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Global Trends in R&D-Intensive FDI and Policy Implications for Developing Countries
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Global trends in R&D-intensive FDI and
policy implications for developing countries1
José Guimón, PhD
Department of Economic Structure and Development Economics
Universidad Autónoma de Madrid, Spain
Abstract: This paper reviews recent global trends in the international allocation of
corporate R&D centers and discusses the policy implications for developing countries.
First, in recent years global R&D networks are becoming more multi-polar, with a
growing relevance of developing countries both as destinations and as sources of R&D-
intensive FDI. However, this is largely associated with the growing importance of
China and India in corporate innovation networks, while many developing countries
remain excluded. Second, the fast growth of R&D-intensive FDI during the 1990s may
be shifting towards a period of stagnation given the maturation of corporate R&D
networks and the effects of the 2007-2010 economic crisis. Third, the changing strategic
motivations behind R&D-intensive FDI are discussed. Building on these trends, the
paper concludes with a discussion of some policy options available to attract and embed
R&D-intensive FDI.
Keywords: absorptive capacity, FDI, innovation, multinational companies, R&D,
spillovers
1. Introduction
The growing relevance of R&D-intensive foreign direct investment (FDI) reflects wider
trends in the global economy. Multinational companies (MNC) are gradually modifying
their strategies and spatial organization, involving an on-going fragmentation of their
international value chains in the search of sustainable competitiveness. This applies to
their manufacturing, logistics, sales or administrative functions, and increasingly also to
R&D activities. Indeed, corporate R&D is gradually evolving from a centralized and
hierarchical node of global supply chains towards one that builds upon an open network
of geographically dispersed R&D centres. As a result, R&D-intensive FDI has grown
substantially since the early 1990s, albeit with significant differences across industries
and countries. Given that MNCs undertake the bulk of global R&D expenditure, their
location decisions determine to a large extent the geography of R&D activity (Jaruzelski
and Dehoff, 2008).
R&D-intensive FDI can be defined as an investment involving a lasting interest and
control by a resident entity in one economy in an enterprise resident in another economy
1 This paper builds heavily on a background report prepared by the author for a High-Level Policy
Workshop organized by the World Bank (“Innovating Through the Crisis”, Dubrovnik, Croatia, June
2011). The usual disclaimers apply.
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for the purpose of deploying R&D activities (UNCTAD, 2005). This may occur through
greenfield investments (creation of a new R&D center overseas by a multinational
company or expansion of an existing subsidiary), through transnational mergers and
acquisitions (M&A) (full or partial acquisition of a domestic company active in R&D
by a foreign company) or through transnational joint ventures (joint ownership of an
R&D center by foreign and domestic entities). In addition to these different possible
entry modes, there are many different types of R&D activities that MNCs may
internationalize, reflecting different strategic motivations. The R&D activities may be
demand-driven, supply-driven or efficiency-seeking; global, regional or local in scope;
radical or incremental; product or process oriented; autonomous or highly integrated
into the global R&D value chain; and so forth (Bas and Sierra, 2002; Florida, 1997;
Kuemmerle, 1999; Sachwald, 2008).
This implies that R&D-intensive FDI is a very heterogeneous phenomenon; in
particular, one must consider the different strategic motivations and entry modes in
order to better frame its developmental impact and policy implications for host
economies. Moreover, although we focus on R&D-intensive FDI as defined above, it
should be understood as part of a wider process that can be characterized as the
globalization of technological innovation (Archibugi and Iammarino, 2002). This
includes not only R&D-intensive FDI but also international collaboration in R&D,
transnational technology contracts and licensing, international technological alliances,
and international trade of high technology products. Indeed, from a development and
policy perspective the critical issue is the nature and extent of cross-border
technological linkages, rather than whether these linkages are organised intra-firm
(through FDI) or inter-firm (through contracts and alliances). Moreover, it should also
be acknowledged that MNCs may undertake other modes of innovation other than
R&D, which may have an equivalent effect on learning, innovation and competence
building in host economies. Under a broad view of innovation, the role of MNCs is not
limited to its contribution to R&D efforts but also to organisational change and new
business models; marketing, branding and design; etc.
R&D-intensive FDI is expected to bring significant benefits to host countries by
enabling an upgrading of technological capabilities as well as a better access to
international markets (Cantwell and Piscitello, 2000; Carlsson, 2006; Santangelo, 2005).
In view of the potential benefits, attracting (and embedding) R&D-intensive FDI is
becoming a critical concern for policymakers across developed and developing
countries alike. But the benefits associated with R&D-intensive FDI do not accrue
automatically; a threshold level of absorptive capacity is required in order to tap into
the potential externalities2. The impact of R&D-intensive FDI on host countries
comprises direct and indirect effects (Görg and Strobl 2001; Narula and Dunning,
2010):
Direct effects are associated with a net increase in domestic R&D activity, involving
more R&D expenditure and the quick creation of job opportunities for highly skilled
labor. The direct benefits will be larger when the subsequent R&D activities of MNC
subsidiaries complement (rather than replace) the R&D activity of local companies.
