Domestic Innovation Support and MNC Activities

• In Event: Attracting and Regulating MNCs

Abstract

To what degree does industrial policy affect outward investment patterns? As industrialized countries increasingly prioritize technology and innovation in their national development and foreign policy, it is important to understand how industrial policy in the form of innovation policies may affect international investment activity. A key feature of innovation policies instituted by advanced economies is that they include incentives targeted at individual firms in a bid to increase production and investments in certain technology areas. And foreign firms are highly motivated to engage in foreign direct investments in order to take advantage of such incentives. This dynamic places other potential investment locations at a competitive disadvantage and risks pulling investments away from these locations towards countries offering attractive policy incentives, thereby prompting the home country and potential host countries to engage in a “competitive bidding” process in order to attract desirable investments from firms.

We argue that home country innovation policies, counterintuitively, can spur multinational firms to expand operations abroad, and that these firms will be able to leverage home country support to expand into countries with higher regulatory barriers and less favorable political relationships. Host countries may also have competing policies to attract innovation-intensive firms, and when host government inducements are strong, home country funding has smaller effects on firm investment. Using data on OECD governments' support for research and development (R&D) activities combined with firm-level subsidiary data, we find that higher home government R&D subsidies are positively associated with a higher number of firm subsidiaries in host country sectors. This is much less the case in host countries with competing incentives for R&D activity. We also find that home country support is positively associated with investment in host countries that have high regulatory barriers and are less politically-aligned with the home country.

To the extent of our knowledge, we are one of the first IPE studies to explore the international political economy of industrial policy. Overall, our study suggests that governments’ policies to support domestic innovation might actually spur more expansion abroad, which is surprising given that industrial policy in the current era is designed to shore up domestic production and enhance innovation capacity within a country’s borders. Our study therefore calls for further study and more nuanced understanding of the unintended consequences of industrial policy.

Authors

• Siyao Li, University of Pittsburgh

• Jian Xu, National University of Singapore