Who Gains from Services FDI—Host or Home Economies? An Analysis of Disaggregated Services FDI Inflows and Outflows of 24 European Economies
| Author | Nadia Doytch |
| DOI | 10.1177/00157325211010230 |
| Published date | 01 August 2021 |
| Date | 01 August 2021 |
Who Gains from
Services FDI—Host or
Home Economies?
An Analysis of
Disaggregated Services
FDI Inflows and
Outflows of 24
European Economies
Nadia Doytch1,2,3
Abstract
This study focuses on a sample of 24 European economies to examine the spillo-
vers from disaggregated services foreign direct investment (FDI) on economic
growth.We study the impact of 20 disaggregated services FDI inflows and out-
flows, respectively, on their host and home country services sector and overall
growth.We find that both financial services and business services FDI are ben-
eficial for growth in both host and home countries. Financial services FDI works
though financial holding companies and home countries benefit especially from
investment in foreign banks, which provides access to credit. Business services
FDI works though management holding companies and home countries benefit,
especially from investment in computer activities, which provides access to spe-
cialised human capital and high-value knowledge assets. The positive spillovers to
home countries provide evidence for arguing against protectionism.
JEL Codes: F2, F21, F43
Keywords
Disaggregated services foreign direct investment (FDI), services FDI inflows,
services FDI outflows, services sector growth, aggregated growth
Article
1 Koppelman School of Business, CUNY-Brooklyn College, Brooklyn, NY, USA.
2 Ph.D. Program in Economics, CUNY-Graduate Center, New York, NY, USA.
3 School of Government (ASOG), Ateneo de Manila University, Quezon City, Manila, Philippines.
Corresponding author:
Nadia Doytch, Brooklyn College, 217 Whitehead Hall, 2900 Bedford Ave, Brooklyn 11210, USA.
E-mail: Ndoytch@brooklyn.cuny.edu
Foreign Trade Review
56(3) 257–288, 2021
©2021 Indian Institute of
Foreign Trade
Reprints and permissions:
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DOI: 10.1177/00157325211010230
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258 Foreign Trade Review 56(3)
Introduction
The past two decades have seen foreign direct investment (FDI) in services
increasing worldwide and gradually supplanting manufacturing FDI (UNCTAD
WIR, 2010, 2020). The services sector is unique in its multiple vertical and hori-
zontal linkages with the rest of the economy where it often operates as a support-
ing sector for activities in manufacturing, mining and agriculture. It is also unique
based on the fact that many services are non-tradable,1 which requires foreign
enterprises to set operation at the location; that is, in the case of the services sec-
tor, FDI acts as a substitute for exports. The rise of services FDI has also spurred
a discussion on national security issues related to the presence of multinational
enterprises (MNEs) in certain services sectors.
The heterogeneity of the services’ activities imposes the need to analyse ser-
vices FDI in its disaggregated form. Previous studies on the spillovers of aggre-
gated services FDI on host countries have produced mixed results. Doytch and
Uctum (2011) find that financial services and non-financial services FDI produce
opposite effects, especially on the manufacturing sector. Further, Doytch and
Uctum (2019) unravel the effects of trade services and business services FDI to
show that foreign participation in trade services hurts domestic manufacturers in
a sample of 14 Asian economies. To the best of our knowledge, further disaggre-
gation has not been attempted.
The question regarding the impact of outbound services FDI on its home econ-
omy is even less understood. The theory behind the positive spillovers hypothesis
of inward FDI rests on several well-known effects: scale effect, composition effect
and technological effect on the receiving economies. Scale effect is an effect on
the level of economic activity, induced by the influx of additional investment in
the economy. Composition effect of FDI is reflected in a structural shift that
changes the industry mix of the receiving economies. Technological effect refers
to a transfer of new knowledge and techniques, including superior technologies
that have the potential to improve productivity. The technological effect occurs
because of a demonstration effect on the local firms, movement of labour or trans-
fer of knowledge from foreign affiliates to their supply chain (Javorcik, 2020).
