Panel 1A Jaana REMES

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This report is solely for the use of client personnel. No part of it may becirculated, quoted, or reproduced for distribution outside the client

organization without prior written approval from McKinsey & Company.This material was used by McKinsey & Company during an oralpresentation; it is not a complete record of the discussion.

Working DraftLast Modified 3/23/2006 3:49:38 PM Pacific Standard Time

Printed 3/22/2006 11:04:52 AM Pacific Standard Time

McKinsey Global Institute

CONFIDENTIAL

FDI and TechnologyAbsorption

Jaana RemesMcKinsey Global Institute

This report is solely for the use of client personnel. No part of it may becirculated, quoted, or reproduced for distribution outside the clientorganisation without prior written approval from McKinsey & Company.

This material was used by McKinsey & Company during an oralpresentation; it is not a complete record of the discussion.


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2

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* Based on estimates from OECD 2000 segmentation of total FDI (developed and developing countries);excludes resource seeking FDI (e.g., for petroleum)Source: OECD; McKinsey Global Institute; WDI

MULTINATIONAL COMPANY INVESTMENT HAS INCREASED

RAPIDLY IN THE PAST DECADE

Inflows

$ Billions

Main drivers Liberalization and

privatization

Decline in transport andcommunication cost

300

250

200

150

100

50

0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002


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Auto

Consumer

electronics

Food retail

Retail banking

IT/BPO*

China India Mexico Brazil

A BROAD FACT BASE PROVIDES RANGE OF INSIGHTS

* Information technology/business process offshoring (IT/BPO); completed individual case studies for IT and BPO,thus bringing the total studies completed to 14


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MOST ECONOMIES CLEARLY BENEFIT FROM FOREIGN INVESTMENT

* BPO** ITSource: McKinsey Global Institute

Positiveor very

positive

impact in

13 out of

14 cases

across

sectors

Verypositive

Positive

Neutral

Negative

Pure market-seeking Tariff-jumping Efficiency-seeking

Motive for entry

OverallFDI

Impact

*

* *


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WE FOUND SOUND ECONOMIC FOUNDATION TO BE KEY, WHILE

INVESTMENT POLICIES WERE INEFFECTIVE AND EVEN HARMFUL

* TRIMs = trade-related investment measures

Impact from FDI

Economic foundations

Macroeconomic stability

Competition

Enforcement Infrastructure

Investment policies

Incentives

Import barriers

TRIMs*

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Increased FDI impact

FOUNDATIONS FOR ECONOMIC DEVELOPMENT ARE CRITICAL

Macroeconomicstability

Precondition for MNC investmentand FDI impact

Competitiveenvironment

Competition most powerful factordriving FDI impact

Legalenforcement

Informality reduced FDI impactand sector performance

Infrastructure Important enabling condition for

FDI impact

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* Actual cars and employment (not adjusted)

Source: MGI; McKinse Global Institute; team anal sis

Labor productivityEquivalent cars per equivalent employee; indexed to 1992-93 (100)

35684

144

38

156

100

Productivityin 1992-93

Productivityin 1999-2000

Improve-ments atHM

Exit ofPAL

Indirect impact of FDI

driven by competition

Entry ofnewplayers

Direct impact

of FDI

Less productivethan Maruti mainly

due to lower scale

and utilizationIncreased

automation,

innovations in

OFT and supplier-

related initiatives

Improve-ments atMaruti

Auto India

IN INDIAN AUTO SECTOR, LARGEST FDI IMPACT CAME THROUGH

INCREASED COMPETITION

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IN MEXICAN FOOD RETAIL, WALMART ENTRY LED OTHERS

TO IMPROVE SUPPLY CHAIN EFFICIENCY

* Share of total sales distributed through centers not updated

Source: Annual reports

20

30

75

40

28

5

85Wal-Mart*

Comercial

Mexicana

Gigante

Soriana

Number of distributioncenters in 2001

Share of total sales distributed

through centers (2001 vs. 2005)Percent

12

4

7

6

Regional player in

more developed

Northern Mexico

ROUGHESTIMATES

60

58

80

Between 1996-2001,WalMart labor

productivity grew by

2% annually, while it

declined by 2%

annually in the rest of

the modern sector

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IN BRAZILIAN FOOD RETAIL, PRODUCTIVITY INCREASES BUT PROFITS

EVAPORATE WHEN AN INFORMAL RETAILER IS ACQUIRED BY A LARGE

FORMAL RETAILER

* Gross margin per employee hour

Note: 1) See next page for more detail on causes for observed changes. 2) Margins based on netsalesSource: ABRAS; PNAD; store visits; interviews; McKinsey

Despite a 32% increase

in labor productivity* . . .Reals

9.3

12.2

Pre Post

32%

Acquisition

1,460Number ofemployees

1,095

Hours

worked/year/

employee

2,328 2,328

-25%

. . . the net margin evaporatesPercent

Pre Post

4.9

0.1

-97%

180

163

Gross sales

R$ millions

Net sales

R$ millions

Gross margin

Percent19

144

125

25

-20%

-24%

29%

0%

Percent change

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INVESTMENT POLICIES HAVE NEGATIVE

AND UNINTENDED CONSEQUENCES

Incentives Fiscal and administrative cost Reduced productivity Race-to-the-bottom dynamics

Import barriers Limited competition Protection of low productivity players

TRIMS Protection of low productivity players Limited flexibility to compete

Reduced FDI impact

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INCENTIVES CONTRIBUTED TO CAPACITY BUILD-UP IN BRAZILS

AUTO SECTOR

Source: McKinsey Global Institute

480

380

3,000

1,800

340

1995capacity

Investmentsbased onlong-termgrowthtrends

2001capacity

Additionalinvestments,due to greatexpectationsfor futuregrowth

Collectively, theindustry builtmore than

double whatwould havebeen expectedunder long-termtrends

Furtherinvestments,due toincentives,Sweetners,and the raceto grow

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HIGH TARIFFS LIMIT COMPETITION AND INCREASE PRICES

IN INDIAS CONSUMER ELECTRONICS SECTOR

Source: McKinsey CII report

100

30

Average tariff/effective

rate of protection on

final goods

PercentTV example Color TV price breakdown

Index, international best practice = 100

Interna-tionalbestpracticeprice

Importduty onfinishedgood

Importduty onrawmaterial

Highermargin

Inefficiencyin theprocess

9-12

8-108-13

The protectionoffered by import

duties on domestic

players finds to

mask inefficiency

14

39

39

30

130Mobile*phones

PCs

Refriger-ators

TVs

Retailprice

Includes raw

material,

conversion costs

and margin

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WE FOUND SOUND ECONOMIC FOUNDATION TO BE KEY, WHILE

INVESTMENT POLICIES WERE INEFFECTIVE AND EVEN HARMFUL

* TRIMs = trade-related investment measures

Impact from FDI

Economic foundations

Macroeconomic stability

Competition

Enforcement

Infrastructure

Investment policies

Incentives

Import barriers

TRIMs*

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Panel 1A Jaana REMES