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What role does trade play in international technology transfer? Do technologies introduced by multinational firms diffuse to local firms? What kinds of policies have proved successful in encouraging technology absorption from abroad and why? Using these questions as motivation, this article surveys the recent trade literature on international technology transfer, paying particular attention to the role of foreign direct investment. The literature argues that trade necessarily encourages growth only if knowledge spillovers are international in scope. Empirical evidence on the scope of knowledge spillovers (national versus international) is ambiguous. Several recent empirical plant-level studies have questioned earlier studies that argued that foreign direct investment has a positive impact on the productivity of local firms. Yet at the aggregate level, evidence supports the view that foreign direct investment has a positive effect on economic growth in the host country.
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 76675 Trade, Foreign Direct Investment, and International Technology Transfer: A Survey Kamal Saggi What role does trade play in international technology transfer? Do technologies introduced by multinational firms diffuse to local firms? What kinds of policies have proved successful in encouraging technology absorption from abroad and why? Using these questions as mo- tivation, this article surveys the recent trade literature on international technology trans- fer, paying particular attention to the role of foreign direct investment. The literature argues that trade necessarily encourages growth only if knowledge spillovers are international in scope. Empirical evidence on the scope of knowledge spillovers (national versus international) is ambiguous. Several recent empirical plant-level studies have questioned earlier studies that argued that foreign direct investment has a positive impact on the productivity of local firms. Yet at the aggregate level, evidence supports the view that foreign direct investment has a positive effect on economic growth in the host country. Economic growth results from accumulation of factors of production or from improve- ments in technology or both. To encourage the generation of new knowledge, industrial countries have elaborate systems of intellectual property rights (iprs) in place and con- duct the majority of the world’s research and development (r&d). Technologies resulting from r&d spread throughout the world via a multitude of channels. On a fundamental level, international trade in technology differs from other indirect channels of interna- tional technology transfer, such as trade in goods and international movement of factors of production. This article critically surveys the literature that explores the roles of trade and foreign direct investment (fdi) as channels of international technology transfer. With respect to fdi, a distinction is made between wholly owned subsidiaries of multi- national firms and international joint ventures. Furthermore, the role of fdi is con- trasted with that of arm’s-length channels of technology transfer, such as licensing. Although the literature has done a decent job of outlining the various channels through which international technology transfer occurs, not enough is known, both The World Bank Research Observer, vol. 17, no. 2 (Fall 2002), pp. 191–235 © 2002 The International Bank for Reconstruction and Development / the world bank 191 in theory and practice, about the relative importance of each of these channels. There is a limited understanding of the role that policy can play in facilitating international technology transfer. For example, the literature continues to debate whether in- creased openness to trade encourages economic growth. Although Dollar (1992) and Sachs and Werner (1995) find support for the view that open economies grow faster, Rodriguez and Rodrik (1999) are quite skeptical about this conclusion. As a practical matter, few economists advocate the imposition of trade restrictions. In fact, the general feeling seems to be that traditional analyses may very well under- state the true cost of protectionism because most utilize static models and do not cap- ture the dynamic costs of trade protection. Underlying this view is the notion that, somehow, trade, fdi, and interaction among countries in various other forms all play roles not only in improving the global allocation of resources but also in transmitting technology globally. How exactly this transmission occurs is not fully understood, making international technology transfer an active area of research. Dynamic trade models shed light on the complex relation between technology and trade. These models frequently lead to ambiguous welfare conclusions. The litera- ture (both theoretical and empirical) does not provide a blanket endorsement of trade as an engine for growth because introducing dynamics in an interesting fashion often requires multiple departures from the neoclassical model of perfect markets. Imper- fect competition and externalities are central to the new dynamic models of trade, and such distortions can easily lead to perverse results. Of course, the argument cuts both ways. Introducing such elements in the traditional static model also fur- nishes additional arguments in support of free trade. Nevertheless, it is difficult to make the unconditional case for free trade purely on the basis of logic. For example, see Krugman (1987) for a pragmatic argument for free trade even in the presence of market failures. It is also not the case that anything can happen if a closed economy opens up to free trade. In fact, the theoretical literature suggests that the scope of knowledge spillovers is a crucial determinant of whether trade necessarily encourages growth (Grossman and Helpman 1995). However, the empirical evidence has been mixed: some studies discover that knowledge spillovers have a limited geographical scope, whereas others find the opposite. The ambiguous nature of this empirical evidence immediately raises the following question: What factors determine the scope of knowl- edge spillovers? Clearly the scope of knowledge spillovers must be determined in part by the interaction between innovators (potential suppliers of technology) and those firms and entrepreneurs that seek access to newer technologies through imitation, technology licensing, and other forms of collaboration with innovators. In other words, a fair bit of technology transfer may indeed be endogenous. In a discussion of the special properties of knowledge as an economic