Impact of OFDI on Domestic R.docx

Impact of OFDI on Domestic R&D Activity：Evidence from Taiwans Multinational Enterprises in low-wage countriesCourse Name:International business and tradeApplicant:汪鑫强Student ID:156001337Class:International business and tradeJune 12,2016Ningbo UniversityContentsAbstract11. The Introduction of Taiwan22. Literature Review23. Theoretical Analysis34. Conclusion4References4AbstractThis paper theoretically and empirically investigates the home-country effects of a firms outward foreign direct investment (OFDI) activity, specifically OFDI motivated by lower labor costs in the host country. A two-country imperfect competition model is developed, and the interaction between a firms R&D spending and its OFDI is examined. Panel data on Taiwanese manufacturing firms from 19922005 are applied to test the validity of the theoretical results. The propensity score matching method is used to construct a comparison group without selection bias.Our theoretical evidence reveals that a Taiwanese firms OFDI is positively related to its domestic R&D spending, particularly in R&D-intensive industries.Keywords: R&D, outward foreign direct investment1. The Introduction of TaiwanTaiwans remarkable economic growth since the 1950s is regarded as one of East Asias economic miracles.Its success can be attributed to policies designed to promote exports and inward foreign direct investment(FDI).Because Taiwans capital outflows were strictly regulated until the late 1980s,it had been a net capital-importing country for several decades.However,following tremendous trade surpluses and rapidly accumulated foreign exchange reserves beginning in the early 1980s,Taiwan started to liberalize its exchange rate policy and outward foreign direct investment(OFDI)policy in the mid-1980s.Since then,the considerable appreciation of Taiwans currency and increasing labor costs have encouraged many Taiwanese firms in traditional industries to migrate to low-wage developing countries.Taiwan is now one of the largest OFDI investors in the world,particularly in mainland China.2. Literature ReviewBecause the decision to engage in FDI is typically voluntary,it is reasonable to expect that OFDI benefits MNC.However,it is not clear whether OFDI is also beneficial to the home country of the MNC. Earlier studies focus on whether production abroad complements or substitutes for exports by the parent company or by other firms in the home country. In those studies, exports are defined as synonymous with domestic production, investment or employment. Empirical results from case studies in the USA, Sweden and Japan mostly reveal a small but predominately positive relationship between OFDI and exports in the home country.3 The findings regarding the impact of OFDI on employment are mixed.For instance, Lipsey et al. (2000) find that OFDI by Japanese and Swedish MNC tends to have a positive effect on domestic employment, while OFDI by MNC in the USA tends to have a negative effect.Regarding the effect of OFDI on home-country R&D, earlier literature (such as Singh (1977) and Thirlwall (1982) suggests that a firms OFDI may replace its domestic investment, including its R&D spending. Many recent studies, however, indicate that outward investment might be beneficial to the technological advancement of industries in the home country. For instance, Cohen and Klepper (1996a,b) demonstrate that a firm that shifts part of its production activities abroad may increase its total sales due to lower labor costs or market expansion induced by its OFDI. The greater the sales are, the greater the output over which it can average the costs of R&D, leading to higher returns from R&D. Cuervo-Cazurra and Un (2007) reveal that a firm may encounter more diverse consumers and increased global competition after engaging in OFDI. Increased competition will shorten product life cycles and induce firms to engage in R&D for techno-logical advances. Diverse consumer preferences regarding quality and price might also stimulate firms R&D. In addition, MNC have more opportunities than purely national firms to learn from a variety of market and cultural perspectives, and this effect is amplified if the firms invest in R&D-intensive foreign countries (van Pottelsberghe de la Potterie and Lichtenberg, 2001). MNC also have access to a variety of diverse resources to invest in innovation. As a result, OFDI motivates firms to invest in R&D to build and maintain innovation (Hitt et al., 1997).3. Theoretical AnalysisFollowing Petit and Sanna-Randaccio (1998, 2000), we consider a model with two countries: a home country and a foreign country. Assume that each country has one firm: firm 1 in the home country and firm 2 in the foreign country. Suppose that the firms manufacture a homogeneous good and compete in the foreign market in output and R&D spending. We consider only process innovations that result in reductions in marginal and average costs.Let Ii be the level of R&D undertaken by firm i, and let ci denote firm is marginal cost (i = 1,2). The following function represents the (negative) relation-ship between firm is marginal cost and its R&D spending:ci ( , I ) = j ( A I i ) , i = 1, 2, j = h, f ,(1)where A is a constant and is considered to be the initial labor requirement per unit output, and wj is the wage rate in country j. The parameter q, with q 0, represents the productivity of a firms R&D activity. Equation (1) implies that a firm can reduce its marginal cost of production in two ways: by either lowering its labor cost or increasing its R&D. Consequently, investing in low-wage countries is a substitute strategy for undertaking domestic R&D spending, and in the present study this is referred to as the substitution effect of OFDI on domestic R&D.In addition, it should be noted that Equation (1) implies that the return on a firms R&D investment is assumed to be higher if a firm faces a higher wage rate in the home market. This suggests that the above mentioned negative impact of OFDI on R&D will be higher if the gap in the wage rates between the home and host countries is larger. The specification of the marginal cost function in this paper differs from that of most previous studies, in which the return on a firms R&D investment is assumed to be independent of the wage rates.It is assumed that firm 1 has two entry modes for serving the foreign market: exports or FDI. If the firm attempts to take advantage of low-wage labor in the host country and decides to start a new plant there, it will incur an additional plant-specific fixed cost, G. The model is specified as a three-stage non-cooperative game. In the first stage, firm 1 determines if it will serve the market via exports or FDI. In the second stage, given the entry mode of firm 1, both firms choose their R&D spending levels simultaneously. In the third stage, given their R&D spending levels, both firms choose their quantities simultaneously.We consider a linear (inverse) demand function,p = a ( q1 + q2 ) ,(2)where p is the output price, and q1 and q2 denote the outputs of firms 1 and 2, respectively. When firm 1 chooses exports as its international expansion mode, the respective profits of firms 1 and 2 are given by 1e = a ( q1 + q2 ) q1 h ( A I 1 ) + s q1 ( I12 ) 2(3) 2e = a ( q1 + q2 ) q2 f ( A I 2 ) q2 ( I22 ) 2,(4)where s is the unit cost associated with exporting activities such as transportation costs and import tariffs, and ( I22 )2 with g 0 is the cost of investment in R&D, which is assumed to exhibit decreasing returns to R&D activity. By contrast, if firm 1 decides to set up a new plant in the foreign country instead of exporting, the two firms profits are then given by 1g = a ( q1 + q2 ) q1 f ( A I 1 ) q1 ( I 12 ) 2 G(5) 2g = a ( q1 + q2 ) q2 f ( A I 2 ) q2 ( I22 ) 2.(6)4. ConclusionThis paper re-examines the impact of a firms OFDI on its domestic R&D spending.Panel data on Taiwans manufacturing firms from 1992 to 2005 illustrate that Taiwanese firms outward investment has tended to stimulated their domestic R&D spending,particularly in the 2000s.It suggests that a firms outward FDI and its domestic R&D strategy are complementary instead of substitute.The finding in this paper have important implications for a countrys investment and R&D policies.First,the positive relationship between OFDI and domestic R&D activity suggests that OFDI may be a useful method for a firm to enhance its technological advancement.Second,because Taiwan has a relatively small domestic market and strong comparative advantages in high-technology industries,in an environment with a complementary relationship between a firms overseas investment and domestic R&D strategies,glo