RESTRICTED  WORLD TRADE  
ORGANIZATION  WT/WGTTT/W/1 
2 April 2002 
 (02-1462) 
Working Group on Trade and Transfer of Technology  
 
  
TRADE AND TRANSFER OF TECHNOLOGY 
 
Background Note by the Secretariat
 
 
 
 
I. INTRODUCTION ................................................................................................................ ....2 
II. TECHNOLOGICAL DIFFERENCES ...................................................................................2 A. H
OW ARE NEW TECHNOLOGIES CREATED ? .................................................................................3 
B. H OW IS INNOVATION DISTRIBUTED GEOGRAPHICALLY ? ............................................................5 
C. H OW DOES TECHNOLOGY DIFFUSE ACROSS COUNTRIES ? ...........................................................7 
III. TRADE AND TECHNOLOGY DIFFUSION........................................................................8 
A. H OW DOES TRADE LEAD TO TECHNOLOGY TRANSFERS ? ............................................................8 
B. W HAT FAVOURS THE ABSORPTION OF FOREIGN TECHNOLOGY ?................................................9 
C. W ILL MORE TRADE LEAD TO MORE TECHNOLOGY TRANSFER ? ................................................11 
D. W HAT IS THE EMPIRICAL EVIDENCE ON THE ROLE OF TRADE FOR INTERNATIONAL 
TECHNOLOGY DIFFUSION ? ........................................................................................................13 
IV. FOREIGN DIRECT INVESTMENT AND TECHNOLOGY DIFFUSION.....................15 
A. H OW DOES FDI  TRANSFER TECHNOLOGY ? ...............................................................................15 
B. W HAT TYPE OF FDI  EMBODIES THE HIGHEST POTENTIAL FOR TECHNOLOGY 
DIFFUSION ?.............................................................................................................................. ..18 
C. W HAT FACTORS DETERMINE THE TYPE OF FDI  THAT A COUNTRY ATTRACTS ?........................19 
D. H OW DOES TECHNOLOGY TRANSFERRED THROUGH FDI  DIFFUSE INTERNALLY ? ....................24 
E. W HAT IS THE EMPIRICAL EVIDENCE ON THE ROLE OF FDI  IN INTERNATIONAL 
TECHNOLOGY DIFFUSION ? ........................................................................................................28 
V. PARTNERSHIP AGREEMENTS AND TECHNOLOGY TRANSFERS ........................31 
A. W HAT DETERMINES THE DECISION BETWEEN FDI  AND PARTNERSHIP AGREEMENTS ?.............32 
B. W HAT IS THE POTENTIAL FOR TECHNOLOGY TRANSFERS FROM PARTNERSHIP 
AGREEMENTS ?...........................................................................................................................33 
C. W HAT IS THE EMPIRICAL EVIDENCE ON THE ROLE OF LICENSING AND JOINT 
VENTURES FOR TECHNOLOGY TRANSFERS ? ..............................................................................33 
 
  WT/WGTTT/W/1 
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 I. INTRODUCTION 
1. The Working Group on Trade and Transfer of Technology was established in accordance with 
the mandate in para. 37 of the Doha Minister ial Declaration, which states that Members 
" agree to an examination, in a Working Group under the auspices of the General 
Council, of the relationship between trade and transfer of technology, and of any 
possible recommendations on steps that mi ght be taken within the mandate of the 
WTO to increase flows of technology to developing countries.  The General Council 
shall report to the Fifth Session of the Ministerial Conference on progress in the 
examination." 
2. The Working Group held an open-ended informal meeting on Wednesday, 6 March 2002, 
presided over by the Chairman designate of the bo dy, at which he suggested, and the meeting agreed, 
that the Working Group begin with an examination of  the relationship between trade and transfer of 
technology and proposed that the Secretariat be asked to produce a factual background document for 
the first formal meeting of the Working Group.  That  document was to contain a factual survey of the 
issues related to trade and transfer of technology that have been dealt with elsewhere.  
3. The present document responds to that request. It  has been prepared by the Secretariat on its 
own responsibility and is intended only for the purpose  of analysis in order to assist delegations in 
their work on trade and transfer of technology.  The note begins by examining how new technologies 
are created and how they diffuse geographically.  Many factors are active in the process by which 
developing countries acquire and exploit tech nologies to their advantage; trade (and a fortiori , trade 
rules) is but one of these factors.  The note therefore moves to an examination of empirical evidence 
on the role of trade in technolo gy diffusion internationally, focussing on how trade leads to 
technology transfer and what factors favour the absorption of technologies.  Another factor in the 
acquisition/exploitation process is foreign direct investment (FDI), which is sufficiently closely linked 
to trade to merit a discussion in the present contex t.  The note considers FDI from the perspectives of 
how it leads to technology transfer, what types of FDI embody the highest potential for technology 
diffusion, what factors determine the type of FDI attracted by a country and how technology acquired 
through FDI diffuses internally.  Empirical evid ence of FDI's role in technology diffusion 
internationally is also reviewed.  Finally, certain of the most important practical mechanisms for the 
transfer of technology (licensing, franchising and partnerships) are examined. 
 
II. TECHNOLOGICAL DIFFERENCES  
4. Technological differences across countries are an important determinant of income levels. 
Empirical economic research has shown that accu mulation of physical and human capital can only 
partially explain different income levels across countries (Easterly and Levine, 2001; Prescott 1988).
1  
5. The standard way to measure the technology level of a country is to look at either 
productivity or unit cost. Productivity is a measure of an economy's efficiency in transforming inputs 
into outputs.  A country's Total Factor Productivity (TFP) is defined as output per unit of all inputs 
(usually capital and labour) combined2.  Table 1 presents data on TFP for a select range of countries 
                                                      
1 This and subsequent bibliographic references in this paper can be found in WT/WGTTT/W/1/Add.1. 
2 Total factor productivity is measured as the ratio between a country's total production and a weighted 
sum of the inputs used.      WT/WGTTT/W/1 
 Page 3 
 
 
 and the per capita income in these countries relative to the US. 3 It illustrates the importance of TFP 
for determining income differences across societies.  
 
Table 1:  Per Capita Income and Total Fa ctor Productivity in 1988 (relative to US) 
 
Country Per Capita Income Total Factor Productivity 
United States 1.000 1.000 
Canada 0.941 1.034 
West Germany 0.818 0.912 
France 0.818 1.126 
United Kingdom 0.727 1.011 
Hong Kong 0.608 1.115 
Singapore 0.606 1.078 
Japan 0.587 0.658 
Mexico 0.433 0.926 
Argentina 0.418 0.648 
U.S.S.R 0.417 0.468 
India 0.086 0.267 
China 0.060 0.106 
Kenya 0.056 0.165 
Zaire 0.033 0.160 
Average, 127 countries 0.296 0.516 
Correlation per capita income with 
labour input (Y/L)  
1.000  
0.889 
Data Sources:  Penn World Tables Mark 5.6. Barro and Lee (1993).  The labour input measure used in these 
calculations has been calculated using Mincer regression results with variable returns from different types of schooling. 
 
6. What determines the level of technology of a country?  Economic literature has shown that 
the rate of technological change is determined not only by domestic innovation but also by the 
international diffusion of technology.  In developi ng countries, where domestic innovation is low, the 
international diffusion of technology acquires a rela tively greater importance from the perspective of 
economic development.  The degree of international diffusion of technology is a major determinant of 
the world's distribution of income.  Rapid international diffusion of technology is a force toward 
convergence.  
 
A. HOW ARE NEW TECHNOLOGIES CREATED ? 
7. Technological progress is only to a limited extent  driven by scientific research or chance.  
Most of the process of technological innovation is th e result of economic forces.  It is the outcome of 
firms' research and development (R&D) activities.  Industrial R&D expenditure accounts for between 
2 per cent and 3 per cent of GDP in each of the major industrialised countries:  the United States, 
France, Germany, Japan and the United Kingdom.  Ab out 75 per cent of the roughly one million US 
scientists and researchers are employed by firms.  UK firm's R&D spending represent more than 20 per cent of their spending on gross investment (Blanchard, 1997).  
8. Firms spend on R&D to increase profits or to keep up with competition from other innovating 
firms.  The higher the expenditure on R&D the hi gher is the probability that a firm innovates, 
i.e. introduces a new or higher qu ality good or a new technique of production.  This innovation if 
                                                     
 
3 The data given is for 1988 and taken from Hall and Jones (1999). The original data set contains 
127 countries and the average value for the 2 measures as well as their correlation is given in the table. 
 WT/WGTTT/W/1 
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 successful will increase the firm's profits or will av oid profit loss if another firm in competition with 
the former innovates. 
9. There is an important difference between spen ding in R&D and buying a new machine.  The 
outcome of the R&D activity is an idea, and as such  it can be appropriated by a competitor at a lower 
price than the expenditure originally needed to ge nerate the idea.  This can reduce or eliminate the 
advantage brought by the innovation.   
10. Three factors determine the level of R&D of a firm: the productivity of the R&D activity, the 
degree of appropriability of research results and the level of R&D expenditure of other firms.  
1. Productivity of R&D 
11. The productivity of R&D is defined by the number of innovations that result from the R&D 
activity.  The higher the productivity, the higher wi ll be firms' incentive to spend in research and 
therefore the faster the process of technological innovation.  
12. What determines the productivity of R&D?  
(a) The successful interaction of basic research (the research for general principle) and 
applied research and development (the application of the results of basic research to 
specific uses, and the development of new products) is one factor.  In the computer 
industry for example, many of the innovations are applications of the invention of 
transistors or microchips.  Linkages the between academic research and R&D activity 
conducted in the private sector would favour productivity of research.  
(b) The quality and the type of the education system are important determinants of the 
productivity of R&D.  The higher the level of education of the researchers and scientists the higher the rate of innovation in a country.  
13. The type of education is also an important factor in determining the level of productivity of 
research.  Some countries are more successful in  basic innovation than in the development of new 
products.  An education system directed toward abstract thinking is shown to produce better 
researchers in basic research than in applied research.  An education system directed to develop a "culture of entrepreneurship" is more likely to lead to success in developing and marketing a new 
product. 
(c) The speed at which basic knowledge leads to  the development of new products is also 
an important determinant of productivity of research.  The profitability of introducing 
a new product or process in a country is therefore an important determinant of the rate 
of productivity of  research.  For example, the upgrading of the performance of a new generation of computers also depends on the extent of demand, the number of people 
that have acquired the knowledge to us e it  and the potential for applications. 
2. Appropriability of research results 
14. The appropriability of research results is defi ned by the extent to which firms can benefit 
from the reward derived by the results of their ow n research.  If the degree of appropriability is low a 
firm will not engage in R&D activity an d technological progress will be slow.  WT/WGTTT/W/1 
 Page 5 
 
 
 15. What determines the extent of appropriability of the benefits from innovation? 
(a) The nature of innovation.  If the innovation is such that it can be easily upgraded, the 
firm can very easily lose the advantage of being the first innovator.  As a 
consequence the incentive to innovate will be low.  
(b) The degree of legal protection granted to inn ovation.  Patents give a firm the right to 
exclude other firms from the use of its innovation.  
3. The level of R&D expenditure of a competitor firm 
16. The decision of a firm to spend on R&D is a strategic decision, which also depends on the 
expenditure on R&D of its competitors.  A high level of expenditure on R&D of a competitor gives 
the firm a high incentive to innovate.  The reason is that if the competitor innovates first, the firm is 
likely to lose market share, experience losses  and possibly be forced to exit the market.  
17. In this respect, the degree of competitiveness of  product market is an important determinant 
of the level of R&D. 
 
