Implications for human capital formation and income inequality Dirk Willem te Velde, Overseas Development Institute December 2001
FDI policy is required to overcome market failures associated with the process of FDI and development Discuss type of FDI policies Discuss framework how to analyse effects of FDI policy on human capital formation and income inequality Examples of FDI policy and their effects Conclusions and suggestions for further research
Information failure in the international investment process (Moran, 1998) FDI attraction policy Market failures in the market for skills and technology (Lall, 2000) FDI upgrading policy Potential spillover effects of FDI for local firms (see various micro/macro spillover studies) TNC linkage promotion policy
What can governments do to attract FDI? (row 1) What can governments do to upgrade FDI to higher value added processes (row 2) What can governments do to promote linkages (row 3)
Economic policies largely under domestic control Industrial policies Macro-economic policies Other policies and factors Affecting potential foreign investors ( determinants ) CELL 1,1 - Financial and fiscal incentives and bargaining - Efficient administrative procedures and rules on ownership - Prom otion, targeting and image building - Developing key sectors (agglom eration and clustering) - Developing export platform s (EPZs) CELL 1,2 - A vailability of infrastructure and a skilled w orkforce and good labour relations - Sound macro-economic performance and prospects - Privatisation opportunities - Development of financial m arket and debt position. - No impediments to trade of goods and services CELL 1,3 - Global econom ic integration and transportation costs - International, regional and bilateral treaties, including BITs and W TO. - Insurance (ICSID, M IGA, EC GD, O PIC) and political risk ratings - Location near large and w ealthy markets - A vailability of natural resources - Historical ties and language-use - Absence of corruption - Financial conditions in hom e countries Affecting established foreign investors ( upgrading ) CELL 2,1 - Taxation - Performance requirem ents (abolished in most cases under TRIM S etc.) - Interaction with research institutions and other firms - Encouragement of R&D - Training of employees CELL 2,2 - Labour market policy - Trade policies, export promotion and infrastructure - Com petition policy - Development of financial m arket CELL 2,3 - Regional and international investm ent treaties - Global econom ic integration - Civil society Affecting the response of domestic firms ( linkages ) CELL 3,1 - Encouragement of linkages w ith TN Cs - Encouraging technological capabilities (R&D) - Encouraging human resources (training) - Supply side management CELL 3,2 - Education and skill generation - Labour m obility - Com petition policy - Export prom otion CELL 3,3 - Global econom ic integration
Analyse effects of TNC activity and FDI policy using a supply and demand framework of the market for skills. Are TNCs different from local firms in terms of skill demand, training (skill supply), use of IT and skill-biased technology, industrial relations and pay? The supply/demand framework allows us to predict effects on human capital formation (employment quality) and income inequality (see paper)
Relative wage (w S /w U ) q S q D q D2 Relative employment of skills (q S /q U )
FDI targeting Export processing zones Promoting skill-upgrading relevant to business
FDI targeting (limited to Ireland, Singapore and Costa Rica?) IDA (1969) targeted aggressively and (US) firm specifically (phonecalls presentations, offering research, visits, specific mailing, staff worldwide) Prepared industrial parks. Shannon (1959) took 5 years to be profitable Strategy built around skill-intensive clusters for last 40 years. 15% of foreign employment in pharmaceuticals/healthcare and 49% in electronic Financial grants: Combined IDA expenditure per job decreased from over IR 35000 in the period 1981-1987 to IR 10000 over 1993-1999. What are the effects on FDI, and effects on type of TNC activities? Fiscal incentives: tax from 0% for exporting TNCs to 12.5% to all firms But also: consistent skill-upgrading, trade liberalisation, EU funds, NLP
Export processing zones EPZs offer liberal regulations to attract export intensive TNCs Activities usually confined to low-skill activities with little training Raise level of employment and low-tech manufacturing exports (may reduce income inequality) However, few countries have used EPZs to step up the value added ladder (low skill-low income trap) What policies/institutions helped Singapore, Malaysia and Costa Rica succeed
Promoting skill-upgrading relevant to business Provide good quality and appropriate education. Skills task force to predict future skill needs (Ireland). Public private partnerships in training (PSDC, Malaysia) Invest in public/private R&D centres (EDB, Singapore) 1% Pay roll tax earmarked for training of low-skilled employees (SDF, Singapore, HRDF, Malaysia and elsewhere) Effect on income inequality differs depending on who receives training / general education
Regulatory (WTO TRIMs WTO TRIPs); constrain domestic policy options, do they lead to more FDI inflows? Concerns about TRIPs and international inequality. Voluntary (codes of conduct, OECD guidelines); growing attention to CSR (attention to training, general education provision) Bilateral Investment Treaties and Bilateral Investment Guarantees (OPIC and ECGD) Regional Trade Agreements
FDI and development is a process associated with market failures and hence FDI policies are justifiable. The use of FDI policy does not only seek to attract FDI, but also to upgrade FDI and promote linkages with TNCs. An active and consistent approach is required; a well-organised IPA helps. Further research on (effects of ) FDI policy should address: - Does FDI lead to an increase in international inequality (Wood and Ridao Cano, 1999); do international agreements exacerbate this, and what are the implications for strategic domestic FDI policy? - What policies and institutions lead to successful upgrading and diversification over time (note WTO ATC and WTO China accession) - Description of institutional environment surrounding FDI and skill formation (Skills task force, IPA structure, Vocational Training Board