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European School of Advanced Studies in Cooperation and Development V INTERNATIONAL UNIVERSITY MASTER IN COOPERATION AND DEVELOPMENT Foreign Direct Investment and Growth «Economists are the same all over: they promise to build bridges even where there are no rivers.» [Nikita Khrushchev] Gabriella Petrina December 2002 Regional Panorama In 2000, worldwide FDI topped US$ 1.1 trillion, which was nearly 14% more than in 1999 and over three times as much as in 1995. These figures indicate that the global expansion of transnational corporations (TNCs) remained on course during the first year of the new century. The geographic distribution of FDI flows in 2000 has held to the trend towards an increasing concentration in developed countries which had emerged in the second half of the 1990s. In the developed world, the main two recipients were the United States and Germany, with inflows of around US$ 250 billion each, followed by such European countries as the United Kingdom, Belgium, France and the Netherlands. FDI flows to developing countries in 2000, on the other hand, remained fairly closed to their 1999 levels, at around US$ 190 billion. This meant that the developing countries ‘ share of worldwide FDI inflows shrank from over one third of the total in 1995 to less than one fifth in 2000. 1 In 2001 world FDI flows were less than US$ 760, which was 40% less than the previous year’s figure and represented the largest single drop in almost three decades and this contraction affected mainly developed countries. This phenomenon was attributable to three interdependent but distinguishable factors: a) the slowdown in the world economy ( particularly in the United States) b) the rate of expansion of the telecommunications sector decreased, which was both a cause and a consequence of more sluggish mergers and acquisitions activity and of the tendency to channel large investments to technological innovations. c) Lastly, investment decisions were affected by the lack of confidence and uncertainty generated by the events of 11 September 2001 in the United States. Among all the developing countries, almost 95% of FDI flows in 2000 were concentrated in just two regions: East Asia and Latin America and the Caribbean. Since 1970s Latin America has received more foreign investments than the other three main regions: East Asia, South Asia and Sub Saharan Africa. Compared to its low level of export, Latin America has received a huge amount of FDI, especially during the nineties. Figure 1 FDI share of export in LA Argentina Brazil Chile 2 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 Mexico 19 73 19 70 80 70 60 50 40 30 20 10 0 -10 Argentina 1999 103,4 Figure 2 FDI share of export in East Asia 15 Hong Kong 13 Korea, Republic of 11 9 Malaysia 7 5 Singapore 3 1 Taiwan, Province of China 19 70 19 73 19 76 19 79 19 82 19 85 19 88 19 91 19 94 19 97 20 00 -1 Hong Kong 2000; 30,7 Figure 3 3 Thailand FDI share of export in SS Africa 30 25 20 Cameroon 15 Côte d'Ivoire 10 Ghana 5 Kenya 0 Nigeria -5 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 Cameroon 1985; 43,8 Figure 4 FDI share of export in South Asia 11 9 Bangladesh 7 India 5 Nepal 3 Pakistan Sri Lanka 1 4 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 19 73 -1 19 70 19 73 19 70 -10 Figure 5 FDI share of export in China 30 25 20 15 China 10 5 20 00 19 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 19 80 0 The large amount of foreign inflows into Latin America and the Caribbean is also easily seen when we consider Foreign Direct Investment as share of gross capital formation, as the following figures show. Figure 6 FDI share of GCF in LA Argentina Brazil Chile Chile 2000 63,6; Argentina 2000 47,4; Chile 1974 -14,4 5 00 20 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 19 73 Mexico 19 19 70 30 25 20 15 10 5 0 -5 Figure 7 FDI share fo GCF in East Asia 33 28 23 Malaysia 18 Singapore 13 Thailand Korea, Rep. 8 3 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 Singapore 1988 42,4; Singapore 1990 41,5 Figure 8 FDI share of GCF in SS Africa 40 30 Cameroon Ghana 20 Nigeria 10 Kenya 0 Figure 9 6 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 19 73 -10 19 70 19 73 19 70 -2 FDI share of GCF in South Asia Bangladesh India Nepal Pakistan 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 Sri Lanka 19 73 19 70 8 7 6 5 4 3 2 1 0 -1 Sri Lanka 1997 11,7 Figure 10 FDI share of GCF China 16 14 12 10 8 China 6 4 2 20 00 19 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 19 80 0 Considering Foreign Direct Investment as share of Gross Domestic Product (Figure 11 and on), leads to the same evidence: Latin America was the main recipient even when compared to East Asia ( leaving the city states - Hong Kong and Singapore – aside). China has been represented separately. 