good, Romer (1990) makes the important point that knowledge is a nonrival good: it can be used simultaneously by two different agents. However, this does not mean that knowledge 192 The World Bank Research Observer, vol. 17, no. 2 (Fall 2002) can be transferred across agents at zero cost. If technology transfer entailed no costs, the room for fruitful policy intervention with respect to assimilation of foreign tech- nology would be quite limited because any technology transfer that would yield even a minutely positive return to any agent would take place automatically. Pack (1992) provides an overview of what can be reasonably expected in terms of technology transfer to developing economies, given that the potential for transfers is large. The nonrival nature of knowledge only implies that if two agents are willing to pay the cost of adopting a new technology, they can do so without interfering with each other’s decisions. Much empirical evidence indicates that international tech- nology transfer carries significant resource costs (Mansfield and Romeo 1980; Ramachandran 1993; Teece 1977). In his survey of 29 technology transfer projects, Teece (1977) found that on average such costs were approximately 20 percent of the total costs of the project, and in some cases, they were as high as 60 percent. The fact that international technology transfer occurs through a multitude of channels makes it difficult to arrive at an aggregate measure of the activity and ac- curately assess its contribution to economic growth. Most research, theoretical as well as empirical, tends to focus on one or two channels of technology transfer. Of these, trade and fdi have received the most attention. If one could somehow rank the differ- ent channels of technology transfer in terms of their relative importance, empirical analysis could then proceed by ignoring the relatively unimportant channels. How- ever, given that multiple options exist in theory, the dominance of any one channel in the data would itself require explanation. Indeed, the emergence and expansion of multinational firms, given the existence of alternative arrangements for transact- ing in technology, has been viewed as a phenomenon that requires explanation. Furthermore, the various channels of technology transfer, though independent to a certain degree, are linked to each other in important ways. For example, the extent to which inward fdi contributes to technology transfer (in addition to international trade) may very well be a function of a country’s trade policy. An important chal- lenge for both theoretical and empirical research is to isolate the marginal contribu- tion of inward fdi to technology transfer and its relation to a country’s trade and investment policies. I discuss the relevant research in this survey to the extent the literature has addressed these questions. Once a technology has been introduced into a country (by a multinational firm, say), how does it subsequently diffuse throughout the rest of the economy? The pres- ence of trade barriers across countries as well as international differences in market conditions and policy environments imply that technology diffusion within a country should be considerably easier than international transfer of technology. For example, the mobility of labor is severely constrained only at the international level (excep- tions include contact with consultants and the return of foreign-educated nationals). Thus labor turnover across firms may be crucial for driving technology diffusion within a country and may not play any role in international technology transfer. This Kamal Saggi 193 article discusses the role of technology licensing, imitation, and fdi in the process of international technology transfer and its subsequent diffusion in the host country. One goal of this article is to help identify the role policy plays in facilitating inter- national technology transfer. The range of relevant policies is clearly quite large. To limit the scope of the discussion, I address the role of trade, fdi, and ipr policies. Given the central questions of interest, I discuss the literature on fdi and iprs in greater detail than that on trade policy. Blomström and Kokko (1998) review the theory and evidence regarding spill- overs from multinational firms. Unlike the present article, their survey is concerned exclusively with spillovers from fdi and does not deal with trade and the effects of policy on international technology transfer. Furthermore, they do not emphasize the endogeneity of international technology transfer. Blomström and Kokko focus on the internal diffusion of technologies introduced by multinational firms. By contrast, this article emphasizes the interaction between domestic diffusion and incentives for inter- national technology transfer. Furthermore, at least in the context of tradable goods, a relevant issue (not addressed by the Blomström and Kokko survey) is that a com- plete definition of spillovers from fdi ought to account for technology diffusion that would result in the absence of fdi but in the presence of international trade. Knowledge Spillovers through Trade Figure 1 plots worldwide exports of goods and services as a percentage of gross do- mestic product (gdp) for 1970–96. During this period, the percentage of exports in- creased from approximately 14.1 to 21.4. An interesting consideration is whether this increase in world trade yielded primarily static efficiency gains or dynamic gains by facilitating international technology transfer. An extensive literature studies the dynamic effects of trade. Much of the relevant work emphasizes two intertwined aspects of the relationship between trade and technology: that trade alters the al- location of resources in an economy and plays a role in transmitting knowledge internationally. Much of the literature on trade and international transmission of technology de- rives from closed-economy growth models. For this article, endogenous growth models are those in which economic growth results from the intentional actions of individuals who seek to profit from their investments in technological innovation. In traditional growth theory, capital accumulation is the major determinant of eco- nomic growth; a natural conclusion of this research was that unless the return to capital accumulation could stay bounded away from zero, growth would peter out or cease in the long run. A natural implication of this finding is that over time, poor countries eventually converge to the per capita income levels of the countries. How- ever, the evidence on convergence is weak; although some areas—such as the Re- 194 The World Bank Research