B. HOW IS INNOVATION DISTRIBUTED GEOGRAPHICALLY ? 
18. In order to provide an indication of the geographical and sectoral distribution of innovation 
we use both R&D and patent statistics.  R&D activity  is highly concentrated both geographically and 
by industry.  Almost the entire R&D activity in the world economy is concentrated in the industrial 
countries.4  And patent ownership is highly concentrated  in developed countries.  (Table 2 provides 
data on the geographical origin of Patent Cooperatio n Treaty (PCT) patent applications filed in 1998 
and 2000.) 
                                                      
4 According to UNESCO (1993) in 1990, the industrial countries accounted for 96 per cent of total 
world R&D expenditure. Moreover, within the OECD the seven largest economies accounted for 92 per cent of 
R&D in 1991. (Coe et al., 1997). WT/WGTTT/W/1 
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Table 2:  Geographical distribution of PCT patent applications filed in 1998 and 2000 
(from figures published on WIPO Website) 
    
Region Country of No. patents filed No . patents filed % of total % of total 
 origin 1998 2000 1998 2000 
     
North America USA 28,356 38,171 42.3 42.0 
 Canada 1,315 1,600 2.0 1.8 
      
Total North America  29,671 39,771 44.3 43.8 
      
Western Europe/EU Germany 9,112 12,039 13.6 13.2 
 UK 4,383 5,538 6.5 6.1 
 France 3,322 3,601 5.0 4.0 
 Sweden 2,554 3,071 3.8 3.4 
 Netherlands 2,065 2,587 3.1 2.8 
 Switzerland 1,293 1,701 1.9 1.9 
 Finland 1,092 1,437 1.6 1.6 
 Italy 925 1,354 1.4 1.5 
 Denmark 624 789 0.9 0.9 
 Austria 421 476 0.6 0.5 
 Norway 394 470 0.6 0.5 
 Others 1,101 1,463 1.6 1.6 
      
Total Western Europe/EU  27,286 34,526 40.7 38.0 
      
East Asia and China Japan 6,098 9,402 9.1 10.3 
 South Korea 485 1,514 0.7 1.7 
 China 322 579 0.5 0.6 
      
Total East Asia & China  6,905 11,495 10.3 12.6 
      
Eastern Europe Russia 429 590 0.6 0.7 
 Others 402 627 0.6 0.7 
      
Total Eastern Europe  831 1,217 1.2 1.3 
      
Australasia Australia 1,048 1,627 1.6 1.8 
 New Zealand 178 264 0.3 0.3 
      
Total Australasia  1,226 1,891 1.9 2.1 
Total Middle East  707 925 1.1 1.0 
Total Rest of Asia  146 473 0.2 0.5 
Total Latin America/  209 252 0.3 0.3 
Caribbean      
Total Africa  26 398.0 <0.1 0.4 
Total applications  67,007 90,948 100.0 100.0 
  WT/WGTTT/W/1 
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19. R&D spending is also highly concentrated by industry.  Among OECD countries, for 
instance, Keller (2001a) reports that about 80 per cent of all manufacturing R&D is conducted in four 
three-digit ISIC industries:  chemical products  (including drugs), electrical and non-electrical 
machinery (including computers and telecommunication equipment), and transportation equipment. 
20. Table 3 reports indicators of sectoral technology  intensity. Indexes refer to the average for the 
five most industrialised countries (France, Japan. UK, US and Germany) over the period 1973-1992.  
Data about R&D are computed as the share of R&D on value added and patent intensity is computed 
as patents per thousand employees.  
 
Table 3:  Some sectoral indicators:  average 1973-92 1 
 
Sector R&D Patents 
Food, beverages & tobacco 0.008 0.01 
Textiles, apparel & leather 0.006 0.01 
Chemical products excl. drugs 0.09 0.28 
Drugs and medicines 0.21 0.19 
Rubber & plastic products 0.03 0.09 
Non-metallic mineral products 0.02 0.05 
Basic metal industries 0.02 0.02 
Metal products 0.01 0.09 
Non-electrical machinery 0.04 0.18 
Office & computing machinery 0.16 0.20 
Electrical machines 0.11 0.12 
Radio, TV & communic. equip. 0.18 0.21 
Transport equipment 0.14 0.05 
Professional goods 0.07 0.45 
Manufacturing sector 0.08 0.09 
1 The first column reports values of R&D intensity (i.e. R&D expenditure over value added).   
In the second column, patents are per thousand employees. 
 
 
C. HOW DOES TECHNOLOGY DIFFUSE ACROSS COUNTRIES ? 
21. There are two ways in which technology transfers across countries: 
(a) Using technologically advanced intermediate products that have been invented abroad. 
(b) Through learning about foreign technology.  There are three channels  through which a 
country can learn about a foreign technology.  These are: 
(i) Accessing the knowledge codified in a bl ueprint.  This may lead to copying 
of the foreign technology and adjustment of the technology to domestic use.5  
                                                      
5 Two important factors limit the potential of technology diffusion through this channel. First, the right 
to use this technology is usually protected by a patent.  Second, not all knowledge is  codified. It is in the interest WT/WGTTT/W/1 
Page 8  
 
 (ii) Communication that stimulates cross- border learning.  This channel of 
diffusion of knowledge is particularly important to transmit tacit knowledge, 
non-codified information.  Part of this  is learning-by-doing, which is the cost 
lowering effect of cumulative production.  
(iii) Interaction between domest ic and foreign firms. 
22. The following section discusses the role of trade, foreign direct investment, licensing, 
franchising and partnership ( mechanisms for technology transfer) in the diffusion of technologies.  In 
particular, the channels of technology transfer used by each of these mechanisms are identified.   
23. Moreover, since there are two parties that play  a role in the diffusion of technology across 
countries (the provider and the recipient of the new technology), the factor which favours the 
absorption of a new technology and its internal diffusion in the recipient country are singled out.   
 
III. TRADE AND TECHNOLOGY DIFFUSION 
A. H
OW DOES TRADE LEAD TO TECHNOLOGY TRANSFERS ? 
24. Technological knowledge is typically the design, or blueprint, of a new product.  Therefore, 
technological knowledge is embodied into a product and travels with it.  Trade leads to international technology diffusion because (a) it makes available for production technologically advanced 
intermediate goods, (b) it makes available for th e study of their technological specifications 
intermediate and final goods, (c) it favours person-to-person communication.   
25. There is an important difference between the technology transferred via the use of advanced 
intermediate inputs and that acquired via the learni ng of the technology embodied into a product.  In 
the former case, employing the foreign intermediate good involves the implicit usage of the design knowledge that was created with the R&D investment of the foreign inventor.  The technological 
knowledge of the blueprint is embodied in the inte rmediate good and the use of the technologically 
advanced  intermediate good increases the importing country TFP.  This is because, as long as the 
intermediate good costs less than its opportunity costs, which include the R&D costs of product 
development, there will be a gain from having access to foreign inte rmediate goods.  This gain is 
sometimes called passive  technology spillover (Keller, 2002).  However, although an importing 
country has access to the results of foreign R&D act ivity, the technological knowledge embodied in 
the imported intermediate as such is not availabl e to domestic inventors, only the manufactured 
outcome of it is.  It is the action of importing itself that leads to technology transfer and thus a 
productivity increase.  If imports of the relevant intermediates are interrupted for one reason or the 
other, the productivity increase cannot be maintained by the country as it is not able to reproduce itself the knowledge embodied in the intermediate goods. 
26. This contrasts with the situation when th e  importing country acquires the knowledge 
embodied in the imported good, whether intermedia te or a final good.  K nowledge is acquired by 
reverse engineering, copying, or communicating with the suppliers of the product.  In this case, the 
knowledge obtained through communication and/or th e copying of imported goods will probably not 
be lost even if communication or imports are inte rrupted.  Once the technology transfer has taken 
place, the foreign technology thus remains in the country. 
                                                                                                                                                                    
 
of the inventor not to reveal all information and some of the information is "tacit" knowledge, in the sense that it 
would be very difficult to codify.  
  WT/WGTTT/W/1 
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 27. This process of learning is likely to be less ex pensive than the original expenditure needed to 
create the knowledge.  There is therefore a gain (spillover) that result from this process.  This gain is 
commonly defined in the economic literature as active  spillover, as it requires the active participation 
of the importer.  
28. For each of the channels discussed above through which trade affects technology transfers, 
the following discussion will consider: 
(a) the conditions that need to be satisfied  in the importing country for technology 
transfer to occur; 
(b) the way the link between trade and technology transfer can be expected to be 
reflected in the data. 
29. The empirical evidence on trade and technology di ffusion will also be reviewed in this light. 
 
B. WHAT FAVOURS THE ABSORPTION OF FOREIGN TECHNOLOGY ? 
30. The following are the channels of technology transfer through trade:  
1. Employing specialized and advanced intermedia te products that have been invented 
abroad 
31. In order for trade to lead to technology transfer s through this channel, it is required that the 
imported  intermediate products be used efficiently in  the domestic production process.  It might also 
be needed that workers have a certain skill level to  be able to use more technologically advanced 
machines and to efficiently organize the production process. 
32. Meyer (2001) provides some evidence of a pos itive and significant effect of the combination 
of the stock of human capital and imports of machinery on economic growth.  In particular, different 
levels of education seem to influence growth th rough different channels.  Tertiary education and 
completed secondary education ha ve a role in domestic R&D activities, whereas it is above all 
medium levels of education that in teract with inte rmediate imports. 
2. Copying foreign technologies and adjusting them to domestic use 
33. Trade enables a country to learn about a product, to copy foreign technologies and to adjust 
them to domestic use.  Imitation is widespread and it has played a major role in the growth of high 
performing economies such as Japan and the newly industrialising economies of east Asia.  
34. In order for it to be possible to copy a foreign technology embodied in a good, it must be the 
case that the blueprint on which the production of the good is based can be reproduced by analysing 
the final product (which may be an intermediate or  final good).  This implies that the technological 
knowledge behind the blueprint is codified and that th e code is directly reproducible from the good.  
If part of the knowledge is not codified ("t acit"), communication with the suppliers need to 
complement the activity of reverse engineering.  
35. If knowledge embodied in a good is codified, the skill level of the workforce of the importing 
country will be important in determining whether a product can be successfully imitated.  The word 
"reengineering" in itself already indicates that relatively high levels of education and technical 
knowledge may be required in order for individual s to be able to copy imported products.  WT/WGTTT/W/1 
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 36. Another important aspect is the entrepreneuria l environment in which the activity of copying 
takes place.  The transfer of technologies will only take place if individuals or firms actually have an 
incentive to invest in the attempt of imitating.  For this to be the case it is important for them to have 
the possibility of commercializing th e product once it has been copied.  
3. International trade provides channels of communication that stimulate cross-border 
learning of production methods, product design, organisational methods and market 
conditions 
37. Knowledge is to some extent tacit.  This is because for example the person who is actively 
engaged in a problem-solving activity may not necessarily be able to define what exactly he or she has 
been doing, and it may be impossible to reconstruct certain actions by only having access to the final 
product.  In order to transfer this non-codified knowledge demonstrations, personal instruction and/or 
expert services may be needed.  The more knowledge is non-codified, the more person-to-person 
communication becomes important for the diffusion of knowledge. 
38. As Nelson and Pack (1999) point out, even if both the product and communication channels 
are available it may not be easy to reproduce the product.  Indeed the attempt to reproduce a foreign technology may involve significant uncertainty and ec onomic risk.  They illustrate their point with the 
description of Hyundai's efforts to produce a car after it had purchased the foreign equipment, hired 
expatriate consultants, and signed licensing agreements with foreign firms.  Their description is based 
on Kim (1997) who concludes: 
Despite the training and consulting services of experts, Hyundai engineers repeated trials and 
errors for fourteen months before creating th e first prototype.  But the engine block broke 
into pieces at its first test.  New prototype engines appeared almost every week, only to 
break in testing.  No one on the team could figure out why the prototypes kept breaking 
down, casting serious doubts even among Hyunda i management, on its capability to develop 
a competitive engine.  The team had to scrap eleven more broken prototypes before one 
survived the test.  There were 2,888 engine design changes.  Ninety seven test engines were made before Hyundai refined its natural aspiration and turbocharger engines.  In addition, more than 200 transmissions and 150 test vehi cles were created before Hyundai perfected 
them in 1992. 
 
