How can Foreign Investment help

a more Inclusive Productivity?

Rodrigo Wagner

University of Chile – Business School &

Center for International Development at Harvard.

Invited keynote talk “New Aproaches to Economic Challenges”

OECD, Paris – February 25th , 2016

A brief history of Chilean wine

French immigration in mid 1800s

bringing know in wine… and other skills*

• Pinochet

• Bachelet.

Phylloxera (Daktulosphaira vitifoliae)

100

years

Circa 1980

New techniques

The pioneer was a

multinational that

understood the needs

of a large market

Domsea farms that started Salmon in

Chile was an aquaculture subsidiary of

Union Carbide, a Multinational

Critical mass in a B2B world

Size of country proportional to overall GDP

Expanding size of the market

may be less of a G2G and

more a B2B issue…

Map source: http://www.worldmapper.org/

Multinationals could help achieve

critical mass (when there are W-shaped cost curves)

• Profitability at the margin is negative, despite big jump being profitable.

• Chicken and egg decision to “jump”; but need the B2B relationships.

Think of current

situation for

domestic firms

If Multinational / JV has

access to larger

customers / market; then

can be more competitive

Multinationals tend to have better Management Practices

50

52

54

56

58

60

62

64

66

68

70

United States Australia Chile Multinationalsin Chile

World Management Survey – Mean for firms between 500 - 1000 workers (Bloom & Van Reenen, 2007; Bloom et al, 2011; Tokman, 2009; Figure from Velasco and Wagner, 2014)

Jumping to the

practices of

multinationals can

increase 5 -15%

productivity

Why do we want multinationals?

• Get critical mass

• Improve management.

• Get organizational capital

• New sectors:

– Learn about production

– Learn about demand or markets

• Experimentation of comparative

advantage…

WHERE DO WE WANT MORE

FDI ?

Where do we want more FDI?

• Everywhere? Maybe

• Ideal: Maximize welfare

• Political Equilibrium: Max utility of “median voter”.

– Additional Taxes for transfers and public goods. » adapting models like Alesina-Rodrik (1996) to FDI.

– Externalities (including pecuniary!) • e.g. Better Jobs

Can FDI fight against skill-biased

technical change?

Principle : Focus a bit more on

sectors/projects that, if grow, would

demand labor from vulnerable groups

• Development is when wages go up in real terms… for people with less opportunities. In the medium run education is given.

• Pineapple packing facility vs. Web startup.

Wage for

non college

Educated

women

Quantity of

Workers

Which type of FDI should one

promote?

In the era of Henry Ford you were unlikely to get rich

without creating many jobs. That’s a fundamental

disconnect created by skill biased technical change.

Long commutes in Mega-cities… Labor market segmentation

(Lat Am vs some Asian)

Well paid service jobs for less skilled groups locate

where rich people live! Tradable manufacturing!

Procurement Managers of

Multinationals

• Key forecast indicator… PMI

• Also agents for change:

• They search linkages!

Have a problem to fix

FDI could matter for…

This does not mean you have to like or dislike Sustaineble Development Goals as currently stated… It’s just an example of a framework…

Key concern: Taxing FDI

Coase Theorem 101

• Challenges of corporate taxation across

borders. • See Foley at al (2009); Feldstein et al. (2009).

• Efforts by OECD on Transfer Pricing … … and other rules. Essential for facilitating goodwill towards

FDI.

• Coase theorem!

• Too sweet for foreigners? Who is foreigner?

I. BEWARE OF HOW WE

MEASURE FDI

Observation # 1

Foreign Direct Investment

is not always investment!

• If Walmart sends to Walmart Mexico $1 of extra cash holdings to park in its balance sheet for provisions, then

– Inward FDI to Mexico grows by $1.

– Investment in Mexico grows by $0 • More cash is not Gross Fixed Capital Formation

$1 cash

Observation # 2

Foreign Direct Investment

may not come from abroad!

• If Walmart Mexico keeps $1 of profits to repair a tile in one of its stores

– Inward FDI to Mexico grows by $1.

– Outward FDI from the US grows by $1

– Mexico’s current account deficit grows by $1

– Investment in Mexico grows by $1 But no penny crossed the Rio Grande !

$1 cash

Locally Produced FDI is a type of Saving!

