Foreign direct investment and reverse technology ... · Foreign direct investment and reverse technology spillovers: The effect on total factor productivity by Edmund Amann and Swati
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Foreign direct investmentand reverse technology spillovers:
The effect on total factor productivity
byEdmund Amann and Swati Virmani*
The paper analyses the “feedback effect” of Foreign Direct Investment (FDI) on TotalFactor Productivity (TFP) growth in emerging economies via technology spilloversacross borders. We study the effect of R–D spillovers resulting from outwardFDI flows from 18 emerging economies into 34 OECD countries over the1990-2010 period, comparing the impact with that of spillovers resulting frominward FDI flows. The result confirms that FDI enhances productivity growth;however the impact is much larger when R-D-intensive developed countries investin the emerging economies than the other way round. Country-specific bilateralelasticities also support this outcome.
JEL classification: F21, F43, F62, O47.
Keywords: Outward FDI, Inward FDI, Reverse technology spillovers, Total factorproductivity.
* The authors are Reader in Development Economics and Head of Economics (Teaching andOperations); and PhD Student, Economics, School of Social Sciences, respectively, at the Universityof Manchester, UK. They would like to thank Bruno Van Pottelsberghe de la Potterie and GiuseppeNicoletti for comments on a previous version. The opinions expressed and arguments employed inthis paper are the responsibility of the authors and do not necessarily reflect the official views of theOECD or of the governments of its member and partner countries.Email: [email protected]; [email protected].
enterprises from the transition economies were engaged in OFDI (Russian Federation).
Table 1 highlights the OFDI flows from four major host countries for emerging
multinationals, the BRIC.
Figure 1. India’s OFDI flows by geographical distribution in first (1975-90)and second (1991-March 2001) waves (in %)
Source: UNCTAD, 2007.
Table 1. OFDI flows in USD million, 1990-2010
Brazil Russia India China BRIC, % of World
1990 624.6 - 6 830 0.605
1991 1 015 - -11 913 0.968
1992 136.7 1 566 24 4 000 2.826
1993 492.3 1 022 0.35 4 400 2.438
1994 689.9 281.37 82 2 000 1.064
1995 1 095.64 605.78 119 2 000 1.052
1996 -469.06 922.82 240 2 114 0.706
1997 1 115.56 3 183.91 113 2 562.49 1.461
1998 2 854.01 1 269.75 47 2 633.81 0.987
1999 1 690.41 2 207.62 80 1 774.31 0.529
2000 2 281.59 3 176.78 514.45 915.78 0.562
2001 -2 257.59 2 532.58 1 397.44 6 885.40 1.145
2002 2 482.11 3 532.65 1 678.04 2 518.41 1.932
2003 249.3 9 727.13 1 875.78 2 854.65 2.577
2004 9 806.99 13 782.03 2 175.37 5 497.99 3.377
2005 2 516.70 12 767.47 2 985.49 12 261.17 3.436
2006 28 202.49 23 151.00 14 284.99 2 1160 6.134
2007 7 066.66 45 915.5 19 594.36 22 468.86 4.324
2008 20 457.07 55 593.5 19 256.5 52 150 7.488
2009 -10 084.23 43 665 15 927.1 56 530 9.024
2010 11 587.57 52 523 13 151 68 811 10.064
Notes: FDI includes the three following components: equity capital, reinvested earnings and intra-company loans.Data on FDI flows are presented on net bases (capital transactions’ credits less debits between direct investors andtheir foreign affiliates). Net decreases in assets or net increases in liabilities are recorded as credits, while netincreases in assets or net decreases in liabilities are recorded as debits. Hence, FDI flows with a negative sign indicatethat at least one of the three components of FDI is negative and not offset by positive amounts of the remainingcomponents. This is called reverse investment or disinvestment.Source: UNCTAD Stat.