39. Table 4 gives an overview of the differences be tween the three channels  through which trade 
affects transfer of technology.   WT/WGTTT/W/1 
 Page 11 
 
 
 Table 4:  Characteristics of the diffe rent channels of technology diffusion 
 
 imports of 
intermediates copying communication 
conditions • availability of 
medium skilled 
work force • technology is 
codified and 
reproducible directly 
from good. 
• availability of 
medium to highly  
skilled work force (re-engineering). 
• appropriate 
entrepreneurial environment. • technology may be 
partly tacit. 
• availability of 
medium to highly  skilled workforce 
(re-engineering). 
• appropriate 
entrepreneurial 
environment. 
will data reflect a 
positive relationship between the size of 
trade flows and the 
level of growth? • only imports of 
intermediate goods 
are relevant. 
• yes, we expect to 
find positive 
relationship in 
data. • both imports of 
intermediate and of 
final goods may 
potentially be 
relevant. 
• not clear whether to 
expect positive relationship in data. • both, imports of 
intermediate and 
of final goods may 
potentially be 
relevant. 
• not clear whether 
to expect positive relationship in 
data. 
 
 
C. WILL MORE TRADE LEAD TO MORE TECHNOLOGY TRANSFER ? 
40. Before turning to the evidence on the impact of trade on technology transfer, consider what is 
the relationship between trade flows and transfer of te chnology to be expected.  First of all it should 
be noted that while transfer of technology occurring through the use of technology advanced inputs 
into the production process refers only to trade in intermediate goods, transfer of technology occurring 
via copying or communication channels can result from trade of both intermediate and final goods.  
Testing the role played by each of the three channels of transfer of technology through trade, therefore 
requires data on trade in intermediate goods or total trade depending on the channel under 
examination. 
41. A large proportion of trade of developing countr ies with rich OECD countries does take the 
form of intermediary inputs, as is evident from table 5.  The large share of machinery and transport 
equipment in imports suggests that there are relatively large amounts of knowledge entering the 
country embodied in intermediary inputs.  WT/WGTTT/W/1 
Page 12  
 
 Table 5:  Trade Structure between High-Income OECD Countries and Low- and 
Middle-income economies (LMI) 
 Composition of Trade (in %) 
 Imports by LMI from OECD 
Food 7.3 
Agricultural raw materials 2.0 
Ores and nonferrous metals 2.1 
Fuels 2.0 
Manufactured goods 83.2 
Chemical Products 11.4 
Mach. and transp. equip. 49.0 
        Other 22.9 
Miscellaneous goods 3.3 
Source:  World Development Indicators, 2001 (World Bank).  
High Income Countries in 1999: Australia, Austria, Belgium, Canada, Denmark, 
Finland, France, Germany, Greece, Iceland, Ireland, Japan, Luxembourg, the 
Netherlands, New Zealand, Norway, Portugal, Spain, Sweden and the United 
Kingdom. 
 
42. The volume of imports is a cr ucial aspect of transfer of technology through the use of 
intermediate goods.  Not only would technology tr ansfers stop if imports ceased, but also more 
imports of the appropriate type of product should l ead to more technology transfers.  If more 
sophisticated technologies increase a country's productivity and if a county manages to use imported 
intermediates efficiently in its production process,  empirical analysis should find a positive correlation 
between the size of trade flows in intermediate goods and a country's level of factor productivity.   
43. This does not necessarily imply that importing co untries manage to reach productivity levels 
close to the ones of the country exporting the intermediate goods.  As Nelson and Pack (1999) point 
out: 
Even within the OECD countries, there is a considerable body of evidence indicating that 
many firms operate substantially below the best practice frontier achieved by the most 
efficient firms.  Even the best firms in LDCs often fail to achieve the efficiency levels of 
firms utilising the identical technology as  that of the developed countries.  
 44. In the case of technology transfers through copy ing, it is not clear whether one should expect 
to find a positive correlation between the size of tr ade flows and a country's productivity.  In principle 
it is only necessary to import one good in order to copy it.  On the other hand one could argue that 
higher imports increase the probability that the imported good falls into the hands of an individual or 
company capable of imitating the product.  If this is the case, there would indeed be a positive link between the volume of trade and the incidence of technology transfer.  
45. Yet, the mere imitation of the imported pro duct will not automatically be reflected in a 
productivity increase of the domestic economy.  In order for this to happen, the imitated good needs to 
be produced and the knowledge of how to produce the good needs to be spread across the economy.  
In other words, in order for the imitation to have a growth effect it may not be enough that only one producer acquires access to the foreign technology.  If the new technology is not diffused within the 
country, it is again not clear whether one should expect to find a positive relationship between trade 
flows and total factor productivity when looking at the data.   WT/WGTTT/W/1 
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 46. A third mechanism is also to play. Once a country has managed to copy a technology and to 
diffuse it internally, imports of the goods embodying this technology will probably decrease.  In fact 
the imitating country may even start exporting the re levant good.  Once total factor productivity has 
increased we would thus expect imports to decrease.  
47. To sum up, theoretical considerations suggest that  even if transfer of technology take place, 
this would not necessarily be reflected in a positiv e correlation between the volume of trade and the 
importing country's total factor productivity (or its rate of growth). 
 
D. WHAT IS THE EMPIRICAL EVIDENCE ON THE ROLE OF TRADE FOR INTERNATIONAL 
TECHNOLOGY DIFFUSION ? 
48. The evidence of the impact of trade on technology transfers is mixed.  To some extent 
differences in the results can be explained by th e different measures of knowledge and technology 
transfers used.  Patent applications, foreign R&D and productivity, international economic 
activity,(e.g. the share of foreign- owned employment in total employment in much of the work on 
FDI spillovers) are all measures of transfer of technology.  Only part of each of these measures of technology transfer is however technological spill over (gain derived to the importing country without 
payment of a price), since some of these measures  could pick up royalties payment and licensing fees, 
for example, or other market-based economic trans actions.  In this respec t, the best measure of 
technological spillover is probably patent citations.  Yet, patent citations do not take into account the 
transfer of "tacit" knowledge. 
49. In order to study the importance of trade for international technology diffusion, a general 
approach of the empirical literature is to study the effect of foreign technology (as measured by 
foreign R&D, patents, etc.) on domestic total fa ctor productivity, where the level of technology 
abroad is weighted by the bilateral import shar e (international R&D spillover regression).  An 
alternative approach is to test whether the technol ogy developed abroad affects the rate of innovation 
in the home country and whether this is related to trade.  
50. Hereafter is presented the result of the empirical  literature on trade and international diffusion 
of technology, dividing between those studies that support the idea of an import composition effect on 
technology diffusion by country of origin, by industry, those that use patents as indicator of 
technology diffusion and those that focus on th e analysis of the determinant of a successful 
international diffusion of technology.   
1. Import composition effect by country of origin  
51. In order to look at the import composition effect, empirical research distinguishes between 
imports originating from developed countries and those originating from developing countries, and 
between imports of technology intensive goods and im ports of non-technology intensive.  The idea is 
that imports originating from industrial countries have a higher embodied technology content than 
imports from developing countries.  Similarly, impor ts of capital goods or imports of machinery and 
equipment have a higher average technological cont ent than total manufacturing;  therefore, the 
former  have a higher potential for technology transfer.  
52. This literature typically studies the extent of technology spillover using the international R&D 
spillover regression.  This approach explains a co untry TFP on the basis of domestic and foreign R&D 
activities.  The role that the R&D of each foreign trading partner plays in determining the domestic 
country level of productivity is weighted by the level of their bilateral imports.   WT/WGTTT/W/1 
Page 14  
 
 53. A benchmark study in this context is that conducted by Coe and Helpman (1995).  They find 
that technological spillovers are higher when a country imports relatively more from high rather than 
low-knowledge countries (i.e. there is an import com position effect).  Second, they conclude that, for 
a given composition of imports, technology transfe rred from abroad is higher the higher the overall 
level of imports. 
54. Doubts about the relevance of trade for technology transfer have been raised by a study by 
Keller (1998), who managed to obtain similar results  to Coe and Helpman, using a "random" import 
shares as weight rather than the actual import shares.  However, Coe and Hoffmaister (1999) 
contested the randomness of the import shares fi gure used in the Keller analysis, and confirmed the 
validity of their results.  Moreover, Keller (1997b, 2000) himself, using the same type of analysis on industry-level data for eight industrialized countries,  finds that import composition might matter.  In 
particular, this is true, if countries receive a re latively high share of their total imports from one 
particular country - such as is the case for Cana da, for example, which imports about 80% from the 
United States. 
55. More recent study also supports the evidence of a significant role for trade on technology 
transfers.  Providing support to the idea that import composition by country is an important determinant of the size of spillovers, Blyde (2001) finds stronger technology spillovers in 
Latin America from imports orig inating from the OECD than fro m imports originating from Latin 
America. 
2. Import composition effect by industry 
56. Evidence of the importance of the sectoral composition of imports in determining technology 
transfers is also strong.  Coe, Helpman and Hoffmaister (1997) study technology diffusion from 
highly industrialized to 77 developing countries.  They show that total factor productivity in 
developing countries is positively and significantly re lated to R&D in their industrial country trade 
partners and to their imports of machinery and equipment from the industrial countries.  They 
estimate that in 1990 the total spillover effect s from R&D in the industrial countries may have 
boosted output in the developing countries by about 22 billion U.S. dollars.  To put this figure in perspective, total official development aid from multi lateral and bilateral sources in 1990 amounted to 
about 50 billion U.S. dollars.  However, the evidence for North-South spillovers employing 
all-manufacturing or total goods and services import data rather than machinery and equipment import 
data (SITC class 7) is weaker. 
57. Like Coe, Helpman and Hoffmaister (1997), Xu and Wang (1999) find evidence of trade-
related technology spillovers using imports of capital goods but not using trade data for 
all-manufacturing goods.  Similar results are obtained by Meyer (2001), who estimates that a role for 
the diffusion of technology for machinery imports is  twice as large as that of all SITC imports. 
58. Some authors have suggested that  advances in ICTs might have strong productivity effects in 
other industries, perhaps even abroad. Gera, Gu, a nd Lee's (1999) estimates of technology spillovers 
from the U.S. to Canada suggest that technology spillovers embodied in ICT imports from the U.S. 
have about four times the effect on labor productivity in Canadian industries as spillovers embodied in 
non-ICT imports. 
3. Patent citations as indicator for knowledge flows 
59. Some studies in the empirical economic literature  that examine the evidence of international 
technology diffusion use patent situations (rather than R&D) as a measure of technology transfer.  WT/WGTTT/W/1 
 Page 15 
 
 
 60. Sjöholm (1996) examines citations in patent ap plications of Swedish firms to patents owned 
by inventors in other countries.  He finds a positiv e correlation between Swedish patent citations and 
bilateral imports, a result consistent with the hypo thesis that imports contribute to international 
knowledge spillovers. 
4. Determinants of successful international technology diffusion 
61. There are big differences in the degree of succe ss that countries have in adopting foreign 
technology.  Another strand of literature has therefore asked what the major determinants of 
successful technology diffusion from abroad are.  Two determinants of successful technology 
diffusion that have been emphasized are a certain level of domestic human capital  (which is proxied 
by the level of education of the population;  Nels on and Phelps, 1966) and of domestic R&D (Cohen 
and Levinthal, 1989).  Both are associated with the notion of absorptive capacity ,  the idea that a firm 
or country needs to have a certain type of skill in  order to be able to successfully adopt foreign 
technological knowledge. 
62. The empirical economic literature that assess es the role of human capital and existing 
domestic R&D activity in determining technology tr ansfers looks at how human capital interacts with 
measures of technology transfers.  For example, Caselli and Coleman (2001) use data on imports of 
office, computing, and accounting machinery as a measure of inward technology diffusion.  They 
argue that since many countries do not have a do mestic computer industry, imports of computers 
represent a measure of transfer of computer technology from abroad.  They find that computer 
imports are positively correlated with measures of human capital.  
63. Hanushek and Kimko (2000), using standardized science and engineering test scores for 
around thirty countries, have recently argued that the quality  dimension of human capital is at least as 
important as its general level in determining the success of technology transfer.   
64. Finally, Griffith, Redding and van Reenen (200 0a) use industry-level da ta from twelve OECD 
countries for the years 1974 to 1990 to study what are the determinants of productivity dynamics in 
this sample.  Consistently with productivity conve rgence theory, they find that subsequent TFP 
growth is negatively related to the initial producti vity gap.  If the productivity gap variable is 
interacted with R&D, the tendency of TFP to conv erge across countries is stronger still.  This is 
consistent with absorptive capacity being empirica lly important, because it says that catch-up is 
particularly rapid if there are substantial R& D investments in low-productivity industries. 
 
