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«VIRTUOUS CIRCLES? HUMAN CAPITAL FORMATION, ECONOMIC DEVELOPMENT AND THE MULTINATIONAL ENTERPRISE by Ethan B. Kapstein Research programme on: Global ...»

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OECD DEVELOPMENT CENTRE

Working Paper No. 191

(Formerly Technical Paper No. 191)

VIRTUOUS CIRCLES?

HUMAN CAPITAL FORMATION,

ECONOMIC DEVELOPMENT

AND THE MULTINATIONAL ENTERPRISE

by

Ethan B. Kapstein

Research programme on:

Global Interdependence and Income Distribution August 2002 CD/DOC(2002)03 CD/DOC(2002)03

TABLE OF CONTENTS

ACKNOWLEDGEMENTS

PREFACE

RÉSUMÉ

SUMMARY

I. INTRODUCTION

II. FDI AND HUMAN CAPITAL FORMATION

III. DOES HUMAN CAPITAL ATTRACT FDI?

IV. FDI AND THE POLITICAL ECONOMY OF HUMAN CAPITAL FORMATION...........18 V. CONCLUSIONS

BIBLIOGRAPHY

OTHER TITLES IN THE SERIES/ AUTRES TITRES DANS LA SÉRIE

CD/DOC(2002)03

ACKNOWLEDGEMENTS

The Development Centre would like to express its gratitude to the Ford Foundation and the Swiss Authorities for the financial support given to the project on “FDI, Human Capital and Education in Developing Countries”, in the context of which this study was carried out.

CD/DOC(2002)03

PREFACE

This paper is one of five presented at a meeting on FDI, human capital and education in developing countries held in Paris in mid-December 2001. They examine the links between FDI and human capital development, notably the interaction between the host country’s policies affecting multinational enterprises (MNEs), its educational and

training system, and the education and training activities of MNEs. The five papers are:

1) by Ethan Kapstein situating this issue in the broader context of current debates on globalisation, growth and poverty; 2) by Matthew Slaughter looking at the implications of FDI for skill demand and supply; 3) by Dirk Willem te Velde examining the interaction between FDI promotion policy and human capital; 4) by Bryan Ritchie reviewing the relationship between domestic policy, FDI and human capital in East Asia; and 5) by Magnus Blomström and Ari Kokko reviewing the literature on human capital spillovers for the purposes of defining a new research agenda.

Over the last ten years, globalisation has become a contentious issue. Much of the debate has focused on the role of capital inflows and FDI. There is substantial evidence that short-term capital flows, and portfolio capital in particular, increase the susceptibility of developing countries to financial crises, while FDI appears to be more stable and less subject to reversal and rapid outflows. Over the last decade an increasing number of emerging market economies have opened their countries to FDI, and have made attracting FDI an integral component of their development strategies. In Latin America alone, for example, net FDI flows climbed from $18 billion in 1990 to more than $85 billion in 1999.

At the same time, the composition of FDI has changed. The majority of FDI from OECD countries to developing countries now goes into services, rather than manufacturing and natural resource production. This change of composition has been accompanied by a change in purpose. As a result, FDI is now more likely to finance a large initial surge in capital goods imports, bringing advanced technology, know-how and organisational techniques. Is, however, FDI causing a race to the bottom as countries compete to attract investors, or to a race to the top as governments recognise the need for an educated workforce? Is it contributing to greater income inequality by increasing the demand for skilled labour, or to an increase in opportunities for workers at all income levels?

The possibility that FDI is contributing to widening wage and income inequalities has revealed an important but relatively unexplored link with human capital and human capital policy, education and training. In this context, and building upon research that the OECD Development Centre has done on globalisation, the Centre’s meeting was organised to examine the links between FDI and human capital development. It

CD/DOC(2002)03

particularly examined the three-way interaction between the host country’s incentives to attract FDI and its policies affecting MNEs, its educational and training system, and the MNEs education and training activities.