Developing countries Developed countries
First wave (1975-1990)
First wave(1975-1990)
86
14
Second wave (1991-March 2001)
40
Second wave (1991-March 2001)
60
FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
words, the paper tries to distinguish between the impact of R-D spillovers resulting from
North-South and South-North FDI flows.2
The analysis involves looking at the OFDI flows from 18 emerging economies into
34 OECD countries over the 1990-2010 period and Inward FDI (IFDI) flows into those
18 emerging economies from the OECD nations. We apply the methodology suggested by
Van Pottelsberghe de la Potterie and Lichtenberg (2001). However, unlike their study
– which looks at FDI flows between 13 industrialised countries (i.e. North-North FDI only) –
our paper contributes more extensively by studying both South-North and North-South FDI
flows. We also extend the analysis by including catalytic factors that affect TFP, such as
human capital, in order to get better estimates of output elasticity of foreign R-D spillovers.
According to the UNESCO (1993) Statistical Year Book, R-D-expenditures in OECD member
countries amounted to 96% of the entire R-D world expenditures in 1990, thus justifying
the choice of OECD nations as the investing partners for our analysis.
The paper is structured as follows: Section 2 describes how FDI is linked to technology
spillovers. It also discusses the mechanisms that drive the spillovers. Section 3 then
provides an overview of the “feedback effect”, i.e. the impact on TFP growth. Section 4
highlights the methodology and data, Section 5 outlines the results, and finally, Section 6
concludes the study with policy implications.
2. Foreign direct investment and R-D spilloversA vast literature surrounds how firms from developed countries generate technology
spillovers for developing country firms. Figure 2 identifies two main channels for such
R-D spillovers, both focusing on the trickling down of technology from developed to
developing countries. The first channel is based on IFDI into the emerging economies from
developed countries’ firms. This is called the Traditional Channel. The second channel
entails the OFDI flows from the emerging economies into the developed countries. As the
figure illustrates, the traditional channel overlooks the possibility that Emerging Market
Multinational Enterprises (EMNEs) could also capture spillovers from Developed Country
Multinational Enterprises (DMNEs), when the former invest in the developed countries. In
other words, learning could also occur in the developed economy as a result of investment
from EMNEs that are motivated by the desire to obtain intangible assets, such as
technology. However, in both cases, the DMNEs act as the so-called “teacher”.
Figure 2. Two channels of R-D spillovers
Note: EMNEs = Emerging Market Multinational Enterprises, DMNEs = Developed Country Multinational Enterprises.Source: Author’s elaboration and Govindarajan and Ramamurti (2011).
Emerging and developing countries
Rich countries
Channel 1: R&D spillovers from DMNEs when they invest in emerging
markets (traditional spillover literature).Here learning occurs within the developing countries.
Channel 2: R&D spillovers from DMNEs when EMNEs invest in
developed countries. Here learning occurs within the developed countries.
FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
This new spillover channel is based on the recent identification of the investing
country learning from local firms in the host country and acquiring knowledge spillovers
at the host sites. This could be especially true in the case of an outward investment into a
host country that is more capital or R&D-intensive than the home country. The
technology-sourcing occurs mainly when firms try to gain access to foreign technology by
either acquiring foreign firms or establishing R-D facilities in “Foreign Centers of
Excellence” (Herzer, 2012). These firms then acquire new technological know-how and
transfer it to the parent company in the home country.
A number of case studies have been carried out, empirically substantiating these
knowledge flows, as summarised in Table 2.
These studies thus point towards a positive correlation between OFDI and knowledge
spillovers, and that the strategic assets acquiring motive could be realised through
technology seeking outward investment.
Focusing, in particular, on the OFDI from emerging countries as the channel for
R-D spillovers, diverse mechanisms drive such spillovers. One of these is “sharing of the
R-D expenditure”; wherein the host and home country firms jointly undertake technological
research. The second method is the “feedback mechanism”, in which foreign subsidiaries of
the MNCs transfer knowledge to their home base. Then there is the “mechanism of reverse
technology transfer”, i.e. acquiring knowledge through direct investment, particularly
effective when firms carry out asset seeking FDI through mergers and acquisitions and joint
ventures. As a result, firms obtain advanced technologies and enhance their core
competitiveness. Finally, there is a fourth way where parent companies “outsource
R-D activities” and relocate them overseas (Zhao and Liu, 2008).
