Transplanting Economic Development: Don’t Pick Winners, Buy Losers!
Economic development both requires and promotes the acquisition of new capabilities. Countries do not specialise as they develop, they diversify. But this diversification is enabled by the specialisation of individual economic agents – in particular new, formal firms – whose productivity is increased by intensified use of technology. The question is: how do they get the technology?
We suggest that there are essentially three alternative modes of acquiring technology: “build” (developing new technology in-house), “borrow” (attracting FDI), and “buy” (buying technology). Given the difficulties that many developing economies have had in utilising the “build” and “borrow” modes, we develop a case for considering the “buy” mode as a means for acquiring technology in developing countries, and one which can be applied by development oriented governments.
At the firm level, the case for the “buy” mode is evidenced by the sheer volume of mergers and acquisitions aimed at expanding firms’ capabilities. In 2013, there were on the order of 40,000 announced deals valued at roughly US$3 trillion, and a good portion of these were for diversification.
At the country level, China has been figuratively vacuuming up companies globally: Lenovo’s acquisition of IBM’s personal computer manufacturing business; CNOOC’s acquisition of firm capabilities through its acquisition of Nexen; and Huawei’s tapping into foreign knowledge networks with over 20 R&D centres worldwide are just a few examples.
But China is the exception that proves the rule: most developing countries do not use this mode and are limited to the “build” or “borrow” modes, both of which have their problems.
Building firms and developing technology de novo is not only time-consuming, it is also clearly difficult, as evidenced by the very high rate of start-up failures. Indeed, developing new product lines is difficult even for established firms – hence the routine use of mergers and acquisitions to round out a firm’s line of products or to establish a presence in a new market segment.
Likewise, attracting FDI is difficult – the competition amongst nations and regions is intense, and the incentives that multinational enterprises (MNEs) may demand can be expensive for fiscally-strapped developing countries. Moreover, MNEs have every incentive to prevent knowledge spillovers to the domestic industry – hence their strong protection of intellectual property (IP) – and their interests may not be well-aligned with a developing country’s developmental agenda. Further, capital tends to flow disproportionately to major destinations, reflecting the positive externalities of proximity to other forms of capital – smaller developing countries simply do not figure in most MNEs’ plans.
Developing countries should consider an outward FDI strategy to complement their inward FDI strategies (i.e., buy firms and the technological and management know-how embedded in them). By applying the “buy” mode, developing countries can establish industrial holding companies that acquire, at a fraction of the original investment cost, the assets (and, temporarily, management) of technologically interesting plants and firms. Although such firms may have failed in their original environment, transplanted to developing country environments and partnered with local firms, they can represent significant technology upgrades for the developing country and help it climb the technology ladder. In other words, rather than “picking winners” to drive development, as traditional vertical industrial policy would propose, we consider the efficacy of “buying losers.”
Why the focus on firms?
Firms may be considered the “operating systems” of the private sector economy. Firms pull together production technologies, business methods, market intelligence, and human capital, and coordinate them for commercial purposes. This “know-how” is based on the accumulation of many technologies and capabilities. Importantly, firms retain this know-how for new employees to absorb – and to take with them when they move on to new employment. The availability of skilled workers to new firms is as much, if not more, due to the churn of employment in other firms as it is to formal educational systems.
The important role that firms perform for the bundling of know-how can be illustrated by a simple example: Pre-1990 technology carries no licensing requirements since patents have expired and are freely available to be copied. Developing countries could accordingly industrialise to a level consistent with early-1990s leading-edge technology, without licensing costs. Yet, even though this would appear to be a significant leap forward relative to the current state of technological advance in many parts of the developing world, this diffusion of technology does not seem to happen. Why? Because in a private sector economy, bits of isolated knowledge (such as patents) not coordinated by firms are like computer software programs without a computer.
Acquiring functional firms that house this tacit knowledge combined with disclosed technology is thus the critical step in acquiring capabilities.
How could the “buy losers” mode of firm and technology acquisition work in practice?
The legal framework for a relocated firm would be a state-owned enterprise statute. The institutional framework would be an industrial holding company created under that statute. Managers of the firm should be enticed to stay with the firm as it relocates, at least temporarily, while bringing along new local employees in the firm. The business strategy would be to privatise as quickly as possible. So the intent of the policy is not to replace private sector with government, but to fill a gap in the “capabilities acquisition" that the private sector is not filling.
In terms of execution by developing country governments, we suggest an experimental approach. The criteria for selecting “losers” should be roughly as follows:
- The firms failed largely for macroeconomic reasons (e.g., exchange rate over-valuation);
- The firms embody a relatively high level of technology and possibly possess proprietary technology;
- The firms operate in sectors where there are backward and forward linkages to local supply chains in the developing country;
- The firms supply goods that are in growing local demand more generally, providing the firm the opportunity to profit from its geographical transplant; and
- The firms can be consolidated with existing, but backward, local enterprises, with the state-owned industrial holding company retaining ownership of its share of the consolidated firm.
Once seeded, the program should be self-financing since the acquisitions are assets that will be subsequently privatised. Successful programs might even attract private venture capital. Ideally, the new firms emerging from this process would succeed and the public sector holding company would be able to privatise the firm and use the proceeds to repeat the process and seed another industry.
Individual failures are to be expected but the assets would move into new hands for second tries. Moreover, there are some other knock-on benefits to take into account in evaluating the success of such a program.
The approach accelerates private sector development in two ways: first by the simple addition of a new firm to the industrial mix; and second, by improving the context for all other firms in the local environment. This externality, well established in the literature on “industrial districts” and clusters, provides a classic ground for public policy intervention.
Second, history shows that the existence of a firm can attract a multinational that would not consider the same with a new project. Accordingly, the “buy losers” approach might also serve to attract inflows of still more advanced technology, not with expensive incentives but by sale of an asset – the MNE pays the developing country rather than the developing country paying the MNE!
Third, an expanding firm base would generate some genuine winners that would have the wherewithal to go abroad and open up new channels of technology flow by establishing a presence abroad through further acquisitions of their own.
Fourth, the acquired firm’s incentives would be shaped by its new shareholders’ objectives. Its mandate could include the public policy objective of maximising horizontal and vertical spillovers. Note that MNEs have the exact opposite incentive in the case of horizontal spillovers: they want to keep proprietary knowledge to themselves. That is why governments have to extract promises of technology transfer from them. The “buy losers” mode is actually superior in this regard.
Finally, due to accrued on the job training, each acquisition would also be an investment in human capital that substitutes to some extent for expenditure on other forms of training. At a minimum, seeding transplants in industrial zones co-located with training facilities should strengthen the training programs because of knowledge spillovers from the co-located transplant.
Our proposal builds on conventional wisdom concerning the establishment of an enabling environment for development. Building on the analogy of a garden, we argue that public policy must not only prepare the soil but also populate it with plants acquired from existing nurseries – the industrial incubators of the industrial world. Applying the principle of buy low, sell high, we suggest developing countries consider buying losers.
Dan Ciuriak is a member of the E15 Expert Group on Reinvigorating Manufacturing: New Industrial Policy and the Trade System. He is Director and Principal at Ciuriak Consulting Inc. (Ottawa), Fellow in Residence with the C.D. Howe Institute (Toronto), and Associate with BKP Development Research & Consulting GmbH (Munich).
Derk Bienen is a founder and managing partner of BKP Development.
This article is based on the paper Transplanting Economic Development: Don’t Pick Winners, Buy Losers!, by Dan Ciuriak and Derk Bienen, which provides a more in-depth development of the argument and references.