Learning by doing: Belt and Road FDI spillovers

FOREIGN direct investment (FDI) has long been viewed as an important catalyst of economic development. It contributes to job creation, productivity growth and infrastructure development, all of which lead to greater living standards and higher economic growth.

It is in this context that China comes into play on the global stage. Covering 65 nations, 64% of the world’s population, 39% of global land area and 30% of the world’s gross domestic product, the Belt and Road Initiative (BRI) is a massive project comprising a chain of infrastructure projects initiated by China, with the aims of improving regional integration and facilitating trade on an unprecedented scale.

Given that many of the BRI partners are underdeveloped or developing nations, this raises an important question of how does the BRI benefit these economies through FDI?

The key component in FDI that drives economic growth in recipient countries is knowledge. FDI from developed countries to developing countries encourages technological diffusion, where advanced technology brought into developing countries encourages domestic technological innovation, especially through learning by doing.

Skill acquisition by domestic labour from multinational employees, direct transfer of technology, healthy competition and technical support are examples of channels through which technological diffusion operates. And through technological diffusion, the production capacity of the domestic economy increases, which ultimately leads to economic growth.

So, given the scale of the BRI, is this the economic miracle the developing world has been awaiting?

A Razzaq, An and Delpachitra (2021) study looked at productivity growth in 58 Belt and Road host countries, and although they generally find that the Belt and Road FDI stimulates productivity growth in host countries, the positive effect is smaller for countries that have much lower technology levels as compared to China.

In contrast, countries that are comparable with China, for example, in terms of human capital, logistics and institutions, experience higher productivity growth from the Belt and Road FDI.

This is a counterintuitive finding. In general, policymakers focus on building up weaker economic sectors, implicitly assuming that by being advanced in every sector, a country can be self-sufficient.

However, the evidence from Razzaq, An and Delpachitra (2021) suggests that this would not be the most prudent decision. While the result is surprising, the logic is straightforward – imagine trying to introduce a kindergarten child to a calculus professor. The child would not benefit much from the interaction, if at all, simply because he is unable to comprehend the fundamental theorem of calculus.

In the context of Belt and Road economies, domestic firms in these economies may have low absorptive capacity – even if new technology is delivered to their doorstep, the lack of human capital, institutions and demand for the technology collectively may mean that these firms are unable to effectively utilise the technology being brought in by FDI.

Hence, what this finding suggests is that host countries should capitalise on their strong points – advanced economic sectors that are comparable to China in terms of technological attainment.

This idea is not new. The 18th century economist David Ricardo proposed that in trading, countries should specialise in goods that they are good at producing, and import goods that they have no advantage in. This has been formalised in what is now known as the theory of comparative advantage.

Analogously, Malaysia, as a Belt and Road host country, should emphasise on cooperating with China in economic sectors that it has advantages in to fully reap the benefits from Belt and Road FDI.

However, such a strategy needs to go hand-in-hand with other long-term initiatives, where Malaysian policymakers need to focus on improving absorptive capabilities among domestic firms. To begin with, the education policies need to focus on embracing technological change. It is not enough to tell students to become entrepreneurs. Instead, it is vital that students become entrepreneurs that embrace technological change.

Without a labour force that is capable of understanding and handling new technology, however useful, new technology will remain a white elephant in the room, and there will not be any meaningful change to the economy.

In addition, it is just as necessary for domestic firms to have the desire to innovate. Very often, new technology will have to be adapted for local needs. Thus, firms need to be given incentives to invest in research, development and commercialisation of technology.

More crucially, healthy competition is needed. The Schumpeterian argument of creative destruction applies here – firms with weak absorptive capabilities that do not adapt to new technology will be weeded out through competition, while firms that readily absorb new technology shall remain.

In conclusion, the BRI is a golden opportunity for Malaysia to break through stagnation in the middle-income level, but only if the country makes full use of the opportunity offered. It is not enough to just accept FDI, but to also direct the FDI to where it will benefit the economy the most and to ensure that domestic firms and producers make full use of the opportunity.

A key to economic development has been given to us on a silver platter, but we still need to take it and unlock the boundless potential that awaits us behind the door.

Daniel Ooi Boon Yann is a lecturer at Tunku Abdul Rahman University College. The views expressed here are entirely the writer’s own.

The SEARCH Scholar Series is a social responsibility programme jointly organised by the Southeast Asia Research Centre for Humanities (SEARCH) and the Centre of Business and Policy Research, Tunku Abdul Rahman University College (TAR UC), and co-organised by the Association of Belt and Road Malaysia.

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