(Local or Cash-bases saving)

ARM

AUS

AUT

AZE BEL

BEN

BFA

BGD

BGR

BIH

BLR

BWA

CAN

CHE

CHN

CIV

CMR

COL

CYP

CZE

DEU DNK

EGY

ESP

EST

FIN

FRA

GAB

GBR

GEO

GHA

GIN

GMB

GRC

HKGHND

HRV

HUN

IND

IRL

ISR ITAJPN

KAZ

KGZ

KHM KORLBR

LBYLKA

LSO

LTULVA

MAR

MDAMKD

MLI

MOZ

MWI

NAM

NER

NGA

NLD NOR

NZL

PAKPHL

PNG

POL

PRT

RUS

SEN

SLE

SVK

SVN

SWE

SWZ

TGO

THA

TTO

TUR

TZA

UGA

UKR

USA

BOL

CHL

CRIDOM

ECU

GTM

MEX

PANPER

PRYSLV

URY

VEN

GLS = GNS - [net Retained Earnings FDI in BOP]

.91

1.1

1.2

1.3

Gro

ss L

ocal S

avin

g [G

LS

]

as s

hare

of G

ross N

atio

na

l S

avin

g [G

NS

]

(200

3-2

00

7)

0 20000 40000 60000GDP per capita PPP (2011 USD)

See Hansen and Wagner (2015). Is the Reinvestment of Multinationals a Capital Flow? Saving and the Cash Based Current Account

Observation # 3

Not all dollars of FDI bring the

same additional “extra bytes” of

new productivity; no easy answers

• Greenfield vs M&A • But still M&A could matter for.

• New vs. Expansion. • How many new “bytes” of information or

externalities does the expansion bring?

• Retained Earnings vs. New Equity (*)

II.

WHAT DOES PREVENT FDI ?

- MARKET FAILURES

- ORGANIZATIONAL FRICTIONS

- POLITICAL FRICTIONS.

Why isn’t the additional desirable

FDI project happening?

• To create a cost-effective policy …

• … one needs at least a working hypothesis

for this question!

Let’s start with some obvious

restrictions to FDI…

• Ownership restriction !

• Still one can by-pass regulations

Only 20% of sectors show some

restriction and 1.5% full prohibition

Do sectors in which more ownership is

allowed to foreigners get more FDI?

Original OECD

countries

Poor African

and Asian

China,

Peru ,

Tunisia Richer Lat Am

& Eastern Europe

Co

rre

lati

on

of

frie

nd

lier

ow

nrs

hip

ru

les o

n F

DI

Do sectors in which more

ownership is allowed to

foreigners get more FDI? … Inverse U – shape on the level of development

• Poor countries. NO POWER

– tax what they can.

• Middle Income countries YES

– Show correlation predicted by “ownership theories” • More restriction goes with less investment

• High income countries. NO POWER

– … with good institutions

– Have other means to secure FDI beyond ownership

Types of constraints…

• Taxes

• Other government imposed frictions.

• Rule of Law

• Coordination: B2B vs B2G…

• Lack of complements/inputs

• Unawareness

Usually less mentioned

Histogram: all possible projects by IRR Project privately pursued if IRR > r [1+t]

0

t1rr

If Cov(IRRi ,ti)=0

Good stuff

happens

anyways!

][ Project ofReturn of Rate i iIRR

)(IRRf

Distortion is not

necessarily a tax

Also known as size related distortions

# 2: Distortion worse for better projects

)(f

][ Project ofReturn of Rate i 0

ir t1

If Cov(IRRi ,ti)>0

Policy reform

has more effect!

Decision to evaluate a project is not

based on IRR but on NPV (area) ! R

etu

rn 7

0%

+ 3

0%

= 1

00%

Amount Invested

US$40,000

Retu

rn 3

0%

Amount Invested

US$1.000.000

How much water does the broken barrel holds?

FDI policies can be…

Complements or Substitutes

Low

socia

l conflic

t

Adm

in B

urd

en

Infra

stru

ctu

re

Hum

an c

apita

l

Low

taxes

Fin

ancin

g

Low social conflict

Admin Burden

Infrastructure

Human capital

Low taxes

Financing

Multiplication*? Summation The minimum

How do measures produce results ?

Reality lies

somewhere in

between…

What constraints the next $1 b of

foreign investment? • Are all the great projects taken?

• Are all project evaluated?

• A single constraint for most sectors? • When in ER / ICU, usually yes…

• But not when you exit ER / ICU.

• Are policies complements or substitutes?

• Do the sectors exist? • Or the industry has not born yet? Coase Theorem does not apply…

» Difficult to negotiate

III.

MODERN “INDUSTRIAL POLICIES”

FOR FDI…

Claim: The hardest challenge is

Public-Public coordination (and for good resons e.g. Tirole, 1986) – No Price System !

• Challenge for FDI projects that need multiple government provided inputs.

• Failure of Coase Theorem.

Ministry 1

Tool 1

Indicator 1

Ministry 2

Tool 2

Indicator 2

Ministry 3

Tool 3

Indicator 3

Ministry 4

Tool 4

Indicator 4

President/Prime Minister or Min of Finance / Planning?

