This work analyzes under what conditions Foreign Direct Investment (FDI) flows to developing countries occur and what host country characteristics determine the extent of benefits associated with FDI. Using a numerical two-country general equilibrium model in which (vertical) FDI arise endogenously I compare welfare situations for the developing country before and after FDI liberalization. I specifically focus on the welfare potential of technological externalities arising from the activity of MNEs. These spillover effects stemming from the transfer of foreign technology and skills to local industries are shown to be welfare-improving if the host country, in particular local firms, possess the ability to absorb benefits from FDI.
Table of Contents
1 Introduction
2 Review of Literature
2.1 Theory about Foreign Direct Investment
2.2 Spillovers from Foreign Direct Investment and Absorptive Capacity
2.2.1 Theoretical Literature
2.2.2 Empirical Evidence
3 The Model
3.1 Model Description
3.1.1 Technology and Market Structure
3.1.2 Fixed Cost Assumptions
3.1.3 Specification for Technology Transfer
3.1.4 Consumption
3.2 Equilibrium Conditions
4 Impact Effects and Partial Equilibrium Analysis
4.1 Factor Price Effects
4.2 A Simple Supply-Side Version of the Model
4.2.1 International Wage Differentials for Unskilled Labor
4.2.2 International Wage Differentials for Skilled Labor
4.2.3 Wage Differentials in a North-South Context
4.3 Trade Costs Effects and the Degree of Accessability of the Host Country
5 Numerical General Equilibrium Analysis
5.1 Calibration and Replication Check
5.2 Model without Spillover Effects (δ = 0)
5.2.1 The Equilibrium Regime
5.2.2 Welfare Gains from FDI Liberalization
5.3 Model with Spillover Effects (δ = 1)
5.3.1 The Role of Skilled Labor in the Absorption of FDI Spillovers
5.3.2 Technological Capacity of Domestic Firms
6 Conclusion
A Appendix A
A.1 Optimal Consumer Behavior
A.2 Optimal Firm Behavior
B Appendix B
B.1 Micro-Consistent Input Data and Calibration Issues
B.2 GAMS (MPS/GE) Code for the Model
B.2.1 Program for Calibration Check
B.2.2 Program used for Analysis in Section 5.2 onward
Objectives and Key Themes
This work aims to determine the conditions under which Foreign Direct Investment (FDI) flows to developing countries occur and identifies host country characteristics that influence the resulting welfare gains. The thesis employs a numerical two-country general equilibrium model to analyze how multinational enterprises (MNEs) affect developing host economies, specifically focusing on technological externalities (spillovers) and the capacity of local firms to absorb these benefits.
- Dynamics of FDI flows to developing countries.
- General equilibrium effects of multinational firms on host country welfare.
- Importance of absorptive capacity in domestic firms.
- Role of skilled labor in technological spillovers from MNEs.
- Trade costs and their influence on host country accessibility.
Excerpt from the Book
Spillovers from Foreign Direct Investment and Absorptive Capacity
This section gives a short review of theoretical literature and empirical findings about externalities arising from FDI in developing countries and identifies determinants of the host country’s (firms’) ability to absorb such spillovers.
There are a number of models showing through which channels MNEs can generate technological externalities for domestic firms, most of them also suggesting under what circumstances these externalities are more likely to be absorbed by firms in the host country.
One transmission channel of spillovers from FDI are linkages between different sectors that arise from the input-output structure of the economy. For instance, backward linkages refer to the interaction of firm that manufacture an intermediate good and supply it to final good producers. In a partial equilibrium framework Markusen and Venables (1999) address the question how the entry of a multinational firm affects the domestic industry of a developing country. They show that there is a pro-competitive effect and a linkage effect from multinational activity. The linkage effect back to local suppliers of intermediate inputs creates complementarities which reduces cost for domestic final-good producers. In their model, the expansion of local production due to backward linkages cause the economy to develop and thus MNEs may work as a catalyst for industrial development. In a static general equilibrium setup Rodriguez-Clares (1996) also focusses on backward linkages as a channel of transmission of externalities from FDI. He shows that the linkage effect of multinational on the underdeveloped host country is more likely to be positive when the final good that multinationals produce, uses locally produced intermediate goods intensively. However, if the interaction between MNEs and the local intermediate industry is too small the MNEs could even hurt the developing economy.
Summary of Chapters
1 Introduction: Introduces the growth of FDI and the research focus on how host country characteristics influence benefits from multinational activity.
2 Review of Literature: Reviews theoretical and empirical literature on FDI spillovers and the factors determining absorptive capacity.
3 The Model: Presents the two-country general equilibrium model, incorporating vertical multinational firms and mechanisms for technological externalities.
4 Impact Effects and Partial Equilibrium Analysis: Examines how factor prices and trade costs influence firm profitability and host country welfare in a restricted model.
5 Numerical General Equilibrium Analysis: Solves the full general equilibrium model to simulate welfare impacts of FDI, both with and without spillover effects.
6 Conclusion: Summarizes findings on the determinants of FDI-driven welfare gains and provides policy implications regarding host country absorptive capacity.
A Appendix A: Derives optimal consumer and firm behavior within the modeled sectors.
B Appendix B: Provides details on data calibration and the GAMS (MPS/GE) code used for the numerical analysis.
Keywords
Foreign Direct Investment, Multinational Enterprises, General Equilibrium Model, Technological Externalities, Absorptive Capacity, Developing Countries, Technology Transfer, Skilled Labor, Trade Costs, Industrial Development, Productivity Spillovers, Market Structure, Factor Endowments, Welfare Analysis, GAMS.
Frequently Asked Questions
What is the core subject of this thesis?
The thesis explores the conditions under which multinational firms invest in developing countries and analyzes how these host countries can best capture the technological and welfare benefits of such investment.
What are the central thematic areas?
The central themes include the endogeneity of multinational firms, the importance of backward linkages, the role of human capital (skilled labor) in technological absorption, and the impact of trade costs on FDI accessibility.
What is the primary objective of the research?
The primary goal is to determine what characteristics of a host country—specifically its technological capacity and skilled labor force—drive the realization of welfare gains when multinational enterprises enter the market.
What scientific methodology is applied?
The author uses a two-country numerical general equilibrium model, formulated as a nonlinear complementary problem, which is solved using GAMS/MPSGE algorithms to simulate complex market dynamics.
What is covered in the main body of the work?
The main body establishes the theoretical modeling of firms, analyzes partial equilibrium effects of factor price changes, and then proceeds to a full numerical general equilibrium analysis of FDI liberalization scenarios.
Which keywords characterize the work?
Key terms include FDI, MNEs, general equilibrium, spillover effects, absorptive capacity, and technology transfer.
How does skilled labor impact the spillover process?
The study concludes that a higher stock of skilled labor significantly enhances a country's ability to absorb superior technology and skills from multinational affiliates, acting as a crucial determinant of absorptive capacity.
Does the model suggest that FDI always benefits the host country?
The findings indicate that while FDI generally offers potential for welfare improvement, the actual realization of these benefits is not automatic and depends on the country's existing technological capacity and its ability to manage linkages.
- Quote paper
- Sebastian Rausch (Author), 2005, Foreign Direct Investment to Developing Countries: Technological Externalities and Welfare Gains, Munich, GRIN Verlag, https://www.grin.com/document/34573
