Inward Investment, Technological Change and Growth: The Impact of Multinational Corporations on the UK Economy

Inward Investment, Technological Change and Growth The Impact of Multinational Corporations on the UK Economy

Edited by

Nigel Pain

INWARD INVESTMENT, TECHNOLOGICAL CHANGE AND GROWTH

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Inward Investment, Technological Change and Growth The Impact of Multinational Corporations on the UK Economy Edited by

Nigel Pain Senior Research Fellow National Institute of Economic and Social Research

in association with NATIONAL INSTITUTE OF ECONOMIC AND SOCIAL RESEARCH

© National Institute of Economic and Social Research 2001 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1P0LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2001 by PALGRAVE Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE is the new global academic imprint of St. Martin's Press LLC Scholarly and Reference Division and Palgrave Publishers Ltd (formerly Macmillan Press Ltd). ISBN 0-333-92536-X This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Inward investment, technological change and growth : the impact of multinational corporations on the UK economy / edited by Nigel Pain ; in association with National Insitute of Economic and Social Research, p. cm Collection of papers presented at a conference held at the British Academy in Sept. 1999 Includes bibliographical references and index. ISBN 0-333-92536-X 1. Investments, Foreign—Great Britain. 2. Technology transfer—Great Britain. 3. Great Britain-Economic conditions—1997- I. Pain, Nigel. II. National Institute of Economic and Social Research HG5432 .1643 2000 330.94—dc21 10 10

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Contents List of tables

vii

List of figures

x

Notes on the contributors

xi

1

2

The growth and impact of inward investment in the UK: introduction and overview Nigel Fain

1

The determinants of host country spillovers from foreign direct investment: a review and synthesis of the literature Magnus Blomstrom, Ari Kokko and Steven Globerman

34

3

Inward investment and technical progress in the UK Florence Hubert and Nigel Fain

4

Host country effects of FDI in the UK: recent evidence from firm data Sourafel Girma, David Greenaway, Katharine Wakelin and Nuno Sousa

5

Why do foreign-owned firms in the UK have higher labour productivity? Nicholas Oulton

66

104

122

6

Regional policy and the impact of FDI in the UK Nigel Driffield

7

A regional computable general equilibrium analysis of the demand and 'efficiency spillover' effects of foreign direct investment Gary Gillespie, Feter G. McGregor, J. Kim Swales and Ya Ping Yin

178

Sticky places in slippery space - the location of innovation by MNCs in the European regions John Cantwell, Simona lammarino and Camilla Noonan

210

8

162

vi

Contents

9

Foreign trade and FDI stocks in British, US and French industries: complements or substitutes? Lionel Fontagne and Michael Fajot

Index

240

265

List of tables 1.1 The global stock of foreign direct investment by recipient area 5 1.2 The composition of the UK inward FDI stock 9 1.3 Foreign-owned firms in the UK manufacturing sector 11 1.4 Business enterprise R&D in the UK 19 1.5 The UK's major exporters in 1997 22 2.1 The proximate determinants of spillovers 40 2.2 Variables related to FDI spillovers 42 3.1 Sectoral composition of employment 75 3.2 Labour productivity per employee hour 75 3.3 Industrial composition of inward FDI stock in the UK 77 3.4 Choosing between different panel estimators 79 3.5 Mean group estimates with endogenous technical change 80 3.6 The contribution of inward investment to UK output growth 83 3.7 Summary statistics from all firms' panel estimates 85 3.8 Share of foreign firms in manufacturing in 1992 86 3.9 Characteristics of foreign and domestic firms, 1983-92 87 3.10Inward FDI and technical progress in domestic firms 90 3.11 Pooled mean group estimates for eleven manufacturing industries 92 3.12Inward FDI and labour productivity 94 3.13Do spillovers vary according to nationality of investors? 95 4.1 Sample means (and standard deviations) 107 4.2 Differentials between domestic and foreign firms 108 4.3 Differentials by nationality of ownership 109 4.4 The impact of FDI on the productivity and wages of domestic firms 111 4.5 Dependent variable: EXPORTS - export decision 116 4.6 Dependent variable: EXPROPEN - propensity to export 117 5.1 Capital intensity (K/L) amongst 1973-93 survivors: manufacturing, by SIC80 class, 1993 128 5.2 Descriptive statistics in 1993 for 1973-93 survivors in manufacturing, by ownership 129 5.3 Growth rates of output, employment and capital, 1973-93: 1973-93 survivors in manufacturing, by ownership in 1993 130

