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Are foreign firms privileged by their host governments? Yasheng Huang MIT Sloan School

Are foreign firms privileged by their host governments? Yasheng Huang MIT Sloan School. Agenda: --Summary of main findings --Issues with the prevailing view in the literature: National preference --Discussions of WBES --Findings --Policy implications.

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Are foreign firms privileged by their host governments? Yasheng Huang MIT Sloan School

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  1. Are foreign firms privileged by their host governments? Yasheng HuangMIT Sloan School Agenda: --Summary of main findings --Issues with the prevailing view in the literature: National preference --Discussions of WBES --Findings --Policy implications

  2. Summary of main findings: Based on subjective evaluations by firms • Host governments privileged foreign firms over domestic firms in five out of nine regulatory arenas; • In the remaining four arenas, host governments treat foreign firms as well (or as poorly) as domestic firms; • Foreign privilege is present only when benchmarked against politically-weak domestic firms; • Foreign privilege appears to be greater in more corrupt countries than in less corrupt countries. • Less robust evidence that foreign privilege is greater in countries with low regulatory quality. • Foreign privilege is NOT absent in institutionally strong countries.

  3. Prevailing view in the FDI literature: National preference • National preference: A building bloc in standard economic theories of FDI • Why FDI does not occur all the time in the face of “presumed penalties for operating across national and cultural boundaries” (Ethier 1986). • Legal and policy advantages of domestic firms (in addition to social advantages). • Thus the importance of possessing “firm-specific” advantages to overcome these natural infirmities. • One theoretical FDI piece postulating foreign privilege • An exercise postulating theoretically exhaustive scenarios facing foreign firms: Both national preference and foreign privilege both included. • Conjecture not straightforward. • Here is what Rugman and Verbeke (1998) have to say: The reason for such preferences is that a symmetrical position of inward and outward FDI at the public policy level, and a dispersed FDI configuration at the firm level, lead to complexities in terms of optimal business-government interactions that cannot be solved at the national level.

  4. Prevailing view in the FDI literature: National preference • Empirical origins of this view: Ray Vernon (1971) • Many governments suspicious of MNCs in the 50s, 60s and 70s. • Imposed various restrictions: Export requirements, equity limitations, local content, etc. • Conceptual origins of this view: Caves (1996) • Domestic residents do not derive dividends from equities held by foreigners • Foreigners do not vote • Governments seek electoral benefits by appropriating income of MNCs.

  5. Issues with the national preference view • An assumption, not yet tested despite wide currency. • An example: “Foreign ownership frequently involves additional verifications and procedures” (Djankov, La Porta, Lopez-de-Silanes and Shleifer 2002). • No evidence cited in the paper to support this view. • Empirical issues: • Media coverage: We know far more about bad things happening to MNCs than those to domestic firms without political clout. • FDI policies have changed dramatically in the 1980s and 1990s. • Conceptual shortcomings: • How about authoritarian regimes? • Voting is not the only political currency: Do MNCs hold a political advantage in other power corridors such as bribery and rent seeking? • Hellman et. al. (2002): Foreign firms bribe more.

  6. Previous research: Case study evidence by regional specialists • Latin America in the 1970s: • Guillermo O’Donnell (1978; 1979): Authoritarianism, import substitution, repression of domestic capitalists and courting of FDI. • China in the 1990s: • Huang (2003): Political pecking order of domestic firms and implications for FDI. • Malaysia in the 1980s and 1990s: • Many scholars: FDI as “an ethnic bypass policy” to repress Chinese businesses.

  7. Previous research: Three statistical analyses by World Bank • All three studies find foreign firms less constrained compared with domestic firms almost across all business constraint areas. • Issues with these studies: • A factual documentation rather than an analysis. • Not focused on adjudicating national preference vis-à-vis foreign privilege. • For some reason, they are very reluctant to accept this finding: “This is an interesting finding in itself since the opposite finding would have been equally possible” (Schiffer and Weder 2001).

  8. WBES • Can we generalize the insights from regional studies? • Cross-country survey data • WBES • Implemented in 1998-2000. • Over 10,000 firms in 81 countries. • Most of the domestic firms are private. • About 20 percent of firms are foreign.