7 Figure 11 FDI share of GDP in LA Argentina Brazil Chile 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 Mexico 19 73 19 70 9 8 7 6 5 4 3 2 1 0 -1 Chile 1999 13,6 Figure 12 FDI share of GDP in East Asia Hong Kong 16 14 12 10 8 6 4 2 0 -2 Korea, Republic of Malaysia Singapore 19 70 19 73 19 76 19 79 19 82 19 85 19 88 19 91 19 94 19 97 20 00 Taiwan, Province of China Thailand Hong Kong 2000 38,1 8 Figure 13 FDI share of GDP in SS Africa 5 4 Cameroon 3 Côte d'Ivoire 2 Ghana 1 Kenya Nigeria 0 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 19 73 19 70 -1 Nigeria 1989 7,9 – 1994 8,3 Figure 14 FDI share of GDP in South Asia Bangladesh India Nepal Pakistan Sri Lanka 2,9 Figure 15 9 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 Sri Lanka 19 73 19 70 1,9 1,7 1,5 1,3 1,1 0,9 0,7 0,5 0,3 0,1 -0,1 FDI share of GDP in China 7 6 5 4 China 3 2 1 20 00 19 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 19 80 0 As figure 16 show, in Latin America, since the 1970s, inflows per capita have been more than US$ 2000. During the nineties, these inflows rose even more, up to more than US$ 4000 per capita. The lines, representing inflows measured in per capita US$ for East Asia, South Asia and Sub Saharan Africa, are well below this amount. Figure 16 10 4500 4000 3500 LA 3000 2500 2000 1500 SS Africa East Asia South Asia China 11 20 00 19 97 19 94 19 91 19 88 19 85 19 82 19 79 19 76 19 73 1000 500 0 19 70 US$ (2000) mln Inflows into regional area,1970-2001 Latin America outlook One of the characteristics of new inflows of FDI to Latin America during the 1990s was its country concentration. The larger regional economies and Chile have continued to be the main targets for transnational corporations. In the first half of the 1990s just four countries (Argentina, Brazil, Chile and Mexico) accounted for 62% of flows; Mexico attracted 29% of the total. There was a greater degree of concentration between 1995 and 2000 (Figure 17), when these four countries accounted for 78% of total FDI flows to the region. Figure 17 Figure 18 in turn shows that since 1995, Brazil was considered to be the main recipient of Foreign inflows followed by Mexico, Argentina (a part from the highest peak in 1999 due to a huge acquisition) and Chile. Figure 18 Inflows of FDI into LA,1975-2000 US$ (2000) mln 25000 20000 Argentina 15000 Brasil Chile 10000 México 5000 Brazil 1998 33107,5 Brazil 2000 32779,0 12 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 0 During the same period though, considering inflows of FDI in per capita terms (figure 19), it easily seen that Chile jumps at the very first place as recipient of foreign inflows followed by Argentina, Mexico and Brazil. Figure 19 Inflows into LA per capita,1970-2001 650 US$ (2000) 550 450 Argentina 350 Brazil Chile 250 Mexico 150 50 2000 1997 1994 1991 1988 1985 1982 1979 1976 1973 1970 -50 It is anyway clear that, according to the chart above, there were four “winners”. Brazil, thanks to the stabilization policy (Real Plan) and the liberalization of the Brazilian economy, saw its FDI inflows strengthen considerably occupying, until the year 2000, the first position as the preferred foreign investment destination in Latin America and the Caribbean. These foreign investments played a major role in the service sector and in particular in utilities, where foreign corporations were able to take advantage from a olygopolistic position. In addition to opening up new business opportunities, the new economic context has also reduced protection levels. Three concurrent trends are largely responsible for these FDI inflows mainly in the service sector (telecommunications, electricity, the retail trade and banking – figure 20-21) where it received about the same as Mexico, Argentina and Chile combined: widespread mergers and acquisitions designed to gain a position in the Brazilian domestic market; the extension and deepening of the privatisation programme in the area of public utilities, including electricity 13 generation and distribution, railways, water, gas, telecommunications and financial institutions; new investments geared to streamlining, reorganizing and restructuring the operations of