viii

List of tables

5.4 Comparison of foreign and UK-owned establishments in manufacturing: cross-section regressions, 1973-93 survivors in 1993 5.5 Regressions explaining productivity differences amongst survivors in manufacturing: dependent variable is log of value added per employee, 1989 and 1993 5.6 Contribution of measured inputs to explanation of productivity gap between foreign and UK-owned establishments: manufacturing in 1993 (1973-1993 survivors) 5.7 Labour productivity and its determinants by ownership type, 1995: distribution of within class means across SIC80 classes (UK independents = 100) 5.8 Ownership and the determinants of labour productivity in 1995 5.9 Effect of ownership on labour productivity and its determinants 5.10Effect of ownership on labour productivity (value added per employee): manufacturing versus non-manufacturing companies in 1995 5.11 Effect of recessions on capital stock growth in subsequent booms: manufacturing, 1973-93 survivors 6.1 Measure of'inward investment' 7.1 Comparison of the structural characteristics of the ownership-disaggregated database (1989) 7.2 Functional forms and key parameter values for foreign and UK-owned plants 7.3 The impact of our standard export FDI shock in terms of capital stock, exports, output and direct employment 7.4 The percentage change in key variables following a 20 per cent increase in FDI with 100 per cent export-intensity 7.5 The impact of efficiency gains to UK manufacturing from FDI using the export FDI shock as the base, with regional bargaining and migration 7.6 20 per cent increase in FDI with 100 per cent exportintensity and 0.8 per cent Harrod-neutral efficiency shock to UK manufacturing with regional bargaining and migration 7.7 Combined employment, value added and output multipliers from the inward investment expansion

132

134

136

139 140 141

143 147 172 185 186 187

190

194

197 199

List of tables 8.1 Distribution (D) and penetration (P) of foreign-owned patenting activity by location, 1969-95 8.2 Regional breakdown of USPTO patent grants to large firms, 1969-95 (percentage of each group's total grants); population and GDP by region (1995) 8.3 Average foreign-owned firm shares of US patents by macrotechnological sector and region, 1969-95 8.4 Regional dispersion of technological specialisation, 1969-95 8.5 Regression results 9.1 Export equations, United Kingdom 1987-96 9.2 Import equations, United Kingdom 1987-96 9.3 Export equations, France 1989-94 9.4 Import equations, France 1989-94 9.5 Export equations, United States 1989-94 9.6 Import equations, United States 1989-94

ix

216

217 220 222 224 250 251 253 254 256 257

List of figures 1.1 1.2 3.1 3.2 6.1 6.2 6.3 6.4 7.1

The stock of foreign direct investment in the UK, 1960-99 UK FDI inflows as a per cent of GDP Labour productivity per employee hour Implied technical progress functions Domestic and foreign fixed capital investment Share of foreign employment by industry Foreign fixed investment expenditure by UK region Foreign share of manufacturing employment by region Sectorally disaggregated employment change for a 100 per cent export FDI shock with regional bargaining and migration with LOOP approximation for foreign-owned sector 7.2 Build-up of efficiency spillover shocks - adjustment path implied by Barrell and Pain (1997) results 7.3 Aggregate employment gains from the efficiency spillover shock (using the results from the export FDI shock as the base), with regional bargaining and migration 7.4 The employment impact of the combined effects of FDI (20 per cent FDI, 100 per cent export-intensity plus build-up of efficiency spillover effects)

