1. Mr. Massimo M Beber Fellow in Economics Sidney Sussex College Cambridge CB2 3HU mb65@cam.ac.uk http://people.pwf.cam.ac.uk/mb65/mpes European Economics Lecture 4 INVESTMENT, INNOVATION AND CORPORATE CONTROL (Provisional Version: last updated 28 th October 2007) M.Phil. in Contemporary European Studies 2007/8 ©Massimo M Beber 2007

2. Lecture Outline A “European Economy” implies integrated production: the combination of labour and capital inputs on a EU, rather than national, scale through FDI The efficiency capital in European production depends on several crucial dimensions, to be examined in turn: –Investment and capital accumulation –Technical change, innovation, diffusion –Competition policy

3. I: Accumulation and Innovation Without technical change, investment is subject to diminishing returns; capital therefore should flow to where it is scarce (from rich to poor countries/regions) and lead to convergence. Technical change can delay/prevent diminishing returns: a virtuous circle (high investment, successful innovation, higher savings, higher investment) can lead to divergence, or at least to convergence clubs. Integrated production is therefore crucial not only to the aggregate performance of the European Economy, but also to its cohesion.

4. Basic Definitions MNE (multi-national enterprise): business including permanent establishments producing value added in more than one jurisdiction FDI (foreign direct investment): expenditure resulting in substantial control of such a permanent establishment abroad through one of the following: –Greenfield investment –Brownfield investment –M&A (mergers and acquisitions)

5. Basic Explanations – the OLI Model Cross-border expansion: FDI vs exports, licensing, franchising FDI the preferred strategy in the presence of advantages such as –Owner-specificity: reputation, tacit knowledge… –Localization: different factor endowments, infrastructure, business/tax culture, political stability… –Internalisation: predictability through vertical integration, avoidance of incentive problems (adverse selection, moral hazard), tax planning…

6. Basic Statistics % World FDI, 1998Inward Stock, % GDP InflowsOutflows19801997 EU153660615 USA502138 Japan14.3.6 Source: Hansen (2001). Memorandum: MNE’s intra-company trade accounts for 40% of world trade

7. The Historical Background Capital mobility one of the “four freedoms” But little progress in the 1950’s and 1960’s –General commitment to the “mixed economy” (direct production of services; nationalised industries); –“commanding heights” (timing of investment; control over the destination of industrial subsidies); –Residual protection provided a painless way to subsidize “national champions”

8. “Old” Industrial Policy Discriminates between different economic activities Impacts upon the economy’s allocation of resources Uses a variety of instruments –Subsidies to investment –Privileged access to credit –Protection and government procurement –Acceptance or promotion of restrictive practices –Nationalisation Sees tension between competition and competitiveness

9. The Rise of Integrated Production National protection undermined by the shocks of the 1970’s Business demands for integration build up from Davignon’s “Round Table” to the 1985 White Paper Trade integration in principle an alternative to production integration (Kindleberger’s “investment creation/diversion” classification) In practice, both have been stimulated by “1992”

10. “New” Industrial Policy Also known as “Industrial and Competitiveness Policy” Broadly defined to include “acts and policies of the state designed to improve a country’s economic performance” “Horizontal” or non-discriminatory amongst sectors Reflecting the neo-liberal twist in the philosophy and ambitions of economic policy since the 1970’s

11. The Single Market and FDI “Investment creation” explains the increase in inward FDI from the rest of the world; “Investment diversion”, however, is inconsistent with the observed rise in intra-EU FDI Economies of scale inside the Single Market less important than –Vertical segmentation –Preservation of market power –Retrenching to core functions –Reduction in sales uncertainty by closer presence in export markets –Transport costs –Strategic motivations (e.g. perceived first-mover advantages

12. Country Distribution of FDI Significant variations over time, both across sectors and countries Overall, strengthened position of the smaller member states as host countries to inward FDI (Finland, Sweden, Denmark, Ireland; the CEEC), especially when FDI measured as a share of total domestic investment When measured as share of total FDI, core countries still play a major role (Germany, France, UK, Italy)