Table 2. Summary results of previous studies
Author(s) and year of study Findings
1. Pradhan and Singh (2009) Examined OFDI in the Indian Automotive Industry during 1988-2008 and suggested a favourableimpact on the R-D intensity. Their study supported that OFDI is an important factor determiningdomestic R-D performance, more so in the case of a joint-venture.
2. Wei and Ling (2008) Addressed the case of China’s OFDI between 1985 and 2004, and found that inverse technologyspillovers exist when Multinational Enterprises (MNEs) invest abroad and transfer technologyfrom overseas subsidiaries to parent companies at home.
3. Deng (2007) Showed in the case of China that firms used their asset seeking FDI behaviour to obtain strategicresources that were available in more advanced foreign markets but limited in their own countryand to access host countries’ centres of innovation.
5. Branstetter (2006) Used “patent citation data” to infer knowledge spillovers at the firm level. The results of the studyindicated that with an increase in acquisitions in the United States by Japanese firms, the latter showeda greater tendency to cite US patents as “prior art” in their US patent application. Thus, OFDIwas a channel for providing Japanese firms access to foreign technology networks.
6. Pradhan and Abraham (2005) Indicated that one of the main motivations behind Indian firms’ overseas acquisitions was to acquirefirm specific intangibles such as technological skills. Because the Indian manufacturing sector is moreresearch intensive and has greater absorptive capacity, it allowed them to integrate acquired foreigncapital assets.
7. Makino, Lau and Yeh (2002) Observed that firms invest more in capital intensive developed nations than in developing countriesin order to fulfil their quest for strategic capabilities.
8. Van Pottelsberghe de la Potterie andLichtenberg (2001)
Investigated econometrically the technology transfers through FDI, and pointed out that such transfersdo take place if a country invests in R-D-intensive foreign nations. Countries such as Japan, Germanyand France have benefitted from the US R-D capital stock through outward investment.
Source: Authors’ compilation.
FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
Manufacturing, and Resource Extraction. Calculating the percentage of R-D expenditure in
these sectors, the United States spends 75.28% of its total R-D expenditure in these three
sectors only. Japan spends 90.31%, Germany spends 92.82%, and Australia spends 61.55%.
The last column expresses R-D expenditure in these three major sectors as a percentage of
GDP of host countries, i.e. the R-D intensity of those sectors. These figures clearly
demonstrate that FDI from developing and emerging economies does take place in those
sectors where the host countries are primarily undertaking R-D, and justify the asset
seeking behaviour of emerging economies. In other words, host country sectors that have
higher R-D intensity attract significant levels of FDI from home countries.
Table 3. Matching sectoral distribution of OFDI with the sectorspecific R-D expenditure in the major destinations
Investing/home country
Majorsectors
Major destinations(host country)
R-D expenditure in majorsectors as a %of total sectoralR-D expenditure
in the host country
R-D expenditurein the major sectors
as a % of GDPin the host country
India Pharmaceuticals, agriculturalinputs, software,IT and broadcasting
US, Russia, Sri Lanka,Southeast Asia, UK
US: 19.97 US: 0.36 (1.89)
UK: 29.24 UK: 0.31 (1.13)
China Trade and services,manufacturing, resourceextraction (oil, gasand minerals), IT
