Editor’s Summary

Foreign direct investment (FDI) plays a critical and growing role in the global economy. FDI refers to companies based in one country making a substantial physical investment or acquiring a lasting managerial interest in an enterprise based in a foreign country. For a host country, FDI promises a source of new resources and new technologies that could spur economic growth and development. For multinational firms, FDI offers the promise of new markets and less expensive production facilities. But there are clearly risks involved as well as legitimate concerns about the extent to which potential benefits are appropriately shared.

This tenth issue of the Brookings Trade Forum examines a variety of dimensions of FDI. On balance, have developing countries benefited from FDI inflows? To what extent has FDI played an important role in China’s impressive economic performance? How do tax and productivity differences between source and host countries affect bilateral FDI flows? How have profits been shared between multinational corporations and host country governments in resource-rich economies? Why do U.S. investors appear to earn substantially higher returns on their investment abroad than foreigners earn on their investments in the United States?

The conference was held on May 10 and 11, 2007. This volume provides revised versions of the five papers presented at the conference, as well as the remarks from invited commentators and brief summaries of general discussants for each session.

In the first paper in the volume, Theodore H. Moran addresses three questions: how to evaluate the contribution (positive or negative) of manufacturing FDI to a developing country host economy, how to search for externalities and spillovers (and identify the channels and mechanisms through which spillovers take place), and how to determine whether host governments should devote public sector resources to attracting FDI in manufacturing.

In each area, he argues that the research would benefit from more extensive usage of multiple investigation techniques. Moran notes that industry and sector studies, business cases, management interviews, firm survey data, and cost-benefit analysis of individual projects are relatively rare among recent studies analyzing the impact of FDI. If these approaches are carefully arrayed to avoid selection bias, he believes that they are generalizable and a valuable complement to the more standard regression analyses.

The paper provides a wide-ranging literature review. It concludes that cost-benefit analyses of individual FDI manufacturing projects assessing net contribution at world market prices show that those oriented toward exports make a positive contribution. In contrast, those oriented toward protected national markets tend to subtract from national income.

Business case studies and sectoral analyses corroborate these findings. They also show that multinational corporations (MNCs) use different production processes and business strategies in response to international competition compared with what MNCs use in protected domestic markets. Firm-level studies highlight ways that plants in protected environments differ from those that compete internationally. The production lines are constructed differently and are almost always subscale. The workers do not receive training in those skills that are needed for large-scale automated plants. The operations do not generate the dynamic learning that is essential for infant industries to mature into competitive adulthood.

In export-oriented FDI plants, in contrast, MNC headquarters incorporate economies of scale and orchestrate their developing country affiliates into a coherent supply network within which latest improvements in production technology and quality control procedures can be transmitted on a real-time basis, within days or hours. Industry and case study evidence showing a similar divergence between production for protected domestic markets in developing countries and production for export in competitive international markets—across time periods and across geographical regions—provides some confidence that these results are robust.

Moran argues that failure to adequately account for these differences in production strategy helps to explain why the first generation of econometric studies on the effects of FDI in host economies generated such muddled results. Studies using data from protected economies did not control for the distortions related to import substitution. In these settings, FDI likely resulted in significant negative as well as (perhaps) some positive contributions to the host economy.

Recent, better-designed studies do show robust econometric...