Academic journal article Contemporary Economic Policy

The Provision of Public Inputs and Foreign Direct Investment

Academic journal article Contemporary Economic Policy

The Provision of Public Inputs and Foreign Direct Investment

Article excerpt

I. INTRODUCTION

Foreign direct investment by multinational corporations has played a significant role in the success of developing nations that have grown into developed economies. Since the 1950s, Taiwan, South Korea, Hong Kong, and Singapore have been but a few that have actively pursued multinationals from the United States, Japan, and Europe in an effort to create jobs and raise wages. Proximity to markets, subsidies, low wages, and tax incentives are common reasons cited for why multinationals choose to invest in these economies. A critical link, often mentioned but given far less attention in theory, has been the role of public inputs. (1) It is no coincidence that multinational activity began to take place in South Korea after the 1953-56 Post War Reconstruction, or in Singapore after massive public investment in telecommunications, or Taiwan after government-funded research institutes and industrial parks were built (see Hobday 1995; Li 2002).

Recently, researchers have begun to examine linkages between multinational corporations and indigenous intermediate input suppliers in the context of the new trade theory. This approach has helped shed light on the welfare impacts of host countries that accept or choose to compete for multinational activity. Because the approach is new, many questions regarding upstream and downstream linkages have not yet been addressed in the literature, especially with respect to public inputs as factors of production and the interaction they create between intermediate goods suppliers and final goods producers. This article contributes to that literature by examining how the provision of public inputs affect multinational location decisions as well as the subsequent wage and domestic market effects associated with competing policy proscriptions.

Recent empirical research suggests that public inputs have a nonnegligible impact on the productivity and cost structure of private firms (see Aschauer 1989; Haughwout 2001; Morrison and Schwartz 1996; Nadiri and Mamuneas 1994). Cost elasticity estimates with respect to infrastructure capital in the Nadiri and Mamuneas (1994) study range from -0.11 to -0.21 depending on the industry, whereas Morrison and Schwartz (1996) estimate an output elasticity of 0.11 for private firms with respect to public infrastructure. (2) In simple bivariate regressions found in the Global Competitiveness Report 2000, strong and significant correlations exist between gross domestic product (GDP) growth and a wide range of public infrastructure measures.

Despite this evidence, universal agreement regarding the contribution of public investment to private sector productivity does not exist. Conflicting studies have found that public investment does not have a statistically significant direct impact on productivity in the private sector (Holtz-Eakin 1994; Holtz-Eakin and Schwartz 1995). Even if such infrastructure has no direct role in the cost structure and productivity of private firms, ample evidence suggests that the indirect spillovers from agglomeration and clustering created by public infrastructure lower costs for firms (Haughwout 2001). The model developed in this article incorporates both the direct productivity enhancing, and indirect, agglomerative aspects of cost savings for multinationals created by the provision of public inputs.

The approach here is different from other papers that look at the impact of public inputs on firm location decisions (such as Martin and Rogers 1995; Baldwin et al. 2003). Prior work has focused on two-country models with agglomeration externalities, where public inputs (infrastructure) are modeled as iceberg trade costs that affect firms' ability to get their products to consumers. In this article, public inputs are modeled as factors of production for intermediate as well as final goods producers in the host country rather than as iceberg trade costs. This approach sheds light on two important aspects of infrastructure development that are not explicitly captured by previous models. …

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