Can Local Content Requirements in International Investment Agreements Be Justified?
18 Pages Posted: 13 Feb 2008
Date Written: October 1, 2006
The paper implementing the imperfect competitive equilibrium model, increasing returns to scale, the coordination failure problem and the learning-by-doing argument discusses the economic efficiency of local content requirements (LCRs). It is shown that the LCRs are economically unjustifiable not only within a simple competitive equilibrium model with perfect information, with no frictions, with constant returns to scale, but also within the world where increasing returns to scale are accrued. It is presented that the LCRs lead to suboptimal allocation of resources and reduce efficiency. However, the analysis demonstrates that the impacts of the LCRs are not as clear as the economic model might suggest once the coordination failure problem is taken into account. Nevertheless, it is proofed that if transportation costs take place and are non-negligible, there still exists a market incentive for investors to set up a production without any LCRs. And this market setting up of production surpasses the coordination failure. The analysis of the LCRs is also incorporating the learn-by-doing argument. It is clear that the learning-by-doing effect reduces the inefficiency arising from the LCRs. Nevertheless, it is shown that it is very uncertain whether future benefits from the technology improvement given by the learning-by-doing effect will outweigh the costs of the LCRs. Based on both economic principles and the results obtained from the carried out analysis the authors conclude that the LCRs reduce economic efficiency and international investment agreements should not allow using them in order to pursue market economy efficiency. As the paper presents, LCRs are not justified even if they are placed in return for receiving FDI incentives.
Keywords: Local content requirements, performance requirements, international investment agreements, economies of scale, coordination failure, learning-by-doing.
JEL Classification: D20, F23, K33, O12
Suggested Citation: Suggested Citation