109 Secondly, FDI can also lead to the increased efficiency of resource use in the host economy. They can, therefore, additionally contribute to decreasing inflationary pressure and to increase productivity. This is linked to competition effects of TNCs entering the factor and product markets and competing for resources and goods. Furthermore, industrial upgrading via TNC entry can also create efficiency gains by improving productivity as well as the servicing the host economy with cheaper final and intermediary products (Enderwick 2005: 104; Markusen/Venables 1999: 346- 347). Thirdly, indigenous firms acting as suppliers can benefit from TNC demand for their products or their involvement in TNC production process through the integration of indigenous firms into global TNC production and value chains. These direct linkages can lead to increased profits and investments as well as technological upgrading (Enderwick 2005: 105). Finally, the host economy’s production structure can also gain from the technological upgrading of indigenous firms bought by TNCs. Depending on the market influence of the firm, this in turn can benefit an industrial cluster or even an entire industrial sector (Enderwick 2005: ibid.). Indirect benefits accruing from TNC engagement in the host economy follow the premise of Endogenous or New Growth Theory (Romer 1986; Romer 1990). It attempts to display the role of the diffusion of intangible assets in the form of knowledge in an economy via spillovers or positive externalities in order to explain the role of knowledge or human capital in capital accumulation (Mankiew 1997: 109; Kottaridi 2005: 82). In fact, TNCs are seen as one of the key institutions in the diffusion of knowledge and technology into an economy (Ozawa/Castello 2001: 3; Moran 2001: 45-46). The aggregate diffusion of technological progress is the result of the import of technological spillovers via the attraction of TNCs. Technological progress is transmitted throughout the whole economy via its internalisation through competition, learning and education effects. This diffusion is guaranteed by the co-operation between indigenous and foreign firms, the existence of demonstration effects of best-practice in marketing, production methods and knowledge (Enderwick 2005: 106; Fink 2006: 49-50). Similarly, knowledge diffusion can also take place through the unleashing of agglomeration economies. This effect describes the unintentional spillover of skills and know-how in industrial clusters between indigenous and foreign firms. Likewise, skills can be transferred by employees changing their workplace from TNCs to local firms (Enderwick 2005: 107). 3.2 Preconditions However, the sustainability of such a capital-import strategy depends on certain preconditions. These requirements are interrelated and refer to aspects of monetary, industrial and trade policy. The first issue is concerned with the construction and implementation of an attraction strategy in order to locate export-oriented TNCs in the host economy. The rationale to devise an attraction strategy stems from the na- 110 ture of FDI, which is defined as the result of international market imperfections and impurities. Secondly, attraction policies have to be combined with an industrial policy aimed at reaping the maximum benefits for the host country’s economic structure. Finally, FDI and especially high tech FDI is by definition a long term investment and hence requires a stable political and social environment (Paus 2005: 22). This, therefore, necessitates a long term political commitment and vision in terms of policy-making and implementation towards guaranteeing a stable environment in which a foreign firm can effect its investment (Dunning 1992a: 25). Especially in the case of democracies, a long term vision and commitment require consent in both the political and social spheres to the development strategy. This necessitates on the one hand a broad consensus on the political and administrative level towards FDI. On the other hand, commitment also presupposes the general acceptance of the development regime by relevant non-state actors such as the social partners and other relevant interest groups (Paus 2005: ibid). 3.2.1 Attraction Strategy The validation of an attraction strategy is closely linked to the nature of FDI. As Kindleberger (1969), Hymer (1960/1976) and Hirsch (1976) show, FDI is justified by the existence of international market imperfections. On the one hand, these constitute barriers-to-entry, as the internationally operating firm is faced with an atmosphere of uncertainty and high risk. These barriers-to-entry are defined by three factors: information costs, administration costs and costs of possible discrimination by host governments and consumers (Hymer 1976: 35). On the other hand, the same market imperfections can also allow TNCs to overcome their competitive disadvantages in foreign markets, as firms choose FDI instead of seeking contractual relations with domestic firms in the host economy or trade (Kindleberger 1969: 14). The apparent costs of international operations are mitigated by the internalisation or internal exploitation of firm-specific tangible and more importantly intangible advantages (Buckley 2006: 146). These advantages are firm-specific and are, hence, unequally distributed amongst all firms (Hymer 1976: 72-73). They, therefore, constitute individual competitive advantages, as they act as barriers to entry for other firms. Hence, they can resemble monopolistic or oligopolistic gains for the individual firm (Kindleberger 1969: 11; Hymer 1976: 25, 86; Dunning 1992b: 4). Furthermore, these intrinsic advantages may be greater for the foreign firm in the host economy than in its home economy (Hymer 1976: 31). Accordingly, FDI “is driven by the desire to control foreign operations” (Buckley 2006: 141). Consequently, FDI poses the possibility to exploit or defend transnational firmspecific monopolistic or oligopolistic advantages by reducing competition (Buckley 2006: ibid). 