Economic Research Forum (ERF)

Foreign investment and domestic production complexity in Turkey

Inflows of foreign direct investment can act as a catalyst for domestic firms to develop sophisticated manufacturing products, according to evidence from Turkey presented in this column. The authors conclude that investment promotion policies can play a key role in facilitating upgrading of the national production structure.

In a nutshell

Enhancing an economy’s productive capabilities across an increasing range of more sophisticated manufactured goods is an integral part of economic development.

Turkey is one of the few countries to have dramatically improved the sophistication of its productive structure in recent decades.

The presence of foreign affiliates is positively correlated with the complexity level of products newly introduced by Turkish firms active in the supplying industries and located in the same region.

There is growing evidence that inflows of foreign direct investment (FDI) make it more likely that host countries will upgrade production. Our research examines the link between FDI and the complexity of new products introduced by domestic firms. We focus on Turkey, a country that experienced a spectacular surge in FDI inflows during the 2000s, and is one of the few countries to have dramatically improved the sophistication of its productive structure in recent decades.

The concept of product complexity is best illustrated by analogy with Lego, the plastic construction toy. Imagine that a country is represented by a bucket of Lego pieces with each piece representing the capabilities available in the country. The set of products (Lego models) a country can produce depends on the type, diversity and exclusiveness of the pieces in the bucket. A bucket containing Lego pieces that can only be used to build a toy bicycle probably does not contain the pieces to create a toy car. But a bucket containing Lego pieces that can build a toy car may also have the necessary pieces to build a toy bicycle.

While two buckets may be capable of building the same number of models, these may be completely different sets of models. Thus, determining the complexity of an economy by looking at its products amounts to determining the diversity and exclusivity of the Lego pieces in a bucket by looking at the Lego models it can build.

Anecdotal evidence suggests that foreign affiliates operating in Turkey may be stimulating product upgrading among their suppliers. For example, Indesit is an Italian white goods producer – recently acquired by Whirlpool – that has been active in Turkey since the 1990s. Its plant, located in Manisa, produces refrigerators.

At the outset of its operations in Turkey, Indesit imported most of the components needed to make the final products. Now, Indesit sources almost all the main components locally. More than half of its supplier base is in Turkey, mostly in the same industrial district as its Manisa plant.

Geographical proximity to suppliers is important for keeping down transport costs and allowing more productive collaboration with suppliers. Indesit regularly conducts audits of its suppliers and also helps them to start production. Its resources of engineering know-how and previous experiences working with local suppliers elsewhere in the world are shared with Turkish business partners.

In 2012, Indesit built a new plant producing washing machines. To become a supplier to this new plant, a local company purchased new presses and automated its production process. This allowed the company to start producing a new and more sophisticated product, and increase efficiency and production volume. It became the only supplier to Indesit in Turkey capable of making a complex product: the flange of a washing machine basket.

Stainless steel components like a washing machine flange are among the most complex products in the industry. For example, the flange is twice as complex as a stainless sink, which in turn is more complex than a pot scourer. The flange needs to be produced with no aesthetic defects by an 800-1,000 tonne metal press. The component’s drawings are statistically controlled for correct assembly with the rest of the washing machine basket. They also need to withstand the stress of between 1,000 and 1,400 revolutions per minute while remaining within a certain range of vibration and noisiness.

Indesit played a central role in the upgrading process of its supplier. Indesit shared some essential tacit knowledge, information processes, instructions and control procedures with the local company. This stimulated and supported the supplier’s complexity upgrading.

Inspired by this anecdotal evidence, we examine the link between the presence of foreign affiliates and production upgrading by Turkish firms located in the same region and active in the input-supplying industries. The presence of foreign affiliates does not seem to affect the propensity of Turkish firms to innovate. But their presence is positively correlated with the complexity level of products newly introduced by Turkish firms active in the supplying industries and located in the same region.

The estimated effect is economically meaningful. A 10-percentage point increase in foreign presence translates into the average complexity of products newly introduced in the supplying industries increasing by 0.297, which implies moving about halfway from the production of pot scourers to producing stainless steel sinks. In a similar way, an increase of about 17 percentage points in FDI in the relevant sectors would be necessary to move from the production of stainless steel sinks to the production of washing machine flanges.