Still, some extent of crowding-out of the technological activity of local firms can be
2 Absorptive capacity can be defined as the firm‟s (or country‟s) ability to acquire, assimilate and exploit
knowledge developed elsewhere (Cohen and Levinthal, 1989).
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expected through intensified competition for limited specialized assets, including
human capital. The risk of crowding-out is especially acute in the case of transnational
M&As, where the only short term effect for the host country is a change of ownership,
while in the medium- to long-run there is a trade-off between the potential for expansion
and upgrading, on the one hand, and the risk that the acquirer ends up reducing the
subsidiary‟s R&D mandate to avoid duplicities with other pre-existing R&D centers
within the MNC‟s global network, on the other hand.
Indirect effects relate to the impact of innovative MNC subsidiaries on other actors of
the national innovation system through different types of formal and informal linkages
and knowledge spillovers. Among other indirect effects, R&D-intensive FDI may
enable locally produced components to be incorporated at the design stage of new
products, opening up new markets for local suppliers and new opportunities to
collaborate with MNCs. R&D-intensive FDI facilitates the transfer of tacit
technological knowledge, which is hard to acquire by other means. Besides
collaborative agreements with local firms and research centers, knowledge spillovers
also unfold through indirect employment effects, whereby the host country benefits from
training provided by MNC subsidiaries to their employees, who subsequently become
available to local firms through the job market or may establish new ventures
themselves (Fosfuri et al., 2001). Other sources of indirect benefits are demonstration
and competition effects, because the presence of innovative MNC subsidiaries spurs
domestic firms to engage in R&D and enhance the efficiency of their operations to be
able to compete. In contrast with direct effects, indirect effects may be larger in the case
of M&As, given that the acquired subsidiary will tend to be more embedded in the local
economic in terms of vertical and horizontal linkages with local firms, universities and
agencies.
Measuring R&D-intensive FDI is not straightforward, since the indicators and statistical
sources available are limited. Moreover, there are different ways of measuring R&D-
intensive FDI, depending on whether the objective is to measure the flows or the stocks.
R&D-intensive FDI flows are the new FDI projects during a certain year(s) which are
connected to R&D. The problem is that official statistics (from national governments,
UNCTAD, etc.) do not provide a functional breakdown of FDI; at best they inform of
its industrial distribution. There are, however, other databases3 that provide detailed
information about new FDI announcements, allowing the analyst to identify the specific
FDI projects where the main activity concerned is R&D. In contrast, when analyzing
R&D-intensive FDI stocks, the unit of analysis is the R&D activity of the whole
population of MNC subsidiaries located in the country concerned. Thus, the main
indicator of R&D-intensive FDI is the R&D expenditure by MNC subsidiaries, often
expressed as a percentage of total business expenditure in R&D4. The R&D intensity of
foreign-owned subsidiaries can be compared with the R&D intensity of nationally-
owned firms5. Further comparisons of the innovative behavior of MNC subsidiaries
versus national firms can be performed using the information provided by official
3 For example, the fDi Markets database of Financial Times or the European Investment Monitor database
of Ernst and Young. 4 The OECD compiles this indicator since the early 1990s, although not all OECD countries are covered.
5 Aggregate comparisons of R&D-intensities need to be done with care, controlling by industry and firm
size as well as considering the potential distortive effect of corporate transfer pricing strategies (Barry,
2005).
4
innovation surveys (e.g. the Community Innovation Survey, for EU countries) or
through new surveys developed for specific research purposes. An additional possibility
for measuring the internationalization of corporate R&D is to use patent data, as patent
applications inform of the address of both the inventor and the applicant, such that when
they are located in different countries this generally reflects the internationalization of
MNCs innovative activities (Guellec and Pottelsberghe, 2001).
In this paper we use data on R&D expenditure of foreign-owned subsidiaries from the
OECD and then rely on the fDi Markets database to further analyze geographical and
industrial trends. This database comprises greenfield FDI project announcements,
excluding M&As. The information in the database is compiled by the Financial Times
Group through global, national and regional media; financial information providers;
corporate websites; and government websites. Despite its limitations, this is one of the
few sources to identify R&D-intensive FDI projects, because it provides information
not only of the sector but also of the business activity associated with each investment
announcement. By selecting only the FDI projects where the business activity is R&D
the flows of R&D-intensive FDI can be proxied6. This database provides a sample of
2275 announcements of FDI in R&D project announcements around the world starting
in 2003 and is updated several times per year.
