1. McKinsey Global Institute LAN-ZZV476-20060302-17254-ZZV CONFIDENTIAL FDI and Technology Absorption Jaana Remes McKinsey Global Institute This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organisation without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

2. LAN-ZZV476-20060302-17254-ZZV 1 *Based on estimates from OECD 2000 segmentation of total FDI (developed and developing countries); excludes resource seeking FDI (e.g., for petroleum) Source:OECD; McKinsey Global Institute; WDI MULTINATIONAL COMPANY INVESTMENT HAS INCREASED RAPIDLY IN THE PAST DECADE Inflows $ Billions Main drivers Liberalization and privatization Decline in transport and communication cost 300 250 200 150 100 50 0 198019821984198619881990199219941996199820002002

3. LAN-ZZV476-20060302-17254-ZZV 2 Auto Consumer electronics Food retail Retail banking IT/BPO* ChinaIndiaMexicoBrazil A BROAD FACT BASE PROVIDES RANGE OF INSIGHTS *Information technology/business process offshoring (IT/BPO); completed individual case studies for IT and BPO, thus bringing the total studies completed to 14

4. LAN-ZZV476-20060302-17254-ZZV 3 MOST ECONOMIES CLEARLY BENEFIT FROM FOREIGN INVESTMENT *BPO **IT Source:McKinsey Global Institute Positive or very positive impact in 13 out of 14 cases across sectors Very positive Positive Neutral Negative Pure market-seekingTariff-jumpingEfficiency-seeking Motive for entry Overall FDI Impact * *

5. LAN-ZZV476-20060302-17254-ZZV 4 WE FOUND SOUND ECONOMIC FOUNDATION TO BE KEY, WHILE INVESTMENT POLICIES WERE INEFFECTIVE AND EVEN HARMFUL *TRIMs = trade-related investment measures Impact from FDI Economic foundations Macroeconomic stability Competition Enforcement Infrastructure Investment policies Incentives Import barriers TRIMs*

6. LAN-ZZV476-20060302-17254-ZZV 5 Increased FDI impact FOUNDATIONS FOR ECONOMIC DEVELOPMENT ARE CRITICAL Macroeconomic stability Precondition for MNC investment and FDI impact Competitive environment Competition most powerful factor driving FDI impact Legal enforcement Informality reduced FDI impact and sector performance Infrastructure Important enabling condition for FDI impact

7. LAN-ZZV476-20060302-17254-ZZV 6 *Actual cars and employment (not adjusted) Source:MGI; McKinsey Global Institute; team analysis Labor productivity Equivalent cars per equivalent employee; indexed to 1992-93 (100) Productivity in 1992-93 Productivity in 1999-2000 Improve- ments at HM Exit of PAL Indirect impact of FDI driven by competition Entry of new players Direct impact of FDI Less productive than Maruti mainly due to lower scale and utilization Increased automation, innovations in OFT and supplier- related initiatives Improve- ments at Maruti Auto India IN INDIAN AUTO SECTOR, LARGEST FDI IMPACT CAME THROUGH INCREASED COMPETITION

8. LAN-ZZV476-20060302-17254-ZZV 7 IN MEXICAN FOOD RETAIL, WALMART ENTRY LED OTHERS TO IMPROVE SUPPLY CHAIN EFFICIENCY *Share of total sales distributed through centers not updated Source:Annual reports Wal-Mart* Comercial Mexicana Gigante Soriana Number of distribution centers in 2001 Share of total sales distributed through centers (2001 vs. 2005) Percent 12 4 7 6 Regional player in more developed Northern Mexico ROUGH ESTIMATES 60 58 80 Between 1996-2001, WalMart labor productivity grew by 2% annually, while it declined by 2% annually in the rest of the modern sector

9. LAN-ZZV476-20060302-17254-ZZV 8 IN BRAZILIAN FOOD RETAIL, PRODUCTIVITY INCREASES BUT PROFITS EVAPORATE WHEN AN INFORMAL RETAILER IS ACQUIRED BY A LARGE FORMAL RETAILER *Gross margin per employee hour Note:1) See next page for more detail on causes for observed changes. 2) Margins based on net sales Source:ABRAS; PNAD; store visits; interviews; McKinsey Despite a 32% increase in labor productivity*... Reals PrePost 32% Acquisition 1,460Number of employees 1,095 Hours worked/year/ employee 2,328 -25%... the net margin evaporates Percent PrePost -97% 180 163 Gross sales R$ millions Net sales R$ millions Gross margin Percent 19 144 125 25 -20%-24%29%0% Percent change

10. LAN-ZZV476-20060302-17254-ZZV 9 INVESTMENT POLICIES HAVE NEGATIVE AND UNINTENDED CONSEQUENCES Incentives Fiscal and administrative cost Reduced productivity Race-to-the-bottom dynamics Import barriers Limited competition Protection of low productivity players TRIMS Protection of low productivity players Limited flexibility to compete Reduced FDI impact

11. LAN-ZZV476-20060302-17254-ZZV 10 INCENTIVES CONTRIBUTED TO CAPACITY BUILD-UP IN BRAZILS AUTO SECTOR Source:McKinsey Global Institute 1995 capacity Investments based on long-term growth trends 2001 capacity Additional investments, due to great expectations for future growth Collectively, the industry built more than double what would have been expected under long-term trends Further investments, due to incentives, Sweetners, and the race to grow

12. LAN-ZZV476-20060302-17254-ZZV 11 HIGH TARIFFS LIMIT COMPETITION AND INCREASE PRICES IN INDIAS CONSUMER ELECTRONICS SECTOR Source:McKinsey CII report Average tariff/effective rate of protection on final goods Percent TV example – Color TV price breakdown Index, international best practice = 100 Interna- tional best practice price Import duty on finished good Import duty on raw material Higher margin Inefficiency in the process 9-12 8-10 8-13 The protection offered by import duties on domestic players finds to mask inefficiency 130 Mobile* phones PC s Refriger- ators TV s Retail price Includes raw material, conversion costs and margin

13. LAN-ZZV476-20060302-17254-ZZV 12 WE FOUND SOUND ECONOMIC FOUNDATION TO BE KEY, WHILE INVESTMENT POLICIES WERE INEFFECTIVE AND EVEN HARMFUL *TRIMs = trade-related investment measures Impact from FDI Economic foundations Macroeconomic stability Competition Enforcement Infrastructure Investment policies Incentives Import barriers TRIMs*

14. LAN-ZZV476-20060302-17254-ZZV 13 www.mckinsey.com/mgi