Does Outward Foreign Direct Investment Reduce Domestic Investment?
An Industry-Level Analysis
S.N.R. Anbarasu (TU Delft - Technology, Policy and Management)
E. Schröder – Mentor (TU Delft - Economics of Technology and Innovation)
Robert M. Verburg – Coach (TU Delft - Economics of Technology and Innovation)
MPM Franssen – Graduation committee member (TU Delft - Ethics & Philosophy of Technology)
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Abstract
With the rise of globalisation, countries have become more connected financially and global cross-border investment flows have become more common. FDI is an important form of cross-border flow which is responsible for the spread of technology across countries and is the main source of external finance for emerging countries. In the last two decades, FDI has increased tremendously. But this has been accompanied by fears about outward FDI taking away production activities and jobs away from the home country. I look at how outward FDI affects home country investment. One can intuitively understand that a dollar of money spent abroad means a dollar less to invest in the domestic economy. Based on the theory of the financially constrained firm, I hypothesize that outward FDI reduces domestic fixed capital investment and R&D spending. I also develop a theoretical framework to distinguish the varying effects of outward FDI on domestic investment across traditional and R&D-intensive industries.By using industry-level panel data for 18 OECD countries covering the period 1995-2009, I regressed the shares of Gross Fixed Capital Formation (GFCF) and R&D spending separately on the share of outward FDI both for all industries as well as specifically for traditional and R&D-intensive industries. While, outward FDI had a negative effect on domestic capital investments at the aggregate level, it did not have any significant effect while looking at specific industry types. This could be because of the reduced sample size in the individual types. Outward FDI had a negative effect on domestic R&D spending at the aggregate level and for R&D-intensive industries, but it had a positive effect for traditional industries. Thus, while fears about outward FDI taking away domestic fixed capital investments are valid, outward FDI can have both a positive and negative effect on R&D expenditure, depending on the type of industry. These results can help MNCs make strategic investment decisions taking into account their effect on their home country industry. It can also help policymakers formulate tax and industrial policies to promote home country investments.