Do Multinationals Deteriorate Developing Countries' Export Prices? The Impact of FDI on Net Barter Terms of Trade

• DOI: http://doi.org/10.1111/twec.12311
• Date: 01 December 2016
• Author: Konstantin M. Wacker
• Published date: 01 December 2016

Do Multinationals Deteriorate Developing

Countries’ Export Prices? The Impact of

FDI on Net Barter Terms of Trade

Konstantin M. Wacker

University of Mainz, Mainz, Germany

1. INTRODUCTION

THE effects of openness on growth and development are a traditional subject of discussion

in economics. Post-war development economists were especially concerned about terms

of trade of developing countries in this context, that is, export prices relative to import prices.

Based on seminal work by Prebisch (1950) and Singer (1950), they argued that deteriorating

terms of trade could nullify gains from trade for developing countries because they entail a

decreasing purchasing power of exports. The latter would ceteris paribus directly cause the

real income of an economy to decline and would increase the import price of required invest-

ment goods and therefore hamper economic growth in the longer run (cf. De Long and Sum-

mers, 1991; Levine and Renelt, 1992; Harrison and Rodr

ıguez-Clare, 2009). While some

authors such as Blattman et al. (2007) have given stronger emphasis to the role of volatility

of terms of trade for development, their general importance for growth is well documented in

the literature (e.g. Mendoza, 1995; Barro, 1996; Kose, 2002; Broda, 2004) and their time-ser-

ies properties remain a heavily discussed issue.

1

The adverse impact of declining terms of

trade on growth has also shaped the industrial policy agenda in many developing countries

and, for example, given rise to policies of import substituting industrialisation.

More recent contributions on openness and growth have stressed the relevance of multina-

tional corporations (MNCs) and their foreign direct investment (FDI). The potential channels

for the latter to promote growth are manifold and range from linkages and positive spillover

effects on the microlevel to general macro-benefits of capital flows (e.g. Borensztein et al.,

1998; Javorcik, 2004; Girma et al., 2008; Blalock and Gertler, 2008; see Herzer et al., 2008,

I would like to thank the associate editor, an anonymous referee, Ron Davies, Imed Drine,

Neil Foster, Stephan Klasen, Inmaculada Mart

ınez-Zarzoso, Chris Muris, Malte Reimers, Kunibert Raf-

fer, Amelia U. Santos-Paulino and Mick Silver as well as participants at seminars and conferences in

Aarhus/Kolding, G€

ottingen, Graz, Hannover, Helsinki, Vienna and at the IMF for helpful comments and

ideas. A considerable part of this research was conducted at the University of G€

ottingen and at

UNU-WIDER, which provided financial support and excellent research infrastructure. Financial support by

the German Academic Exchange Service (DAAD) is also gratefully acknowledged. The usual disclaimer

applies.

Highlights: (i) I empirically investigate the relationship between FDI to developing countries and their

terms of trade; (ii) FDI has a significant and important positive impact on developing countries’ terms of

trade; and (iii) The absorptive capacity of the host country matters.

1

The most influential contributions include Spraos (1980), Sapsford (1985), Thirlwall and Bergevin

(1985), Grilli and Yang (1988), Cuddington and Urz

ua (1989), Powell (1991), and Reinhart and Wick-

ham (1994). Kim et al. (2003), Harvey et al. (2010), and Ghoshray (2011) were among those to address

the issue more recently.

©2015 John Wiley & Sons Ltd

1974

The World Economy (2016)

doi: 10.1111/twec.12311

The World Economy

for a critical review of this stand of literature). It has hence become an explicit policy goal of

many governments to attract FDI (see e.g. Harding and Javorcik, 2011).

Simple cross-country ordinary least squares (OLS) regressions depicted in Figure 1 show

preliminary support for both lines of argumentation: GDP growth in developing countries pos-

itively correlates with terms-of-trade developments and the magnitude of FDI inflows.

2

If eco-

nomic policy attempts to foster growth by generating favourable terms of trade and attracting

FDI, it is hence necessary to understand the extent to which these two aims interfere with

each other. Given the quest for growth and the relevance of the transfer problem in macroeco-

nomics,

3

it is surprising that this question has not yet attracted more attention.

4

The aim of this article was to close this existent gap in the literature. Therefore, I first

show in section 2 that previous economic work suggests a link between the operations of

multinationals, their FDI and terms of trade, but has not come to precise statements about the

theoretical impact of MNCs and FDI on terms of trade. After introducing the data and

methodology in section 3, the issue is thus addressed empirically by investigating data of

more than 50 developing countries between 1980 and 2008. The results dismiss concerns that

MNCs and FDI would deteriorate developing countries’ export prices. On the contrary, FDI

0.050.025–0.025–0.05

–0.07 –0.02

Terms of Trade Trend p.a.

82 obs, b = 0.18 (Robust t-stat 1.13), R-s

q

uared 0.04 81 obs, b = 0.002 (Robust t-stat 2.25), R-s

q

uared 0.16

Mean of FDI Flow/GDP

0105152025

0.03 0.08

0

Conditional Growthrate p.a.

0.05 0.1–0.05 0

Conditional Growthrate p.a.

FIGURE 1

Growth, Terms of Trade and FDI in Developing Countries Since the 1980s

2

The conditional growth rate on the vertical axis is the residual of the growth rate regressed on initial

GDP. This is calculated per annum (p.a.), using the first to the last observation available in the interval

1980–2008. The terms-of-trade trend p.a. in the left panel is the terms-of-trade development p.a. over

the same years. FDI/GDP in the right panel is the average over all available observations of FDI flows/

GDP between these years. The data sample is described in more detail in section 3.

3

The ‘transfer problem’ suggests an adverse impact of international transfers on relative prices, see

subsection 2.2 below and Lane and Milesi-Ferretti (2004). A textbook treatment is given in Dixit and

Norman (1980) and Krugman and Obstfeld (2000).

4

An exception being the concern raised by Li et al. (2007) for the case of China.

©2015 John Wiley & Sons Ltd

THE IMPACT OF FDI ON NET BARTER TERMS OF TRADE 1975