Hong Kong, US, Japan,Australia, Germany
US: 75.28 US: 1.36 (1.89)
Japan: 90.31 Japan: 1.55 (1.73)
Germany: 92.82 Germany: 1.28 (1.53)
Australia: 61.55 Australia: 0.51 (0.93)
Brazil Energy, mining, services US, UK, Portugal,Netherlands
US: 29.04 US: 0.52 (1.89)
UK: 19.24 UK: 0.20 (1.13)
Portugal: 41.83 Portugal: 0.17 (0.35)
Netherlands: 17.54 Netherlands: 0.15 (0.98)
Russia Resource extraction (oil, gasand metal), manufacturing,telecommunication
European Union, US, CEE US: 71.40 US: 1.28 (1.89)
Germany: 92.65 Germany: 1.27 (1.52)
Hungary: 77.54 Hungary: 0.46 (0.60)
Netherlands: 81.77 Netherlands: 0.68 (0.98)
Portugal: 56.92 Portugal: 0.18 (0.35)
Argentina Oil and gas, iron and steel,food, pharmaceuticals,telecommunications
US, Europe, Japan US: 11.77 US: 0.21 (1.89)
Japan: 11.97 Japan: 0.21 (1.73)
Malaysia Oil and gas, finance, realestate, construction, trade,hotels and restaurants
US, Singapore, ASEAN US: 13.12 US: 0.24 (1.89)
Singapore Finance, transport,manufacturing, real estate,construction
UK, Netherlands, Germany,Australia
UK: 94.02 UK: 1.01 (1.13)
Netherlands: 91.07 Netherlands: 0.76 (0.98)
Germany: 98.34 Germany: 1.36 (1.53)
Australia: 76.33 Australia: 0.64 (0.93)
South Africa Mining and natural resources,trade, finance, businessactivities, wood and woodproducts, machinery
US, UK, Netherlands,Germany, Australia
US: 9.85 US: 0.18 (1.89)
UK: 8.99 UK: 0.09 (1.13)
Netherlands: 16.75 Netherlands: 0.14 (0.98)
Germany: 11.77 Germany: 0.16 (1.53)
Australia: 30.43 Australia: 0.27 (0.93)
Notes: CEE = Central and Eastern Europe, ASEAN = Association of Southeast Asian Nations. Parentheses in column 5= Total sectoral R-D expenditure/GDP. All figures in columns 4 and 5 are averaged across the 1990-2010 period.Source: OECD STAN Database, World Bank Data Series, UNCTAD 2007.
FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
Group rho-Statistic 7.2695* 7.3411* 5.2867* 6.9358*
Group PP-Statistic 2.3469* -0.8474 -2.9220* -5.2221*
Group ADF-Statistic 4.0912* -2.5403* 4.2913* -29.9276*
Notes: Figures in parentheses give t-statistics. * denotes significance at the 5% level, ** denotes significance at the10% level. RDd = Domestic R-D capital, RDfo = Foreign R-D capital embodied in OFDI, RDfi = Foreign R-D capitalembodied in IFDI. The cointegration tests reject the null hypothesis of no cointegration.
FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
Group rho-Statistic 7.1583* 8.4405* 4.1801* 8.3704*
Group PP-Statistic -5.4812* -5.0593* -1.8470** -5.7148*
Group ADF-Statistic 5.5249* -0.8882 2.9465* -0.9036
Notes: Figures in parentheses give t-statistics. * denotes significance at the 5% level; ** denotes significance at the10% level. RDd = Domestic R-D capital, RDfo = Foreign R-D capital embodied in OFDI, RDfi = Foreign R-D capitalembodied in IFDI, PA = Number of patent applications filed by residents, H = Human capital defined as the averageyears of total schooling (age 25+). The cointegration tests reject the null hypothesis of no cointegration.
FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
United States 1.3072 0.2622 0.5568 1.6029 24.8770 0.3801 1.6836 1.1010 -0.0133 0.8655 -0.0558 0.0290 3.8768 -0.0979 -0.1890 0.0301 -0.0510 4.4471
Note: Estimated TFP growth elasticity in the country column with respect to the R-D capital in the row country, based on regression equation (i) of Table 4a.
United States 1.9900 1.5719 2.0963 0.7298 2.5052 1.7371 2.7743 1.4130 0.1863 1.8760 -0.4461 0.0315 2.1667 0.3546 0.1280 0.8365 0.3274 3.8178
Note: Estimated TFP growth elasticity in the country column with respect to the R-D capital in the row country, based on regression equation (ii) of Table 4a.
FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
of new technology or diffusion of technology (Tolentino, 1993). Since developing countries
have limited technological capabilities, the transfer of technology across borders through
direct investment provides the initial basis for technological development. Such transfers
therefore assist the developing countries in narrowing down the technological gap, and
hence attain profitable improvements in productivity and efficiency. However, the success
of technology transfer depends on a number of factors. On the one hand, factors such as
the ability of the country to adapt and develop the transferred technology could pose a
challenge. This requires the development of human resources and a better absorption and
implementation of advanced techniques through innovation. On the other hand, adequate
infrastructure, such as scientific and technical training institutions, R-D facilities, and
socio-economic environment play an important role in influencing the absorption of new
and advanced technology. It is therefore imperative that government policies directed
towards effective assimilation of foreign technology are set in motion.
It is often considered that OFDI enhances the interests of multinational corporations
only; however the paper brings out opportunities for the economy as a whole by way of
factors such as technology and productivity spillovers. With the understanding that OFDI
has a positive impact for developing economies, the study encourages a high quality
institutional environment to offer favourable conditions for running business, and hence
make the business entities strong and competitive for foreign expansion. Given that OFDI
constantly adds to the knowledge stock through reverse technology spillovers, and thereby
affects productivity, the link between institutions and OFDI could be seen as a channel
through which institutions promote productivity growth. In other words, the research
suggests the need to devise strategies to develop a common lobby of interests between
MNEs and policymakers in enhancing the positive effects of globalisation for growth and
development of the country.
Notes
1. Dunning’s IDP model suggests that a country’s outward and inward FDI are partly a function of itslevel of development, and that countries go through different stages as their economy develops.
2. We consider technology transfers from resource rich to emerging economies. A number of reasonscould be identified for why we take into account only FDI embodied spillovers, and not importembodied spillovers. First of all, it may be difficult to validate that the emerging economies areimporting from advanced countries mainly to acquire strategic assets. Also, emerging economiessuch as India and China are rising exporters. Therefore by taking into account only FDI, we haveconcentrated on the increasing levels of outward investment from developing countries mainlyaimed at fulfilling their asset-seeking motive. Further, two countries could import homogeneousgoods from another country j, and such imports may benefit one country more than another. Itmay be difficult to ensure that goods sold by country j to country i were embodied by R-D intensitysubstantially different from the R-D intensity of goods sold to another country (Griliches andLichtenberg, 1984). However, the FDI based weighting matrix that we attach embodies differentR-D intensity for different i and j (as M&As, Greenfield investment, Joint Ventures are countryspecific). Also, even if FDI is classified as a technology flow matrix (rent spillover), the hierarchicalclustering analysis shown in studies such as Van Pottelsberghe de la Potterie (1997) reflects that itis more likely to catch up knowledge spillovers than the Input-Output (IO) matrices because of amuch closer clustering of the former to the technology proximity matrices. Lastly, studies haveshown that knowledge spillover matrices yield higher returns than the IO matrix (Goto and Suzuki,1989; Vuori, 1997; Verspagen, 1997).
3. TFP growth – measured as the change in GDP growth over the compensation-share weightedgrowth of combined factor inputs (labour and capital inputs, adjusted for change in their quality).
4. Modified versions of this methodology have also been tested and employed by Coe and Helpman(1995), Lichtenberg and Van Pottelsberghe de la Potterie (1998), and Zhu and Jeon (2007).
FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
5. We use the TFP index values. These values are generated using the growth rates obtained from theTotal Economy Database (the Conference Board). We do so to avoid the loss of observations [as ln(X)is undefined for X < 0] in using TFP growth rates.
6. Statistical data on FDI flows are more readily available than stocks. It is difficult to construct thestock values due to missing data and heterogeneous methodologies adopted in different countries.
7. Our source of data on Patent Applications is the World Bank Database, defined as – “Patentapplications are worldwide patent applications filed through the Patent Cooperation Treaty (PCT)procedure or with a national patent office for exclusive rights for an invention”. PCT is aninternational treaty providing a unified procedure for filing patent applications, and incorporatesboth priority and second filings. Statistics based on PCT applications are less subject to geographicbias, eliminate any institutional bias, and the timeliness of the indicator is also good. Also asdefined, in addition to PCT, the World Bank data also incorporate data from the National PatentOffice. But as we are looking at emerging economies the bias of using domestic filings is subsided.This is because the home offices attract the majority of priority filings, as in the case of patents byinventors from developing countries such as Brazil, China, Russia (de Rassenfosse et al., 2013).