IV. FOREIGN DIRECT INVESTMENT AND TECHNOLOGY DIFFUSION 
A. HOW DOES FDI  TRANSFER TECHNOLOGY ? 
65. FDI inflows from a developed to a developing country are likely to ha ve positive effects on 
the host country productivity.  FDI is seen to increase technological knowledge in the developing 
world by relocating high productivity production into the developing countries.  This phenomenon 
implies a passive and an active knowledge spillover ef fect.  First, investments by MNEs in developing 
countries tend to increase the productivity level in the developed country directly , simply because 
these foreign affiliates tend to be of greater produc tivity themselves and their production is included 
in the national statistics.  Like for trade of technology advanced inputs, this is a form of passive  
technology diffusion, insofar it does not require a process of active learning.  Moreover, this increase 
in productivity is lost if the MNE relocates.  
66. Potentially more important (as they would not be lost when the MNE relocates in a different 
country) are active knowledge spillovers, i.e. the technological know-how that disseminate from WT/WGTTT/W/1 
Page 16  
 
 foreign production plants into the domestic economy
6.  In this respect, FDI might be an even more 
important source of technology diffusion than trade,  because it involves not only the entering of goods 
into the developing country, but also of whole parts of the production chain of MNEs.  In particular, 
FDI leads to imports of factors of production to the developing countr ies in the form of highly skilled 
individuals and/or capital goods of high technological content.  In addition, FDI brings new 
management techniques, new production lines, etc.. 
67. In this respect, FDI fosters knowledge spillove rs through the interaction between domestic 
and foreign firms and  person-to-person communication. 
1. Interactions between domestic and foreign firms 
68. FDI favours interaction betwee n domestic and foreign firms by bringing foreign firms 
geographically close to domestic firms.  Three basic effects of the interaction between domestic and 
foreign firms lead to technology diffusion:  (a) backward and forward linkages, (b) demonstration 
effects, (c) competition effect. 
(a) Backward linkages  favour technological diffusion, by providing higher incentive to 
local suppliers to adopt new technologies.  The foreign affiliate engages its suppliers 
in its production chain and requests from them higher quality and faster delivering 
standards.  Technological knowledge spills from foreign more technologically 
advanced firms to local firms as the form er often support their suppliers in their 
efforts in the form of inventory and quality control methods, standardisation 
information, etc.. 
  Forward linkages  favour technological diffusion, as technologically advanced foreign 
affiliates help the host country firms forward in the production process to raise their 
quality and service standards.  Other fi rms in the market, not only the foreign 
affiliate, can then enjoy the higher standards of suppliers and distributors.  In this way 
technology diffuses internally.  
 
 FDI favours the diffusion of technological knowledge through its demonstration and 
competition effects. 
 
(b) Demonstration  effect consists in the copying, imitating and reverse engineering of 
new technologies and the adoption of managerial, marketing and production 
processes of higher efficiency (one of the most often cited examples is that local 
firms can learn and benefit fr om the export perfomance of fo reign affiliates, that often 
have larger expertise in exporting and a larg er portfolio of international contacts).  
(c) Competition  effects are important because local firms may start to adopt new 
managerial habits and to imitate new technologies when they feel the pressure of foreign competitors in the market that ha ve an advantage consisting of superior 
technologies or organisational methods. 
2. Person-to-person communication 
69. FDI also favours person-to-person communication as it brings foreign experts in contact with 
domestic workers.  FDI may enhance human capital formation and knowledge sharing.  This may 
                                                     
 
6 Blömstrom and Kokko (1998) have recently surveyed a number of ways in which FDI can lead to 
spillovers.  WT/WGTTT/W/1 
 Page 17 
 
 
 happen in the form of formal training (on-the-j ob training, schooling, personnel exchange) as well as 
informal knowledge sharing (infor mal contacts, academic contacts, technical publications, etc.).  
70. Production in these foreign affiliates will also entail a learning effect for the workers engaged 
in the production process.  The learning of employees  in foreign affiliates takes the form of learning-
by-doing but also involves formal training for wo rkers and management.  Th at foreign affiliates tend 
to train their employees more than local firms ha s been documented by Gershenberg (1987) in the 
case of Kenya (see Box 1) and for Hong Kong by Chen (1983).  Learning-by-doing is not amenable to 
statistical record keeping and thus not as easily em pirically verifiable, but has been identified as one 
of the major channels of productivity growth over time.  Learning-by-doing might simply consist in 
obtaining basic skills required to work machiner y, such as sewing machines.  But it might also 
involve domestic managerial employees learning better management and administrative skills.  Since 
the function of managers is to achieve an effici ent combination of inputs, the learning effect of 
managers might be very important for achieving productivity gains. 
71. Training and learning-by-doing increase productivity directly, since they represent ways of 
accumulating human capital (intended as a higher le vel of expertise) that are not captured by the 
conventional measures of human capital, which is based on years of schooling.  If this type of 
skill-investment by foreign affiliates in their work force is large and productive, we can expect an 
increase in the output of the economy.  This increase will occur without a corresponding increase in 
"measured inputs", thus we can in turn expect to see increases in TFP7 of the host economy.  Given 
the way we measure productivity and treat it as synonymous to technological knowledge this does 
represent an increase in the te chnological level of the economy.8  
 
72. Foreign knowledge acquired via learning-by-doi ng might successively spread throughout the 
domestic economy, when a worker leave the MNE and starts up his own business or joins a local firm.  
Labour mobility spreads the gains from learning-by- doing and training in the fo reign affiliates to the 
local economy and as such enables domestic producers to adopt new production techniques.  The evidence from Kenya presented in  Box 1 addresses the effects of FDI on skill levels in the host 
economy and the importance of labour mobility to spread acquired knowledge throughout the 
economy. 
73. To sum up, there are four channels of technology diffusion through FDI: 
- backward and forward linkages 
- demonstration effects 
- competition effects  
- learning by doing. 
                                                     
 
7 Recall that TFP is the average output produced per unit of inputs into production. Inputs are generally 
physical capital, labour and human capital.   
8 It should be emphasized that this process of learning-by-doing represents a form of knowledge 
spillover, to the extent that foreign affiliates provide some of the training and learning opportunities to their 
employees free of charge.  Indeed, the knowledge and training received by workers in foreign affiliates becomes embodied in the workers receiving them and their property rights over these are well defined.  In principle under 
perfect markets (if there were not liquidity constraints, or it was possible to insure again oneself the risk of 
uncertainty of future earnings for example) the value of this knowledge could be paid for by the employees (the employee should be able to take into account that this train will provide him with higher future earnings).  If this 
was the case we would not be in presence of knowledge spillover.  There would be a transfer of knowledge, but 
this would not represent an externality  (see Acemoglu and Pischke, 1998). WT/WGTTT/W/1 
Page 18  
 
 74. The type of FDI  (as defined by its technological content and potential for technology 
diffusion) together with the economic conditions  of the host country, such as its IPR regime, general 
level of education of the popula tion, degree of labour mobility and entrepreneurial environment, 
determine how effective these four channels are in transferring technology from abroad and diffusing 
foreign technology internally in the domestic country. 
75. In the following sections are examined first, what types of FDI embody the highest potential 
for technology diffusion and second, what factors determine what type of FDI a country attract.  It is 
shown how foreign technology acquired through FDI diffuses internally.  In particular the role of 
education, IPR and labour mobility are examined.  Fi nally, a survey of the empirical evidence of the 
impact of FDI on technology diffusion concludes this section. 
 
B. W
HAT TYPE OF FDI  EMBODIES THE HIGHEST POTENTIAL FOR TECHNOLOGY DIFFUSION ?  
76. The potential for technology diffusion of FDI might depend on the technology content of the 
FDI itself and on the extent of integration of th e MNE with the economy of the host country.   
1. Technology Content 
77. The technology content of FDI can reflect on the level of technology advancement of the 
good produced by the MNE or on the technology intensity of the activity undertaken by the MNE in 
the host country.  Foreign firms can decide to relocate in the host country the production of a high 
technology good, such as computers (as for example Intel in Costa Rica) or they can choose to 
produce low technology goods, such as T-shirts.  Also, MNEs can locate in the host country high 
technology activities such as research and develo pment, or only low technology activities such as 
assembling.  
78. If the intensity of spillovers from FDI varies across industries, then the composition of FDI 
matters for the evolution of productivity in the develo ping country.  In order to capture the fact that 
types of FDI characterised by different levels of technology intensity have a different impact on TFP, 
empirical analysis should study the impact of technology-intensive FDI on the host country TFP 
separately from low-technology FDI9.  Unfortunately, the lack of reliable sectoral data on bilateral 
FDI pose an important limit to this analysis.  As  a consequence the size of technology transfers 
through FDI could be largely underestimated. 
79. It might seem intuitive that technology spillovers  are greater in high-technology industries.  
However one should be aware that th is does not need to be the case.  On the contrary, there is some 
empirical evidence that spillovers are greater in  those industries in which the technological gap 
between developing and developed economies is smalle r.  One explanation for this is that when the 
technology gap is small, the do mestic producers can build on already acquired knowledge to imitate 
foreign affiliates.  Kokko, Tansini and Zejan (199 6) use plant level data for Uruguay over the 
period 1988-1990 to test the existence of spillovers within industries.  They find spillovers only for 
plants in industries with small technology gaps vis- à-vis foreign firms.  They define the technology 
gap as the difference in labour productivity betwee n domestic and foreign firms and they find a 
positive impact on labour productivity of the presen ce of foreign firms only in the sample with low 
technological gap.  They interpret this as meaning that the ability of the domestic economy to generate 
knowledge spillovers from FDI requires the knowledge in foreign affiliates to be close to the 
technology frontier of the domestic economy. 
                                                      
9 An alternative could be to estimate the different impact of FDI originated by various countries, each 
of which is characterised by a different level of tech nological development (see Girma and Wakelin, 2001).  
This would however only partially overcome the problem.   WT/WGTTT/W/1 
 Page 19 
 
 
 2. Extent of Integration with the local economy 
80. For a given level of technology intensity of FDI, the extent of integration with the local 
market and with the local labour force also de termine FDI's potential to diffuse technology. 
81. What determines the extent of integration of FD I with the local market?  A crucial distinction 
in this regard is whether the FDI is intended to use the cheap labour in the local market and then 
export to developed countries;  or to serve the demand in the local market, using intermediate goods produced by local producers and lo cal skilled as well as unskilled work force.  In the former case, 
backward and forward linkages, demonstration ef fects and competition effects are not used as 
channels of international diffusion of technology.  Technology is in this case transferred from the 
investor to the local economy only via the training and learning-by-doing of the local labour force 
employed by the investor.  If the main reason for the investor's location in the host country is to 
exploit cheap labour, it is also likely that the co mpany is engaged in a low-technology intensive 
activity.  Therefore, the technology transfer occurri ng through learning by doing will also be limited 
in scale.  If the investment is focussed on the do mestic market, however FDI acts as a mechanism of 
technology transfer through all possible channels.  As a consequence, the potential for technology 
spillovers into the local economy is larger. 
82. This leads to the differences between vertical  and horizontal FDI.  The distinction between 
these two types of FDI is important because they are likely to be characterised by a different degree of 
integration with the economic network of the host country.  
83. Vertical FDI  characterise, investment decisions of firms from developed countries in 
developing countries (Maskus 1998).  Vertical FDI is typical of those firms that fragment their 
production chain into stages, matching factor intens ities of their activities with factor endowments of 
host countries.  
84. Vertical FDI generally relates to production fo r export (be it of consumer end products or 
intermediate goods).  It is often concentrated in Export Processing Zones which have very few 
linkages with the country where they are located (CEPAL, 1998; Buitelaar and Padilla Perez, 2000).  
Therefore it is likely to present a very  low potential for technology transfer.  
85. Horizontal FDI  concerns the foreign production of goods for the foreign market that are 
similar to those produced at home.  In the horizontal-type FDI, multiplant firms produce similar goods 
in all locations.  Horizontal FDI is sometimes refe rred to as market-seeking FDI, and it is more 
common in FDI between industrialised countries of similar size and characteristics.  In this case the 
MNE is likely to develop strong backward and forward linkages with the host economy, and is likely 
to induce a strong competition and demonstration effect together with learning-by-doing. 
 
