize initial effects. u Few good empirical studies. MNCs seem to speculate on disequilibria in currency markets.

8. Ari Kokko Effects on R&D and technology u Main effect: FDI allows more R&D and more innovations (creation of more intangible assets) u Another effect: FDI may be a source of new technology. u Small problem: Is R&D moving to affiliates? u Big problem: Where are R&D results used? Who captures the spillovers from R&D?

9. Ari Kokko Structural effects of FDI FDI causes changes in the production structure. More exports of intermediates. u Positive view: Sharpens comparative advantages. We concentrate on a few good things. u Sceptical view: What types of industries will expand? What is their strategic value? We may be focusing on the ”wrong” activities.

10. Ari Kokko Policy dilemmas u Should we (the people) try to influence the production decisions of our MNCs? How? u What would happen if FDI was prohibited or discouraged? u If the effect of FDI is not positive, what can we do to make it hurt less?

11. Ari Kokko SUMMARY u Effects on firms fairly simple: firms can grow stronger and invest in more intangible assets –What would have happened without FDI? u Effects on countries more complicated: MNCs decide where to locate production, and that must not be the home country –What can governments do? –What would have happened without FDI?