Building on an analysis of these statistical sources and on a literature review, the rest of
this paper discusses some key global trends which may be relevant to shape government
policies aimed at attracting and embedding the R&D of multinational companies.
Section 2 argues that the fast growth in R&D-intensive FDI during the 1990s may be
shifting towards a period of stagnation given the maturation of corporate R&D networks
and the effects of the 2007-2010 economic crisis. Section 3 shows that in recent years
global R&D networks are becoming more multi-polar, with a growing relevance of
emerging countries both as destinations and as sources of R&D-intensive FDI. Section 4
elaborates on the evolution of strategic motivations behind R&D-intensive FDI. Finally,
Section 5 attempts to translate these global trends into a set of policy implications for
developing countries.
2. Is the recent growth of R&D-intensive FDI coming to an end?
Although it is not a new phenomenon, the internationalization of R&D accelerated
sharply during the 1990s, partly as a side effect of the internationalization of production
and of the rise in transnational M&As, and partly as a deliberate strategy of building up
global innovation networks by MNCs. A study by Booz Allen Hamilton, a consulting
firm, indicates that the largest 1000 companies by R&D expenditure allocate on average
55 percent of their R&D budget outside the countries where they are headquartered
(Jaruzelski and Dehoff, 2008). Other interesting findings of this study are that 91
6 This implies underestimating to a certain extent the R&D that occurs through FDI, because projects that
are classified in a different business activity such as manufacturing may also bring along some associated
R&D expenditure even if it is not the main focus of the project (besides R&D, other business activities in
the database include sales, marketing & support; manufacturing; business services; retail; distribution &
transportation; customer contact centers; extraction; retail; headquarters; and others). Moreover, the
database is not exhaustive: there may be some other FDI projects that are not accounted for by fDi
markets database because they do not appear in the primary sources used to gather the data.
5
percent of MNCs conduct some R&D in their subsidiaries abroad and that their total
number of overseas R&D sites increased by 6 percent from 2004 to 2007.
Global estimates from the United Nations Conference for Trade and Development show
that in 2002 firms allocated 15.9 percent of their R&D expenditure in their subsidiaries
abroad, up from 10.3 percent in 1993 (UNCTAD, 2005). This implies that the R&D of
foreign-owned subsidiaries grew much faster than the R&D of local firms. More recent
estimates show that the internationalization of corporate R&D continued growing from
2002 to 2006 in most OECD countries (OECD, 2009). A similar picture emerges by
looking at other indicators of the internationalization of corporate R&D, such as the
share of total patents that originate from foreign-owned MNC subsidiaries (Guellec and
Pottelsberghe, 2001).
The growing relevance of foreign MNC subsidiaries in domestic R&D effort is
widespread, but there are large differences across countries in the actual level of foreign
participation, reflecting not only their different attractiveness for R&D-intensive FDI,
but also their degree of openness and the intensity of R&D by national firms. In 2006
the share of foreign affiliates in domestic business R&D was 5.4 percent in Japan, 13.8
percent in the US, around 30 percent in most European countries7, and over 60 percent
in Slovakia and Ireland (OECD, 2009). Table 1 shows the evolution of this indicator
from 1994 to 2006 in a set of OECD countries. It is worth noting that the relevance of
foreign subsidiaries in domestic R&D expenditure rose in all countries of the sample
and that this trend is especially intense in Eastern European countries.
*** TABLE 1 HERE ***
With regard to industrial trends, it can be expected that R&D-intensive FDI will
concentrate in the most global and high technology sectors such as pharmaceuticals and
ICT. However, the internationalization of R&D extends across many different sectors,
as illustrated in Table 2 by the specific case of inward R&D-intensive FDI into the EU.
Therefore, although it makes sense to design specific policy strategies for the dominant
industries, it is worth also to be open-minded and look for opportunities in other market
niches. Another trend to consider is the growing importance of R&D in the services
sector: in contrast to R&D in manufacturing, which has shown little growth in recent
years, R&D in services is growing rapidly in most countries, and this trend also reflects
itself in the internationalization of corporate R&D (European Commission, 2007).
*** TABLE 2 HERE ***
With the global economic crisis that started in 2007, there was a sharp decline in global
FDI flows, albeit with a slight recovery starting in 2010 (UNCTAD, 2010). It can be
expected that R&D-intensive FDI flows also declined or at best stagnated. Indeed,
between 2007 and 2010 a total of 1004 greenfield FDI in R&D projects were recorded
globally, compared with 1271 from 2003 to 2006, which represents a 26.6 percent
decline (Source: fDi Markets database).
7 The figures for EU countries include intra-EU investment flows, i.e. when a firm based in a EU country
conducts R&D in another EU country. Therefore they are not directly comparable with the US, where
inter-State flows are excluded.
