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McKinsey Global Institute

CONFIDENTIAL

FDI and Technology Absorption

Jaana RemesMcKinsey Global Institute

This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organisation without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

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*Based on estimates from OECD 2000 segmentation of total FDI (developed and developing countries); excludes “resource seeking” FDI (e.g., for petroleum)

Source: OECD; McKinsey Global Institute; WDI

MULTINATIONAL COMPANY INVESTMENT HAS INCREASEDRAPIDLY IN THE PAST DECADE

Inflows$ Billions

Main drivers Liberalization and

privatization Decline in transport and

communication cost

300

250

200

150

100

50

0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

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Auto

Consumer electronics

Food retail

Retail banking

IT/BPO*

China India Mexico Brazil

A BROAD FACT BASE PROVIDES RANGE OF INSIGHTS

* Information technology/business process offshoring (IT/BPO); completed individual case studies for IT and BPO, thus bringing the total studies completed to 14

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MOST ECONOMIES CLEARLY BENEFIT FROM FOREIGN INVESTMENT

* BPO** ITSource:McKinsey Global Institute

Positiveor very positive impact in 13 out of 14 casesacross sectors

Verypositive

Positive

Neutral

Negative

Pure market-seeking Tariff-jumping Efficiency-seeking

Motive for entry

Ove

rall

FD

I Im

pac

t

*

* *

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WE FOUND SOUND ECONOMIC FOUNDATION TO BE KEY, WHILE INVESTMENT POLICIES WERE INEFFECTIVE AND EVEN HARMFUL

*TRIMs = trade-related investment measures

Impact from FDI

Economic foundations Macroeconomic stability Competition Enforcement Infrastructure

Investment policies

Incentives Import barriers TRIMs*

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Increased FDI impact

FOUNDATIONS FOR ECONOMIC DEVELOPMENT ARE CRITICAL

Macroeconomic stability

• Precondition for MNC investment and FDI impact

Competitive environment

• Competition most powerful factor driving FDI impact

Legal enforcement

• Informality reduced FDI impactand sector performance

Infrastructure• Important enabling condition for

FDI impact

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7*Actual cars and employment (not adjusted)

Source: MGI; McKinsey Global Institute; team analysis

Labor productivityEquivalent cars per equivalent employee; indexed to 1992-93 (100)

35684

144

38

156

100

Productivity in 1992-93

Productivity in 1999-2000

Improve-ments at HM

Exit of PAL

Indirect impact of FDI driven by competition

Entry of new players

Direct impact of FDI

Less productive than Maruti mainly due to lower scale and utilization

Increased automation, innovations in OFT and supplier-related initiatives

Improve-ments at Maruti

Auto India

IN INDIAN AUTO SECTOR, LARGEST FDI IMPACT CAME THROUGH INCREASED COMPETITION

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IN MEXICAN FOOD RETAIL, WALMART ENTRY LED OTHERS TO IMPROVE SUPPLY CHAIN EFFICIENCY

*Share of total sales distributed through centers not updated

Source: Annual reports

20

30

75

40

28

5

85Wal-Mart*

Comercial Mexicana

Gigante

Soriana

Number of distribution centers in 2001

Share of total sales distributed through centers (2001 vs. 2005)Percent

12

4

7

6

Regional player in more developed Northern Mexico

ROUGH ESTIMATES

60

58

80

Between 1996-2001, WalMart labor

productivity grew by 2% annually, while it

declined by 2% annually in the rest

of the modern sector

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IN BRAZILIAN FOOD RETAIL, PRODUCTIVITY INCREASES BUT PROFITS EVAPORATE WHEN AN INFORMAL RETAILER IS ACQUIRED BY A LARGE FORMAL RETAILER

*Gross margin per employee hourNote:1) See next page for more detail on causes for observed changes. 2) Margins based on net sales Source:ABRAS; PNAD; store visits; interviews; McKinsey

Despite a 32% increase in labor productivity* . . . Reals

9.3

12.2

Pre Post

32%

Acquisition

1,460Number of employees

1,095

Hours worked/year/ employee

2,328 2,328

-25%

. . . the net margin evaporatesPercent

Pre Post

4.9

0.1

-97%

180

163

Gross sales R$ millions

Net salesR$ millions

Gross marginPercent

19

144

125

25

-20%

-24%

29%

0%

Percent change

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INVESTMENT POLICIES HAVE NEGATIVE AND UNINTENDED CONSEQUENCES

Incentives• Fiscal and administrative cost• Reduced productivity• “Race-to-the-bottom” dynamics

Import barriers• Limited competition• Protection of low productivity players

TRIMS• Protection of low productivity players• Limited flexibility to compete

Reduced FDI impact

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INCENTIVES CONTRIBUTED TO CAPACITY BUILD-UP IN BRAZIL’SAUTO SECTOR

Source:McKinsey Global Institute

480

380

3,000

1,800

340

1995 capacity

Investments based on long-term growth trends

2001 capacity

Additional investments, due to great expectations for future growth

Collectively, the industry built more than double what would have been expected under long-term trends

Further investments, due to incentives, Sweetners, and the “race to grow”

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HIGH TARIFFS LIMIT COMPETITION AND INCREASE PRICES IN INDIA’S CONSUMER ELECTRONICS SECTOR

Source:McKinsey CII report

100

30

Average tariff/effective rate of protection on final goodsPercent

TV example – Color TV price breakdownIndex, international best practice = 100

Interna-tionalbest practiceprice

Import duty on finishedgood

Import duty on raw material

Highermargin

Inefficiencyin the process

9-128-10

8-13

The protection offered by import duties on domestic players finds to mask inefficiency

14

39

39

30

130Mobile* phones

PCs

Refriger-ators

TVs

Retailprice

Includes raw material, conversion costs and margin

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WE FOUND SOUND ECONOMIC FOUNDATION TO BE KEY, WHILE INVESTMENT POLICIES WERE INEFFECTIVE AND EVEN HARMFUL

*TRIMs = trade-related investment measures

Impact from FDI

Economic foundations Macroeconomic stability Competition Enforcement Infrastructure

Investment policies

Incentives Import barriers TRIMs*

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