The Case for Globalization: The Results of McKinsey's Latest Study of the Pros and Cons of Emerging Market Foreign Investment

By Farrell, Diana | The International Economy, Winter 2004 | Go to article overview

The Case for Globalization: The Results of McKinsey's Latest Study of the Pros and Cons of Emerging Market Foreign Investment


Farrell, Diana, The International Economy


Few topics are more intensely debated or generate more contrasting emotions than the merits and costs of globalization, particularly foreign direct investment (FDI) by multinational companies in emerging markets.

To bring new facts to this heated debate, the McKinsey Global Institute studied the impact of FDI on local industries in China, India, Brazil, and Mexico. The industries included manufacturing and service sectors: automotive, consumer electronics, banking, food retailing, and information technology and business process outsourcing. In each of fourteen industry studies, we looked at the change in industry dynamics, sector productivity, output, employment, and prices before and after foreign players entered time market, and we conducted interviews with foreign and local executives. The complete collection of fourteen in-depth case studies is likely the broadest ever evaluated in a single research project and provides a strong base for our conclusions.

The research shows that FDI is indeed good for the economic health of developing nations--regardless of the policy regime, industry, or time period studied. In thirteen out of fourteen case studies, FDI improved productivity and output in the sector, raising national income while lowering prices and improving quality and selection for consumers.

And contrary to what critics charge, our case studies showed that foreign companies paid higher wages and were more likely to follow local labor laws than domestic companies in time same sector.

The McKinsey Global Institute also found that FDI impact on host countries differed depending on whether investors were seeking lower costs or new markets. Investment by companies seeking lower costs--so called "efficiency-seeking" investment--consistently improved sector productivity, output, employment, and standards of living in the host countries, with few negative consequences. This type of export-oriented FDI also posed little threat to domestic producers, who instead often benefit as foreign companies look for local distributors and suppliers. They can also benefit by copying and building on what the foreign players are doing, as seen in the domestic Chinese consumer electronics and high tech industries, or the formidable Indian outsourcing players.

Companies that sought to expand their markets in the host countries also had a positive economic impact. In these "market-seeking" cases, however, the impact on employment was mixed and the benefits often came at a cost to incumbent, less productive companies, as seen in the case of Wal-Mart's entry into the Mexican food market, which drove down average margins for companies in the industry.

The impact on domestic living standards is the great success story of FDI and one that is seldom discussed. In nearly every one of our case studies, we saw lower prices and better selection after foreign players arrived. The reason? Foreign players improve the efficiency and productivity of the sector by bringing new capital, technology, and management skills and forcing less efficient domestic companies to either improve their operations or exit. Although some incumbent companies stand to lose, consumers benefit. In many cases, lower prices then led to an increase in demand and industry growth.

In market-seeking FDI cases, prices to consumers declined in seven out of ten cases, and product selection increased in all but the retail banking cases. The impact on prices was very large in some cases: for example, Chinese consumers saw passenger car prices drop by more than 30 percent between 1995 and 2001, though consumer prices more broadly grew by 10 percent during the same time period.

We found efficiency-seeking FDI cases to have a more limited impact on host country consumers as most production is for export and benefits global consumers. But even in these cases, the presence of foreign players benefited domestic consumers--either in the form of broader selection enabled by local production, or as in the case of the Mexican auto sector, by FDI players introducing innovative financing options in the Mexican market. …

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