Internal and external armed conflicts are its key characteristics. Military coup detats are also common. Moreover, spillover effects from neighbouring countries instability often in some way affect those countries that experience internal stability.
Today FDI plays a deterministic role in growing the total volume of investment in developing countries and is likely to generate knowledge spillover effects that may raise the productivity of existing domestic capital thereby affecting growth positively. The surge in FDI flows to developing countries represents perhaps the most beneficial recent development in the relating to the whole world capital markets. In fact the main objective of the emerging economies behind attracting FDI is that they firmly believed that FDI promotes growth. This chapter attempts to better understand the meaning of FDI, next section will focus on definition of FDI, determinants of FDI and spillover effects of FDI.
2.1. Definition of foreign direct investment
There is no specific definition of FDI owing to the presence of many authorities like the OECD, IMF and UNCTAD. All these bodies attempt to illustrate the nature of FDI with certain measuring methodologies. According to the OECD Benchmark definition and the IMF Balance of payment, FDI "reflects the objective of obtaining a lasting interest by a resident entity in one economy ('direct investor') in an entity resident in an economy other than that of the investor ('direct investment enterprise'). The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise'' (OECD, 2009 and IMF, 2005:86).
The World Investment Report 2009 defines FDI as "an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or affiliate enterprise or foreign affiliate)". (UNCTAD, 2009:243)
A common feature shared by the above definitions lies in the use of terms such as 'lasting interest' and 'long-term relationship'. According to Moosa (2002) these terms are used to distinguish FDI from portfolio investment since the latter represents a short-term investment with high turnover of securities. Additionally, a non-clear distinction can complicate the assessment of the effects of FDI inflow as well as its policy formulation in the host country (Francis, 2010).
Nonetheless, there are some disagreements about the size of ownership that constitute control (Kvinge, 2008:17). For instance, while the UNCTAD (2009) consider the threshold for control of assets as being at least 10% of the original shares or voting, for the OECD (2009), the ownership of at least 10% implies that the investor can participate and exert influence on management without necessarily having an absolute control of the enterprise. For this reason the OECD considers that the 10% is not required as a threshold.
2.2. Determinants of foreign direct investment
Despite the fact that the determinants of FDI are not the focus of the present paper, it is necessary to identify them in order to understand the types and constraints in the supply of FDI and consequently its spillover effects. The pioneer in the studies of FDI determinants was Stephen Hymer with the publication in 1976 of his PhD thesis having its theoretical contributions inspired subsequent research in that area (Calvet, 1981:43).
Nowadays, the literature on FDI has identified a range of factors that determine where FDI allocated their production facilities. Those factors have been divided into microeconomic, which is related to firm performance and macroeconomic, that emphasizes the characteristics of the host country. Table 1 summarizes the major determinants of FDI identified by various authors.
Table 1: Determinants of FDI
Dunning (2000), in his eclectic paradigm, suggested a framework with three key factors to explain the extent and patterns of FDI and foreign activities of multinational enterprises (MNEs) determinants, namely, ownership, location and internalization (OLI).
Ownership - refers to the competitive advantages of the MNEs that are specific to their ownership, so the greater the advantages comparing to the ones in the host country firms, the greater the allocation of the firms abroad (Dunning, 2000:168-174).
Location - refers to the attraction of regions that can create a value added to the activities undertaken by MNEs, namely market seeking, resources seeking, efficiency seeking, asset seeking (Dunning, 2000:174-179).
Internalization - explains that if the local costs of licensing rights are higher than the net internalization benefit abroad then firms will choose to allocate their investment in other countries (Dunning, 2000:179-183).
The literature identified a fourth determinant regarding firm's factors which was not contemplated into the Dunning (2000) framework. The linkage determinants mean that firms can enhance their competences by the learning process for investing abroad (Kaplinsky and Morris, 2009:14).
All these determinants are related to the productions undertaken by MNEs and reflect the nature, strategy and competence of the foreign firms.
In terms of host country factors that motivate firms to invest across national borders two broad determinants are identified:
i) Economic context - a strong private investment record acts as a signal of high returns to capital and an adequate public investment in infrastructures can reduce the cost of doing business and raise the marginal return of FDI as well as the cost of inputs and intermediate inputs are key factors for FDI location (Dunning, 2000 and 2004 ; Ndikumana and Verick, 2008).
ii) Institutional and structural context - other studies have highlighted the institutional factors and evaluated the impact of structural reforms on FDI (Calvet, 1981; Onyeiwu and Shrestha, 2004; and Singh and Jun, 1995). For instance, in their study, Sing and Jun (1995) found that political risk, macroeconomic stability and business environment were all significant in determining the allocation of FDI.
2.3. Spillover effects of foreign direct investment
Theoretically, FDI can provide new technology, training for staff and managers, and technical assistance to local suppliers. This is positive as it improves productivity and competitiveness of local firms, forcing them to operate efficiently by transforming the knowledge acquired into practical and commercial use (Kokko, 1994 and Lall, 1976), but these gains cannot be internalized by the foreign firms. As a result this effect is known as 'spillover' effects (Fan and Warr, 2000:2).
