Should Countries Promote Foreign Direct Investment

By Gordon H. Hanson. 2001

561 citations recorded by the source corpus.

This paper examines whether policies to promote foreign direct investment (FDI) make economic sense. The discussion focuses on whether existing academic research suggests that the benefits of FDI are sufficient to justify the kind of policy interventions seen in practice. For small open economies, efficient taxation of foreign and domestic capital depends on their relative mobility. If foreign and domestic capital are equally mobile internationally, it will be optimal for countries to subject both types of capital to equal tax treatment. If foreign capital is more mobile internationally, it will be optimal to have lower taxes on capital owned by foreign residents than on capital owned by domestic residents. Absent market failure, there is no justification for favouring FDI over foreign portfolio investment. In practice, countries appear to tax income from foreign capital at rates lower than those for domestic capital and to subject different forms of foreign investment to very different tax treatment. FDI appears to be sensitive to host-country characteristics. Higher taxes deter foreign investment, while a more educated work force and larger goods markets attract FDI. There is also some evidence that multinationals tend to agglomerate in a manner consistent with location-specific externalities. There is weak evidence that FDI generates positive spillovers for host economies. While multinationals are attracted to high-productivity countries, and to high-productivity industries within these countries, there is little evidence at the firm or plant level that FDI raises the productivity of domestic enterprises. Indeed, it appears that plants in industries with a larger multinational presence tend to enjoy lower rates of productivity growth over time. Empirical research thus provides little support for the idea that promoting FDI is warranted on welfare grounds. Subsidies to FDI are more likely to be warranted where multinationals are intensive in the use of elastically supplied factors, where the arrival of multinationals to a market does not lower the market share of domestic firms, and where FDI generates strong positive productivity spillovers for domestic agents. Empirical research suggests that the first and third conditions are unlikely to hold. In the three cases we examine, it appears that the second condition holds, but not the first or third conditions. This suggests that Brazil’s subsidies to foreign automobile manufacturers may have lowered national welfare. Costa Rica appears to have been prudent in not offering subsidies in the case of Intel. There clearly is a need for much more research on the host-economy consequences of FDI. The impression from existing academic literature is that countries should be sceptical about claims that promoting FDI will raise national welfare. A sensible approach for policy makes in host countries is to presume that subsidizing FDI is unwarranted, unless clear evidence is presented to support the argument that the social returns to FDI exceed the private returns.

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Citations in the corpus

Environmental leapfrogging in developing countries: A critical assessment and reconstruction (2003, result): “…of local firms possess sufficient capabilities to capture spillovers associated with the involvement of foreign TNCs (Felipe, 2000); this skepticism seems justified in view of recent empirical work which has found only limited evidence of positive spillovers in practice (Saggi, 2000; Hanson, 2001).”
Multinational Enterprises, International Trade, and Productivity Growth: Firm-Level Evidence from the United States (2003, unknown): “7 Among the other studies are Baldwin, Braconier and Forslid (1999), Keller (2002b), and Xu (2000) who find some evidence consistent with FDI spillovers using industry-level data, as well as Branstetter (2000) who shows that FDI between the U.”
Much Ado About Nothing? Do Domestic Firms Really Benefit from Foreign Direct Investment? (2004, background): “Aitken, Hanson and Harrison (1997) estimate a probit model and include a proxy for export information externalities, namely the export activity by multinationals in the industry and region.”
FDI and Economic Growth: Evidence from Nigeria (2007, background): “…and domestic suppliers and consumers; horizontal linkages between the affiliates and firms in the same industry in the host country (Lim, 2001; Smarzynska, 2002); labour turnover f rom affiliates to domestic f irms; and internationalization of R&D (Hanson, 2001; Blomstrom and Kokko, 1998).”
FDI, Productivity and Financial Development (2009, background): “2 In a survey of the literature, Hanson (2001) argues that there is weak evidence that FDI generates positive spillovers for host The authors would like to thank Holger Görg and two anonymous referees for comments and suggestions.”
FDI spillovers, absorptive capacities and human capital development: evidence from Argentina (2003, background): “In 1998, for example, 103 countries offered special tax concessions to foreign corporations that set up production facilities within their borders (Hanson, 2001).”
The Effects Of Foreign Direct Investment On The Host Country'S Economic Growth: Theory And Empirical Evidence (2013, background): “Hanson (2001) and Zhang (2001b) report that the increase in income in the national economy is not equal for all players in the economy: multinationals have increased income which justify the increases at the national level, but local firms are suffering a decline in income which, in the limit, may…”
Multinationals and Linkages: An Empirical Investigation (2004, background): “Hanson (2001) shows how competition for skilled workers may negatively affect domestic firms, but he does not show how this would affect their measured productivity. zone in Costa Rica suggest that the inputs bought locally by multinationals are more tradable than those bought by domestic firms.”
FDI and Growth : a Causal Relationship (2005, background): “Hanson (2001) has found weak evidence that FDI generates positive spillovers for host countries.”