FDI, TNC-spread don’t necessarily lead to technology transfer

by Chakravarthi Raghavan

Geneva, 22 Feb 2001 -- Some of the current assertions and dogmas about positive correlation of trade, economic growth, intellectual property protection, foreign investment and international technology transfer came under question at a seminar at the WTO on 14 February on Technology, Trade and Development.

While acknowledging that technology is the most important determinant of competitiveness and the growth and development of developing countries, and thus depending critically on their ability to harness the latest technology, the views presented at the seminar were rather ambiguous on the dogmatic assertions about the role of IPRs in promoting FDI and technological development and trade.

A presentation by Kamal Saggi, of the Department of Economics at the Southern Methodist University of Dallas, Texas (and a study of literature prepared by him for the World Bank) suggested that there can be no automatic assumption that Foreign Direct Investment (FDI) necessarily contributed to the transfer of technology and strengthened IPRs protection in the South.

In another presentation at the seminar, the Indian ambassador, Mr. S.  Narayanan, said that available evidence in fact showed that there was “some sort of negative correlation between FDI and transfer of technology.” He noted that Prof Saggi’s presentation (as also that of two WTO staffers) clearly brought out that there could be no assumption that FDI necessarily contributed to transfer of technology.

Both Narayanan, and earlier, Zambia’s Edward Chisangu, stressed that technical assistance and technology transfer were not one and the same.

While it is necessary to provide encouragement to innovation and creativity, said Narayanan, such encouragement should not conflict with broader public policy objectives. There has to be a balance between enhanced private profits to encourage innovation and broader public interest. “This balance between private profit and public good has not been arrived at properly in the TRIPS Agreement,” he said, noting that even the World Bank and the UNDP have officially acknowledged that TRIPS went too far in favour of private profits. TRIPS has not promoted transfer of technology, though Articles 7 and 8 of the TRIPS were meant to facilitate transfer of technology, but both these articles have no operational content. And TNCs were not interested in transfer of technology.

At the WTO seminar, Ms Lee Tuhill of the WTO’s Services Division, promoted the view that liberalization of trade in services and market access commitments of developing countries are “transfer of technology provisions” favouring developing countries.

[The same point has also been made by the WTO Director-General Mike Moore, in a recent article in the Canadian newspaper, Globe and Mail, and reproduced in the WTO’s daily file of clippings. Moore, in attacking NGO critics, and dubbing them as suffering from paranoia, has claimed that the WTO’s Services Agreement, and the freeing up of trade in commercial services would mean access to vitally needed technology and capital investments.]

The Indian envoy at the seminar questioned Tuhill’s views, saying he could understand the interest of major developed countries in getting into the services market of developing countries, but did feel concerned when a secretariat official argued as she did. “If a developing country opened up its telecom sector completely and allowed 100% foreign equity holding, and a company like the US firm AT&T established a presence, and people had mobile phones, “does it mean that technology transfer has taken place... Are foreign companies willing to allow local people in R&D work, and whether foreign companies are willing to transfer technology to a local company over a period of time?” Developing countries, the Indian envoy suggested, could legally attach some limitations to their market access commitments in services, and provide that foreign equity participation is subject to the condition that local people are involved in R&D or that technology would be transferred locally over a period of time.”

Another WTO official, from the investment division, however said that putting conditions for foreign entry into the services sector would be ‘counter-productive’.

Narayanan disagreed and said that it was up to the developing countries, in the ongoing mandated negotiations on services, to exploit fully the provisions of GATS and to ensure transfer of  technology.

On the view that since most of the technology is held by the private sector, there is no point in discussing technology transfer issues at the WTO, Narayanan said that governments had undertaken enormous obligations under TRIPS. But when the provisions of the TRIPS agreement, like those in Articles 7 and 8, were not being implemented, they could not be told it was a private sector issue. “We cannot accept a situation where it is effectively being said that provisions of the TRIPS favourable to developing countries are not enforceable, while obligations undertaken by developing countries are,” he added.

