A common definition of FDI is an investment involving a long-term relationship reflecting a lasting interest and control of a resident entity in a host economy. Yet paradoxically, many host governments show little or no lasting interest in the activities of foreign subsidiaries, overlooking their importance as a source of innovation and competitiveness.

Understanding that the completion of an investment project is not an end in itself has driven some governments (or national investment promotion agencies) to design aftercare programmes. In most cases this implies successful completion of a project handled by an investment promotion agency. Aftercare usually lasts a few years after project completion because these years are the most crucial.

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Aftercare programmes should be perceived as a bridge between FDI promotion and subsidiary development because they are often restricted to investment projects recently mediated by an investment promotion agency and do not involve other foreign subsidiaries. Subsidiary development is a broad policy area, which requires identification of all foreign subsidiaries located in the host economy and the application of a set of comprehensive policy measures.

Although investment promotion agencies possess precise information about their ongoing and completed investment projects, many of them do not even know the exact number of foreign subsidiaries existing, their co-ordinates and their contribution to the national economy.

Subsidiary development should have a twofold goal: retaining foreign subsidiaries and contributing to their evolution. Naturally, this calls for the subsidiaries’ embeddedness into national economic and innovation systems.

No guarantees

The argument for this goal is compelling. First, even if a host country manages to complete an investment project, it is no guarantee that a multinational company will stay there. Although FDI is not as volatile as portfolio investment, global competitive pressures from low-cost economies can lead to the withdrawal of a multinational company from a host economy. Withdrawal is more likely if a subsidiary is engaged in low-value-added activities such as assembly and has few links to other agents in an economy. If a subsidiary is deeply embedded in a host economy and possesses a portfolio of corporate functions ranging from sales to R&D, the decision to withdraw will be painful and uneasy. At worst, a parent company can decide to relocate the low-value-added activities and leave the subsidiary with more advanced functions.

This relates to the issue of re-investment of earnings because the majority of new foreign investment is linked to the existing subsidiaries. Both theory and practice of international business suggest that despite the recent changes in corporate governance, such as supply chain fragmentation and internationalisation of corporate R&D, multinational companies still engage in sequential investment. In academic literature this is known as subsidiary development (evolution) or functional upgrading.

Testing the water

Multinationals learn from their presence in a host economy before locating activities there which are considered strategic by their headquarters. This implies that multinational companies rarely establish subsidiaries with a whole range of corporate functions (sales, distribution, manufacturing, development, research) at once. It is relatively easy for host country governments to support the acquisition of new higher-value- added functions for existing foreign subsidiaries, than to rush into fierce competition for a tiny share of best FDI (in the most advanced corporate functions or novel technological areas). Successful subsidiary development of multinationals may also encourage others to invest, following the ‘success breeds success’ principle.

It is hardly possible to apply hard policy instruments (such as taxation) to subsidiaries. A host country’s government cannot treat subsidiaries worse than domestic firms because of the principle of national treatment; and it cannot conduct a policy of preferential treatment towards them at the expense of domestic firms. Host country governments risk multinational companies capturing public resources and making use of policies, with no expected multiplier for the economy.

However, they can design soft policy instruments. Subsidiary development implies regular monitoring of subsidiaries with the goal of offering them complementary assistance, adapted to their level of development. This includes developing and maintaining a network of contacts between subsidiaries and domestic firms. This network should provide ideas for co-operation, mergers and expansions.

Another important soft policy instrument is the attraction of new suppliers to subsidiaries and improving the efficiency of the existing supply chain. In the modern knowledge-based economy, an educated workforce plays a crucial role in the performance of a company. Therefore, governments should ensure adequate education systems and training schemes to provide the necessary workforce for the higher-value-added functions. Subsidiaries should benefit from these policy initiatives in a way that will ultimately be beneficial to the national economy.

It is essential to develop formal and informal contacts between subsidiary executives and national investment promotion agency officials. A strong effort must be made to discuss with subsidiaries (and their headquarters) their future plans and prospects. This can help to identify ways that the host country authorities might assist in reaching these goals.

Although the promotion of FDI inflows is typically carried out by an investment promotion agency, a multitude of actors can be involved in subsidiary development. They should be charged with the task of fostering trust, collaboration and innovation between firms (and academia). They may include regional economic development agencies, technology transfer organisations, and ministries of economy, technology and innovation.

Performance indicators

As for investment promotion agencies, mentality and performance indicators should be changed – because their success is mostly measured in terms of new investment projects and jobs created, not in terms of investor development and quality of investment.

Ideally, subsidiary development should focus on all subsidiaries established in a national economy. However, it is obvious that they do not represent a homogeneous bloc. They are highly heterogeneous units in terms of their functions, scope of responsibilities, power relations with parent companies and sectoral specifics, etc.

The first question is whether the management of foreign subsidiaries expect any support from a host government. The management of some subsidiaries might oppose any type of policy intervention, even if it is for their benefit.

Second, there is a question of subsidiary autonomy, ie, different relations exist between a subsidiary’s management and its headquarters within a corporate network. Although some subsidiaries have significant freedom in decision making, others are more dependent on the decisions of their headquarters. Therefore, the management may be enthusiastic about subsidiary development but may not have the necessary authority to proceed in this direction.

Third, subsidiaries can be divided into different groups in terms of the urgency of FDI policy intervention. The main group includes mid-players that work in a stable manner in mature technological sectors. There is not much scope for policy interventions here. Similarly, the scope for policy-making is quite restricted in two extreme cases – established market leaders (highly embedded and advanced subsidiaries) and subsidiaries under imminent danger. In the case of the leaders, once they have reached a high level in their evolution, the support of public policy is no longer crucial. In the case of the other group, the danger may be caused by global developments in a particular technological sector or problems that the whole multinational company faces; it is either too late for public authorities to intervene, or intervention would be futile anyway.

However, subsidiary development can be exceptionally effective in two scenarios: foreign subsidiaries showing signs of growth and subsidiaries showing signs of decline. In the former scenario, policy measures should provide support to avoid failure in the growth process because there can be barriers hampering development (lack of skilled labour in the chosen location, etc). The latter scenario is perhaps the most interesting. The subsidiary may be showing signs of decline, which can be caused by a variety of factors, ie, pressure from competitors based in low-cost locations – a parent company may be considering relocating the subsidiary to such a location too. For the host country government, it is not too late to intervene and agree (with subsidiary and parent company management) on a comprehensive programme to retain the subsidiary.