The general conclusion that can be drawn from these papers is that MNEs can and do generate substantial human capital spillovers in developing countries and that appropriate policies can maximise these. For instance, training policies are essential to creating positive synergies with MNEs but must be seen as not FDI-specific — they are necessary for the competitiveness of all enterprises. At this point very little is known about the training activities that MNEs are actually engaged in, and to what extent local employees and managers of MNEs subsequently work in domestic firms, or start new firms themselves.

Further research is needed on the relationship between human capital and FDI, that could be extremely fruitful for both policy makers and MNEs. In particular, we need to know more about the transmission mechanisms and the ways in which policies can support them. These five Technical Papers, each of them written by eminent specialists, provide a sound basis for further work which can enhance development potential in very practical ways.





–  –  –

Technical Paper No. 191, Virtuous Circles? Human Capital Formation, Economic Development and the Multinational Enterprise, by Ethan B. Kapstein, August 2002.

Technical Paper No. 192, Skill Upgrading in Developing Countries: Has Inward Foreign Direct Investment Played a Role?, by Matthew J. Slaughter, August 2002.

Technical Paper No. 193, Government Policies for Inward Foreign Direct Investment in Developing Countries: Implications for Human Capital Formation and Income Inequality, by Dirk Willem te Velde, August 2002.

Technical Paper No. 194, Foreign Direct Investment and Intellectual Capital Formation in Southeast Asia, by Bryan K. Ritchie, August 2002.

Technical Paper No. 195, FDI and Human Capital: A Research Agenda, by Magnus Blomström and Ari Kokko, August 2002.

CD/DOC(2002)03

–  –  –

Au cours des dernières années, chercheurs et décideurs ont insisté sur le rôle de la formation du capital humain dans le développement économique. En créant du capital humain, les pays deviennent plus attractifs pour l’investissement privé, qu’il soit national ou étranger. Et cet investissement apporte croissance et prospérité.

Les données empiriques à l’appui de cette théorie sont toutefois ambiguës. Bien que l’investissement direct étranger se soit fortement accru dans nombre de pays depuis les années 80, son effet sur la croissance n’est pas très bien établi. Pourquoi ?

Ce Document technique met en évidence des orientations d’économie politique susceptibles d’éloigner les pays d’une croissance durable. En particulier, dans les pays qui n’ont pas un marché bien développé des capitaux et de l’éducation, beaucoup d’individus qualifiés ne trouvent pas les compétences de base dont ils ont besoin pour participer pleinement au développement économique national. A mesure que les sociétés se clivent, elles deviennent plus conflictuelles ; ces conflits ralentissent la croissance, quel que soit le niveau de l’investissement direct étranger.

SUMMARY

In recent years, academics and policy makers have emphasised the role of human capital formation in economic development. By creating human capital, countries become more attractive to private investment, both domestic and foreign. And through such investment, countries grow and prosper.

Yet the empirical evidence in support of this theory remains elusive. While foreign direct investment (FDI) has multiplied in many countries around the world since the 1980s, its effects on growth are uncertain. Why is that the case?

In this paper I argue that political economy pathways exist that may lead countries away from sustained growth. In countries that lack well-developed capital and education markets, many otherwise qualified citizens may be denied the basic skills they need in order to contribute fully to the nation’s economic development. As societies become divided, they become more conflicted, and this conflict dampens growth, irrespective of the level of foreign direct investment.

–  –  –

Since the early 1990s, an increasing number of emerging market economies have welcomed foreign direct investment in the hope of stimulating development and growth.

In Latin America alone, net FDI flows climbed from $18 billion in 1990 to more than $85 billion in 1999. The firms making these investments at present constitute over 13 per cent of manufacturing employment in Brazil and more than 17 per cent in Latin America.