In his paper, made available at the seminar, in surveying trade literature on international transfer of technology, Saggi notes that economic growth results either from accumulation of factors of production or from improvements in technology or both. And, while there are various potential channels through which international technology transfer takes place -  international trade in technology, trade in goods and international movement of factors of production - not enough is known, both in theory and practice, about the relative importance of each of these channels, thus limiting the understanding on the role policy plays in facilitating the process of technology transfer.

There is also the notion that, somehow, trade of goods and services, FDI and interaction among countries play a crucial role in improving global allocation of resources and transmitting technology globally.  But how this takes place is not fully understood.

Trade models shed little light on relationships between technology and trade, and often lead to ambiguous welfare conclusions. Existing literature, theoretical or empirical, do not provide blanket endorsement of  trade as an engine of growth either. In theory, knowledge spillovers may be a crucial determinant of whether or not trade necessarily encourages growth, but empirical evidence does not settle the issue either.

In Saggi’s view, a central role in knowledge spillovers is the interaction between innovators, as potential suppliers of technology, and firms and entrepreneurs seeking to gain access to newer technologies “either through costly imitation, technology licensing or other forms of collaboration with innovators.” A fair bit of technology transfer, Saggi implies, may indeed be endogenous.

And when a technology does get introduced into a country, how does it diffuse across the country? He suggests that labour turnover across firms may be crucial for driving technology diffusion within a country.

Another presentation at the seminar, by two WTO staffers from the Economic Research and Analysis division (Marion Jansen and Roberta Piermartini), said that while FDI is a channel through which foreign technology is transferred to the host country, a minimum level of human capital is necessary to apply foreign technology efficiently. Also, foreign technology could spread to other domestic firms or sectors through labour mobility, the two said, citing the example of the garment industry in Bangladesh.

But given that the skills in this case are at a lower end of the technology/industrial ladder, this leaves the question open about diffusion in newer and high-technology areas, and some of the contracts of employment that foreign corporations (more so in the services area, such as financial services) write-in, to ensure that local employees leaving their service can’t set up either their own business or join rival firms for a given period of time.

In fact, at a meeting with African trade negotiators in the services sector, the US coalition of service industries this week said that their objective for  the new round of service talks is to  increase market access in Africa (and the developing world) and have rules to ensure that their local employees do not transfer their skills by joining rival firms or starting up their own in competition.

Standard neo-classical economic growth models that capital accumulation is the major determinant of economic growth and over time, one should expect poor countries to converge to per capita income levels of the rich. However, evidence of such convergence is weak, and most developing countries are not on a convergence path with the rich.

These models assume technology transfer to be costless, and that trade barriers (and differences in legal, regulatory, political and social factors) come in the way of technology adoption, and if trade is liberalised, technology acquisition will be less costly.

Other models and theories emphasising endogenous technological growth, have the common idea that entrepreneurs will conduct R&D to gain temporary monopoly power, where this is made possible through IPRs and thus strong IPRS regimes will promote innovation, and thus human capital accumulation, and growth and development.

However, the Saggi paper notes, while the R&D-based endogenous growth theory is appealing, empirical evidence does not provide a strong endorsement.

As for knowledge spillovers and the role of trade, while some studies suggest that international R&D spillovers are substantial and international trade is an important channel, another study (Hakura and Jaumette, IMF Working Paper No WP/99/58), using data for 87 countries, shows that trade indeed serves as a channel for international technology transfer to developing countries, and that inter-industry trade plays a stronger role in technology transfer than intra-industry trade.  Comments Saggi: “Since intra-industry trade is more pervasive among developed countries than it is between developed and developing countries, an immediate implication of their findings is that developing countries will enjoy relatively less technology transfer from trade than developed countries.”

As for FDI, technology transfer and spillovers, the Saggi paper says convincing evidence is hard to find, but there are several facts pointing in that direction, and cites in this regard the UNCTAD World Investment Report (1997); that over 80% of global royalty payments for international transfers of technology were made from subsidiaries to their parent firms.