C. W
HAT FACTORS DETERMINE THE TYPE OF FDI  THAT A COUNTRY ATTRACTS ? 
86. The previous section noted that technology transfers through FDI might depend on the level 
of technology intensity of the FDI and the exte nt of integration between the activity of the 
multinational and the local economy.  It is in general believed that ve rtical FDI is characterised by a 
lower degree of integration with the local market and a lower level of technology intensity then is 
horizontal FDI.  
87. This section considers what determines the level of technology intensity of FDI that enters a 
country, and in particular the role of the level of  education and the strength of the FDI regime in 
determining what type of FD I a country will attract.  WT/WGTTT/W/1 
Page 20  
 
 1. What determines the level of technology content of the FDI that enters into a country?  
88.  In order to answer this question it is nece ssary first to define what determines the 
decision of investment.  An early attempt at explaining why firms become multinationals was 
developed by Dunning's, (1981) O-L-I framework.  Dunning identifies three types of advantage that a 
firm needs to enjoy in order to become internationa l and be able to face the competition of local firms 
in foreign markets. 
(a) O
wnership advantage.  The firm has to own ta ngible or intangible (technology, trademark) 
assets that confer it a comparative advantage.  Intangible assets tend to play a larger role in 
this case.  These are often knowledge-based assets that can easily be transferred within the 
firm across borders but not between firms. 
(b) Location advantages.  It must be advantageous  to locate abroad rather than servicing the 
foreign market through exports.  This can occur when high transport costs divide two 
countries, when the host country has low labour costs or large natural resources of the type 
used as input in the investing firm, for example.  
(c) Internalisation advantages.  Firms must enjoy an advantage in servicing the market locally 
themselves rather than licensing, or selling their knowledge abroad and letting local firms 
serve the market.  The most obvious reason for internalisation advantag es is the inability to 
design contracts that satisfy both the multinational and the local firm.  
89. Firms that enjoy these three advantages will find  it more efficient to serve foreign markets via 
FDI rather than by exports or licensing.  Elabora ting on this framework, other economists (Markusen 
and Maskus, 1999a and 1999b) have argued that the most common reason for a firm to become a 
multinational is that the firm possess a specific knowledge-intensive asset that can be easily (and 
cheaply) transferred within the firm and used in several plants at minimal extra cost (economies of multiplant production), but cannot be easily transfer red across firms.  It is the knowledge-intensive 
nature of MNE activities that makes FDI so important for technology spillovers. 
90. It follows that the regime of IPR (ownership advantage) and the availa bility of skilled labour 
(location advantage) in the host country are two important factors in determining the location of 
high-technology firms.  These issues are discus sed more extensively in the next sections.  
2. IPR and FDI inflows to developing countries 
IPR and the volume of FDI to developing countries
 
 
91. It is generally argued that a strong IPR regime favours FDI inflows into a country, because it 
ensures that the inventor can appropriate monopol y profits from innovation.  Yet, the empirical 
evidence on the effects of IPRs on FDI is mixe d (see Kondo, 1995, Ferrantino 1993, Mansfield (1995) 
Lee and Mansfield, 1996; Maskus 2000a)10.  
92. A plausible explanation of the weak evidence for a positive impact of a stronger IPR regime 
on the volume of inward FDI is based on three arguments.  First, the strength of the IPR regime is likely to affect differently different types of FDI (ver tical versus horizontal FDI).  Second, the type of 
FDI that a country attracts largely depends on its level of development.  Finally, trade, FDI and 
                                                     
 
10 Maskus (2000a,b), Mansfield (1995) and Lee and Mansfield (1996) find a positive and significant 
effect of the strength of IPR and US FDI; Maskus' results hold only for FDI to developing countries.  Ferrantino 
(1993) and Kondo (1995) do not find evidence of a significant effect.   WT/WGTTT/W/1 
 Page 21 
 
 
 licensing are substitute ways of serving a foreign ma rket.  The regime of IPR determines which of 
these mechanisms is chosen by a foreign firm.  
(i) IPR and vertical versus horizontal FDI 
93. In the case of vertical FDI, the firm locates in  a specific country to take advantage of lower 
production costs or natural resource s not available elsewhere.  The inve stor is neither interested in the 
local demand for its products nor in how IPRs in th at country affects that demand.  Local IPR regimes 
play a role in the location decision of vertical F DI only to the extent that lack of protection could 
interfere with the pr oduction process, or that local firms coul d develop into international competitors 
by imitating technologies.  Developing countries have too large a technological disadvantage with 
respect to developed countries to be able to represen t a threat to the MNE in the international market.  
Therefore a strengthening of the IPR regime is not likely greatly to affect the decision of a firm 
located in a developed country to invest directly  (in the form of vertical FDI) in a developing 
countries. 
94. In the case of horizontal FDI, firms locate in a specific country to serve its market more 
efficiently.  This is more often the case when the r eason why a firm directly invests abroad is to take 
advantage of its ownership of intangible assets (trade mark, patents, copyrights).  In these 
circumstances, the attractiveness of a market (market size, purchasing power of its population) and the 
strength of the IPR regime play a crucial role in the firm's decision to invest abroad.  A weak IPR 
regime could hinder the offer of IPR-sensitive products  – i.e. those that can be easily copied, via FDI 
as cheaper imitation or copied products could r each the market, preventing the appropriation by the 
multinational of its reward to innovation.  It follows that stronger IPR regimes are likely to be 
associated with higher horizontal FDI. 
(ii) The type of FDI and the level of development of the host country  
95. In general, the type of FDI that a country attracts is highly correlated with its development 
stage (Maskus 1998, Figure below). LDCs attract virt ually no FDI (except in natural resources), since 
they lack the necessary infrastructure and human capit al.  As countries develop, they are increasingly 
able to attract vertical FDI, mainly attracted by  low wages.  As countries climb the development 
ladder, their wage level rises and they become less attractive for vertical FDI.   However, rising wages 
usually mean rising purchasing power of the popu lation, and countries beco me more attractive for 
horizontal FDI. WT/WGTTT/W/1 
Page 22  
 
 Figure 1: Inward Vertical and Horizontal FDI Fl ows and the Level of Development of an Economy 
 
FDI 
 
 
 
 
 
 
   
 
       
Horizontal 
 
        V e r t i c a l  
 
        GDP per capita 
Source: Zhang (1996) and Maskus (1998b) 
 
 
(iii) IPR and the choice between Exporting, FDI or  Licensing 
96. A firm has three ways to supply a foreign market.  It can export the product, produce it there 
or sell the license to another firm.  The decision among these different mechanisms to serve the market is in part related to the level of enforcem ent of IPRs in the foreign market.  In particular, 
economic theory suggests (see Maskus 2000b) that firms first serve markets with exports.  As 
countries improve their IPRs regimes, exports are substituted by FDI and when a certain threshold of 
protection is reached FDI is substituted by licensing. 
97. The results of some of the empirical literature  support this theory.  For example, Maskus 
(2000b) finds a negative correlation between US FDI and the strength of IPRs in the country of 
destination for a sample of both developed and developing countries, but a positive correlation for the 
sub-sample of developing countries.  A plausible explanation is that the negative sign captures the 
substitution effect of FDI versus licensing for developed countries, whilst the positive sign arises from 
the fact that few developing countries have reached the IPR threshold yet. 
98. To sum up, the weak evidence of a strong relatio nship between the strength of the IPR regime 
and the flow of FDI to developing countries can be explained by the fact that most of the FDI flows to 
developing countries are vertical FDI and that vert ical FDI is not very sensitive to the extent of 
enforcement of IPRs.  As far as FDI to developed countries is concerned, th e level of IPRs is in 
general very high so a stronger IPR regime could l ead to the choice by firms to serve the market by 
licensing rather than FDI.  
IPR and the technology content of FDI
 
 
99. There is only weak evidence of a positive eff ect of the strength of the IPR regime on FDI 
inflows.  This raises the question whether the IPR regime affects the composition of FDI in terms of 
its technological content.  It is indeed likely that  the regime of IPR plays a different role in the 
investment decisions of a firm engaged in high technology activities (such as R&D) or producing a 
technology intensive good as compared to a firm producing a low-tech commodity, for example.  WT/WGTTT/W/1 
 Page 23 
 
 
 100. A survey conducted by Mansfield (1995) on several American, German and Japanese 
companies shows that, as the technology intensit y of the activity of a firm increases -from 
sales/distribution to R&D activities-, the percentage of  firms reporting that the strength of IPRs is an 
important factor in the decision of whether to locate their direct investment in a country or in another 
one increases.  In another study, Lee and Mansfiel d (1996) using data of US FDI at the firm level 
found that IPRs play a larger role in determ ining the location of FDI for technology intensive 
activities, and when technology is easily copied.  
101. Overall, evidence on the relationship betwee n strength of the IPR regime and FDI flows 
shows that a strong IPR regime is an important factor in attract of investment by high technology 
firms. 
3. Education as a pull factor for FDI: a reason for a sound education policy  
102. There is a two way relationship between educati on and FDI.  FDI raises the overall level of 
expertise of the workforce in the host country, through training and learning-by doing.  As long as 
multinationals hire local labour, training and l earning-by-doing represent a spillover of knowledge 
generated abroad to the host country.  
103. In this section it is seen that a high level of  education is also a pull factor for FDI.  An 
economy with a large pool of skilled workers might be  able to attract more FDI.  In addition, it is 
possible that education levels affect the composition of FDI by industrial sector.  
Education and FDI inflows  
 
104. It can be argued that the availability of a cheap  workforce is the main reason for multinational 
enterprises to locate in a developing country.  An increase in the relative supply of skilled labour will 
lead to an increase in the relative wages for unskille d labour and could as such have an adverse effect 
on total FDI.  However, installation of capital and administration of production processes requires 
skilled labour, so the supply of skilled labour also affects the cost of investing in a country.  Foreign 
affiliates tend to import productio n processes originating in the de veloped world and these processes 
often require a workforce that is relatively skilled co mpared to the local popula tion.  The availability 
of skilled labour will thus increase the incentive fo r FDI flows into a country.  In addition, since the 
reliance of foreign investors on skilled labour varies across industrial sectors, the relative supply of 
skilled versus unskilled labour will influenc e the sectoral composition of FDI. 
105. There is evidence that foreign affiliates hire  more skilled labour than their domestic 
counterparts, thus showing the importance of the local availability of skilled labour for location 
decisions of MNEs. Aitken, Harrison and Lipsey (1996) provide data for Mexico and Venezuela on 
the pay structure of foreign affiliate s as compared to domestic firms.  In the case of Venezuela, wages 
paid by foreign affiliates were on average 31 per ce nt higher than those paid by domestic producers.  
In Mexico this premium reached 38 per cent.  These premia are paid, either because the mix of the labour force foreign investors hire contains more  high-skilled, high-wage employees or because the 
workers acquire skills while working for foreign invest ors that increase their re servation wages.  What 
matters in the context of pulling FDI is to what de gree the demand of foreig n affiliates is relatively 
"skill-heavy".  Aitken et al. (1996) provide evidence of the fact that foreign firms tend to locate in 
industries and regions that are skill-intensive relative to the rest of the economy.  This indicates that 
the wage premium is not only due to the skills acquired by employees while working in foreign 
affiliates, but also that foreign affiliates tend to hire  more highly skilled labour to  start off with.  It can 
be concluded that an increase in the supply of sk illed labour would benefit foreign investors and likely 
induce FDI flows into the economy. WT/WGTTT/W/1 
Page 24  
 
