Local content requirements and industrial development : economic analysis and cost modeling of the automotive supply chain

This dissertation addresses the issue of performance standards in developing nations, focusing on the role of local content requirements. It proposes a theoretical framework to understand the impact of this policy on the decisions of firms and the welfare of the domestic economy, and offers a methodology to apply the analysis to the context of the automotive supply chain. The central conclusion of the thesis relates to the existence of a gap between private and social opportunity returns and costs, an aspect that has been overlooked by previous literature. In a developing country, resources employed by foreign investors and their local suppliers often generate spillovers and learning effects that are not accounted for in the valuations of private economic agents. This creates an externality-from-entry, whereby positive economic effects of new domestic suppliers are overlooked in the sourcing decision of the foreign firm. This dissertation proposes a model to illustrate how this gap between social and private valuations justifies the enactment of domestic content requirements, which become welfare enhancing. The analysis also reveals that content requirements are a preferable policy to tariffs and subsidies as a means to increase domestic purchases and discusses the use of subsidies and requirements as incentive mechanisms to align firm decisions with government objectives. A case study of the automotive industry, where content restriction policies are extremely active, is used to demonstrate the applicability of the model. This entailed the development of a new methodology, called Systems Cost Modeling (SCM), which uses simple metrics and rules to build bottom-up cost structures where estimates for large number of components have to be considered. Detailed empirical data from a particular car is then used to build a sourcing cost structure.