111 The barriers to entry for foreign firms are defined by transaction and production costs. Following Hirsch (1976: 263), FDI will only be a substitute for a foreign firm’s exports to the host economy, if the costs of exporting are higher than the costs involved with setting up and running productive facilities and producing in the host economy in comparison to the firm’s rivals. States can, therefore, be favourable locations for FDI, if they can successfully lower these cost factors via locational policies (Dunning 1992a: 20; Oxelheim/Ghauri 2004: 16). In line with Dunning’s (2006: 192, 201; 1993: 66-95) eclectic OLI-paradigm, a foreign firm will invest if the firm can reap the benefits from the ownership of specific assets (O) and locational advantages (L) via the internalisation of the host economy’s assets (I-advantages) into the productive network of the TNC (UNCTAD 1998: 89). Locational advantages influence O-specific advantages (UNCTAD 1998: ibid) and are defined by location-specific assets (Paus 2005: 18). These encompass institutional, educational, infrastructural, fiscal and geographical aspects, which enhance the competitive position of the investing firm (UNCTAD 1998: 90). In practice, attraction policies entail a multilevel approach. They are defined by the ability of the state to implement a successful package of instruments to attract FDI. The policies ensure and enhance the intrinsic assets of a firm, thereby allowing the TNC to continue to reap its intrinsic oligopolistic or monopolistic rents. If in contrast to neoclassical assumptions, production factors are not immobile, factor mobility results in the relative scarcity of capital. Therefore, capital has to be lured into the economy via an attraction programme (Moran 1998: 38). Such a programme attempts to remedy information deficits causing imperfect competition, thereby resembling an important barrier to entry for the foreign firm to the host economy. One instrument is the provision of business-facilitation services. This includes the promotion of an investment location, the sourcing of a suitable investor and the gathering of relevant information for the investor and on the prospective TNC in order to accurately estimate the investor’s specific requirements and attempt to meet them (Lall 2002: 78; UNCTAD 1998: 99, 101). Furthermore, transaction costs are additionally targeted by offering investmentfacilitation services, designed to lower the administrative burden and to further minimise information deficits (Lall 2002: 77). Finally, post-investment facilitation is aimed at constantly looking after the investor once the investment has been effected. The aim is to attain a sequential investment by an affiliate in order to thwart a potential disinvestment, reduce the amount of repatriated profits and to attain the reinvestment of earnings (UNCTAD 1998: 101). A further important element is the provision of pecuniary and non-pecuniary investment incentives designed to reduce the production costs and to increase the rate of return on the investment. Pecuniary incentives refer to fiscal and financial instruments. Non-pecuniary incentives refer to specialised exemptions for the foreign investor to rules and regulations governing the firm’s operations in the host economy. These measures include special legislation for specific policy fields, specific strategies and sectors. They can award foreign investors certain market preferences (Oman 2000: 20-21; UNCTAD 1998: 102). 112 3.2.2 Macro and Micro-Coordination Essentially, attraction instruments are discriminatory in nature (UNCTAD 1998: 102). International rules on trade related investment measures (TRIMS) as stipulated by the WTO (Wade 2003: 627-628) and by regional accords, such as those laid out in the Treaty of Rome, concerning the issue of “State Aids” in the EU, effectively rule out specific discriminatory measures to the detriment or to the benefit of TNCs (Oman 2000: 67-68). Consequently, attraction policies are combined with the state’s industrial policy. As the development strategy is centred on the generation of exports, polices to promote export orientation are a central feature of the development strategy and, therefore, equally apply to indigenous and foreign firms (Stephan 1999: 215). Hence, the creation of an attraction strategy only implies one feature of the FDI-led development regime. Industrial policy is the other. Both should be combined by a holistic approach of state policies (Dunning 1992b: 42). Accordingly, the spheres of governance, which define the realm of state capacity, are characterised by a dichotomy in order to unleash the envisaged macro and microeconomic effects. They are designed to complement the TNC’s locational strategy of reducing both production and transaction costs (Dunning 1992a: 15-16). They are also aimed to reap the maximum benefits from TNC engagement. The first level, macro-coordination, is associated with the macroeconomic management of the economy. This governance sphere encompasses policy areas concerning aggregate demand and supply, fiscal, budgetary and monetary issues. These determine the economic stability and the running of the host economy, thereby constituting a possible locational determinant for both indigenous and foreign firms by influencing inflation and interest rates, taxes and exchange rates (UNCTAD 1998: 97-98; Dunning 1992a: 22). Therefore, income and monetary issues are closely related to industrial policies, as they determine an industry’s cost structure and its international competitiveness. They are an integral feature of a state’s locational attractiveness, which is characterised by guaranteeing low production costs to prospective investors through ensuring competitive wage levels. The latter point is important within the context of the import sensitivity of consumption in small and open economies (Stephan 1999: 192- 193; O’Malley 1989: 83). In order for such an economy to produce sufficient export surpluses, it is necessary for income policies to be stability oriented. Wage rises above the productivity rate can fuel inflation and accordingly lead to interest rate rises, harming entrepreneurial investment and competitiveness. Furthermore, they can incur balance of payments difficulties; wage-fed consumption increases can induce additional imports (Stephan 1999: 215). Similarly, state expenditure should be balanced to avoid extra consumption above the absorptive capacity of the economy. In this case, extra consumption could lead to import surpluses and an increase in foreign indebtedness due to a balance of payments deficit and ultimately culminate into a deterioration of the country’s monetary