13. Sectoral Distribution of FDI Negligible role of agriculture (until Eastern enlargement, net disinvestment); Services accounting for over 2/3 of total FDI, and likely to increase further as public services reform “marketises” further services in health, education, utilities… Anomalous pattern in manufacturing, with the bulk of FDI involving relatively low-tech sectors

14. Cross-country patterns Analysis of EU-15 cross-country FDI flows in the 1990’s did not support the basic neoclassical prediction, whereby capital (net FDI outflows) move to where it is scarce; Rather, there is some evidence that countries of similar income levels have intense two-way (gross) FDI flows; Also, gross FDI is higher where bilateral trade is more intense

15. II: Science and Technology Policy (STP) Why having a STP at all? –Uncertainty –Indivisibility –Inappropriability Why fearing policy failure? –Public choice –Legitimacy and evaluation difficulties –Conflict with competition criterion, both internally and globally

16. Historical Background EEC Treaty: elements, but no framework: Euratom the main exception. The poor precedent of the JNRC (Joint Nuclear Research Centre) More independent collaborations since the 1960’s –Concorde –Airbus –ESA (the European Space Agency, launched in 1973) January 1974: Council decision on launching a European STP overtaken by stagflation/Eurosclerosis

17. One Market, One STP? By the early 1980’s, business pressures for a single market also imply a co-ordinated approach to science and technology In 1979, Davignon initiative for an industrialists’ “Ronnd Table” ESPRIT (European Strategic Program of Research in Information Technologies) runs successfully in 1982-7 In 1987, the SEA’s Title VI establishes the aims and structure of a EU STP: central role of the 5-year “Framework Programme”

18. Legitimacy and Effectiveness Evaluating STP raises a number of issues: –Ambit –Horizon –Additionality –Counterfactuality Yet for STP to be sustainable at the EU level, its legitimacy must be based on demonstrable effectiveness – to an even greater extent than in the case of national STP’s; In practice, EU STP – including both Framework Programme and ESA allocations – still accounts for less than 15% of total EU STP spending

19. Unresolved Tension in EU STP Pre-competitive research/applied research Euro-networks/clusters vs. global IICAs (Inter- Institutional Collaborative Agreements) STP as a redistribution policy (resentment in rich, stagnant economies if STP disseminates their technological advantage to faster-growing new members) The primacy of NSI’s (National Systems of Innovation)

20. III: Competition Policy Setting standards of conduct rather than achieving specific goals Anchored in the principles of market capitalism Direct Function: to guarantee the economic efficiency of integrated production within the European Economy A “meta-policy” expanding (industrial and R&D) and informing (media, telecoms) EU competencies Indirect Function: by preventing abuse of market power by business, to maintain and enhance public support for the integration process

21. Historical Background A core requirement from the start: the Spaak Report warned against –Market segmentation –Collusion to restrict output/technological change –Abuse of Dominant Position A legalistic approach –Business Conduct: Art 81 (1) and (3), 82; –Market Structure: the 1989 Merger Control Regulation –Public Relationship with Industry: Art 86-88

22. A Competitiveness Renaissance As late as the early 1990’s, “an afterthought” a raft of big ticket cases raised the profile of EU competition policy –Nestle/Perrier (1993), Boeing/McDonnell Douglas (1997), GE/Honeywell (2001) –Microsoft, the Hoffman-La Roche vitamin cartel –EdF

23. Current Issues in EU Competition Policy Progressive move from legalistic to economic philosophy in assessing effective competition, reflecting both greater technical competence and a shift to “market optimism” Modernisation and streamlining of decision-making, to keep pace with greater dynamism in market structures (M&A, Schumpeterian monopolies in new products) Enforcement, especially of the 1999 Regulation on State Aid, in the face of persistent member state support of strategic/politically sensitive national firms and industries.

24. Conclusions Regionally integrated production is a relatively recent stage in European economic integration (post-SEA) FDI decisions are complex, and the observed patterns generally do not fit a simple convergence scenario EU-wide public governance - science and technology policy, and competition policy - have significantly expanded and changed in philosophy and practice as a result