6
Even before the crisis unfolded, Gammeltoft (2006) argued that “the fire growth in
R&D internationalisation, well documented in the previous literature, may have come to
an end” and that the focus is now shifting towards the “organisational consolidation of
the existing complex international R&D structures”. Similarly, Hegde and Hicks (2008)
spoke of a “maturation” of globalized corporate R&D.
After the fast expansion of global innovation networks during the 1990s - sometimes
fuelled by international M&As rather than by deliberate R&D internationalization
strategies - in many cases the resulting structures turned out to be overly complex and
unmanageable, leading many MNCs to streamline their organisations and exert a larger
hierarchical coordination (Gammeltoft, 2006). It is reasonable to assume that the crisis
has further spurred the restructuring of global R&D networks in search for efficiency,
possibly resulting in divestments in some countries but expansions in others. In a survey
of the 1000 largest EU companies by R&D expenditure, over half of respondents made
changes to the management of their R&D investments as a result of the economic crisis,
concentrating their research agenda via reallocation of resources, narrowing of focus,
and higher outsourcing of R&D work (European Commission, 2010). Filippetti and
Archibugi (2011) show that, within the EU, MNC subsidiaries located in Eastern
Europe are those that have suffered the larger cuts in R&D activity following the 2007-
2010 economic crisis, compared to the more important R&D nodes placed in the
Western Europe.
3. The shift towards developing countries
R&D-intensive FDI was formerly a triadic rather than global phenomenon, with both
inflows and outflows heavily concentrated in the US, Western Europe and (to a lesser
extent) Japan. However, during the last decade the relevance of developing countries in
global innovation networks has increased substantially8. This can be ascribed largely to
the sharp increase in new R&D investments by MNCs in China and India during the last
decade, although starting from a very low base: the number of R&D centers owned by
foreign MNCs rose from only 100 in each of the two countries in 2001 to 1100 in China
and 780 in India by the end of 2008 (Bruche, 2009). According to Jaruzelski and Dehoff
(2008) eighty-three percent of all new R&D sites opened between 2004 and 2007 by the
largest 1000 MNCs by R&D expenditure were located in China or India.
Based on Ernst and Young‟s fDi Database, Table 3 shows the geographical distribution
of FDI in R&D projects from 2003 to 2010. From 2003 to 2010 there were a total of
2275 announcements of new FDI in R&D projects in the world, out of which 43 percent
were located in Asia-Pacific. Western Europe attracted almost 25 percent of all new FDI
in R&D projects during that period, while the share of North America was around 13
percent9. The table also indicates the share of R&D projects in total inward FDI by
region. For example, in Western Europe around 2.3 percent of all new FDI projects
were directly related to R&D, while in the rest of Europe the share was below 1 percent.
It is worth noting that R&D-intensive FDI projects are not employment-intensive: on
8 It is important here to differentiate between flows and stocks: although developing countries are
attracting a growing share of new flows of R&D-intensive FDI in recent years, they still represent a lower
share of the total stock, and thus of the total overseas R&D expenditure by MNCs. 9 However, it should be noted that the EU figure includes intra-EU investment flows (see note 3).
7
average, each new R&D center opened by foreign-owned firms in EU 27 countries
between 2003 and 2010 created just 86 new jobs.
** TABLE 3 HERE **
From a different perspective, with outward FDI from developing countries rapidly
increasing, emerging market multinationals have also become important sources of
R&D-intensive FDI (Sauvant et al., 2010). For example, Chinese and Indian companies
such as Huawei, Tata or Lenovo operate large R&D centers in the US and Europe in an
effort to enhance their global competitiveness by tapping into foreign sources of
knowledge and leading technological clusters. This also applies to other developing
countries (e.g. Brazil, Russia, South Africa), newly industrialized countries (e.g.
Singapore, South Korea, Taiwan) and oil producing Arab countries.
Developing and transition economies are increasingly aware of the importance of R&D-
intensive FDI and its role as a mechanism for technological transfer and catching-up.
But a critical challenge is that many developing countries lack the absorptive capacity,
large markets and specialized clusters that MNCs are looking for when deciding where
to locate their international R&D activities. Moreover, corporate R&D has the tendency
to be sticky, implying that MNCs tend to display a strong inertia towards maintaining
their most strategic R&D activities in already existing locations (Narula, 2002). Indeed,
path-dependencies, agglomeration economies and first mover advantages act as barriers
for latecomers. As argued by Lall (2004), “the cumulative nature of capabilities means
that once FDI takes root in particular locations and global sourcing systems become
established, it becomes more difficult to newcomers to break in, particularly in the more
complex activities and functions”.