When we investigate the change in the overall complexity of the firm’s portfolio of products, the data corroborate the finding of a positive relationship between the presence of foreign affiliates and increasing sophistication of Turkish manufacturers in supply industries.

Our findings matter for policy. Enhancing the economy’s productive capabilities across an increasing range of more sophisticated manufactured goods is an integral part of economic development.

Our results imply that FDI inflows can act as an important catalyst for this process. Thus, there is room for investment promotion activities, a policy that is known to be effective in developing countries. In contrast to many other industrial policies, investment promotion (as distinct from fiscal incentives) is relatively inexpensive and causes few distortions. Therefore, there is little downside even if the government gets it wrong.

Further reading

Javorcik, Beata, Alessia Lo Turco and Daniela Maggioni (forthcoming) ‘New and Improved: Does FDI Boost Production Complexity in Host Countries?’, Economic Journal.

A longer version of this column is available at VoxEU.

Most read

Fair competition is needed to empower women economically in the Arab world

The participation rates of women in the labour market in Arab countries are the lowest in the world. This column argues that remedying the under-representation of women in the labour force is a social and economic imperative for the region. There are three dimensions for action to realise the potential of Arab women: amending laws and regulations; instilling fair competition in markets; and promoting the digital economy.

Recession without impact: why Lebanese elites delay reform

The survival of Lebanon’s political elites is highly dependent on the wellbeing of the economy. Why then do they delay necessary reform to avoid crisis? This column examines the role of politically connected firms in delaying much-needed economic stabilisation policies.

Competition laws: a key role for economic growth in MENA

Competition policy lacks the attention it deserves in the countries of the Middle East and North Africa (MENA), a region characterised by monopolies and lack of market contestability. As this column explains, there are many questions about the extent of anti-competitive barriers facing new market entrants in the region. What’s more, MENA’s weak overall performance on competition is likely to be hindering economic growth and the path towards structural transformation.

The future of Egypt’s population: opportunities and challenges

Egypt’s potential labour supply depends on the growth and changing composition of its working-age population. This column reports the latest data on labour supply and fertility rates, concluding that the country has a window of opportunity with reduced demographic pressures to try to address longstanding structural challenges for the labour market.

Formidable challenges facing the Middle East require a sea change in economic policies

Weakening global growth, endemic conflicts and increased tensions within the Middle East and North Africa (MENA) – as well as emerging challenges such as climate change and rapid demographic shifts – are likely to have an adverse impact on the region’s economic, social and political stability in the coming years. This column outlines the policy responses that are needed to avert disaster.

Domestic demand and competition: a new development paradigm for MENA

A lack of competition in domestic and regional markets is holding back development in the Middle East and North Africa. This column argues that the region and the international community must ensure that barriers to market entry and exit are eliminated, and that independent regulatory bodies at the national and regional levels help to promote domestic demand as the main engine for sustainable and inclusive growth.

Effects of urbanisation on productivity and wages: evidence from Turkey

Are the substantial productivity gains associated with larger cities in developed countries similar for developing countries? This column provides evidence on urbanised economies in the non-Western world by focusing on Turkey, a country that has experienced fast urbanisation and a high rate of growth of the urban population.

Gender discrimination in small business lending: evidence from Turkey

Discrimination in access to financial services can prevent women from exploiting their entrepreneurial potential. This column reports on a ‘lab-in-the-field’ experiment to test for the presence of gender discrimination in small business lending in Turkey.

How import dependence could lead to corruption in MENA

Export-led development strategies have had little success in MENA countries; what’s more, instruments of earlier import-substitution strategies – such as state-owned enterprises, high tariffs and subsidies – have survived. As this column explains, these legacies have created crony-capitalist industries that have limited the level of competition in many sectors of the economy and furthered the region’s dependence on imports.

Social security for young workers in Arab countries

Social security coverage of young workers in Arab countries is low – in part because many are employed in informal jobs; and in part because they do not see the value of the system. This column reports survey evidence on young workers’ attitudes towards participation in both social security and politics. It also explores policy reforms that might make access to social security universal for young workers.