The Effects of Greenfield FDI and Cross‐border M&As on Total Factor Productivity

• Author: Peter Nunnenkamp,Ayesha Ashraf,Dierk Herzer
• Date: 01 November 2016
• DOI: http://doi.org/10.1111/twec.12321
• Published date: 01 November 2016

The Effects of Greenfield FDI and

Cross-border M&As on Total Factor

Productivity

Ayesha Ashraf

1

, Dierk Herzer

1

and Peter Nunnenkamp

2

1

Department of Economics, Helmut Schmidt University, Hamburg, Germany and

2

Kiel Institute for the

World Economy, Kiel, Germany

1. INTRODUCTION

ACCORDING to the so-called Monterrey Consensus agreed at the UN summit on Financ-

ing for Development in 2002, foreign direct investment (FDI) ‘is especially important for

its potential to transfer knowledge and technology, create jobs, boost overall productivity,

enhance competitiveness and entrepreneurship, and ultimately eradicate poverty through econ-

omic growth and development’ (United Nations, 2003, p. 9). This may explain why policy-

makers in various host countries compete fiercely for FDI inflows.

Heterogeneous firm models pioneered by Melitz (2003) and Helpman et al. (2004) predict

that productivity at the firm level drives microeconomic decisions on cross-border activities.

While less productive firms tend to produce for the domestic market only, firms with interme-

diate productivity are more likely to export, and the most productive firms are most likely to

engage in outward FDI.

1

This major insight from Helpman et al. (2004) has been refined in

the recent literature on outward FDI by heterogeneous firms. Specifically, among the firms

that self-select into becoming direct investors, the more productive ones are likely to prefer

greenfield FDI over mergers and acquisitions (M&As) (e.g. Raff et al., 2012; Stepanok,

2015).

2

Importantly, firm-level productivity is considered a driver of internationalisation

strategies in this literature.

3

At the same time, host countries of inward FDI may expect that

luring the most productive foreign firms will improve their chances to benefit from FDI-

induced increases in macroeconomic growth and productivity.

4

In particular, policymakers

may prefer greenfield FDI over M&As since they expect the presence of the most productive

1

Greenaway and Kneller (2007) as well as Melitz and Redding (2015) provide recent overviews of

theoretical research and empirical findings.

2

Raff et al. (2012) present empirical evidence on Japanese firms supporting this hypothesis. In contrast,

Nocke and Yeaple (2007) argue that there are systematic differences in the productivity ranking, depend-

ing on whether decisions on the mode of entry are taken in industries where firms differ mainly in their

internationally mobile capabilities (e.g. technological know-how) or, alternatively, in their country-

specific and immobile capabilities (e.g. marketing skills).

3

However, as noted by Melitz and Redding (2015, p. 49), ‘the productivity of the firm remains largely

a black box’ and relatively little is known on ‘the separate roles played by production technology, man-

agement practice, firm organization, and product attributes’.

4

Raff et al. (2012, p. 867) conclude that the selection of firms ‘into different investment and ownership

modes should also be taken into account when analyzing the effects of FDI, for instance, on local firms,

market structure and social welfare’. In contrast to such effects in the host countries, the model of Melitz

(2003) explicitly links firm heterogeneity with industry productivity in the home country of more pro-

ductive (exporting) firms, through rationalisation and interfirm reallocation (see also Greenaway and

Kneller, 2007).

©2015 John Wiley & Sons Ltd

1728

The World Economy (2016)

doi: 10.1111/twec.12321

The World Economy

foreign firms to result in higher productivity gains in the host country.

5

FDI-induced produc-

tivity increases could then be particularly likely in developing host countries, considering that

greenfield FDI constitutes the dominant type of inward FDI in most of these host countries.

However, it is open to question whether the self-selection of heterogeneous firms int o the

group of direct investors or exporters, and into the subgroups of greenfield investors or acquir-

ers of existing local firms is associated with macroeconomic productivity increases in the host

country. First of all, the firm-level productivity ranking in heterogeneous firm models derives

from plausible assumptions about the fixed costs of different internationalisation strategies. In

other words, higher firm-level productivity is required for the firms to bear higher fixed costs

of undertaking FDI (instead of exporting) and entering via greenfield FDI (instead of M&As).

Furthermore, the literature on the macroeconomic effects of inward FDI suggests that FDI-

induced productivity increases in the host country mainly depend on technology spillovers

from foreign to local firms and the capacity of the latter to absorb superior foreign knowledge

(Saggi, 2002; G€

org and Greenaway, 2004).

The empirical evidence on the effects of inward FDI on economic growth and factor pro-

ductivity in the host countries is rather mixed.

6

Empirical findings could be inconclusive since

macroeconomic studies typically rely on overall FDI inflows and do not disaggregate FDI by

type and mode of entry. Blomstr€

om and Kokko (2003) observe that policymakers compete

mainly for greenfield FDI by offering subsidies and incentives. The survey of voters in the

United States by Jensen and Malesky (2010) shows that this incentive-based competition pro-

vides ‘a useful tool for politicians to win reelection’. It appears that voters clearly reward

politicians for attracting new investment projects. By contrast, the chances for re-election are

unlikely to improve in the case of M&As. UNCTAD (2000, p. 159) observes that ‘concern s

are expressed in political discussions and the media in a number of host countries that acqui-

sitions as a mode of entry are less beneficial for economic development than greenfield invest-

ment, if not positively harmful’. Greenfield FDI is typically perceived to create new capital

assets and additional production capacity, whereas cross-border M&As only involve a change

from local to foreign ownership of existing assets and production capacity.

This dichotomy may be overly simplistic, as we discuss in Section 2. Howeve r, the lack of

reliable data on greenfield FDI rendered it almost impossible to assess in a convincing way

whether M&As are less effective than greenfield FDI in promoting macroeconomic growth

and productivity in a large sample of developing and developed countries.

7

We overcome this

problem by drawing on a new data set on greenfield FDI, available from UNCTAD since

2003 for a large sample of host countries. We employ this data set to compare the impact of

greenfield FDI and M&As on total factor productivity (TFP) in developed and developing

host countries.

5

Greenfield FDI means that foreign investors establish new entities by setting up plants and factories

from scratch, whereas the M&A mode of entry means that existing firms are taken over by foreign

investors. See also Section 3b.

6

Prominent studies include Borensztein et al. (1998), Alfaro et al. (2004, 2009), Carkovic and Levine

(2005) and Woo (2009). G€

org and Greenaway (2004) conclude that the evidence on spillovers from for-

eign to local firms is mixed.

7

The few studies analysing the growth effects of different modes of FDI approximated greenfield FDI

by subtracting M&A sales from total FDI inflows (Calder

on et al., 2004; Wang and Wong, 2009a;

Harms and M

eon, 2011). As shown in Section 4, this procedure is likely to distort empirical findings.

Ashraf and Herzer (2014) provide an exception. They use the new data set on greenfield FDI to assess

the effects of different modes of FDI on domestic investment.

©2015 John Wiley & Sons Ltd

THE EFFECTS OF GREENFIELD FDI & M&As 1729