transnational already present in Brazil, and investments by newcomers. Figure 20 Brazil FDI sectoral distribution, 1996-2000 35000 US$ (2000) mln 30000 25000 Servicios 20000 Manufacturas 15000 Primario 10000 5000 0 1996 1997 1998 1999 2000 Figure 21 Brazil FDI detailed distribution,1996-2000 Primario 4% Telecomunicaci ones 33% Productos Químicos, Petroleros, Maquinaria y Carbón y Equipo derivados 6% 6% Vehículos y Equipo de Transportes 6% Bancos y Otros Servicios Financieros 25% Electricidad, Gas y Agua 20% Brazil during the last two years continued to attract flows of investments, outstripped, since 2001, only by Mexico. FDI inflows were 30% less than the previous year, but still within the average of the last five-year period. The downturn reflects not only worsening global conditions, but also uncertainty generated by the crisis in neighbouring Argentina, which is a major trading 14 partner within MERCOSUR. The reduction in flows with respect to the late 1990s was also attributable to the fact that the wave of privatisations, especially in utilities, has largely passed. The counterpart to this is an increase in concessions to the private: the bulk of these concessions were awarded in telecommunications sector, to Telecom Italia. Figure 22 Argentina FDI sectoral distribution, 1992-2000 US$ (2000) mln 25000 20000 Servicios 15000 Manufacturas 10000 Primario 5000 2000 1999 1998 1997 1996 1995 1994 1993 1992 0 FDI inflows have been growing in a very rapid way during the nineties in Argentina as well. Contrary to what happened in the 60s and in the 70s, the government implemented far-reaching reforms that, together with macroeconomic stability, facilitated the operation of foreign firms and enabled them to expand into many activities that had previously been closed to them. The Argentine authorities implemented a development model that afforded foreign investors almost unlimited access to the country's generous endowment of natural resources (40% of FDI in the primary sector). In this respect some of the state assets became assets in the portfolios of foreign firms (YPF – Yacimientos Petroliferos Fiscales - purchased by the Spanish firm REPSOL). Likewise, this regulatory framework boosted mining activities, which has been lagging far behind due to a lack of financing. Many foreign firms moved into the areas of infrastructure and public utilities (33% of FDI in the service sector), mainly within the framework of privatisation process: a gradual concentration of ownership came about through an intensive process of M&A (which has not necessarily served to expand the country's production 15 capacity), in which TNCs were once again winners. A phenomenon called “asset stripping” is a clear example of what many foreign investments did within the host countries in cases such as the acquisition of Aerolineas Argentina made by IBERIA, where Spain took all the credit of the firm and gave back to the government what was left. Lastly, within the manufacture sector (20%), two factors have to be considered: trade liberalization, that obliged subsidiaries to make investments in order to compete with imported goods and the establishment of MERCOSUR that added a new, sub regional perspective to investment in Argentina. Notwithstanding the FDI boom of the 90s reported in figure 22, the country does not seem to participate with the same strength to the qualitative aspects associated to the boom. The exports continue to be concentrated in low-level productivity sectors and in the case where they experienced a big expansion – in the automobile sector, for example – there is a parallel increase in imports. Member countries of MERCOSUR are, except for commodities, the main receivers of the exports of local affiliate. The biggest recipient of per capita FDI has been Chile. These inflows were mainly concentrated in primary commodities, which between 1990 and 1997 received more than the respective figures for Brazil, Mexico and Argentina combined. In the 1990s the Chilean economy posted one of the best performances in Latin America in terms of FDI inflows. In fact, the country was one of the main destinations for international investors in a period in which the region was slowly beginning to recover from the effects of the external debt crisis of the 1980s. In the case of Chile, a very significant share of the first investments made during this boom period were for new projects, particularly in sectors linked to the extraction and processing of natural resources for export. Figure 23 shows that ,in the period between 1990 and 1997, these inflows accounted for 46% of total FDI inflows. FDI and the presence of transnational corporations have thus radically altered the Chilean economy over the last decade. These capital inflows, and particularly the heavy investments made in the mining sector, have been largely responsible for the increase in exports. 