But does this lead to spillover or diffusion of the technology inside the country?

Saggi raises the question (in a footnote) that it may not be reasonable to expect spillovers, since it may be natural for the transnational to prevent spread of their technologies to potential rivals - with a possible exception of diffusion to potential suppliers of inputs or buyers of goods and services sold by the TNC.

The potential channels of spillover are: demonstration effects (firms adopting technologies introduced by TNCs through imitation or reverse engineering); labour turnover (workers transferring important information to local firms by switching employers or starting their own firms); TNCs transferring technology to potential suppliers of intermediates or buyers of their own products.

The empirical evidence on the geographical scope of R&D spillovers is mixed, and the studies that reach optimistic conclusions typically involve data from industrialized countries and require qualification.  In terms of demonstration effects, FDI may expand the set of technologies available to local firms, but a mere expansion in choices need not imply faster technology adoption. The net effect on incentives for adopting new technologies may indeed be ambiguous.

A point not clearly addressed in the paper is whether WTO-TRIPS and its enforcement enable or inhibit imitating and reverse engineering, though Saggi (in an unpublished mimeo) appears to suggest that stronger IPRs may have an endogenous decline in imitation (by increasing the costs).

Overall, says Saggi, several studies have cast doubt on the view that FDI generates positive spillovers for local firms, though this does not imply that host countries have nothing significant to gain from FDI: domestic firms may suffer from increasing competition, and relatively inefficient domestic firms will be weeded out, and resources thus released will be put to better use.

As for labour turnover, and the technology diffusion that results, Saggi notes that policies designed to encourage technology transfers do not always raise the welfare of recipient countries. Local competition policy may also effect labour turnover. In many industrialized countries, trade secret laws protect firms against loss of valuable information to their rival firms, though it is difficult to see how such laws can protect against the kind of basic technology diffusion resulting from labour turnover from TNCs in developing countries.

Saggi notes that it is difficult to see how technology spillovers from FDI can ever be in the interests of the TNCs. Under most circumstances, TNCs would rather limit diffusion in the local economy. In fact, the whole theory of emergence of TNCs is that such firms are able to compete with local firms precisely because they possess superior technologies, management and marketing. Why then would TNCs not take actions to ensure that such diffusion to local competitors do not take place? Such actions are of course costly. A difficulty could arise if all potential TNCs benefit from curtailment of technology diffusion, but only one takes legal action.

Developing countries hosting TNCs may expect rivalries among such firms to result in some degree of technology diffusion. TNCs can take actions to limit diffusion, and while making their decisions as to where to set up subsidiaries, the expected costs of technology diffusion will enter their calculus of profit maximisation.

[However, under WTO-TRIPS and the dispute mechanism, and the push for investment rules, in fact, may result in the cost of safeguarding the rights of the foreign investor and preventing technology diffusion falling on the host country.]

What is the effect of IPRs’ enforcement on host countries?

Saggi cites a 1993 study by Elhanan Helpman, providing a detailed welfare analysis of IPRs enforcement in the South, showing that a strengthening of IPRs protection is not in the interest of the South and that imitation in the South may even benefit the North, provided the rate of imitation is not too fast.

Treating stronger IPRs protection as an endogenous decline in imitation due to increased imitation costs (stemming from stricter uniqueness requirements), and where Southern imitation targets both TNCs producing in the South and purely Northern firms producing in the North, a study (by Amy Glass and Kamal Saggi, 1999) finds that FDI decreases with the strengthening of Southern IPRs protection. An increase in the cost of imitation is found to crowd out FDI through tighter Southern resource scarcity. Additionally, the contraction in FDI tightens resource scarcity in the North

Saggi also points out that while products like books, videos and CDs (and their imitation) receive much media attention about conflicts over IPRS protection, imitating most products is not simple, and imitation is indeed a costly activity for a wide-range of high-tech goods such as chemicals, drugs, electronics and machinery   - the costs averaging about 65%, and very few below 20%.-SUNS4843

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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