4. The evolving strategic motivations
The motivations underlying R&D-intensive FDI may be demand-driven, supply-driven
or efficiency-seeking. Demand-driven R&D is associated with knowledge-exploiting
motivations and primarily oriented towards the adaptation of products, services or
processes to overseas markets. This kind of R&D is often closely connected to the
internationalization of manufacturing operations and attracted by large and dynamic
markets. In contrast, supply driven R&D is related to knowledge-augmenting
motivations, i.e. to tapping into foreign sources of knowledge. In this case the location
decision is driven by the quality of local universities, human capital, research
infrastructure and the presence of specialized clusters, rather than by the size or
dynamism of the domestic market. In other circumstances the international allocation of
R&D is driven mainly by efficiency-seeking motivations, where certain segments of the
R&D value chain are relocated to lower cost locations. These different strategic
motivations are closely related to the distinction between competence creating and
competence exploiting mandates of MNC subsidiaries (Cantwell and Mudambi, 2005).
In practice, the different R&D motivations are often hard to differentiate, and a single
subsidiary may undertake different R&D projects, some of them demand-driven, others
supply-driven, etc. Moreover, the strategic content of international R&D mandates
evolves through time in response to changes in corporate strategies and subsidiary
competencies.
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Demand-driven R&D tends to be more footloose and highly dependent on the
continuation of manufacturing or sales activities, while supply-driven R&D tends to be
more autonomous and knowledge-intensive, and implies a greater reliance on domestic
knowledge sources. The internationalization of corporate R&D was primarily demand
driven in the past, following the internationalization of manufacturing and sales
(Mansfield et al., 1979). But, even though demand driven motivations remain important
today, in recent years supply driven motivations are gradually growing in importance
(Carlsson, 2006; Hegde and Hicks, 2008). Indeed, the role of subsidiaries in global
innovation networks is becoming more active, involving not only incremental
innovations but also multi-technology product development and even basic research.
However, while the number of supply-driven R&D centers may have increased in recent
years, MNCs often operate with just a few of such global R&D labs in carefully
selected locations, with the historical core R&D unit in the country of origin often
holding a coordinating role (Sachwald, 2008). Demand-driven and efficiency-seeking
R&D centers are the most numerous and geographically dispersed, constituting the
majority of overseas R&D centers.
In principle, developing countries are more likely to attract demand-driven or
efficiency-seeking rather than supply-driven R&D, given their lower technological
capabilities relative to developed countries. Along these lines, Thursby and Thursby
(2006) show that the kind of R&D activities by MNCs in emerging countries normally
entails familiar science (i.e. applications of science currently used by the firm and/or its
competitors) rather than new science (i.e. novel applications of science), which remains
concentrated in the core developed countries. Beyond mere adaptation of existing
products and processes, another possible demand-driven motivation which is gaining
importance in recent years is related to the design of new products for low cost
manufacturing, in order to tap into the vast market of low income customers who cannot
afford products such as refrigerators or clothes washing machines within the range of
existing high-end options designed for the middle classes of developed countries
(Eyring et al., 2011). It is more likely that engineering talent and new business models
to design new, lower-end options to meet those needs will come from developing
countries. Another example concerns the race to design a low-cost, high-quality car that
can be affordable to the “middle market” of developing countries. These kinds of
motivations are closely connected with the growing interest of firms in innovation for
the bottom of the pyramid (Kaplinsky, 2011).
Demand-driven and efficiency-seeking R&D subsidiaries tend to focus initially in
lower-end and routine R&D activities (Manning et al., 2008). Puga and Trefler (2010)
suggest that developing economies normally engage initially only in incremental (rather
than radical) R&D, related to addressing production-line bugs and suggesting minor
product improvements. But these lower-end R&D activities may act as a seed in the
sense that, with time, they may enable a shift towards higher value adding R&D
activities following learning and competence building in the subsidiaries (Chaminade
and Vang, 2008; Medcof, 2007; Puga and Trefler, 2010). Indeed, the developmental
impact of demand-driven and efficiency-seeking R&D should not be neglected. Rather,
such R&D activities should be seen as an invaluable opportunity for an evolutionary
upgrading of technological capabilities.
9
Whatever the strategic motivations, R&D mandates normally emerge as a sequential
process where pre-existing manufacturing or customer support subsidiaries get
progressively engaged in R&D, and in subsequent phases may further expand the
competence and scope of their R&D activity. This reflects that R&D-intensive FDI
normally occurs through the upward evolution of existing subsidiaries rather than
through completely new investments (Costa and Filippov, 2008; Guimón, 2009;
Mudambi and Mudambi, 2005). R&D mandates are often assigned through a
competitive bidding process involving several potentially-capable subsidiaries of the
MNC already present in different countries and regions. This kind of intra-corporate
competition to attract R&D is becoming more intense as global innovation networks
have become more mature and as a growing and more diverse set of locations have
acquired the threshold level of technological capabilities and infrastructure required for
hosting R&D facilities. MNCs are continuously rationalizing and restructuring their
international network of R&D units, often resulting in an increase in R&D expenditure
overseas but a reduction in the total number of R&D units, through strategies such as
regional integration of R&D efforts (e.g. one dominant R&D center for Europe, with a
smaller network of collaborating units).
