September 24, 2023

FDI Inflows: Employment and Technology Diffusion

Sanjay Roy

A SIGNIFICANT change in the composition of global trade and investment perhaps marks the process of current phase of globalisation. Two decades before, north-north trade was around 60 per cent of the global trade, north-south trade accounted around 30 per cent and south-south trade was roughly 10 per cent of global trade, which is now almost equally distributed between these three directions of trade. Also in terms of foreign investment inflows, developing countries account for roughly three-fourth of global FDI flows with a substantial rise in the past two decades.

However, the inflows are highly concentrated in developing Asia. The region accounts the largest share of global FDI inflows and within this group almost half goes to East Asia. In 2022, global FDI inflows dipped by 12 per cent amounting to 1.3 trillion dollars which actually showed a sharp rise of 58 per cent in 2021 after the pandemic. FDI inflows increased in India from 45 billion dollars to 49 billion dollars, an increase of 10 per cent in the past year. China’s FDI inflows grew by 5 per cent from 181 to 189 billion dollars during the same period. The largest inflow of FDI is accounted by the US in 2022 amounting to 285 billion dollars which of course is a smaller amount than last year’s 388 billion dollars.

The growth of foreign direct investment in developing countries is also concentrated within few countries while Africa and less developed countries record a steep fall in FDI inflows. The major investments are recorded in industries that are integrated through global production networks such as electronics, automobile, machinery and so on. Recently there has been a surge in investment in semiconductors because of the global chip shortage. India this year emerged to be the third largest host country for announced greenfield projects and second largest for international project finance deals.

Investments are driven by a relocation of production which defines the new international division of labour in the globalised world. Developing countries’ share in global FDI flows has increased by 28 percentage points reaching 70 per cent within five years 2017-22. This is also important that roughly 83 per cent of global manufacturing employment is located in the global south. This simply shows that foreign investors are keen in investing in developing countries and that has significantly altered the geography of production in the past four decades. But the share in FDI stocks which measures the level of FDI at a particular point in time is still far higher in advanced economies compared to developing countries. Even today the share of advanced countries in global FDI stocks is two-third and the developing countries account for one-third of the global share of FDI stocks.

Similarly, even though the share of FDI inflows for developing countries has increased significantly and that also of share of global manufacturing employment, but the larger share of manufacturing value added, that is 69 per cent, is still owned by the advanced economies. The rise in the share of global FDI inflows for the developing countries is more on account of China. Although developing countries account roughly 70 per cent of global FDI inflows, India’s share in global FDI inflows has only increased by 1.4 per cent in the past five years reaching 3.8 per cent of global FDI inflows while China’s share increased by 8.7 per cent during the same period and China accounts roughly 25 per cent of global FDI inflows.

The flow of foreign investment in developing countries is primarily because of cheap labour and other natural resources. Top hundred corporations have shifted 60 per cent of their production and global sales to foreign affiliates. And a study by McKinsey Global Institute estimates that offshoring reduces cost to the firm in the range of 40 to 60 per cent. This precisely explains the growth of foreign investment in developing countries. It is also important that cheap labour does not mean only unskilled labour.

In most of the MNCs the share of skilled labour and professionals use to be much higher in their total number in pay rolls, and the difference in wages or salaries compared to advanced economies is in many cases higher for professional workers compared to low skilled workers. Suppression of income or income deflation in developing countries is the prime source of surplus extraction from these regions. In fact, liberalisation in developing countries has made the huge reserve army of labour located in the global south accessible to global capital. This reserve army has different layers. In other words, a low skilled labour may not be relevant for the production facilities of a sophisticated MNC plant but such production structure requires components and services which are produced by local producers who might be depending on relatively low skilled workers. Hence the reserve army helps containing wages at different levels.

The most important questions related to FDI are issues of employment creation and technology diffusion. One may argue that even if wage differential between developing and advanced countries continues to be high and that labour arbitrage constitutes the major source of surplus creation and transfers to MNCs, but such investments create employment in the host country and generate capabilities for higher exports. True, any investment in industry may add to absolute number of employment but that possibly does not ensure net gain for developing countries. Firstly, most of these foreign investments are occurring in sectors such as machinery and equipment, chemicals, motor vehicles, electrical and optical equipment and so on which are labour intensive in advanced country standards of capital intensity but for developing countries these are not labour intensive sectors and do not create huge employment as might be the case in garments or leather industries. This is of course not to say that only investments in labour intensive industries are desirable but the point is such industries are not going to solve the huge unemployment problem in India.

Secondly, profits earned by these industries are largely repatriated to the headquarters and hence the amount that could be reinvested and the consequent impact through multiplier effects would be less. The other important fact that there is hardly any convincing evidence that suggests that expected diffusion of technology has happened in sectors where foreign investments came in the past decades. There might be some spillovers through indirect means of diffusion of human skills and knowledge but essentially the technology gap increases as property rights on knowledge has been adequately protected through various means of patenting or through royalty and copyrights. On the top of that, foreign producers tend to depend on their reliable suppliers located abroad for long and increases the import content of production as well as that of exports. Hence the social costs of subsidies and lax in implementing environmental regulations as well as the perpetual loss in potential employment and capabilities need to be factored in while assessing the gains and losses of FDI.

In fact, a large part of FDI has been heading towards developing countries particularly East Asia and that to China and India because of the high growth experienced in these countries in the past decades. The huge growth of the middle class market in China and marginally in India is one of the major reasons of attraction besides these countries being repositories of cheap labour and natural resources. Policy makers rather than becoming happy with the FDI inflows, considering them as mere source of funds, should design appropriate policies that effectively use bargaining power of the growing market to insist upon increasing domestic content of production and technology transfer. China could harness the possible gains of FDI as it could design appropriate policies for the interest of their own country and build capabilities over a period through strategic intervention rather than just succumbing to the dictates of foreign capital in order to ensure higher inflows.