8. We carried out the Hausman test to select between the Fixed and Random Effects Model. TheHausman Test tests the null hypothesis that the coefficients estimated by the Random EffectsEstimator are the same as the ones estimated by the Fixed Effects Estimator. If they are(insignificant P-value) then it is safe to use the Random Effects Model. However, if the P-value issignificant, then the Fixed Effects Model is used. We obtain a significant P-value for the estimatedequation, therefore justifying the use of the Fixed Effects Regression Model for our analysis.
9. A few drawbacks could be identified about the Patent Applications series used in this study. Firstof all, under PCT applications usually are of higher value, thus filtering out low value patents. As aresult, it may put developing economies at a disadvantage. Also, companies (particularly smallcompanies) are less likely to target foreign markets and mainly carry out inventions of localrelevance. Overlooking these local patents therefore precludes a full view of the inventive activityof developing countries. This could also be a possible reason for an insignificant coefficient in ourresult. Further, PCT counts could be highly correlated with other counts such as USPTO, EPO andtriadic. Therefore, as suggested by de Rassenfosse et al. (2013), the worldwide indicator thatimproves the measurement of inventive activity, especially in the case of emerging economies(because of no geographic bias and no filter on patent value) could be used to improve theestimation. However, as the main aim of this paper is not to focus on a detailed examination ofpatent counts, we tried to stick to using World Bank data to maintain a consistency for thecountries under study.
10. The United States is a large industrialised country, and greater magnitudes of output elasticities ofR-D spillovers embodied in OFDI and IFDI flows signify a much higher impact compared with othersmaller OECD investing partners. This is consistent with the findings of previous studies (VanPottelsberghe de la Potterie and Lichtenberg, 2001) that suggest a larger effect of FDI inducedR-D spillovers for larger economies such as G7 countries.
11. Other than studying a different set of countries, our paper also differs from Van Pottelsberghe dela Potterie and Lichtenberg (2001) in terms of the definition of the key spillover variable. Unlike ourstudy, they use a four year moving average of the flow of FDI. Also, the denominator of theirspillover term is gross fixed capital formation of country j, whereas we use GDP of country j. Thesefactors also explain differences in our results.
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FOREIGN DIRECT INVESTMENT AND REVERSE TECHNOLOGY SPILLOVERS: THE EFFECT ON TOTAL FACTOR PRODUCTIVITY
Summary resultsfor larger industrialised (G7) partner countries
The table shows the results that allow output elasticities with respect to foreign
R-D capital stock to differ between G7 and other countries. The additional variables
LnRDfo* G7 and LnRDfi* G7 are created by including a dummy that takes value one for
G7 countries in the construction of foreign R-D spillovers term. This is done to test whether
the estimated parameters are different for larger than for smaller investing partner
countries.
The results clearly indicate that in the case of foreign R-D embodied in OFDI from the
18 emerging economies, the impact is much greater and significant when these economies
undertake investment in the larger industrialised countries. However, the reverse is true
for the spillovers embodied in IFDI flows into the emerging economies.
Estimation results – including dummy for G7 countries
Within
(i) (ii)
Domestic R-D
LnRDd 12.4063* 12.2284*
(2.75) (3.76)
Foreign R-D
LnRDfo (outward FDI) 1.9862 -(1.52)
LnRDfi (inward FDI) - 7.5333*
(7.60)
Larger countries
LnRDfo * G7 2.3661** -(1.85)
LnRDfi * G7 - -1.0824
(-1.04)
Notes: Figures in parentheses give t-statistics. * denotes significance at the 5% level, ** denotes significance at the10% level. RDd = Domestic R-D capital, RDfo = Foreign R-D capital embodied in OFDI, RDfi = Foreign R-D capitalembodied in IFDI.