5. Conclusions and policy implications for developing countries
Some emerging countries like China and India are attracting increasing flows of R&D-
intensive FDI. Their specialization in manufacturing and other activities like business
process outsourcing shows signs of evolution towards more knowledge intensive
segments of corporate value chains, including R&D. However, many developing
countries (and peripheral regions within developed countries) lack the large and
dynamic markets that BRIC countries can use as a bargaining tool to attract the R&D of
MNCs, and they also lack the technological infrastructure, human capital and
specialized clusters that MNCs are looking for when deciding where to locate their
international R&D centers (Narula and Guimón, 2010). Indeed, although the emerging
new geography of corporate R&D is clearly becoming more multi-polar, this does not
necessarily imply that it will be inclusive. Countries that fail to raise their technological
capabilities in line with MNC needs risk becoming marginalized from global innovation
networks. According to Velde (2001) pro-active and strategic FDI policy interventions
affecting the dynamic pattern of national comparative advantages become necessary in
order to avoid the risk of a low-skill, low-income trap. Lall (2004) also argues that the
need for policy intervention has become stronger given the fast pace of globalization
and technological change. Attracting R&D-intensive FDI requires a more proactive kind
of intervention, unlike generic FDI policies which can rely largely on investment
liberalisation along with marketing and promotion.
Developing and peripheral countries normally face more difficulties in attracting the
R&D of MNCs and see a higher need of government intervention because of market
failures or systemic inefficiencies. An example of market failure is that those who
decide the allocation of R&D centres within global innovation networks lack perfect
information about all potential countries and regions, which implies that their location
decisions may be biased. This would justify policy intervention in the form of FDI
promotion. Another market failure in R&D investment is that firms are not sensitive to
the positive externalities of knowledge creation and, if left to the market, they would
tend to under-invest in R&D due to appropriability concerns and to the duration and risk
10
inherent in R&D projects. This applies arguably to a larger extent to the specific case of
MNC subsidiaries in developing countries, given that the risk of knowledge spillovers
may be perceived as higher. This would justify policy interventions to improve the
intellectual property rights regime. In addition to market failures, the literature on
innovation systems has played an important role in shaping a new policy approach,
bringing along the notion of systemic failures, beyond market failures, as a rationale for
innovation policies (Smith, 2000). Under this framework policy makers are expected to
intervene when the system of knowledge generation and diffusion does not achieve its
objectives of contributing to innovation and technological progress in an efficient
manner, because of the lack of well developed networks between the different actors of
the system, because of institutional weaknesses, because of an inadequate provision of
research infrastructure, and so on. Thus the role of governments extends further to
facilitating linkages and enhancing the dynamism of the national innovation system.
Table 4 provides an overview of the key policy objectives and instruments associated
with the attraction of R&D-intensive FDI. The implementation of this kind of policy
strategies requires a close interplay of innovation policy and inward investment
promotion (Costa and Filippov, 2008; Guimón, 2009). On the one hand, the role of
innovation policy is to improve the investment climate for R&D by identifying and
acting upon the strengths and weaknesses of the national innovation system. On the
other hand, the role of inward investment promotion is to improve the image of the
country as an R&D location and to provide targeted services to both potential and
existing foreign investors in R&D. Another policy objective at the intersection between
FDI and innovation policy is to build clusters and stimulate linkages around existing
MNC subsidiaries. The goal is to enhance the benefits for the domestic innovation
system and to increase the strategic importance of the subsidiary to the MNC
headquarters, such that sequential investments become increasingly knowledge
intensive.
*** TABLE 4 HERE ***
Attracting R&D-intensive FDI can be interpreted as an evolutionary and sequential
process following the development of local capabilities. The objective guiding FDI
policies would be to create the conditions that enable existing subsidiaries to penetrate
into higher value-added segments of global value chains, and in particular into R&D, by
providing the necessary infrastructures, public R&D and human capital development, in
addition to fiscal and financial incentives to private firms undertaking R&D. An
important policy to attract R&D-intensive FDI is the non-discrimination of foreign-
owned firms against indigenous firms in national technology programs and R&D
funding. Initially, the kind of R&D being attracted will be local and incremental in
scope, motivated by demand-driven or efficiency-seeking strategies. But with time these
R&D mandates might expand to more sophisticated, supply-driven activities following
local learning and competence building. This may culminate in a self-reinforcing
process where dynamic and innovative clusters emerge through the upgrading of local
capabilities and MNC subsidiaries‟ mandates in tandem, and where the subsidiaries
become simultaneously deeply integrated within the MNC global structure and deeply
embedded within the domestic innovation system; a situation that has been defined as
dual embeddedness (Meyer et al., 2011).