Kugler (2006) and Zhang et al. (2010) defined "spillovers" as positive externality on local producers derived from the presence of MNEs that result in an improvement of the local firms' productivity. In this paper, spillover effect of FDI is defined as the positive (or negative) external effects of the technology transfer and diffusion from foreign to domestic firms that can lead to a greater (or less) productivity, efficiency and competition.
Table 2: Spillover effects- channels and determinants
The spillovers of FDI can occur through different channels. Table 2 shows some mechanisms that are suggested by the literature (Blomström and Kokko, 1998; Görg and Greenway, 2001; Spencer, 2008 and Zhang et al., 2010).
i) Imitation effects
This is the classical channel for new processes and products, in which the exposure to foreign technology and management practices can lead to an increase in productivity as local firms can observe and copy the best practices (Blomström and Kokko, 1998; Görg and Greenway, 2001; and Zhang et al., 2010).
ii) Competition effects
In the competition effects, if the local firms can imitate the production process from the FDI, and also make effective and efficient use of the available technology, this may result in more competition (Blomstrom and Kokko, 2003:3). In turn, greater competition leads to reduction in X-inefficiency which is the source of major gain in productivity (Görg and Greenway, 2001:6).
iii) Human capital
In human capital, positive spillover effects are created because MNEs invest in training workers (Blomstrom and Kokko, 2003). Therefore, labor migration from foreign to domestic firms generate improvements in the productivity as these workers take with them all the knowledge (direct agents of technology transfer) and the unskilled workers tend to improve their productivity (Görg and Greenway, 2001 and Zhang et al., 2010).
iv) Export effects
Export effects refer to the channels in which MNEs may serve to export to world markets, hence establishing the networking distribution and connecting local firms to foreign buyers (Aitken et al., 1994). This gives access to regulatory arrangement and other overseas information that local firms would not acquire without the FDI entry (Görg and Greenway, 2001). Consequently, exports may raise productivity due to the economies of scale, the exposure to other new production methods and practices.
v) Allocative effect
According to Blomstrom and Kokko (2003:10) foreign firms entry into countries where there are strong entry barriers improve the allocative efficiency by reducing monopolistic distortion at the same time as imposing competition pressures to host country firms and demanding from these firms high technical efficiency.
vi) linkage effects
A linkage effect is the idea that FDI can result in backward and forward linkages. These concepts were initially introduced by Hirschman (1958:98-104) to explain the interdependency between industries and how it leads to industrialization. The demand and supply of intermediate inputs by and for multinationals by local suppliers and distributors may lead to a transformation and development of local industry as knowledge, skills, techniques and technology can be transmitted (Barrios et al., 2005; Kugler, 2006; Smarzynska, 2001 and 2002; and Spencer, 2008).
Nonetheless, it is crucial for policy design to understand the nature and magnitude of the determinants of FDI efficiency spillover because there are factors that are firm specific and/or country specific which may reduce these effects (Blomström et al., 1999 and Lall, 1992). The second half of table 1 summarizes the supply and demand force that determines the spillover from FDI to local market.
On the supply side, issues such as firm size, the value of technology, organizational and managerial skills, absorption costs, and existence of commercial benefits can influence the decision to make technology available for appropriation (ibid). On the other hand, on the demand side, the absorptive capacity of firms in terms of skills and information to get new technology and transform it into production and also the degree of protectionism in some firms may make technology acquisition and assimilation difficult and delay the process of upgrading (Lall, 1992 and Zhang et al.2010).
Morrissey (2011) argued that the developing countries' government main constrain is to identifying the existing absorptive capacity to choose the right FDI policies that can fulfill those capacities. Morrissey (2011:26-28) doubt the studies on spillover effects of FDI in developing countries, especially in SSA, as the term spillover is problematic. There is no clear distinction between spillover, linkages and externalities (ibid). Domestic firms can benefit from FDI supply and demand goods and services without any transfer of technology. Hence, linkages are being created without any spillover effects and externalities from MNEs may be available even in firms that are not in transaction with them (Morrissey, 2011 and Narula and Driffield, 2011).
Additionally, the notion of spillover effects requires that some sort of knowledge and technology is being transferred from foreign firms to domestic firms but in practice studies measure spillover effects through the performance of domestic enterprises and a figure of MNEs, consequently the learning process is rarely acknowledged and studied (Morrissey, 2011). Most often a simple linkage (no technology and knowledge transfer) is treated as spillover (technology and knowledge transfer). Hence, the lesson to learn is that without linkages, spillovers do not happen but not all linkages can lead to spillovers.
Antecedents of FDI knowledge spillovers
Traditional International Business literature suggests that MNCs are provided with a knowledge endowment made up of patents, proprietary technology, trademarks and know-how, which can be transferred abroad through the establishment of foreign subsidiaries (Dunning, 1981; Carr et al., 2001). When this transfer takes place, the interaction between MNCs' subsidiaries and the local firms may produce knowledge spillovers, allowing host-country competitors to gain access to MNCs' technology (Haskel et al., 2007), and improve their products and processes.
