Foreign direct investment and spillovers of technology

This paper summarizes some of the literature on the links between FDI and the transfer and diffusion of technology. We argue that the positive effects of FDI postulated in much of the recent debate are not automatic, that the effects of FDI will vary depending on the host country's characteristics and policies, and that there is a role for economic policy in maximizing the potential benefits of FDI. Many developing countries have traditionally relied on a combination of various fiscal incentives and performance and technology transfer requirements to attract foreign multinational firms and to control their operations. However, these measures may not be sufficient to generate significant knowledge spillovers if the majority of local firms employ technologies that are very different from those used by foreigners. The studies reviewed in the paper suggest two additional areas for host country policy. Firstly, policies to support local technological capability and labour skills may facilitate spillovers of technology from foreign MNCs. The reason is not only that the local industry's ability to absorb foreign technology improves, but also that a more skilled local labour force reduces the costs of intra-firm technology transfer within the MNC, which is likely to encourage affiliates to import, 'more' technology from their parents. Secondly, policies to ensure that the foreign affiliates operate in a competitive environment appear to be essential. Foreign MNCs that are protected by trade or entry barriers can afford to employ obsolete technologies and still generate significant profits, without generating much diffusion of valuable knowledge and skills to local firms. Foreign MNCs facing national or international competition, by contrast, must continuously adjust their operations and technologies to changing market conditions, which creates a greater potential for spillovers to local industry.