16 Figure 23 Chile FDI sectoral distribution, 1990-1997 6000 US$ (2000) mln 5000 4000 Servicios 3000 Manufacturas Primario 2000 1000 0 1990 1991 1992 1993 1994 1995 1996 1997 At the end of the 1990s a new breed of firms were embarking on active strategies of mergers and acquisitions to consolidate their global, regional and local positions. This trend was particularly strong in the service sector (figure 24), (especially in the sectors of electrical energy, telecommunications, drinking water, sanitation and financial services), in the wake of market opening, liberalization and changing conditions in local markets. Figure 24 US$ (2000) mln Chile FDI sectoral distribution, 1998-2000 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 Servicios Manufacturas Primario 1998 1999 2000 Finally Mexico "succeeded" in manufacturing, receiving between 1990 and 1997, twice as much as Brazil, Argentina and Chile combined. Over the last 15 years, FDI inflows have shown considerable growth. More than half of 17 these inflows have gone into the manufacturing sector. During the 1994-1997 period (figure 25), 59% of investments were concentrated in manufacturing activities, particularly those oriented towards export markets. Figure 25 Mexico FDI sectoral distribution, 1994-1997 14000 US$ (2000) mln 12000 10000 Servicios 8000 Manufacturas 6000 Primario 4000 2000 0 1994 1995 1996 1997 Figure 26 Mexico FDI detailed distribution, 1994-1997 Comercio 18% Primario 2% Bancos y Otros Servicios Financieros 16% Maquinaria y Equipo 31% Alimento, Bebida y Tabaco 21% Productos Químicos, Petroleros, Carbón y derivados 12% The electronics and computer industries, particularly those operating under the maquila system, and the automotive industry have become the fastest-growing recipients of FDI inflows in Mexico. The maquila industry has attracted a fast-growing share of foreign investment flows in recent years. Between 1994-1997, about 31% of FDI inflows to the manufacturing sector went to this industry. These resources were mainly used for importing machinery and equipment for production purposes. These investments 18 consists of fixed assets brought in by parent companies in foreign countries to their subsidiaries in Mexico, on a commodatum basis, whereby the use of the asset is transferred cost-free to the maquila enterprise to enable it to carry on its activity, but ownership of the asset is not transferred, and the Mexican company cannot include it in its accounts. From 1998 as it is represented in figure 27, on the manufacture sector increased though an increasing share in the service sector (bank acquisition) is appearing. In the year 2001, FDI flows to Mexico, and the country's share of total flows to Latin America increased from 17% in the period 1996-2000 to 35% in 2001. Figure 27 Mexico FDI sectoral distribution, 1998-2000 14000 US$ (2000) mln 12000 10000 Servicios 8000 Manufacturas 6000 Primario 4000 2000 0 1998 1999 19 2000 Figure 28 Mexico FDI detailed distribution, 1998-2000 Bancos y Otros Servicios Financieros 21% Comercio 13% Alimento, Bebida y Primario Tabaco 2% 8% Productos Químicos, Petroleros, Carbón y derivados 13% Maquinaria y Equipo 43% This increased was attributable to the largest operation ever conducted by a United States bank in Latin America - the acquisition of the Mexican financial group Banamex - Accival, known as Banacci, by Citigroup. Mexico thus became the largest recipient of FDI inflows to Latin America and the Caribbean, leaving Brazil - which occupied this position throughout the second half of the nineties - in the second place. In 2001 FDI inflows dropped in both maquila-dominated sectors and other branches of industry oriented towards the domestic and external markets reflecting both the slowdown in the US economy and the climate of uncertainty generated by the events of 11 September, as well as the stagnation of economic activity in Mexico. 