 Education and the Composition of FDI
 
 
106. The question of whether the composition of FD I is affected by the relative skill levels 
available in different economies is at least from a theoretical point of view easier to answer.  Changes 
in the supply of educated workers can be expected to affect the industrial composition of FDI flows 
according to how skill-intensive these are, since it directly affects the costs of production in these 
industries.  An example of a transition economy attracting FDI in high technology sectors is Costa 
Rica, where large FDI flows over recen t years occurred in relatively high technology industries.  The 
decision by Intel to locate a significant part of its chip production in Costa Rica in 1998 is a noticeable 
example.  The major reasons given by Intel at the ti me for this decision have been the high skill level 
and literacy in English of Costa Rica's workforce, ne xt to stability and respect for the rule of law. 
107. The educational mix (the relative supply of a work force of different types of qualifications) is 
also very important.  It will lead to differences not only in the industries in which FDI takes place, but 
also in the type of activity MNEs choose to transf er to their foreign affiliates.  Consider the car 
industry as an example.  An increase in the su pply of skilled labour might induce a MNE to upgrade 
its production from purely final assembly of the car to include actual construction of complicated 
components, such as the axle or engine. As the skill supply rises further, part of the firm's R&D 
activity might also be moved to the foreign affiliate. 
108. If FDI is important for the international diffus ion of technological knowledge, the evidence 
that the level and the type of education affect the flow of FDI into a country and the type of FDI that 
the country attracts stresses the importance of a soun d education policy for development.  As seen in 
the next section, a sound education policy is also important for development, insofar as the level and 
the quality of education in a country is also an impor tant determinant of its "absorptive capacity", i.e. 
its ability to adopt innovations originated abroad.    
 
D. HOW DOES TECHNOLOGY TRANSFERRED THROUGH FDI  DIFFUSE INTERNALLY ?  
109. The previous section considered how IPR and e ducation act as pull factors of FDI.  It was 
shown that the strength od the IPR regime and the level and quality mix of the supply of skilled labour 
force affect not only FDI flows but also their sect oral composition and the type of activity in which 
MNEs will engage.  It was also explained that the volume and the type of FDI that a country attract 
are important determinant of the size of international technology transfers.   
110. Technology transfer is a two party business.  There is a technology provider and a technology 
recipient. Successful technology transfers require that the host country be able to acquire the 
technology and that this technology diffuse internally .  In this section the focus is on IPRs, education 
and labour mobility as factors determining how easily foreign technology is acquired diffuses 
internally in the host country.  
1. IPR and the internal diffusion of technology 
111. It was seen in the previous section (section C.2) that a stronger IPR regime can lead to larger 
flows of FDI or FDI with higher technology content.   This will increase the technology transferred.  
How will a stronger IPR regime impact on the abso rption and internal diffusion of technology in the 
host country, for a given flow and composition of FDI?  The  answer requires looking at each of the 
channels of technology transfers analysed in section A.  
112. Technology diffusion through backward and forward linkages is affected in two opposite 
ways by the strength of the IPR regime.  On the one hand, if IPRs are weakly protected, a foreign firm 
can fear suppliers or distributors as potential compe titors, or it can fear losing the advantage over  WT/WGTTT/W/1 
 Page 25 
 
 
 other competitors deriving from the exclusive access to higher quality inputs or distribution services 
that a strong IPR regime could guarantee.  It w ill thus tend to develop few backward and forward 
linkages.  On the other hand, if technology is disc losed to all potential supplie rs or distributors, the 
foreign firms can enjoy the benefits of stronger competition among suppliers and distributors.  From 
this view point, weak IPR protection will constitut e a disincentive to develo p backward and forward 
linkages. 
113. On the other hand, technology diffusion through demonstration and competition effects of 
FDI may be seriously curtailed by a strong IPR re gime.  Demonstration and competition effects can 
only take place if local firms are allowed to copy  and imitate the new technologies and managerial 
skills of the foreign entrant.  
114. As far as technology transfers through training and learning-by-doing of local managerial 
staff are concerned, labour mobility allows the spr ead within the host country (internal diffusion) of 
the know-how of foreign af filiates.  This occurs when workers trained in multinationals move to local 
firms.  An IPR regime that is too strong may curta il the spread of information, but an IPR regime that 
is too weak may lead firms to bring most manageri al staff from their home country and involve local 
staff only in the lower ends of the production chai n where it does not fear the spread of the know-how 
learnt.  Sherwood (1990) reports findings of surveys in Brazil and Mexico where MNE executives 
argue that workers' exposure to new technologies is constrained by the infeasibility of protecting 
proprietary technologies in case the workers were hired away. 
115. There is also an indirect positive effect of stronger IPR on the internal diffusion of 
technology.  As previously noted, the strength of the IPR regime may determine what type of activity 
foreign firms will locate into the host country.  Fo r example, a protected IPR regime may favour the 
location of R&D activity rather than assembling, say.  This may have an indirect effect on the 
capacity of a country to acquire technology and spr ead it internally, insofar as a strong IPR regime 
alleviates the brain drain problem for developing countries, by giving high qualified individuals the 
possibility to work in their home country (McGrath, 1996).   
2. Education and the host country absorptive capacity 
116. How does the education of the domestic workforce influence the diffusion of knowledge to 
the local economy?  It was earlier noted that the level and the quality mix of the education of the 
workforce (i.e. the availability of human capital) is an important determinant of the composition of 
FDI.  This composition effect can influence the overall intensity of technological diffusion into the 
host economy, if certain industries display greater or lower propens ity to transfer knowledge (see 
section B).  
117. However, the level and the quality mix of the ed ucation of skilled workers, also determine the 
absorptive capacity of a country.  As in the case  of trade induced spillovers, the reengineering of 
knowledge depends on the availability of skilled labour in the developed country.  Technology transfers cannot occur, if the host country lacks adequate human capital. 
118. A survey of the empirical studies underlying the importance of a country minimum education 
level in order to be able to be nefit from FDI originated in developed countries is provided in the 
subsequent section E.  It can be anticipated th at there is in general evidence of a positive and 
significant effect of education achievements an d the magnitude of technology transfers.  
3. Labour Mobility and Technology Diffusion 
119. The training and the learning-by-doing that MNEs offer to local workers is embodied into the 
worker.  The knowledge accumulated as human capital will diffuse internally into the local market if WT/WGTTT/W/1 
Page 26  
 
 this employee leaves MNE to go to work in a local firm or start up a new business.  In this context the 
flexibility of the labour market and the efficiency of the financial market in the host country play a 
crucial role in determining internal diffusion of kn owledge.  If the labour market is not flexible local 
firms cannot match the wage required to attract a trained worker from the multinational.  On the other 
hand, if financial markets are inef ficient, the worker may face liqui dity problems that would hinder 
any decision to leave the MNE or start a new business. 
120. What are the effects of training on a worker's probability to leave the MNE?  It is rational to 
expect that those individuals who have received the mo st training are the least likely to move from the 
MNE, since MNEs will attempt to pr otect their investment through greater salaries and other benefits.  
Earning profiles of workers receiving more  training should appear to be steeper. 
121. On the other hand, it must also be the case that those individuals who have acquired a 
knowledge that is not available in other firms, are especially attractive to local producers.  In 
particular, the value of skills learned in the foreign affiliates is larger for do mestic producers than for 
other MNEs.  Therefore, if a worker of a MNE leaves the current employer, local producers have an 
incentive to outbid other MNEs in order to be able  to benefit from his/her services.  Thus conditional 
on leaving the MNE, individuals will be more  likely to switch to domestic producers.  
122. To sum up, internal technology diffusion will depend mainly on the flexibility of the labour 
market.  There are two opposing forces that determ ine the spread of the knowledge accumulated in the 
form of expertise through the host economy.  On the one hand, the MNE will try to reduce the 
probability that a trained worker leave the firm, by  offering higher wages, say.  On the other hand, 
local firms have a higher incentive than other multinati onals to hire a worker th at has been trained in a 
MNE.  Therefore, if a worker leaves a MNE the probability is high that he will be hired by a local 
firm.  The evidence of Kenya and Bangladesh presented in Box 1 confirms these predictions. 
 
Box 1: Labour Mobility and FDI - Evidence from Kenya and Bangladesh
 
 
In the OECD, switching between employers has become commonplace for employees, as they attempt 
to find better matches for their skills, new challeng es and simply higher wages and better career 
opportunities.  Is this mobility of  workers between firms also present in the developing world and 
does it contribute to the spread of knowledge betw een foreign affiliates a nd domestic producer?  
 
These questions are significant for all types of employment, but managerial employment does deserve 
special attention because of the central role it plays in achieving efficient production practices. 
Furthermore domestic managerial personnel are rare in many developing countries.  In Kenya, for 
example, at the time of independence in 1963, 81 per cent of top-level administrators and 55 per cent 
of all managerial personnel in the private sector were foreigners.  Since then the share of Kenyans 
amongst the managerial employment has increased substantially, so that in 1980 77.5 per cent of 
managerial personnel were Kenyans.  What role di d MNEs play in this transformation?  Do local 
employees get additional training and learn modern pr actices in foreign affiliate s of MNEs?  Does this 
knowledge spread to the domestic sector?  
 
Answers to these questions can be obtained from Keny an detailed survey data of 72 middle to higher 
level managers working at local firms, affiliates of  MNEs or in joint ventures between international 
firms and public enterprises.  All the firms in question employ at least 50 workers.  
 
The first observation this data permits is that local  managers in foreign affiliates receive considerably 
more training than managers at locally owned firms.   Figure 2 presents the amounts of training given 
to managers of different firms and the breakdown of th is training into different forms of training.  The 
height of the bars represents total training receiv ed, whereas the different patters show the type of  WT/WGTTT/W/1 
 Page 27 
 
 
 training.  Firms with international connections, especially foreign affiliates of MNEs provide 
substantially more training to their managers and most of this additional training takes the form of 
more formal instruction (seminars and schooling), with some additional training taking place outside 
of Kenya.  By contrast, locally owned firms tend to  train their managers much less and almost all of 
this training takes the form of on-the-job training. 
 
The professional mobility of managers, who get traine d by foreign affiliates an d then fill positions in 
the domestic sector, contributes to the spread of knowledge throughout the economy.  However multi-
national firms are interested in recouping the invest ment made into their managers and thus to reduce 
turn-over amongst their managerial staff.  Manage rs in MNEs do consequently exhibit much less 
mobility than those at local producers.  Whereas  in the whole surveyed sample 39 per cent of 
managers were working in MNEs, the proportion of  employees of MNEs amongst those that never 
switched employers was 53 per cent.  For local managers the proportion in the sample was 22 per 
cent, but they only represented 11 per cent of the 'loyal' managers.  Thus the managers in the MNEs 
tended to be much more loyal than those in local fi rms, who received substantially less training.  In 
addition, even among the managers within the differen t firm categories, the tendency to stay longer in 
a firm increases in the average training received by the employee.  Managers who never switched 
firms have on average received substantially more tr aining than those that did switch, regardless of 
whether they worked in local firms, joint ventures or multi-national enterprises.  This confirms that 
firms are keen to reduce turnover in general and ev en more so amongst those managers that receive 
the most training.  
 