7 8 76 81 165 165 166 166

188 192

195

198

Notes on the contributors Magnus Blomstrom is Professor of Economics at the Stockholm School of Economics. He is also a Research Associate at the National Bureau of Economic Research in the US and a Research Fellow at the Centre for Economic Policy Research in the UK. John Cantwell is Professor of International Economics at the University of Reading. He has been a Visiting Professor of Economics at the University of Rome 'La Sapienza', the University of the Social Sciences, Toulouse, Rutgers University, New Jersey and the University of Economics and Business Administration, Vienna. His main research areas are the economics of technological change and multinational firms. Nigel Driffield is a Senior Lecturer in industrial economics at Birmingham Business School. His main research interests concern the impacts of foreign direct investment on host country firms. In this vein, recent papers include the impact of FDI on profitability, productivity, employment and wages in domestic firms. Lionel Fontagne is Professor of Economics at the University of Paris 1 Pantheon-Sorbonne and director of the Centre d'Etudes Prospectives et d'Informations Internationales (CEPII). He is also an adviser at the International Trade Center. His research interests cover European integration, international trade theory and trade liberalisation in developing countries. He has written recently on foreign direct investment and the prospects for tax co-ordination in Europe, exchange rate strategies in the competition for attracting FDI and endogenous symmetry of shocks in a monetary union. Gary Gillespie is affiliated to the Fraser of Allander Institute, Department of Economics, University of Strathclyde. His research interests include foreign direct investment, regional economic modelling and regional policy. Sourafel Girma is a Research Fellow in the Centre for Globalisation and Labour Markets at the University of Nottingham. He has worked at the Business School at the University of Nottingham and in the Economics Department at the University of Manchester where he completed his XI

xii

Notes on the contributors

PhD. His research interests are primarily in panel data modelling and productivity analysis. Steven Globerman is the Director of the Center for International Business at Western Washington University. He has published extensively on a range of issues related to international trade and foreign direct investment, and he has also consulted for businesses, governments and international organisations on those matters. David Greenaway has been a member of staff at the University of Nottingham since 1987. He is a Professor of Economics and has been a Pro-Vice-Chancellor since 1994. His research interests lie primarily in the fields of international trade policy, economic development and European integration. Florence Hubert is a Research Officer at the National Institute of Economic and Social Research, where she has been investigating topics such as foreign direct investment, European economic integration and the location of multinational production. She is also involved in the European forecasting exercise carried out by the NIESR. Simona lammarino is currently working as a researcher at the Italian Institute of Statistics and as a senior economist a the Institute for International Affairs in Rome. Her main research interests are in the fields of international trade, economic integration and regional and international aspects of technological change. She collaborates with the Department of Economics of the University of Reading in the field of multinational corporations, technology and regional systems of innovation in the European Union. Ari Kokko is Professor of International Business at Abo Akademi University, Turku, Finland, and research associate at the European Institute of Japanese Studies in Stockholm. His research deals with foreign direct investment, trade and economic integration. Peter G. McGregor is affiliated to the Fraser of Allander Institute, Department of Economics, University of Strathclyde. His research interests include regional economics, regional policy and applied general equilibrium analysis.

Notes on the contributors

xiii

Camilla Noonan is a lecturer in International Business at the Michael Smurfit Graduate School of Business, University College Dublin. Her research interests include innovation and technological change, multinational corporations and the global business environment. Nicholas Oulton has been a full-time consultant to the Bank of England since 1998. Before that he was a Senior Research Fellow at the NIESR. His research interests centre round the study of productivity at the level of both the company and the industry as well as the whole economy. He is also interested in structural change and how this influences aggregate productivity performance. Nigel Pain is a Senior Research Fellow at the National Institute of Economic and Social Research. Before joining NIESR he worked in the Treasury. He has published widely on the determinants of location choice by multinational corporations and on their impact on the growth prospects and industrial structure of host and home economies. Michael Pajot is affiliated to TEAM (Theorie et Applications en Microeconomie et Macroeconomie) at the University of Paris 1 Pantheon-Sorbonne, where he researches into foreign direct investment and international trade. Nuno Sousa is a PhD student in the Centre for Globalisation and Labour Markets at the University of Nottingham. His PhD is on the effects of multinational companies' activities in host economies. J. Kim Swales is affiliated to the Fraser of Allander Institute, Depart of Economics, University of Strathclyde. His research interests include regional economics, regional policy and applied general equilibrium analysis. Katharine Wakelin is a Research Fellow in the Centre for Globalisation and Labour Markets at the University of Nottingham. She has worked at MERIT in Maastricht and at the National Institute of Economic and Social Research in London. Her research interests include international economics, the economics of technical change and foreign direct investment. Ya Ping Yin is affiliated to ESST, University of Hertfordshire Business

xiv

Notes on the contributors

School. His research interests cover imperfect competition and open economy macroeconomics, applied general equilibrium analysis and trade and development.

