Foreign Direct Investment, Local Contents Requirement and Profit Taxation

In the paper of Lahiri and Ono, the authors have provided an important notice on the benefit gives rise by Foreign Direct Investment (FDI). The writers try to express the benefit of local contents requirement regulation imposed by host government against foreign investor. The local contents here refere to employment of host country labor.

In reality, we observe the inflow of foreign firm into developing country like Cambodia, seeking for lower labor cost. The local content requirement might not be necessary regarding labor however if we take into account the other kind of input produce or endowed by host country we can realize the opportunity of growth of intermediate supply industry. Host country firm can grows by becoming the main supplier for multinational corporation. This is usaully known as backward linkage. Government of host country should play role in embedding multinational firm within a favorable industry structure that provide this linkage effect.

Returning to Lahiri and Ono paper, I notice a few extreem assumption that should be revise to make the model applicable for developing countries such as Cambodia.

The assumption that input cost in home country is higher than host country
The assumption that ouput or product produce by multinational subsidiary in host country is target for host country market.
In reality, as I said above most FDI tend to seek benefit from different in factor price across countries and also most FDI that came to host country is export oriented-aim at exporting to third country rather than host country market. For example, garment industry in Cambodia is most owned by chinese-owned enterprise which target EU and US market.

However, the conclusion with the two extreme assumption offer a significant insight on the benefit of local content requirement regulation. Mainly the two effect raised by authors that is the unemployment reduction effect and price-lowering effect (Higher consumer surplus). It is true that FDI lead to job creation, mostly in unskilled labor employment. Nevertherless, the price reduction effect is subject to emprical studies whether FDI leads to reduction in monopolistic power or not.

My opinion is that the welfare analysis tool used by author based on price lowering effect in term of Consumer surplus is applicable only in the case large country with high potential market such as China or India but is inappropriate for Cambodia.

The conlcusion is the welfare anlaysis should be enrich by relaxing the two extreem assumption and I think it may give rise for new research to fill this gap.

The detain of paper is Sajal Lahiri and Yoshiyasu Ono (1998) , “Foreign Direct Investment, Local content requirement and Profit taxation”, The Economic Journal, 108, pp. 444-457.