Foreign Direct Investment

The literature on MNEs has made important advances that inform policymakers. In particular, this VoxDevLit highlights how quantitative models provide frameworks to evaluate aggregate gains from MNE integration at the country-level in a multi-country context. This is an important advance given that MNEs influence multiple factor and product markets within countries, affect international trade flows, and operate across many countries. These quantitative models also provide useful frameworks for evaluating the economy-wide effects of MNEs related to the environment, climate, and assessment of climate risk, implications of MNEs in natural resource sectors, and how MNEs and responsible sourcing practices impact employment and wages in the overall economy. 

The empirical literature has made large progress on measuring and identifying linkages to local firms, implications of MNEs for the environment, and labour market effects. High-quality representative data on MNEs and their supply chain linkages has been identified as key for the research progress achieved on the topics covered in this survey.  Such data, often available for individual countries, have been assembled by matching different datasets such as customs data, economic censuses, and value-added tax databases often maintained by the country’s tax authorities. Importantly, researchers have also increasingly relied on randomised control trials that allow for a detailed evaluation of a particular mechanism at hand in the relationship between MNEs and third-parties in lower-income settings (see specific examples in natural resource and labour section). 

Despite these advances, some remaining open questions remain. First, gaps in data have been identified as a key barrier to research progress in all reviewed topic areas. Policymakers should prioritise building data systems and collaborating with researchers to better understand and manage MNE impacts. Second, it is important that researchers continue to use multiple methodologies to assess the impacts of MNEs. These range from quantitative frameworks, to structural models and estimation that take into account the nuances of institutional details of industries and market structure, and to well identified empirical studies examining the implications for outcomes in local labour markets or communities, to randomised control trials recently used to examine the effects of MNEs on labour standards and the interactions of MNEs with producers and intermediaries in lower-income settings. As discussed in the survey, the appropriate methodology depends on the question at hand. Third, the chapters identified and discussed several open areas for future research ,which we briefly review below. 

The macroeconomy: While quantitative models have been useful in addressing the overall macroeconomic effects of MNEs on an economy, they currently do not incorporate knowledge spillovers from multinationals to local firms or workers.  They also do not allow for multinational engagements that simultaneously involve horizontal and vertical linkages. In addition, more work is needed to understand the role that MNEs play in transmission of various shocks across countries and synchronisation of international business cycles.

Linkages with local firms: First, further research should seek to establish whether the results about linkages between the MNE and domestic competitors within an industry (i.e. so called horizontal linkages) are driven by the firm's foreign ownership or merely by its large size. Second, while the existance of positive vertical linkages between MNEs and local firms are better identified in recent research, the question remains open as to whether the observed productivity gains are externalities. More research is also needed on the extent to which MNE affiliates actually rely on local supply chains, the reasons behind their low reliance, and the scope for policymakers to intervene to increase this reliance. Finally, opening to FDI in service sectors such as banking, insurance, telecommunications, and electricity provision is likely transformative for domestic firms in downstream sectors. Further work is needed in this area that can better address whether the positive downstream effects in part reflect the endogenous timing and structure of FDI liberalisation episodes in service sectors and the role that more concentrated market structure in services plays for downstream effects. 

Environment: First, despite substantial evidence showing that foreign-owned plants emit less, we need to learn more about the mechanisms behind this result. Evidence is also mixed about whether MNEs from countries with stricter environmental regulations reallocate their dirtier production to countries with laxer policies. More research is also needed about the environmental spillover of MNEs to domestic firms.  Although evidence is mixed, carbon leakage is an important concern, particularly in industries that are both trade-intensive and energy-intensive and requires further research (see chapter for details). Second, evidence suggests that emerging economies are increasingly becoming a source of technology transfers in clean technologies. However, much of the research on clean technology transfers has focused on MNEs from high-income countries. A key open question is how new companies from China and India might play a role now for other low-income countries, having benefited from FDI themselves over the years. Finally, while research on the exposure and adaptation of MNEs to climate risk is emerging, substantial knowledge gaps remain.

Natural resources: Because a small number of large MNEs often operate in natural resource sectors, it is important to continue to consider the role of MNEs for host economies in these sectors. The research in this area—quantitative and empirical—is still small. As the chapter highlights, there is substantial scope for progress in terms of modelling economic features that are ubiquitous in markets of natural resources, including oligopoly and market power, the investment decisions and strategies for expanding supply chains under uncertainty, and optimal policy design to maximise the potential benefits of MNEs where they are heavily involved in commodity markets. 

Labour markets: The survey has identified several open questions on the effects of MNEs on labour markets and labour standards. For example, research needs to incorporate the connections between MNE activities and the informal sector, which accounts for a large share of the workforce in lower-income countries. Likewise, it is important to consider how MNE jobs influence economy-wide employment and wages in the presence of unemployment or underemployment, that MNEs, directly or indirectly, help employ. Finally, randomised control trials that help us further understand the incentives or collaboration practices that encourage enforcement and compliance with labour market standards, seem a promising way to continue to understand how MNEs influence labour market conditions through labour standards in settings with weak enforcement and employer market power. The same applies to further exploring relational contracting of MNEs with third parties in global value chains.