By Diana Tello (LSE)
FDI can act as a channel of transmission to international shocks and as a relevant component of regional resilience, writes Diana Tello. By looking at the economic conditions of Spain before and after the Great Recession, FDI can boost the resilience of regions. However, the extent to which FDI affects resilience varies across sectors.
The Great Recession impacted countries and regions around the world in different scales. It is argued that its impact was stronger on globalised economies as they were more closely linked to international financial and trade markets as well as to the ‘housing bubble’. In Europe, Spain was one of the most affected countries. The top panel of Figure 1 shows how Spanish regions experienced drastic declines in their annual growth rates of per-capita Gross Domestic Product (GDP) after 2008. However, the more dynamic regions before the crisis were not necessarily the ones less affected between 2008-2014. The interaction of other factors, such as the sector where this growth was taking place, influence the resistance process of a region. Additionally, in 2013 Spain displayed the highest unemployment rate in the European Union (EU) at 26.9% , with heterogenous negative growth rates in regional domestic employment after 2008, as shown by the bottom panel of Figure 1. The negative impact is still present, as Spain holds the second highest unemployment rate in the EU, with more than 40% of its young population jobless .
The influence Foreign Direct Investment (FDI) can have on a regional economy around a period of crisis such as the Great Recession is not straightforward. It can be the case, as it is often claimed, that foreign investments contribute to the region’s economic growth by transferring technology and innovation capabilities to the host territories. However, FDI can also act as a channel of exposure to global shocks, and be the ‘cause’ of the crisis in the first place. In the case of Spain’s international integration with the EU, coupled with Spain being one of the main receivers of FDI, the country’s economy looked prosperous between the 1980s and early 2000s. The country grew at annual rates of 3%, higher than in other developed countries in the EU. FDI was one of the main catalysts of this boost. However, it is also true that the country’s high global connectivity increased Spain’s exposure to international shocks and regional vulnerability.
An analysis of FDI inflows and regional growth indicators of Spain’s 17 regions from 2001-2014, reveals that there is a positive link between FDI and the process of regional resilience in the country. In general, regions that were receiving more FDI during this period were experiencing both higher GDP per capita growth rates and domestic employment growth rates. In other words, foreign investments were not only boosting economic growth in Spanish regions, but also generating a multiplier effect in the local labour market where a job in a multinational corporation was generating job(s) in domestic firms.
Not all FDI has the same impact
However, FDI does not exhibit a uniform impact on the economy across all sectors. FDI in each sector interacts differently with local capabilities and sustainable growth. This interaction influences the production structure of the host economy, resulting in a specific mix between internal and external sources of new knowledge. This blend, along with the environment where it is located, is a key factor for the regional resilience of a territory. Moreover, it is argued that a specific focus on innovative sectors is particularly relevant for the process of regional resilience due to their greater capacity to re-adjust after a shock. These sectors would have the capacity to absorb the shock, adapt their core activities to the new reality, and replace their obsolete and inefficient components.
Moreover, for those sectors positively linked to the local economy, differentiation should be made between those boosting productivity and those promoting domestic employment. On the one hand, one of the main receivers of FDI in Spain before and after 2008 was the manufacturing sector. According to the analysis, investments in ‘high-tech industries’ are linked to stronger and innovative regions, boosting productivity; however, FDI shifted to ‘low-tech industries’ after 2008. On the other hand, ‘Information and Communications Technology’ (ICT) is one of the sectors considered to promote innovation, and in the case of Spain, FDI in ICT is linked to the creation of domestic employment before and after 2008. However, foreign investments in this sector decreased after 2008. The impact of FDI on each sector should be considered when trying to attract investments to a region.
Insights for regional governments
The relationship between FDI and regional resilience is highly relevant for regional governments due to the positive impacts FDI can generate in their territories. Regional policy makers should address special attention to building international bridges to connect local territories and foreign regions and countries. However, not every investment showed a positive link with regional economic resilience. Attracting ‘any kind’ of FDI is not recommended. The direction of the impact is highly dependent on the sector where the investment is made, and the connections made with domestic actors and capabilities.
Moreover, FDI alone will not create a resilient territory and should only be a short-term solution to boost local knowledge and innovation. Policies should consider a local framework, integrating the promotion of local capabilities and a good political and governance context. Strong institutions that can set the ‘rules of the game’, linking not only the local territory with other countries, but connecting actors internally, need to be prioritised in parallel with the attraction of FDI.
This post is based on a leading dissertation from the MSc Local Economic Development programme at LSE. It represents the views of the author and not those of the GILD blog, nor the LSE.