It isn’t “picking winners”, but max

“treatment effect” of FDI policies

• Max “Treatment Effect menus cost”

– Different from what a Venture Capital would like…

• g is a VECTOR of multiple government inputs

• Think as a Portfolio…

– It diversifies risk …

– Changes political economy of evaluation

– Makes easier an evaluation…

Differences with 1960s FDI for Import Substitution…

• Focus on “Consumer Durables” in small markets.

• Inability to adapt procurement or spillovers

• Avoid cannibalization of Import Substituter FDI in neighbor

New Container Manufacturing Plant…

Awareness: somebody evaluated the project!

• No tax breaks!

• Provision of specific public goods.

• 2000+ jobs; half of them for women Marginal

How to create “signals of scarcity”

in Gov. to promote FDI?

• Voucher per job…

• Evaluate Projects for Private Sector. – When problem is not the $...

– … But the organizational bandwidth.

• Land & Local Govs prepared to receive FDI…

• Coordinating Office. Not a new Ministry! Not new Silo – Committment at the top…

A checklist for Targeted Policies (e.g. FDI project)

Questionnaire for industrial policy targeting Answers

1. If successful, can it “make a dent”? Can it be large enough

either directly or indirectly?

2. “The Chicago Questions”

a. If so profitable, why isn’t the (FDI) project already working?

a. If there are market failures, what prevents an efficient

negotiation? (Failures to Coase Theorem)

3. Contributes to other goals besides “plain vanilla” growth?

(better jobs, hedging, stepping stone to other industries…)

4. What do the proxies for success probability suggest?

5. What are the implementation challenges

6. Exit strategy. A policy with costly exit? How to mitigate or

provision for them?

Summing up • Some FDI might be a tool for development goals.

• Beware of measuring what you want! NPV of taxes and externalities…

• Include pecuniary externalities (better jobs!)

• Distortions to FDI may not be taxes & procedures…

• Sometimes it is too little State Involvement rather than too much…Sometimes.

• “Industrial policies” attracting FDI should target today’s most binding constraints… which might not be yesterday’s constraints (when agencies were created)

• Usual institutions related to taxes, legal security (mining)

• New channels on State Coordination, GVCs…

• Use some kind of smart & flexible checklist…

Thinking of a Scorecard (case by case risk assessment)

• Why and when was this regulation imposed?

• What’s the risk of tax revenue reduction if ownership regulation is removed? (Profit shipping as Desai &

Foley, 2001; Limited Fiscal Capacity Besley & Persson,2010)

• What’s the risk that the powerful groups that receive rents from FDI ownership restriction require some other (potentially more distortive) rent? (Seesaw effect in

Acemoglu & Robinson,2003)

• Are there reasons to justify that joint ownership can create learning? (Javorcic, 2004)

Why too little FDI?

Financiamiento

Low social

return

¿Y Utilidades

reinvertidas?

Management Factores

“Contratos”

Firmas con alto

potencial que

NO Nacen

(Start-up)

Problemas de

Scale-up

Infraestructura

y Bienes

públicos

Tamaño del

Mercado y

Masas críticas

SOME EXAMPLES OF NEW

PRODUCTS…

Wagner, Rodrigo & Zahler, Andrés, 2015. "New exports from emerging markets:

Do followers benefit from pioneers?," Journal of Development Economics

Despite centuries of know how,

modern wine exports from Chile…

started with a foreign firm

Thinking of a Scorecard (case by case risk assessment)

• Why and when was this regulation imposed?

• What’s the risk of tax revenue reduction if ownership regulation is removed? (Profit shipping as Desai &

Foley, 2001; Limited Fiscal Capacity Besley & Persson,2010)

• What’s the risk that the powerful groups that receive rents from FDI ownership restriction require some other (potentially more distortive) rent? (Seesaw effect in

Acemoglu & Robinson,2003)

• Are there reasons to justify that joint ownership can create learning? (Javorcic, 2004)

FDI and Jobs…

OPEX

• Manufacturing is unskilled

labor intensive in its

Operational Expenses.

• Day to day business…

CAPEX

• Mining is NOT labor

intensive…

• But in the investment

stage it is very labor

intensive

Claim: A better image of FDI in

recipients cannot come only

from CSR

• Jobs

• Taxes.

SOME COUNTRIES INTERNALIZE

THE EXTERNALITY OF A

COUNTRY’S BRAND AS

INVESTOR…

Why do the Chinese send more

FDI to Argentina than to Chile?

0

100

200

300

400

500

600

Argentina Chile

Ch

ines

e F

DI M

illio

n

USD

(fd

iMar

kets

)

Clearly NOT a China-Latin America exception

The model as an example

Labor Demand shifter !

• Think about *FDI* as a black box

that can raise the demand for the type of

labor that needs more inclusion.

• Could be a sustitute for