Managers who received training and learned about advanced technological production processes in 
the MNEs tend to be especially valuable to domestic producers.  The marginal product of those 
workers after acquiring the training in the MNEs is higher in the domestic firms than in the MNEs, 
who already possess the knowledge embodied in these managers.  This is reflected by the fact that 
conditional on leaving a MNE, the managers are more likely to start working at a domestic producer 
than to move to another MNE.  Consider the tabl e below.  The data show s substantial fluctuation 
between MNEs and local firms of the pattern described above.  Both managers from MNEs and from 
local firms are more likely to change the type of firm, than the pure employment shares would 
warrant.  A manager coming from an MNE was 16 percentage points less likely to be hired by another 
MNE than if the hiring was done randomly according to employment shares.  Likewise for managers 
coming from locally owned firms the likelihood to sw itch to an MNE is also higher than warranted by 
the employment share of MNEs. 
 
The data from Kenya thus suggests that the presen ce of multi-national firms increases the amount of 
managerial training given to indigenous managers and that even though MNEs take steps to reduce 
turn-over, there is a substantial amount of fluctua tion between local firms and the affiliates of MNEs.  
MNEs do train their employees more than domestic  producers and these acqui re skills in MNEs that 
are valuable to domestic producers.  One of the ma in conditions for diffusion, the mobility of factors 
between local and foreign-owned firms is given.  Th e indirect effect of dispersion of skills through 
labour turn-over adds to the direct effect of traini ng by foreign affiliates on the productivity levels in 
the host economy. 
 
The evidence from Kenya for the managerial level is complemented by an interesting study of the 
emergence of the Bangladeshi textile industry descri bed in the World Investment Report (1992).  It 
describes the technological cooperation of Daewoo with  Desh, the first locally established exporter of 
manufactured textiles in Bangladesh.  Of 130 initial wo rkers, 115 eventually left either to work for 
other new local garment manufacturers or in order to set up their own manufacturing plant for 
garments.  This illustrates the spread of skill an d technological knowledge from joint-ventures and 
FDI through the mechanism of labour mobility. 
 WT/WGTTT/W/1 
Page 28  
 
  
  Table 6:  Employment Switch for Manage rs Between MNE and local firms (Kenya) 
 
 To MNE To Local 
From MNE 48% 52% 
From Local 75% 25% 
Pure Employment shares 64% 36% 
 
Note:  The top two rows of the table give the conditio nal transition probability for a manager of a firm 
of either type.  Thus the top left entry reads:  48% of managers conditional on leaving a MNE and 
hired by either MNE or local producers were hired by an MNE.  The bottom row gives the 
employment shares for different types of firms in the sample.  From this we see that a manager coming from an MNE was 16% less likely to be hired by another MNE than if the hiring was done randomly according to employment shares. Data from Gershenberg (1987). 
 
 
E. WHAT IS THE EMPIRICAL EVIDENCE ON THE ROLE OF FDI  IN INTERNATIONAL TECHNOLOGY 
DIFFUSION ? 
123. This section reviews the results of recent empi rical economic literature on the importance of 
FDI as a channel of international technology diffusio n.  The approach generally used in the literature 
to estimate the contribution of FDI to domestic productivity consists in explaining domestic 
productivity levels with domestic and foreign R&D effort (as measured by patent count or R&D 
expenditure).  The contribution of each foreign country R&D on domestic productivity is weighted by Figure 2:  Training by type of Firm
00.511.522.533.544.5
Multinational Local Joint VentureOverseas
Seminars&Schooling
On-job WT/WGTTT/W/1 
 Page 29 
 
 
 the volume of bilateral FDI or other measures of  multinational activities such as subsidiary GDP, 
sales or its number of employees.  
124. A general result is that FDI increases the host country total factor productivity.  Yet, this 
effect is in general not as strong as the estimated t echnology spillover effect of trade.  To some extent, 
this result can be ascribed to the fact that data on bilateral FDI are not as good as trade data.11  
1. The impact of FDI on productivity: various measures of FDI  
125. Below are reported some of the results of the studies on FDI and productivity.  These studies 
differ mainly in the measures of FDI used net capita l flows, share of subsidiaries' value added, their 
share of employment, number of plants, patents.  
126. Using a sample of thirteen OECD countries, Li chtenberg and van Pottelsberghe de la Potterie 
(1996) find positive knowledge spillovers from outw ard FDI, but insignificant spillover effects from 
inward FDI.  Using industry level data, Baldwin, Braconier and Forslid (1999) find some indication of 
positive spillover effects from inward  FDI.  However, overall, their results are mixed.  Both these 
studies rely on figures for FDI derived by the balan ce of payment – a quite imprecise measure of FDI, 
since not all net capital flows are FDI, on the cont rary capital flows can be generated in the local 
capital market.  
127. The study conducted by Xu (2000) uses the share of subsidiary value added over the host 
country GDP as a measure of multinational activ ity.  He finds a positive correlation between US 
outward FDI and productivity growth in the host coun try.  In addition, he shows that technological 
spillovers from US multinationals subsidiaries are stronger for rich countries than for poor countries;  
and provides evidence that this result might be rela ted to the different levels of human capital in the 
two groups of countries. 
128. Other studies use firm-level data.  Among these, Aitken and Harrison (1999) find a negative 
effect of FDI on productivity of Venezuelan plants between 1976 and 1989.  Here FDI is measured as 
the ratio of employment of foreign owned plants to  total employment.  This measure presents some 
shortcomings.  For example, a lower level of tota l employment would increase the measure of FDI 
adopted by Aitken and Harrison, even if the presence of foreign firms has not changed.  So, Aitken 
and Harrison' s result it is likely to capture a s hort term effect, rather than a long term one.  
129. The studies conducted by Girma and Wakelin (2001) and Haskel, Pereira and 
Slaughter (2001) are subject to the same shortcomings as Aitken and Harrison.  Girma and 
Wakelin (2001) study the impact of inward FDI on the UK electronic industry between 1980 
and 1992.  The level of inward FDI is measured by the ratio of foreign owned plants to all plants.  
Productivity growth in the elec tronic sector is explained by th ree types of technology transfer, 
intra-industry spillovers (measured by inward FDI in  the electronic industry at 4-digit level) divided 
by foreigner investor country, in ter-industry spillovers between i ndustries that are technologically 
similar (measured as the FDI in the electronic in dustry at the 2-digit industry) and inter-industry 
spillovers between industries that are located in the same geographic region within the UK.  The data 
show evidence of positive spillovers from most  of the countries but the US, and from plants 
technologically similar, but not stronger spillo vers from plants geographically close.    
                                                      
11 A secondary explanation is that the productivity effect of imports of intermediate goods are overestimated due 
to the fact that the quality of inputs is not adequately taken into account when the productivity of industries 
using imported intermediate goods is computed (unavailable or slowly adjusted price indices are two possible 
reasons for this problem).  
 WT/WGTTT/W/1 
Page 30  
 
 130. Haskel et al. extend the sample set used by  Girma and Wakelin and repeat their estimation 
using a different techniques.  Their results differ in the finding that US FDI shows positive spillover 
effects, whilst Japan shows negativ e effects;  but they confirm the finding that there are positive 
spillovers between plants technologically simila r, whilst their geographical proximity is not a 
signficant source of spillovers. 
131. Globermann, Kokko and Sjöholm (2000) and Br anstetter (2001) examine the correlation 
between patent citations containe d in the applications for a patent (as a measure of domestic 
innovative performance) and FDI.  The former use data on Swedish firms and find that only outward 
FDI gives access to foreign technology.  The latter uses data on patent cita tions between the US and 
Japan and finds a significant correlation. 
2. Simultaneous analysis of multiple channels of technology diffusion  
132. Keller (2001b)'s industry-level analysis of  spillovers among the G-7 countries finds 
significant effects for imports, inward FDI, as well  as communication links on productivity.  In a 
breakdown of the total effect, he attr ibutes more than 50 per cent of the total effect to imports, and the 
remainder to equal parts to FDI and communication links. 
3. The role of education 
133. As far as the role of education in determining the technology intensity of FDI is concerned, a 
study by Kokko and Blomström (1995) relates skill levels in the host economy to transfers of 
technology to foreign affiliates for majority-own ed foreign affiliates of US MNEs in 1982.  
Technology transferred to the fore ign affiliate are measured by the licensing and royalty payments 
and the imported capital goods as fr action of total sales by foreign affiliates in the host economies.  
They find greater licensing payments per worker in  countries with higher skill levels, capital imports 
however are not systematically related to skill leve ls in the host economies.  These results can be 
interpreted as weak evidence that  greater skill levels in the host economy induce greater technology 
transfers by MNE into their foreign affiliates.  This  obviously does not prove that more technology is 
transferred to the host country.  
134. As far as the role of education in determining the absorptive capacity of a country is 
concerned, Kinoshita (2000) analyses the impact of inward FDI on productivity for the 
Czech Republic between 1995 and 1998.  In his paper productivity growth is the result of the own 
research of a firm and spillovers from abroad.  He  finds that in-house expenditure is a significant 
factor of productivity growth (thus suggesting that R&D is perhaps an important omitted variable in 
other studies); whilst FDI shows a positive effect only when interacted with the R&D variable.  This 
result suggests that FDI contributes to productivity  growth only if there is  a sufficient level of 
technology absorptive capacity.  
135. In their study on FDI and education, Borensztein, Gregorio and Lee (1998) relate growth in 
the 1970s and 1980s to the level of FDI and find that FDI increases the growth rate provided the 
education level in the economy is sufficiently high, emphasizing the need to evaluate the link between 
FDI and education.
12 
                                                      
12 Their result, that a minimum level of education in the economy is needed, relies on an extrapolation 
from the interaction effect between FDI and education in a linear regression of growth on the latter and should therefore be regarded with suspicion.  Furthermore se e the sensitivity analysis by Levine and Renelt (1992) 
concerning the lack of robustness in this type of study.  The authors don't report robustness checks and it is 
therefore hard to judge to what extent their results are spurious.  WT/WGTTT/W/1 
 Page 31 
 
 
 4. How can the weak evidence of  spillovers through FDI to developing countries be 
explained? 
136. Overall, the evidence about the technological spillover effects is weak.  There are three main 
reasons for this.  First, data on FDI are not as good as data on trade.  Second, most of the studies on 
FDI  suffer from omitted variable problems, since data  on R&D are not always available.  Third, some 
of the analyses fail to captur e FDI' s long term effects. 
137. In particular, the evidence of positive technolo gical spillovers from inward FDI is stronger for 
developed countries than for developing countries.  This can be due to the fact that FDI directed to 
developed countries carries a higher learning potential  or to the fact that developed countries have a 
higher absorptive capacity than developing countries.   In both cases the higher level of human capital 
and expenditure in R&D in developed countries  seem to be the discriminating factor.  
138. Another important possible explanation of the evidence that international diffusion of 
technology through FDI is stronger between develope d countries is the fact th at most research takes 
place in developed countries (about 35 per cent of  all R&D takes place in the US and more than 
90 per cent in the OECD countries) and is directed  towards the needs of the developed countries.  
139. R&D performing firms are motivated by the desire to capture the returns from this research.  
These returns can't be as easily captured in the So uth as in the North, since property rights are less 
well protected in the South.  This leads R&D performing  firms to direct their efforts into research that 
is most effective in reducing costs in the North.  Their research investments center on technologies to 
complement the production processes and the factors of production mainly employed in the developed 
countries.  Foremost amongst the factors of production mainly employed in these developed countries 
are skilled workers.  The investment s into R&D are thus made in proj ects that promise to complement 
an educated work force.  Therefore, gains from technology innovations developed in the North can be 
very small for the South. 
140. The evidence that there are larger spillovers when the technology gap between foreign and 
host country is smaller (Kokko et al., 1996) corroborates this explanation. 
141. Backward and forward linkages between foreig n and domestic firms are a good vehicle for 
technology diffusion.  A similar level of development between the host and investor country makes 
easier a development of a series of useful inter linkages between firms at different stages of the 
production process.  Moreover, a high technology  activity can actually carry a higher level of 
technology content.  Finally, local effort is cl early necessary for successf ul technology adoption.  
142. Among the reasons why the evidence of positive spillover effects of FDI on productivity is 
weak specially for developing countries is the fact that empirical analysis does not distinguish between vertical  and horizontal FDI.  Empirical ev idence is in accord with the theoretical prediction 
that developing countries mainly attract vertical FDI, characterised by a low-level of technology 
intensity and few backward and forward linkages.  
 