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From a systemic approach, policy interventions should aim at stimulating linkages and
building clusters around MNC subsidiaries. This kind of policies are based on the
premise that the opportunities for upgrading and the benefits for the host country are
magnified when MNC subsidiaries become embedded in the domestic milieu by
collaborating with other agents of the national innovation system. Empirical studies
have shown that spillovers of R&D-intensive FDI (measured in terms of increased
productivity in local firms) tend to be positive through vertical linkages (i.e. with
suppliers or customers) but inexistent or negative through horizontal linkages (i.e. with
competitors) (Javorcik, 2002). The existing literature also sustains that the potential for
linkage creation is closely related to the scope assigned to the subsidiary within the
MNC global structure and to the subsidiary‟s initiative and upward influence
(Birkinshaw, 1997; Jindra et al. 2009; Santangelo, 2009). In order for linkages to
unfold, governments should focus on improving the quality standards of domestic
suppliers, such that they turn more likely to become suppliers of MNC subsidiaries.
Many countries such as the Czech Republic and Ireland have successfully used linkage
programmes to support the development of supplier networks and technology clusters
around MNC subsidiaries. The role of governments as linkage facilitators and skills
coordinators is not limited to promoting linkages between MNCs and domestic
suppliers or partners; it should extend further to linkages with universities and public
research centres. This includes joint-research projects as well as subcontracting of
certain research activities. Universities and public research centres also offer MNCs
technical services for testing and consultancy. In addition, training-oriented linkages
between MNCs and local universities should also be encouraged.
With regard to investment promotion policies, beyond advertisement and pre-
investment services, countries targeting R&D-intensive FDI place a higher emphasis in
providing customized value-added services to foreign investors in R&D. This implies a
higher focus on aftercare services, which makes sense given that the R&D mandates of
MNC subsidiaries tend to occur sequentially rather than overnight. Along these lines,
investment promotion agencies should evaluate the existing stock of foreign
subsidiaries in order to identify specific opportunities for upgrading, which would be
followed by enhanced dialogue and collaboration with subsidiary managers and by the
offering of customized aftercare services and incentives. The identification of
prospective companies for policy intervention is followed by efforts to gain audiences
with decision-makers in these companies but, in the words of Loewendahl (2001, p. 22),
“approaching companies should not be seen as a methodical exercise: it is not about
one-off approaches to a fixed number of companies each day, but rather a market
intelligence gathering and relationship building campaign”. These efforts should aim at
identifying new ways in which host country governments might assist MNC subsidiary
managers in upgrading towards higher value adding R&D mandates. In addition, an
important role of investment promotion agencies is to provide advice to other spheres of
government in order to better guide policy reform towards the dynamic technological
needs of MNCs.
Policies to attract R&D-intensive FDI cannot be isolated from wider FDI and industrial
development strategies, and it is important to consider possible tradeoffs. For example,
Mudambi and Mudambi (2005) show how FDI policies aimed at maximizing R&D and
technology transfer do not contribute to reducing regional disparities, since knowledge-
intensive subsidiaries will gravitate towards the most technologically advanced regions.
12
Moreover, they find that subsidiary operations with high R&D content generate lower
employment levels, suggesting some extent of quality/quantity trade-off. This trade-off
becomes more apparent in the current times of global economic crisis where
employment and capital accumulation return to the top of the policy agenda. While from
a long-term perspective the target might remain on R&D-intensive FDI that generates
larger knowledge inflows and linkages, FDI policy is also subject to short-term political
pressures. The need for more obvious and easily measurable local benefits, such as
headcount employment, often drives policy making and evaluation.
While the case for public intervention may be strong, governments should set realistic
targets to guide their policies by coupling their country‟s potential location advantages
with the dynamics of global innovation networks. Attracting R&D-intensive FDI is not
an easy task because it requires advanced technological infrastructure and capabilities
and because competition among countries is becoming more intense, within a context of
continuous restructuring and segmentation of global value chains. Policy-makers are
confronted with the challenge of selecting specific policy interventions to improve the
location‟s attractiveness and to promote and embed the R&D of MNCs. Clearly, there
are no magic formulas that can be applied across the board; each individual country
would require a different mix of policies depending on its technological and
institutional profile. The aim then is to design a coherent and efficient policy mix that
encompasses the right set of policies considering the country‟s circumstances and
developmental strategies. Specific government actions and strategies should follow
from an intelligence gathering and technology foresight exercise in continuous dialogue
with the managers of existing MNC subsidiaries. But determining the optimal policy
mix is a very difficult task because it involves different government departments and
agencies and because the relative efficiency of the different policy instruments is
uncertain ex ante and hard to evaluate ex post. Some of the policy instruments may have
a short term impact, such as fiscal and financial R&D incentives, while others such as
improving the education system will only have visible effects in the long run after
sustained investments. The policy mix is not a static structure: it necessarily changes
through time in response to structural transformations of markets and technologies and
to changes in broader economic development strategies.