On the other hand, an economy with outbound FDI flows may be experiencing a
negative scale effect in the form of disinvestment and composition effect, possibly
reflected in deindustrialisation. Therefore, we can hypothesise that scale and com-
position effect work in the opposite direction for the host and home countries.
However, there is no negative technological effect for home countries, since knowl-
edge does not decrease at the source when there is a knowledge transfer via Outward
FDI (OFDI). On the contrary, the competitive positioning of the MNE worldwide
can bring up advantages that result in positive spillover in the home country, for
example, when MNE acquires or creates knowledge-specific assets abroad.
In addition, services FDI is a lot more nuanced with respect to their knowledge
transfer in comparison to manufacturing FDI. They are known to transfer ‘soft
technology’ in the form of technical, management and marketing know-how,
expertise, organisational skills and information, whereas manufacturing FDI pri-
marily transfers equipment and industrial processes technology (Chari, 2013;
Doytch 259
Chen et al., 2012; Nayyar & Mukherjee, 2020). MNEs tend to establish services
subsidiaries oftentimes in support of other firms that are part of the same MNE
conglomerate, and services subsidiaries play the role of extensions of these firms.
The current study is focused on inward and outward FDIs in the European
Union (EU). The economic policies of EU are guided specific fiscal, monetary,
trade and investment regulations. The FDI linkages in the region of EU are strong
due to EU policies of trade liberalisation and integration. Most of the Eastern
European countries joined the European Union in the 1990s and 2000s by signing
the Europe Association Agreement. The agreement establishes free trade between
signatories and leads to elimination of trade barriers for industrial production and
trade liberalisation of trade in agricultural goods. The first phase of enlarge-
ment of EU into the East European region took place in 2004 when Cyprus,
the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland,
Slovakia and Slovenia joined the EU (Feliciano & Doytch, 2017). Bulgaria and
Romania, which joined in 2007, could be considered a part of the second wave
(Kalotay, 2008).
In addition, the EU has adopted regulations setting the rules for bilateral invest-
ment agreements between individual EU members and non-EU countries, to make
sure that they are consistent with EU law and with the EU’s investment policy.
The regulation sets the conditions for more than 1,400 bilateral investment agree-
ments and the conditions for EU members to modify existing agreements and
negotiate or conclude new ones (European Commission, 2021). Although the
bilateral investment agreements are signed between individual EU members, the
conditions for these are set by common EU policy.
The empirical research to date, however, has almost entirely been focused on
the impact of inward FDI. In part, this is because of the negative policy connota-
tion of analysis on OFDI. No government would like to incentivise outflows
because of the associated loss of jobs. Recently, a few studies have focused on
Chinese outward FDI. Knoerich (2017), who investigates whether Chinese out-
ward FDI has made a contribution to the development of the Chinese economy,
finds that in fact, activities of Chinese enterprises in pursuing assets and advan-
tages abroad yield capability, capacity and macroeconomic returns to the main-
land economy. The author finds that these are specifically related to areas of
challenges that China has faced. In that sense, OFDI can be viewed as a complement
to international trade, inward FDI and emigration. Meanwhile, Jiang et al. (2020)
find evidence in favour of the existence of positive technological spillovers from
Chinese OFDI on the industrial structure of the Chinese economy, with some
regional heterogeneities and dependence on the level of financial development.
To date, there have been no studies exploring the impact of disaggregated ser-
vices inward and outward FDI, respectively, on their host and home countries.
This study focuses on a sample of 24 European economies to examine the spillo-
vers from disaggregated services FDI on economic growth. We examine the ser-
vices sector growth effects and the aggregate growth effects of both disaggregated
services FDI inflows and outflows on their respective host and home countries. To
that goal, the article analyses the effects of 20 disaggregated services FDI indus-
trial flows: (a) aggregate services; (b) trade and repairs; (c) hotels and restaurants;
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