  9. Issues with WBES • Not clear why the surveyed firms were chosen. • Sectoral composition according to GDP contributions but firms randomly chosen within an economic sector? • Quota sampling of foreign firms (at least 15%, although not met in reality): Best or most visible firms were chosen and thus their rosy views? • Lack of a common reference point: • A cross-sectional evaluation by foreign firms but a historical evaluation by domestic firms • Not a severe problem: 1) Correlations in fact high and 2) Easier to confirm national preference if this bias is strong. • Unbalanced sampling: • Heavy sampling of SOEs and light sampling of foreign firms in CIS and CEE. • Nearly opposite patterns elsewhere. • Difficult to compare foreign firms with SOEs.

  10. Descriptive analysis • Table 1 • WBES questions: Higher value=Greater constraint • Table 2 • Domestic>Foreign: 4 out of 9. • Domestic=Foreign: 2 out of 9 • Domestic<Foreign: 3 out of 9 • Domestic>Foreign: Some of the most important areas for business: 1) general tax and regulatory constraint, 2) business licensing, 3) tax administration and 4) high taxes

  11. WBES: Key variables • Dependent variable: Taxes and regulations • One general constraint variable: TXREG • Eight specific constraint variables: 1) business licensing, 2) customs, 3) labor, 4) foreign exchange, 5) environment, 6) fire and safety, 7) tax administration, and 8) high taxes • Rating from 1 (=no obstacle) to 4 (major obstacle) • Three formulations of the dependent variables (mainly TXREG) • TXREG4=1 if TXREG=4 (probit) • TXREG3_4=1 if TXREG=3 or 4 (probit) • TXREG itself (ordered probit) • All three formulations produced consistent findings although TXREG3_4 is the weakest.

  12. WBES: Key variables • Independent variables: • Key variable: Whether FOREIGN is positive or negative (and whether statistically significant) • Firm-level controls: 1) Export status, 2) Large firm (>500 employees), 3) startup firm since 1994, 4) sales/fixed asset ratios to control for capital intensity • Industry and country dummy variables included in most regressions. • Also country-level economic variables in lieu of country dummies: 1) FDI stock/GDP, 2) per capita GDP, 3) per capita GDP growth and 4) ratios of sampled foreign to sampled domestic firms. • Results reported below are consistent across different specifications and different firm- and country-level controls.

  13. Table 4: Need to control for firm-level, industry-level and country-level characteristics • Negative=less constrained: • FOREIGN is negative and statistically significant for 1) general tax and regulatory constraint, 2) labor, 3) environment, 4) high taxes, and 5) tax administration • No evidence that business licensing is more onerous on foreign firms. • Controlling for export status, firm size, new firm dummy, sale/fixed asset ratios, industry and country dummies. • Not a single FOREIGN coefficient is positive AND significant.

  14. Various experiments: Tables 5 and 6 • Dependent variables not supposed to vary between firms: QTEL and QWAT • FOREIGN is not significant. • Results are robust to • Different formulations of TXREG • Inclusion or exclusion of firm, industry or country controls • Different definitions of FOREIGN: Foreign vis-à-vis domestic or more foreign-owned vis-à-vis less foreign-owned. • Controlling for: • Import activities and cross-border transactions: Placing more transactions outside host government purviews? • Transfer pricing potentials: Less subjected to host tax regimes? • Influences on government: Greater influence on government by foreign firms=better treatment?

  15. Political power of domestic firms • Two definitions of political power: 1) state ownership and 2) self-rated influence on government (WBES question 25) • Table 7 • FOREIGN negative and significant when benchmarked against politically-weak domestic firms • But not when benchmarked against politically-strong domestic firms.

  16. Institutional contexts • World Bank Governance Project ranks countries along six institutional dimensions: • 1) Voice & accountability, 2) control of corruption, 3) government effectiveness, 4) regulatory quality, 5) rule of law and 6) political stability • Table 9: • Foreign privilege most noticeable in corrupt countries (i.e., ranked at or below 20th country) • Foreign privilege somewhat present in countries with low government effectiveness and low regulatory quality. • Foreign privilege is also present in institutionally strong countries.

  17. Policy implications • Positive view of regulations • Need to strengthen regulations of foreign firms • Negative view of regulations • FDI weakens regulations. • Whether a lag or a delay • Does deregulation of foreign firms precede deregulation of domestic firms? • Or does deregulation of foreign firms prolong regulations of domestic firms?

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