Business Networks and Enclave Formation: Why Foreign Direct Investment Fails to Transfer Technology

Abstract

Foreign Direct Investment (FDI) frequently fails to provide transfers of important ideas and technologies to host countries. Incorporating insights from network theory, we argue that this is a predictable outcome of foreign investment because there is a natural tendency among multinational enterprises (MNEs) toward enclave formation. MNE subsidiaries face risks associated with poor information in host countries, which they mitigate by partnering with known firms in their existing business networks. In-group dynamics and network inertia perpetuate the closed nature of foreign enclaves and prevent technology transfer to the local enterprises. Thus, rather than specific host country conditions – absorptive capacity, institutions, or culture – a general tendency toward enclaves among MNEs works against local technology transfer. We illustrate this tendency with three cases that a-priori should not be characterized by poor levels of technology transfer: the electronics clusters in Guadalajara, Mexico and Costa Rica and the automotive sector in Ontario, Canada. Recognizing the role of business networks in shaping MNE behavior has important analytical implications for scholars and underlines the importance of policymakers moving beyond FDI attraction to local network-building policy instruments.