On the light of the insights on the role of MNCs for the knowledge spillover effect, along the last years, governments have been strongly committed to adopt measures to attract and facilitate foreign direct investment, in prospect of acquiring modern technology as well as managerial, marketing and distribution skills (Singh, 2007).
Both international economics theorists and international business scholars have dedicated their research attention to these knowledge flows, the former being interested in FDI as "a mechanism that helps a country to overcome the geographic localisation of knowledge diffusion" (Singh, 2007; p.765), the latter trying to understand the consequences of this phenomenon for the international management of knowledge assets within MNCs. However, while there is a long tradition of analyses regarding the macro-level determinants of FDI spillovers, the influence that
the firm itself (and, in particular, its subsidiaries) may exert on the patterns of local knowledge outflows has started to be investigated only in latest years. The reason for this emergent attention
lies probably in the recent acknowledgement, by international business scholars, of the importance of our disciplines for a comprehensive understanding of the topic. In the following section, we review the most important contributions on both types of antecedents, at macro- and
micro-levels of analysis, and highlight their main strengths and limitations.
Vertical and horizontal spillovers from FDI
In the past decades there has been a noticeable policy competition between governments to attract FDI. Government intervention to attract multinational enterprises are based on the conviction that FDI brings several benefits to host economies. Firstly, it is believed that there are direct effects stemming from increases in the demand for labour, R&D expenditure, in addition to injection of additional capital in the host economy. All these factors are thought to have positive implications both at local and national level.
Secondly, it is generally believed that there are indirect benefits (i.e. externalities) arising from firm specific asset (FSA), such as a better production technique, know-how, or management strategy, which multinationals are supposed to posses (Caves, 1996). [1] The possibility for positive spillovers arises because multinationals may find it difficult to protect a leakage of their FSA to other firms in the host country. The public good uniqueness imply that once the FSA is out on the external market it can be used by other firms as well, due to it being in any case to some extent non-rival and non-excludable. The inability of multinationals to protect the asset is due to for instance to labour mobility between firms, but also to buyer-supplier linkages between domestic and foreign firms [2] .
Spillovers from FDI are typically classified into one of two categories according to their 'direction': horizontal (intra-industry spillovers), and vertical (inter-industry spillovers). As put forward convincingly by Blyde, Kugler and Stein (2005) , the main difference between them is that the former are more likely to involve sector specific technical knowledge that would benefit competitors. There is therefore greater incentive to prevent spillovers of this type. Possible channels through which such spillovers might occur are the acquisition of human capital (MNEs train local workers, on specific production techniques, who may be subsequently hired by indigenous businesses taking the acquired human capital therein), and imitation (reverse engineering).
Vertical spillovers are likely to concern general rather than sector specific technological knowledge and would bring benefits those firms in upstream industries (suppliers) and downstream industries (buyers) which foreign affiliates deal with. These firms represent stakeholders of the subsidiaries of MNEs, not direct competitors, and therefore foreign affiliates may have some incentive to share general technological know-how with them, in order to achieve higher degree of co-ordination and automation in their production activities, and thereby higher profits.7
The importance of buyer-supplier linkages between foreign and domestic firms for spillovers has been underlined by several authors. Dunning (1993) claimed that the incentive for foreign affiliates to share general technical knowledge with firms in upstreamand downstream sectors with which they have business linkages may have effect on both the quantity and quality of the inputs supplied. Reviewing the literature to date he affirmed there was little doubt that foreign affiliates raise the quality of inputs produced and the productivity of suppliers.
Theoretical models have dealt with the effects of linkages between foreign and domestic enterprises. Rodriquez-Clare (1996) shows how linkages between foreign subsidiaries and indigenous firms may boost the productivity of the latter. Similarly, Markusen and Venables (1999) argued that contacts between domestic and foreign enterprises (supported by production complementarities and scale economies) may foster the development of domestic sectors with wider consequences for the host region and industry. They also link vertical spillovers to market structure. Backward spillovers may occur if foreign affiliates establish a supply arrangement to encourage competition in the upstream sector.
Thus far empirical evidence about inter-industry and intra-industry spillovers have regarded
productivity only. Findings on horizontal spillovers have been so far rather inconclusive (see Görg and Greenaway (2004) for a review of the literature) with some studies even reporting negative horizontal productivity spillovers (e.g.: Aitken and Harrison, 1999). The lack of evidence of positive productivity spillovers may due to the fact that foreign affiliates are successful in avoiding leakage of sector-specific technical knowledge on which their success is based. Other studies have reported significant vertical productivity spillovers (e.g.: Smarzynska-Javorcik 2004; Girma, Görg and Pisu 2004; Blyde, Kugler and Stein 2005); this corroborates the hypothesis that MNEs might have incentives in sharing generic technical knowledge with buyers and suppliers.
