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Policies to Facilitate a Virtuous Circle

Written by: OECD Development Centre

Article Overview: There are only limited experiences of host countries that have succeeded in continuously attracting FDI while effectively moving-up the value chains through solid HRD and technology transfers.

Policies to Facilitate a Virtuous Circle

There are only limited experiences of host countries that have succeeded in
continuously attracting FDI while effectively moving-up the value chains through solid HRD
and technology transfers. Among these, Singapore, Ireland and, to some extent, Costa
Rica are the few countries that are considered to be in the process of a virtuous circle. All
three countries started their industrial development with a large fraction of unskilled
workers and minuscule level of FDI. All three countries have acknowledged the important
role of foreign firms in the economy, consequently made rapid HRD, and have
continuously increased the supply and quality of education. They have all initially started
attracting low value-added MNEs, and have gradually succeeded in attracting high valueadded
MNEs in the past one or two decades, which went hand in hand with an upgraded
investment climate and a policy environment driven by a well-functioning IPA. The following
describes the common policy fundamentals behind the success of these countries.
i) Flexible Demand-Driven Policies
One of the most important fundamentals behind the FDI policies in the three
countries is a demand-driven principle. The establishment of effective IPAs with strong
authorities to co-ordinate human resource development was a key starting point. All IPAs in the three countries had good links with industries and MNEs which helped identify the
skill needs of the economy. This was crucial in devising effective educational policies and
establishing government funded skills development institutions.
Another important feature of the successful demand-driven policies among the
three countries is its flexibility. With the rapid innovation in technologies and increased
importance of the services industry, the mode of MNE operation has been substantially
transformed over the past ten years. This calls for host developing countries to devise
HRD policies that are highly flexible, reflecting fast changes in the skill demands of the
economy. In order for this to happen, industry involvement in HRD policy making, with
industry-driven training schemes becomes a key.

ii) Targeting Inwards FDI
In the short run, increasing the amount of inward FDI is feasible for most countries
by simply providing attractive tax exemption policies or rewarding preferential status to
particular MNEs that host countries seek. This, however, is not likely to be effective in the
long run since it will lead to a large fiscal burden, and the very MNEs, high value-added
MNEs bringing skills and technology, that countries seek most are usually not attracted
solely by tax incentives policies. Indeed, section III has shown that high value-added
MNEs require other host-country conditions including a high level of human resources.
The experiences in these three countries indicate that it is crucial to target the type
of MNEs that the host country is likely to benefit in the long-run as well as in the short
run. If host countries attract MNEs that will not lead to much skill upgrading of the
economy, the virtuous circle can never be attained, and its impact on the economy is
expected to be one-shot. Thus, host developing countries must first identify the type of
MNEs that they would not only like to attract in the short run (potentially increasing
employment and tax revenues), but also the types that would most likely benefit the
economy in the long run, through increased training opportunities and technology
spillovers. The next step is to assess whether the country has the right investment
climate for this type of MNE to be attracted. If not, rapid policy reforms to improve the
investment climate become imminent.
iii) Co-ordinating Education and Training Policies
Past experiences in the three successful countries show that HRD policies to
attract FDI and HRD policies to promote skills transfers were both critical in each of the
steps of the virtuous circle. In particular, formal education policy was shown to be
important for the former while training policy was shown to be critical for the latter. Is it
then sufficient that host countries simply make efforts in improving education and training
policies as described in the previous sections? The answer to this question is most likely
to be no. One reason could be that education policies that simply increase the number of
school graduates may crowd-out enterprise training. Increased numbers of students
finishing basic schooling level and above may give financially constrained firms
incentives to increase hiring of these students instead of providing job-specific training
that may be more beneficial for these workers and firms in the long run (Miyamoto and
Todo, 2003). Another reason comes from evidence that the contents of enterprise training programmes are in many cases very similar to what is taught in formal
education33. While low-educated workers in the labour market who had missed basic
education may gain from such training programmes, other workers may not benefit at all.
All these policy/market failures can be reduced if formal education policies and (postformal)
education and training policies are well co-ordinated. In fact, one of the important
goals of adult-learning and/or life-long learning policies adopted in many of the OECD
countries emphasises the importance of co-ordination of formal schooling and education
and training during the post formal schooling stage (OECD, 2003). They stress the
importance of policy coherence and a co-ordinated approach to adult (life-long) learning
by bringing all the relevant partners at different education and training levels together
(OECD, 2003).
Co-ordination is important since formal schooling, depending on its contents, can
reinforce or hinder post-schooling training. If workers gain the right skill/knowledge mix in
formal schooling that would later increase the benefits of continuous training, both
workers and firms would have more incentives to provide training. Unfortunately, even in
most of the European Union member countries, there is as yet no coherent strategy to
co-ordinate the different phases of education and training either in terms of curricula
and/or recognition/certification of formal and non-formal learning. Co-ordination, thus, is
an issue not only for countries concerned with adjusting workforce skills to the ever
evolving skills demand, it is particularly important for developing countries that seek
further gains by attracting and mobilising FDI.

OECD DEVELOPMENT CENTRE
Working Paper No. 211
HUMAN CAPITAL FORMATION
AND FOREIGN DIRECT INVESTMENT
IN DEVELOPING COUNTRIES
by
Koji Miyamoto

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Article Tags: developing countries, development institutions, eco, educational policies, fdi, flexibility, host countries, hrd, human resource development, investment climate, ipas, policy environment, principle, quality of education, rapid innovation, skill demands, technology transfers, unskilled workers, value chains, virtuous circle



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