1

The growth and impact of inward investment in the UK: introduction and overview Nigel Pain1

This volume contains a collection of papers from a conference held at the British Academy in September 1999. The objective of the conference was to help identify the channels through which inward investment can affect host economies and provide some quantitative evidence on the impact of foreign-owned firms on the size and industrial structure of the UK and other developed economies over the last decade. There is considerable interest in government and academic circles in the extent to which international transfers of technology and knowledge by multinational companies may affect the performance of host economies. The location of economic activity could be an important endogenous influence on the size of host economies. Many new theoretical models view the creation and exploitation of knowledge as two of the key factors driving the process of economic growth. The Competitiveness White Paper issued by the UK government in 1998 argued that foreign direct investment is one of the main transmission mechanisms behind the diffusion of knowledge, both codified and tacit, across national borders (DTI, 1998). This appears to be supported by empirical evidence that international openness raises economic growth in the UK and other Western European economies (Proudman and Redding, 1998; Barrell and Pain, 1997, 1999b; Hoeller et al., 1998). Foreign investments by multinational companies can provide a channel through which new ideas, working practices and technologies can arrive in host economies, as well as a means by which indigenous companies are exposed to greater competitive pressures. Previous competitiveness White Papers had also suggested that the high level of inward investment into the UK during the 1980s played an important role in the transformation of the production process (Eltis and Higham, 1995; Eltis, 1996).

1

2

Inward investment, technological change and growth

The desire to attract inward investment is one of the few industrial policies pursued consistently by successive UK governments over the past 25 years. Similar interest in the behaviour of multinational corporations is apparent in other advanced economies, with intergovernmental agencies such as the OECD, the World Trade Organisation and the Bank for International Settlements all having undertaken studies exploring the impact of foreign direct investment on trade and employment in host and home economies. The collection of papers in this volume will help in the evaluation of the net benefits of inward investment for host economies and the design of appropriate national policies and institutions to maximise the potential size of those benefits. There is a particular focus on three key issues: whether foreign-owned firms have specific, ownership advantages compared to indigenous companies, the extent to which such advantages subsequently become available to improve the performance of indigenous companies, and whether there are spillovers across industries and regions as well as within the industry and region in which investment takes place. The majority of papers focus in detail on the quantitative impact of foreignowned companies in the British economy, which has long been the primary location for inward investment within Europe. However the methodologies employed can readily be applied to other host economies, and the empirical papers are complemented by a synoptic paper from Magnus Blomstrom, Ari Kokko and Steven Globerman which provides a comprehensive overview of the existing literature on spillovers into productivity and employment in developed economies and highlights a number of issues worthy of further research. Comparatively little is known about the quantitative importance of spillovers from inward investment in industrialised economies, despite the interest of policymakers in this issue. This is especially true of Britain, which even lacks a comprehensive official data source on the activities of foreign-owned firms throughout the economy as a whole. There is some indication from qualitative survey evidence that new technologies and standards have been adopted by UK producers as a result of inward investment. In a study of the impact of technology transfer by US multinational companies, Mansfield and Romeo (1980) found that over half of the UK firms in their survey had introduced new products or processes more quickly because of a transfer of a new product or process by a US-based firm to its overseas subsidiary, with around

The growth and impact of inward investment in the UK

3

two-thirds of the UK firms indicating that their technological capabilities had been raised by such transfers. However there were doubts about the strength and durability of the linkages established by many overseas investors in the UK at that time, particularly in some regional economies (Young etal., 1988). More recent evidence suggests that inward investment in the UK has helped to bring about a significant improvement in the product quality of suppliers (Dunning, 1988; PACEC, 1995). The quantitative importance of such findings is not clear. The detailed statistical and econometric analyses in the papers in this volume help to fill this gap by providing a comprehensive overview of the relative performance of foreign-owned firms in the UK and the extent to which their presence has had a sustained impact on the performance of UKowned firms over time. In order to understand the growing impact of foreign-owned firms and the importance attached to inward investment by the policy community it is useful to review briefly the factors behind the global growth of inward investment and the particular characteristics of inward investment in the UK. This serves to highlight some of the most important channels through which inward investors might influence the performance of indigenous companies.