In central and eastern Europe, foreign direct investment has risen from negligible levels in the early 1990s to nearly $20 billion in 1999, with countries in that region also relying heavily on FDI as a stimulus for growth. In Asia the numbers are most staggering of all, with FDI flows climbing from $60 billion in 1990 to $120 billion in 2000; today, FDI makes up more than 10 per cent of the region’s gross fixed capital formation (UNCTAD, 2001).

But what have been the effects of this tidal surge of FDI on economic development? Has it buoyed economic growth prospects, or submerged them?

Surprisingly, there is no established consensus. Despite the success of many developing countries in attracting FDI over the past ten years, economists and public officials continue to debate its effects on long-term economic growth. For example, former InterAmerican Development Bank (IADB) economist Ricardo Hausmann has asserted that the share of FDI in capital inflows is “not a measure of anything good happening in the economy” (Hausmann, 2000).

In neo-classical development theory, with its emphasis on capital accumulation, there is less controversy over the contribution of FDI to host-country growth. From a macroeconomic standpoint, the Keynesian identity reminds us that domestic investment depends on the level of savings. Since developing countries tend to lack the domestic savings required to fund their various investment projects, they must rely on foreign savings. This can come in the form of foreign aid, bank loans, or direct investment. By importing foreign capital, developing countries loosen the resource constraints on their investment and growth, and therefore FDI should be welcomed.

More recently, economic models influenced by endogenous growth theory hypothesise that the relationship between FDI and growth would be essentially a function of technology and human capital. By transferring technology to the host country and developing local labour skills, for example, multinational enterprises (MNEs) generate CD/DOC(2002)03 externalities with broad economic effects. Workers who are trained within MNEs may ultimately bring their skills and know-how to the domestic economy by changing jobs and working for domestic companies, or becoming entrepreneurs. The policy lesson here is that foreign direct investment has the potential to encourage human capital development and technology transfer, the latter of which is generally considered to be one of FDI’s unambiguous benefits.

These models have become especially relevant given the recent emphasis on the “knowledge economy” and the fears expressed of a north-south “digital divide.” Bilateral and multilateral donors alike have sought to encourage developing countries to deregulate and privatise their telecommunications markets, at least partly, in order to make them open to and attractive for foreign direct investment — investment that would presumably modernise their information infrastructure. This evolution towards the “e-economy” is also likely to increase demands for skilled workers, and perhaps as a consequence motivate developing country governments to invest more in education and training.

Other economists, however, have questioned whether FDI really creates dynamic growth gains for host countries. After all, it should be recalled that these gains are mainly due to such forces as competition and technological diffusion. But if the multinational enterprise displaces domestic sources of competition, markets may become more concentrated, and if its technology does not diffuse, then the firm’s wider benefits may be limited (Richardson, 1980).

Further, concerns are being raised about the effects of FDI on income inequality within recipient countries, which mirrors the broader worldwide debate about the relationship between openness and income dispersion. This debate is relevant to the FDI-growth connection because of the political economy argument that inequality may be bad for growth. There is substantial evidence that the globalisation process of the last 15 years has contributed to widening wage differentials between skilled and unskilled labour (even if its precise contribution remains controversial), especially in middleincome countries in Latin America and elsewhere. The mechanism driving this outcome is not yet well understood, but may be due to skill-biased technological change or technology transfer. However, if accelerating FDI and the accompanying technology transfer are profiting only a skilled few and serve to widen inequality, then the gains these changes could bring become less compelling, and FDI itself could become the subject of political controversy.

After all, it must be emphasised that educational markets — especially at higher levels — in most developing countries are truly open only to those in the upper income quintiles. Those from lower income backgrounds do not have access to the financial markets that would make it possible for them to remain in school rather than go to work.

As a consequence, the very economic and technological forces that could be driving countries towards a higher growth path could also be leading them towards a “winner takes all” outcome in which the rich become the main beneficiaries of greater international integration. The inequality thus produced may become a source of domestic social tensions, which could act to undermine growth.



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