Globalization for Development? Inward FDI and the Size of the Market

By Tomohara, Akinori | Southern Business Review, Fall 2004 | Go to article overview

Globalization for Development? Inward FDI and the Size of the Market


Tomohara, Akinori, Southern Business Review


One of the recent policy concerns in the area of development is whether globalization really helps to improve standards of living in developing countries. International organizations advocate the merit of accessing the global economy via foreign direct investment. Anti-globalization movements do not necessarily agree with this view. Those opposing globalization argue that selfinterested multinational companies exploit the resources of developing countries and impair development. Thus, for the purpose of long run economic growth, it may be better to protect domestic infant industries rather than rely on foreign capital.

This article considers a policy issue of whether enlarged markets would result from closer ties with foreign-owned multinational companies during the development process. Whereas the gains from free trade have been thoroughly explored in the trade literature, very few attempts have been made at proving the trade of multinational companies is a more effective growth engine than the trade of domestic companies. Recent empirical literature (Levine & Renelt, 1992; Harrison, 1996; Frankel & Romer, 1999) shows a positive relationship between trade and growth. This relationship is not sufficient, however, to conclude that multinational companies are advantageous. Trade openness is enhanced when domestic companies increase their transactions with foreign countries. The possible gains from the activities of multinational affiliates in developing countries have been explored in the following two areas. One is technology spillovers to domestic companies (Haddad & Harrison, 1993; Kokko, 1994; Aitken & Harrison, 1999; Blomström & Sjöholm, 1999). The other is wage spillovers to domestic companies (Aitken, Harrison, & Lipsey 1996; Feenstra & Hanson 1997); however, as Lipsey (2002) points out, little attention has been given to the effects of Foreign Direct Investment, henceforth FDI, on consumers in the literature.

This article relates two branches of the literature: trade openness and inward FDI (i.e., the presence of foreign affiliates in host countries). The possible gains of an open-door policy to the markets in developing countries by examining the effects of inward FDI on market size is investigated. For this purpose, two alternative industrial policies are compared. One policy would involve the promotion of a domestic company. The second policy would require the hosting of a foreign-owned multinational company.

The model falls among those found in the standard industrial organization literature on the interrelated markets (the seminal work of Spengler, 1950; Greenhut & Ohta, 1979; Tirole, 1988) and the more recent ones that appear in the literature on the taxation of multinational companies (Horst, 1971; Gopithorne, 1971; Eden, 1985; Kant, 1990; Prusa, 1990; Gresik & Nelson, 1994; Stoughton & Talmor, 1994; Bond & Gresik, 1996). Specifically, a theoretical model is constructed by referring to the recent tax regulations concerning multinational companies (Elitzur & Mintz, 1996; Tomohara, 2004). Furthermore, the analysis focuses on the vertical model of a multinational company. The knowledge-capital model predicts the emergence of vertically integrated multinational companies when countries differ in relative factor endowments (Markusen et al., 1996; Markusen, 1997; Carr, Markusen & Maskus, 2001; Markusen & Maskus, 2002; Blonigen, Davies, & Head, 2003). Such differences in relative factor endowments between developing and developed countries are often observed.

Analysis reveals the possibility an open-door policy will improve the welfare of consumers through the increased trade of multinational companies. If the markets between a developed country and a developing country are interrelated through intra-firm trade by multinational companies, the developing country's domestic market becomes larger as the volume of trade increases. This is because a multinational company tries to maximize its global profits by exporting more goods to the host country. …

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