T H E G R O W T H OF GLOBAL F O R E I G N DIRECT INVESTMENT The rapid growth of foreign direct investment over the last 25 years has made an important contribution to the ongoing globalisation of economic activities. Of course by some measures, such as the ratio of total trade and capital flows to income, it might be said that many industrialised economies are no more open at present than they were a hundred years ago. However changes in the feasible span of managerial control and the nature of technical progress mean that the implications of, and the motivations for, dispersed production are quite different now. New business advances are increasingly knowledge-based, arising from specific ideas and organisational innovations, both tacit and codified. The potentially infinite expansibility of knowledge means that many of these assets can be utilised simultaneously across multiple establishments under common ownership, generating economies of scale for the firm as a whole.

4

Inward investment, technological change and growth

Empirical evidence for countries such as the United States, the UK and Germany suggests that outward investment is more likely to occur in industries with a high level of R&D expenditure in the home country (Barrell and Pain, 1999b; Pain, 1997; Hubert and Pain, 1999), suggesting that new ideas and technologies are being utilised in host economies. Foreign direct investments are no longer dominated by the establishment of free-standing subsidiaries operating mining, agriculture and transportation facilities in emerging markets or producing finished goods at sub-optimal scale in host economies with significant barriers to external trade. Whilst there continues to be a net capital flow from the industrialised economies to the developing ones, postwar capital market integration has been characterised by the high level of gross flows between the industrialised economies. Business strategies have changed, with many multinational firms choosing to reorganise their activities on a regional or global basis. Many leading brand names now have global recognition. Investments in non-manufacturing sectors such as financial services and public utilities have expanded rapidly, helped by widespread use of privatisation policies by many governments and the need for a local presence in foreign markets in activities which rely heavily on professional expertise, personal contacts and international reputation as well as price competitiveness. In recent years national and regional governments and local development agencies have actively competed to attract inward investment through policy inducements and promotional campaigns in so-called 'location tournaments'. If product markets were perfectly competitive such policies would be unlikely to have permanent effects. Location patterns would be driven by geographical endowments, transport costs and production costs in different regions. Investment incentives might succeed in attracting new industries, but these would soon depart if subsidies were withdrawn (Wheeler and Mody, 1992; Barrell and Pain, 1999b). Developments in the theories of international trade and economic geography under imperfect competition have quite different implications for the organisation of firms, as Lionel Fontagne and Michael Pa jot discuss in their paper. Temporary differences in national or regional characteristics, such as investment incentives, can have permanent effects on the location of activities if firms are drawn to particular regions by the availability of agglomeration economies (Fujita etal., 1999). Such economies arise from any location-bound economic activity in an area

The growth and impact of inward investment in the UK

Table 1.1. The global stock of foreign direct investment by recipient area

World ($ billion) of which (%): Developed countries Western Europe UK

1960

1973

54.5

166.7

67.3 22.9 9.2

72.9 36.5 8.9

1985

1990

1998

782.3 1,768.5 4,088.1 69.7 32.4 8.2

78.8 44.4 12.4

68.1 38.4 8.0

Sources: Dunning (1988, Table 3.2) and UNCTAD (1999, Annex Table B3).