With regard to outward R&D-intensive FDI, the governments of some developing
countries like South Korea and China are increasingly aware of its benefits as a
mechanism for reverse technology transfer, while others remain neutral (rather than
promoting it explicitly) in view of the potential negative effects in terms of crowding-
out of intra-mural business expenditure in R&D. In any case, policies towards R&D-
intensive FDI remain in an experimental phase and very underexplored in the existing
literature (Edler, 2008), especially in the specific case of developing countries.
13
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Table 1. R&D expenditure of foreign subsidiaries (% of business expenditure in R&D)
1994 2006
Ireland 66.8 75.9
Slovakia 4.1 64.1
Czech Republic 20.9 58.6
Hungary 22.6 57.8
Belgium n.a. 56.8
Portugal n.a. 47.4
Sweden 19.3 42.3
United Kingdom 29.1 38.4
Germany 13 38.3
Spain 30 35.6
Netherlands 20.4 27.5
Italy n.a. 26.6
Poland 10.3 21.7
France 14.2 20.8
Finland 13.9 17
EU average 23.7 38.5
United States 13.3 13.8
Canada 29.8 34.7
Japan 1.5 5.4
Notes: The EU average is an unweighted mean for the EU countries included in the table; no information
available from the sources on other Member States; n.a. means not available
Sources: OECD (2009) for 2006 and UNCTAD (2005) for 1994. 1995 for Czech Republic, Finland,
Germany, Ireland, Spain and Sweden. 1997 for Poland and Netherlands. 2005 for Belgium, Germany,
Hungary, Ireland, Portugal, Slovakia, Spain and Sweden. 2004 for Netherlands. Manufacturing sector
only for Germany, Ireland, Portugal, Slovakia and Spain, across all years
17
Table 2. Distribution by sector of inward R&D-intensive FDI in the EU 27 (percentage of each
sector in total number of projects, 2003-2010)
Pharmaceuticals 20.7 Metals 1.9
Software & IT services 15.8 Plastics 1.7
Biotechnology 12.8 Healthcare 1.6
Communications 5.8 Business Services 1.4
Automotive Components and OEM 5.0 Aerospace 1.3
Chemicals 4.5 Consumer Electronics 1.3
Electronic Components 3.9 Building & Construction Materials 0.9
Industrial Machinery, Equip. & Tools 3.8 Alternative/Renewable energy 0.8
Semiconductors 3.4 Business Machines & Equipment 0.8
Medical Devices 3.0 Coal, Oil and Natural Gas 0.8
Food & Tobacco 2.7 Engines & Turbines 0.8
Consumer Products 1.9 Other sectors 3.6
Notes: Based on number of greenfield FDI announcements per sector where the main business activity is
R&D, without considering the quantity of the investment. M&As are excluded. Sample size of 639
greenfield FDI projects in the 27 Member States of the EU. “Other sectors” comprises several sectors
representing less than 0.8 percent of the total: Ceramics & Glass; Financial Services; Minerals; Non-
Automotive Transport OEM; Paper, Printing & Packaging; Rubber; Space & Defence; and Textiles
Source: Author‟s calculations based on fDi Markets database
18
Table 3. Distribution by region of inward R&D-intensive FDI (2003-2010)
Number of FDI
in R&D projects
Percentage of
world total
Percentage of
total FDI projects
Asia-Pacific 987 43.4 13.8
Western Europe 566 24.9 2.3
North America 289 12.7 7.1
Middle East 209 9.2 1.3
Rest of Europe 132 5.8 0.8
Latin America & Caribbean 68 3.0 1.3
Africa 24 1.1 0.1
World total 2275 100 2.1
Note: Based on number of greenfield FDI announcements per sector where the main business activity is
R&D, without considering the quantity of the investment. M&As are excluded
Source: Author‟s calculations based on fDi Markets database
19
Table 4. Policies towards inward R&D-intensive FDI
Policy objectives Selected policy instruments
Enhancing the R&D investment
climate
Universities, public research centers, science and technology
parks
Human capital and attraction of foreign talent
Fiscal and financial incentives to business R&D
Systemic policies to stimulate linkages and interaction
Intellectual property rights regime
Targeting R&D in FDI promotion
International promotion of national technological capabilities
Pre-investment services to MNCs
Post-investment (“aftercare”) services to MNCs
Reaping the benefits from inward
R&D-intensive FDI
Building clusters and linkages around MNC subsidiaries
(supplier upgrading and technology linkage programs)
Promoting collaboration through R&D incentive schemes