Observer, vol. 17, no. 2 (Fall 2002) Figure 1. Worldwide Exports over GDP, 1972–96 23.0 22.0 21.0 20.0 19.0 Percent 18.0 17.0 16.0 15.0 14.0 1972 1977 1982 1987 1992 Source: World Bank (1999). public of Korea; Taiwan, China; and Hong Kong, China—have achieved enviable rates of growth for sustained periods, most developing economies do not seem to be on a path of convergence toward rich countries (Pritchett 1997). Standard neoclassical growth models assume costless technology transfer by pos- iting a common production function across countries. The fact that chosen produc- tion techniques differ across countries is not evidence against the neoclassical view; when faced with different factor prices (due to differences in factor endowments), firms typically adopt different production techniques in different countries. Thus, the issue is whether all firms can access the global pool of technologies at the same cost. Parente and Prescott (1994) emphasize barriers to technology adoption as a key determinant of differences in per capita income across countries. In their model, although any firm can access the underlying stock of knowledge in the world economy, the cost of such access differs across countries due to differences in legal, regulatory, political, and social factors. Thus in their view, some countries make it inherently costlier for their firms to adopt modern technologies and thereby retard the development of the entire economy. In fact, Parente and Prescott (1994) go on to suggest that trade may affect growth by lowering the barriers to technology adoption. In contrast to neoclassical models that stress capital accumulation, the new growth theory emphasizes technological change and the accumulation of human capital Kamal Saggi 195 (Lucas 1988). For the purposes of this survey, the literature on r&d -based growth models is clearly more relevant, and I restrict attention to this strand of growth theory. Romer (1990), Grossman and Helpman (1991), Aghion and Howitt (1990), and Segerstrom and others (1990) are among the pioneers of r&d -based models of eco- nomic growth. These models provide a coherent framework for the Schumpeterian notion of creative destruction. Although they differ from each other in important ways, the models all share the idea that entrepreneurs conduct r&d to gain tempo- rary monopoly power made possible by patents and other iprs. Grossman and Helpman (1991) provide a unifying framework for two widely used strands of r&d-based endogenous growth models: the varieties model, which builds on foundations laid by Dixit and Stiglitz (1977), Ethier (1982), and Romer (1990), and the quality ladders model developed by Aghion and Howitt (1990), Segerstrom and others (1990), and Grossman and Helpman (1991). In a closed economy, growth is sustained in the varieties model through the assumption that the creation of new products expands the knowledge stock, which then lowers the cost of innovation. As more products are invented, both the costs of inventing new products and the profits of subsequent innovators are lower because of increased competition (no products disappear from the market in this model). By contrast, the quality ladders model as- sumes that consumers are willing to pay a premium for higher-quality products. As a result, firms always have an incentive to improve the quality of products. The im- portant assumption that sustains growth in this model is that every successful inno- vation allows all firms to study the attributes of the newly invented product and then improve on it. Patent rights restrict a firm from producing a product invented by some other firm but not from using the knowledge (created due to r&d) that is embodied in that product. Thus, as soon as a product is created, the knowledge needed for its production becomes available to all; such knowledge spillovers ensure that anyone can try to invent a higher-quality version of the same product. Although r&d -based endogenous growth theory is quite appealing theoretically, empirical evidence does not provide a strong endorsement (Pack 1994). In fact, Jones (1995a, 1995b) explicitly tests the empirical implications of r&d-based growth models and finds that the data reject these implications. However, rejecting a par- ticular model of r&d- based economic growth does not imply that r&d is not an important determinant of growth. In fact, a reasonable conclusion may be that al- though r&d is crucial for the generation of new ideas (and economic growth), early variants of r&d- based growth models do not adequately capture the relationship between r&d and growth. The newer strand of growth theory has not abandoned r&d as a determinant of growth; instead, it has focused on creating models that do not have the “scale effects? that Jones demonstrates are not supported by the data. Roughly speaking, scale effects imply that large economies grow faster than small economies (see Dinopoulos and Thompson 1999 for a discussion of scale effects in endogenous growth models). 196 The World Bank Research Observer, vol. 17, no. 2 (Fall 2002) r&d-based models of growth argue that new products result from new ideas; there- fore, trade in goods could help transmit knowledge internationally. This is the cen- tral insight of many open economy growth models. Of course, trade in ideas can take place without trade in goods. Rivera-Batiz and Romer (1991) analyze two different models (the lab equipment model and the knowledge-driven model) of endogenous growth to highlight the role of trade in goods versus trade in ideas. The general con- clusion of their analysis is that trade in either goods or ideas can increase the global rate of growth if such trade allows a greater exploitation of increasing returns to scale (in the production of goods or ideas) by expanding market size. Multicountry models of endogenous growth have two strands: those that study trade between identical countries and those that have a Northern Hemisphere–South- ern Hemisphere structure. Although knowledge spillovers are central to both, tech- nology transfer in the sense emphasized here is a central feature only of North–South models. Prominent early works include Krugman (1979), Rivera-Batiz and Romer (1991), and Grossman and Helpman (1991). The literature is now rather large and a complete discussion requires a survey of its own (see Grossman and Helpman 1995). North–South models that emphasize the product-cycle nature of trade have been par- ticularly useful for understanding international technology transfer and merit some further discussion. Product-cycle models assume that new prod
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