that generates positive externalities for nearby firms. If the new technologies and ideas brought by foreign firms do generate spillovers for host economies, there is a possibility of cumulative causation, with agglomerations attracting new investments which then influence the growth process. This suggests that the relative size of host locations is endogenous, rather than fixed by current factor endowments and access to common technologies. Several recent studies have suggested that agglomeration effects are an important determinant of investment decisions by multinational firms. Wheeler and Mody (1992) and Mody and Srinivasan (1998) find that the global location of foreign direct investment by US and Japanese multinationals is positively related to variables reflecting the total stock of past inward investment in the host economy. In two detailed studies using plant-level data, Head et al. (1995,1999) report that the location of new Japanese investments in the United States is closely related both to the location of existing investments in the industry in which investment takes place and to the location of investments by other Japanese companies. Devereux and Griffith (1998) and Barrell and Pain (1999b) find that agglomeration effects also help to determine the location choice of US multinationals in Europe. Within the UK the concentration of financial services within the City of London is an obvious example of a self-reinforcing agglomeration. The long-term trends in the location of direct investment are shown in Table 1.1. In the first half of the 20th century some two-thirds of all investments were located in the developing economies. Over the last 40 years the picture has been quite different. Over two-thirds of all inward investments are now held within the developed economies. The rate of growth of the nominal investment stock has accelerated from an average 9 per cent per annum between 1960 and 1973, to around 133/4 per

6

Inward investment, technological change and growth

cent per annum between 1973 and 1998. Controlling for movements in the global price level during these periods, as proxied by the GDP deflator for the OECD economies, indicates that in real terms the growth of the global FDI stock has risen from AVA per cent per annum during 1960-73 to 7 per cent per annum since that time. The UK has been relatively successful in attracting inward direct investment, accounting for 8-9 per cent of the global stock throughout most of the period. Inward investment grew especially rapidly in the latter half of the 1980s, and by 1990 the stock of inward FDI in the UK is estimated to have been almost \2xh per cent of the global total. Even though the UK share is estimated to have slipped to 8 per cent by 1998, this remains approximately 2Vi times the share of UK output in global GDP measured on a purchasing power parity basis. 2 The growth of inward investment in the UK needs to be viewed not only in terms of the national policies and institutions that have served to make the UK a desirable location for investors, but also in the context of the policies pursued collectively by all European governments and the European Commission. Western Europe has now become the dominant host region for investment amongst the developed economies. The amount of investment held in Europe has risen especially rapidly since 1985. This period has coincided with moves towards greater European integration. The implementation of the measures to remove capital controls and non-tariff barriers to trade in the Single Market Programme (SMP) has clearly stimulated the mobility of capital and generated a significant change in investment patterns and levels of foreign involvement in production. Work undertaken for the European Commission by Arrowsmith etal. (1997) and EAG (1998) on European capital markets and on foreign direct investment shows clear positive effects from the SMP on the level of inward direct investment in both service and manufacturing activities in the UK. At the same time, the external barriers to trading with the European Union faced by producers located outside Europe have encouraged additional flows of investment into the EU, with production bases now having guaranteed access to a Europe-wide market. This has been particularly important for many Asian companies (Barrell and Pain, 1999a; Belderbos and Sleuwaegen, 1998). A low level of labour costs per unit of output compared to that in many other EU member states has helped the UK to attract many of the resulting investment projects.

The growth and impact of inward investment in the UK

7

I N W A R D I N V E S T M E N T IN T H E UK The long-term trend in the stock of inward foreign direct investment in the UK is shown in Figure 1.1. By the end of 1999 the stock was equivalent to 27 per cent of GDP, compared to approximately 6V2 per cent of GDP in 1960. This is considerably larger than the share of inward FDI in most other large industrialised economies, although comparable to that seen in a number of other small, open European economies such as the Netherlands. There are two periods in which the UK inward stock has risen especially rapidly in real terms, the latter half of the 1980s and, more recently, since 1997. This is particularly clear from the trends in the flow of new investments summarised in Figure 1.2. Inflows averaged 21/4 per cent of GDP per annum over 1985-9 and just under 3Vi per cent per annum over 1995-9, compared to a long-run average of 1.6 per cent per annum since 1960. Indeed the first official estimates suggest that 1999 was an exceptional year, with FDI inflows of £50.8 billion, equivalent to 5.7 per cent of GDP. The impact of the growth of inward investment in the 1980s is studied in greater detail in the papers by Florence Hubert and Nigel Pain, and by Nigel Driffield. The impact of the high level of inward investment in the late 1990s has yet to be examined. 30

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