Foreign direct investment, technology transfer and knowledge diffusion

Introduction Foreign direct investment (FDI) is certainly a topical issue nowadays, at least among those who are concerned with the interconnections between nations, economic integration, or more broadly, the more recent wave of globalisation. There are many reasons for the rise in the general interest on the issue. The first one is the dramatic increase in annual global inflows. Between 1985 and 2006, global FDI inflows rose from approximately $60 billion to $1,306 billion, thereby becoming a major source of investment funds for a large number of countries. As a consequence of the financial crisis, the global inflows of FDI declined by 14 per cent, from a historic high in 2007 to 2008. The inflows to developing and transition countries however increased despite the crisis (UNCTAD 2009). Global stocks of FDI have been growing accordingly; the latest estimated values reported by UNCTAD indicate that sales figures for foreign affiliates of transnational corporations (TNCs) in foreign international markets are about twotimes the value of international trade (UNCTAD 2007c). Furthermore, intra-firm trade among TNCs accounts for more than one-third of world trade and TNCs’ exports to non-affiliates account for a little bit less than one-third of world trade, with the remaining one-third accounted for by trade among national (non-TNC) firms (WTO 2008). The general interest in FDI is also due to the growing importance of foreignowned production and distribution facilities. Foreign direct investment is a major source of foreign financing by means of finance capital, and is also largely perceived as a potential channel of new technology inflows to less-developed countries (LDC), as well as a source of international transfer of intangibles such as organisational and managerial skills, and marketing networks. The economic literature on the role of FDI in the growth process indicates various ways in which foreign investments can promote growth. They can directly increase competition in closed domestic markets, promote innovation, induce savings and capital formation, and indirectly affect the local labour market – reinforcing job creation and promoting an increase in wages – in addition to fostering the transmission of knowledge, both a more specific technical knowledge and one of a more general purpose which is equally relevant in a knowledge-based global society. In spite of these positive effects, theory provides conflicting predictions concerning the growth effects of FDI. For example, Romer (1993) points out the important ‘idea gaps’ between rich and poor countries, and states that foreign direct investment can ease the transfer of technological and business know-how to poorer countries if these transfers generate substantial spill-over effects to the entire economy, boosting productivity of all domestic firms and not just of those directly involved in foreign capital transfer. In contrast, some theories predict that in the presence of distortions, FDI will further distort resource allocation and slow growth (Boyd and Smith 1992). Thus, theory produces ambiguous and conflicting predictions about the growth effects of FDI; some models suggest that FDI will only promote growth under adequate policy and institutional conditions. Also, empirical evidence shows mixed results (for a recent and comprehensive empirical analysis of those predictions, see Carkovic and Levine 2005).