V. PARTNERSHIP AGREEMENTS AND TECHNOLOGY TRANSFERS 
143. Licensing, franchising and joint venture agreemen ts may substitute for FDI as a way to serve 
a foreign market and act as alternative mechanis ms for the transfer of foreign technology.  
Technology diffuses across countries via partnership agreements in the same way as via FDI.  
Therefore the same considerations relative to the role of education and the IPR regime in attracting 
specific types of investments and in determining how effectively technology diffuses also hold for 
partnership agreements.  WT/WGTTT/W/1 
Page 32  
 
 144. The focus here is on what factors determine the decision of a firm to enter in a partnership 
agreement rather than directly invest in the foreign market and what characterises partnership 
agreements with respect to FDI in terms of technol ogy transfers.  A survey of the empirical evidence 
on the effectiveness of partnership agreements in diffusing technology across countries conclude this 
section.  
 
A. W
HAT DETERMINES THE DECISION BETWEEN FDI  AND PARTNERSHIP AGREEMENTS ?  
145. Four main motives are commonly cited in th e economic literature for the formation of 
partnerships (Hennart, 1988). 
• Through a partnership agreement, firms can take advantage of economies of scale in their 
production process while remaining separa te identities, thus diversifying risk; 
 
• Partnership agreements can be used to overcome entry barriers into a new market, such as the 
presence of high tariffs and quotas for example; 
 
• Research joint ventures, allow the pooling of complementary bits of knowledge, thus 
favouring productivity of research by increas ing knowledge level and reducing duplications; 
 
• Foreign companies may enter into a partnership agreement with a local company to allay 
xenophobic reactions. 
 
146. Overall, partnership agreements provide scop e for reducing the political and economic risks 
associated with direct investment, and are therefor e preferred to FDI when these risks are relevant. 
147. However, licensing, franchising and joint ventur es present a disadvantage with respect to FDI 
from the point of view of a tech nologically advanced foreign firm that enters into a partnership 
agreement with a local firm.  In a partnership agr eement, the foreign firm discloses information about 
the technology to the domestic firm and therefore the extent of the risk from imitation that the 
originating firm faces is an important factor of decision as between FDI and partnership agreements. 
148. An important factor in this regard is the strength of the IPR regime.  If enforcement of IPRs 
increases beyond a certain threshold, foreign fi rms may be willing to engage in joint ventures, 
franchising or licensing agreements with local firms.   This is because str onger IPRs will reduce the 
threat of local imitation (imitators  have the advantage of not paying the license fee), thus augmenting 
expected profits on both sides.  Likewise, licensing, franchising and joint ventures are also preferred 
when imitation is very difficult. 
149. In other circumstances, licensing, franchising an d joint ventures are the only feasible way to 
serve the market.  In many countries FDI is constr ained by the government.  Sovereignty concerns 
may be a reason for some governments to prefer foreign firms to engage in licensing agreements 
rather than FDI.  
150. Other studies point to the characteristics of th e host countries as an important factor in 
determining the choice between FDI and partnershi p agreements.  Nogues (1993) argues that the 
decision to engage in licencing agreements depends both on the legal strength of the licensing 
agreement and the capacity of licensees to absorb and exploit the technology transferred rather than 
on the strength of IPRs.  In addition, Das (1999) shows the importance of the riskness of the project 
and the host country political enviro nment in determining the mode chosen by the multinational firm 
to enter productive activity in a developing country.  Das' paper also provides a framework to study 
the choice between licencing and joint ventures, wh ere licensing typically involves an up-front fee  WT/WGTTT/W/1 
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 and royalty payments based on revenues earned by the local firm, while joint ventures pay a share of 
the profit to the local firm. 
151. Mansfield (1994, 1995) and Lee and Mansfield ( 1996) provide empirical evidence that firms 
may refrain from engaging in joint ventures and licen sing to third parties if the strength of protection 
is not adequate.  A study by Tom linson (1970) for a sample of Br itish firms in India and Pakistan 
which formed joint ventures shows that the most cited reasons for choosing the option of a joint 
venture were.  (i) pressures by the host country's g overnment, (ii) spreading of the risk, (iii) need for 
local facilities or resources,  (iv) and local identity. 
 
B. WHAT IS THE POTENTIAL FOR TECHNOLOGY TRANSFERS FROM PARTNERSHIP AGREEMENTS ?  
152. It is commonly believed that, other things being equal, there is a higher potential for 
technology transfers from licensing, franchising an d joint ventures agreements than from FDI.  
Indeed, all channels through which technology diffuses via FDI (backward and forward linkages, 
competitive and demonstration effect and learning- by-doing) are also activated by any of these 
partnership agreements.  But in addition, the tech nology spillover component of  these partnership 
agreements is likely to be larger than from FDI.  Th is is because, first, firms engaging in FDI retain 
control of their proprietary technologies;  they do not disclose their knowledge to third parties.  In 
contrast, in a licensing agreement, the local licens ee is provided with full information of the newest 
technologies.  
153. Second, local licensees do not have to spend re sources in imitation (recall that technology 
spillover is the technology gain acquired without paying for it).  On the contrary, often licensors 
acquire a responsibility for the ability of their licen sees to absorb and benefit from the technology 
transferred. 
154. It is important, however, to note that this presumption that the technology flow from the 
licenser to the local licensee might be higher than the technology transferred to the local economy via 
FDI, may be contradicted by the fact that IPRs  are more protected in the country in which the 
licencing activity takes place, than in other countries.   Thus, the potential for international diffusion of 
foreign technology might actually be lower under licensing than FDI, the chosen mode of serving the 
market when enforcement of IPRs is weaker. 
155. A similar point is raised by Fosf uri (2000).  He shows that when  IPR protection is not strong, 
so that the licenser faces the risk of imitation by th e licensee, the firm can strategically use the vintage 
of the technology to deter imitation by the licensee.   As a result, transfers to affiliates of MNE might 
be of a later vintage than technologies sold to outsiders.   
156. As far as the relative importance of licensing ve rsus joint ventures in determining technology 
transfers is concerned, Marjit an d Mukherjee (2001) show that te chnological collaboration together 
with equity participation improves the quality of the technology transferred relative to the case of a 
pure technology licensing agreement. 
 
C. WHAT IS THE EMPIRICAL EVIDENCE ON THE ROLE OF LICENSING AND JOINT VENTURES FOR 
TECHNOLOGY TRANSFERS ? 
Licensing  
 
157. Empirical evidence generally points to a positive effect of licensing agreements on 
technology transfers. WT/WGTTT/W/1 
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158. Pack (2000) shows that technology transfers through licensing do not play a significant role in 
the early stage of the development of poor countries.  But as industrialisation in more technologically 
advanced sectors take place, licensing assumes more relevance. 
159. The paper by Montalvo and Yafeh (1994) examin es investments in foreign technology by 
Japanese firms.  The relationship between the ac quisition of a foreign tech nology and the affiliation 
with a corporate group is analysed.  The results in dicate that affiliated firms acquire more foreign 
technology than independent firms, suggesting that corporate groups have played an important role in 
Japan's technological progress. 
160. Similarly, Dowling (1994) finds that licensing  was the method of technology transfer on 
which Japan, Korean and Taip ei, China primarily relied. 
161. Yang and Maskus (2001) test empirically whether stronger IPRs foster licensing activities and 
whether this in turn lead to more technology transfers.  They find that the strength of the IPRs regime 
has a positive impact on several measurements of li censing activity.  However, they are not able to 
conclude that stronger IPRs foster technology diffusion via increased licensing activity.  
162. This is because, first, their measurement of li censing activity is the US receipts of affiliated 
and unaffiliated royalties and licensing fees.  It may well  be that the increase in licensing activity only 
means that licensing fees have increased because of  the stronger market power of IP owners (stronger 
IPR protection gives IP owners greater bargaining po wer with respect to the licensee, who face more 
difficulties under stronger IPR protection in acquiring the same technology through imitation) whilst 
the amount of technology transferred is the same.  
163. Second, one cannot exclude the possibility that  what is being captured by the increased 
measure of licensing activity is an increase in payments  for technology transfers,  that were previously 
being acquired without cost.  In this case, the country may be pulling resources away from other 
forms of technology transfers (like imitation, reve rse engineering etc…) so that in fact, although 
licensing activity increases, technology transfers actually decrease. 
Joint ventures
 
 
164. A common belief is that joint ve ntures tend to be an efficient mechanism of transfer of 
technology because characterised by an active part icipation of the parent organisation, including 
national research centres, in the development proc ess.  Accordingly, empirical evidence shows the 
presence of positive spillovers from joint venture.  
165. A noticeable example is that reported by Campbe ll and Hand (1998).  Their study shows that 
joint ventures foster transfer of technologies from distant water fishing nations to developing 
resource-owning countries.   
166. For the case of the European semiconductor industry, Hobday (1997) shows that European 
technological competencies improved with the ad option of pro-active technology activities (joint 
ventures and technology exchange) as opposed to passive activities such as licensing, thus showing a 
positive contribution of joint ventures to technology transfers.  
167. A study conducted by Katz et al. (1996) examines  the transfer of technology over a three-year 
period in an international joint venture comprisi ng three operating divisions of large multinational 
chemical companies located in Germany, United States and Japan.  A total of 208 technologies are 
identified as having been transfer red between the venture partners.  WT/WGTTT/W/1 
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 168. What determines the success of technology transfers through joint ventures?  A critical 
examination of the experiences of the pioneer joint ventures in Shan ghai (Martinsons, 1995) points to 
management skills in bridging cultural differences as  a main determinant of success.  The result of an 
empirical study conducted on 50 major international pr ojects put in place by the 36 largest Canadian 
consulting engineering firms in developing countries po int to the investment in training of workers as 
a major factor of success (Niosi et al. 1995).  It also finds that successful transfers occur when the 
transferees themselves conduct research and deve lopment and do not suffer from host government 
restrictions in the case of technology transferred via trade or FDI, empirical evidence on the 
effectiveness of technology diffusion seems to sugg est the importance of adequate absorptive capacity 
of the transferee country. 
169. How does technology diffuse from firms that have foreign links to those that have not?  Using 
firm level data for the Czech Republic during 1992-96, Djankov and Hoekman (2000) find a negative 
technology spillover effect of joint ventures and FDI together on firms that do not have foreign 
partnerships. 
170. Part of the literature on joint venture and technology transfers focuses on the role played by 
national research centres.  In a recent study, Steffensen et al. (2000) show that the success of a spin-off company in absorbing technology transfers relie s on the degree of support that it receives from its 
parent organisation
13.  In their investigation, based on the experience of 6 of the 19 spin-offs from the 
55 research centres in the University of New Mexi co in 1997, they show that university research 
centres continue to provide labora tory facilities and access to resear ch equipment to the successful 
spin-offs.  
171. This evidence highlights the role that pub lic-private initiatives, national centres for 
technology and manufacturing, research and development consortia, and university outreach centres 
can assume in enhancing economic development.   
 
172. Few other studies outline cases of successful experience of technology transfers through 
partnerships and collaboration.  One which does re lates to the partnership agreement between Fujitsu 
and ICL, where the exchange of competencies help ed to enhance the technological capabilities of both 
firms (Lynskey, 1999). 
 
__________ 
 
 
                                                      
13 A spin-off is a company that is formed by individuals who were former employees of the parent 
organisation (a research centre or a foreign firm) and a core technology that is transferred from the parent 
organisation.