Three essays on direct foreign investment and technology transfer

Direct foreign investment (DFI) by transnational enterprises (TNEs) is an important vehicle of capital and technology transfer among countries. Yet, the possibility of heavy taxation and expropriation by the governments of host countries seems to be a serious impediment to the more extensive use of DFI as a means of improving resource allocation and technology transfer among countries.The first essay develops a game-theoretic model of direct foreign investment (DFI) in a country where the government cannot commit to refraining from expropriation of sunk investments by transnational enterprises (TNEs). In this situation, when the government lacks the necessary resources to finance the sunk costs of investment, DFI would be possible if there are self-enforcing contracts that give the investing TNE a minimum amount of the surplus generated by the project. We argue such contracts may exist if there are possibilities for transfer pricing on the part of the TNE. While transfer pricing is often seen as a negative aspect of TNE investments, our findings suggest that some transfer pricing opportunities may indeed enhance DFI. This also implies that in a country with severe government time-inconsistency problems, investment in detection of transfer pricing may be counter-productive for the extension of DFI benefits to the country.The second essay argues that the role of the TNE as a guarantor of product quality can serve to secure DFI and transfer of technology. In a market subject to producers' moral hazard arising from unobservable product quality, guaranteeing quality by individual producers may require high reputational rents when the cost of delivering high-quality products fluctuates. TNEs operating in a large number of countries may have less incentives to cheat because cheating in one country costs the TNEs the loss of reputation in other countries. Thus, they produce high quality at a lower quality premium in each country. This incentive effect of "risk pooling" provides the TNEs an advantage over independent local firms in terms of guaranteeing product quality and this advantage may make foreign investment attractive to host countries and deter opportunistic policies. It also helps TNEs transfer their technologies through arm's length agreements with greater confidence.The third essay consists of an emprical study of Korean electrical/electronics industry focusing on the effects of imported foreign technologies on local technological progress. It is shown that that the technologies developed by the local firms in Korean electrical/electronics industry are mainly peripheral or adaptive to imported foreign technologies. When learning-how is not essential and technolgical progress is quite rapid, continued import of foreign technologies is crucial for keeping pace with international technological progress. Contrary to the conventional view of the role of exports in Korean economic development, the role of exports is limited to facilitating enhancing technological capabilities for production and generation of new technologies requires conscious investments on R & D and imports of foreign technologies.U of I OnlyETDs are only available to UIUC Users without author permissio