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Policy Coherence for Development: A Background Paper on Foreign Direct Investment

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  • Thierry Mayer

Abstract

Increasing the flow of foreign direct investment (FDI) to developing countries is a cornerstone of new international development commitments. Accordingly, this paper reviews the state of knowledge regarding i) the factors that lead firms to build a plant overseas and ii) the influence that other policies (notably foreign aid) might have on those decisions. There are two broad motives for FDI: a “horizontal” motivation (to gain access to markets in the recipient country) and a “vertical” one (to exploit differences in production costs at various points in the production process). The clear message of the empirical literature (much of it focused on FDI flows between rich countries) is that market access is quantitatively far more important than production costs. What are the lessons for policy coherence? Positive effects of FDI on growth depend on a country’s absorptive capacity; aid can be used to promote human-capital accumulation while trade policies can facilitate the export orientation of the host economy. Both of these actions increase the likelihood of reaping rewards from FDI inflows. In particular, aid policies can aim at improving a recipient country’s communication infrastructure and institutional capacity. These policies attract FDI in turn, as they lower production costs and improve the prospects for productivity gains. Finally, trade facilitation between poor countries (to enlarge the market access represented by a given FDI destination) and temporary non-reciprocal market access improvements granted by rich countries could help attract FDI. Augmenter les flux d’investissements direct à l’étranger (IDE) vers les pays en développement est une pierre angulaire dans les engagements pris en terme de développement international. Dans une telle perspective, cet article évalue l’état des connaissances en ce qui concerne : i) les facteurs qui conduisent les entreprises à construire des usines à l’étranger, et ii) l’influence que les autres politiques (notamment l’aide étrangère) sont susceptibles d’avoir sur ces décisions. Les deux principaux facteurs à l’origine des IDE sont tout d’abord une motivation « horizontale » (pour gagner l’accès aux marchés du pays récipiendaire) et une autre « verticale » (pour exploiter les différences de coûts de production à plusieurs niveaux de la chaîne de production). La littérature empirique (une grande partie d’entre elle se concentrant sur les flux d’IDE entre pays riches) énonce clairement que l’accès au marché est une motivation quantitativement plus importante que les coûts de production. Quelles sont les leçons à en tirer quant à la cohérence des politiques ? Les effets positifs des IDE sur la croissance dépendent de la capacité d’absorption du pays ; l’aide peut être utilisée pour promouvoir l’accumulation de capital humain tandis que les politiques commerciales peuvent faciliter l’orientation des exportations dans l’économie récipiendaire. Ces deux actions augmentent la probabilité pour un pays de récolter les fruits des afflux d’IDE. En particulier, les politiques d’aide peuvent avoir comme objectif d’améliorer les infrastructures de communication et la capacité institutionnelle du pays récipiendaire. Ces politiques attirent alors des IDE en retour, car elles réduisent les coûts de production et améliorent les perspectives liées aux gains de productivité. Finalement, la promotion des échanges entre pays pauvres (afin d’élargir l’accès au marché représenté par une destination d’IDE donnée) et les améliorations provisoires de l’accès unilatéral au marché accordé par les pays riches sont susceptibles d’aider à attirer des IDE.

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Paper provided by OECD Publishing in its series OECD Development Centre Working Papers with number 253.

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Date of creation: 31 Jul 2006
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Handle: RePEc:oec:devaaa:253-en

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Cited by:
  1. Kang, Sung Jin & Lee, Hongshik & Park, Bokyeong, 2011. "Does Korea follow Japan in foreign aid? Relationships between aid and foreign investment," Japan and the World Economy, Elsevier, vol. 23(1), pages 19-27, January.
  2. Hakan Mıhcı & Selim Çağatay & Onur A. Koska, 2011. "The determinants of foreign direct investment outflows from the European Union countries," Economics Bulletin, AccessEcon, vol. 31(3), pages 2653-2666.

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