20 Impact of FDI on Development: the case of Mexico Foreign investment in Latin America and the Caribbean has traditionally favoured manufacturing activities that supply protected domestic markets though developments in the international markets and grater competition (stemming from trade and financial liberalization) led to growing interest among new entrants and forced transnational corporations already in the region to redefine their strategies. In recent years, manufacturing has concentrated on countries with large domestic markets (Mexico, Brazil) or those used as export platforms (Mexico and the Caribbean Basin). Two types of strategies in manufacturing industry can be identified, linked to: Increasing the efficiency of transnational corporations internationally integrated production system Seeking access to national and sub regional markets for manufacturing The first strategy includes investment in and exports from Mexico. Since 1989, the regulatory framework for FDI has been substantially liberalized, and additional export incentives have been created, particularly for maquila industries. As a result, between 1990 and 1997 Mexico's exports – mostly of manufactured good (80%) – rose form US$ 40.7 billion to US$ 123 billion. This increase in export value though, was not followed by an increase in the valued added. This liberalised trade regime, lead to an appreciation of the exchange rate as well, making cheaper imports increase thus worsening the current account deficit. Between 1993 and 1996 (ECLAC 1999), foreign enterprises share in Mexico's total exports increased from 47.8% to 56.2%, primarily through the maquila system. In 1994, this trade policy was consolidated when Canada, the United States and Mexico signed the North American Free Trade Agreement (NAFTA). Mexico has at least three comparative advantages with respect to the US that encouraged this Agreement: unlimited supply of cheap labour, a favourable geographical location and a substantial amount of "complementary" capital as a result of a huge infrastructural and complementary investment done by the government in the period of ISI. The 21 development of the maquila industry has also been decisive in this context, since it has enabled foreign investors to benefit from major tariff exemptions granted by the United States to maquila enterprises assembling products of United States origin. Thus, in 1997, the maquila industry in Mexico accounted for 40.9% of total exports, and 83.9% of that figure corresponded to exports to the United States. In Mexico, efficiency criteria were applied mainly to the automotive, electronics and apparel industries operating under the maquila system. These industries are still seriously limited by the low level of Mexican value added and their excessive concentration in the North American market: the Mexican automotive industry is in fact focused essentially on the North American market, is dominated by foreign companies and has limited national linkages Maquila exports grew even faster than "non-maquila" ones and, given the export orientation of this sector, output growth and the growth of employment were also particularly high. This was not the case , as showed in figure 29,for wages and productivity, which respectively, fell and stagnated because of the lack of incentives to invest in a sector that can otherwise grow by adding unlimited amounts of cheap labour. 22 Figure 29 MEXICO: main indicators of the 'maquila' and 'non-maquila' manufacturing sectors, 1981-2000 average annual rate of growth 20% 20% 'maquila' 'no-maquila' 16% 16% 12% 12% 8% 8% 4% 4% 0% 0% exports v added employment pdd wages Source: Palma (2002) The extraordinarily low level of domestic inputs in its operations (increased only from 1.6% in 1991 to 2.9% in 2000) is the main weakness of the maquila industry. 23 TABLE 2: Some Indicators of the 'Maquila' Industry (US$ 2000) 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 X maq (1991=100) X non-maq 100 100 115 100 131 106 154 120 177 163 206 194 247 210 283 202 331 221 401 259 X maq/X non-m (%) 59 68 73 76 64 62 69 82 88 91 M maq (1991=100) M non-maq 100 100 115 123 132 122 161 143 201 109 229 136 267 167 305 183 351 197 419 236 31 29 34 35 57 52 49 51 55 55 net X maq (billion) net X non-maq 5 (14) 6 (25) 6 (22) 7 (28) 6 2 7 0 10 (9) 11 (19) 14 (20) 18 (26) emp maq (1991=100) emp non-maq 100 100 108 98 116 93 125 89 139 82 161 83 193 85 217 87 245 89 275 91 19 21 23 26 31 37 43 47 52 57 1,914 2,075 2,114 2,085 2,130 2,411 2,717 2,983 3,297 3,590 M maq/M non-m (%) emp maq/emp non-maq (%) number establishment maq The recent success of many developing countries in expanding their manufactured exports and improving their share in world trade cannot be taken at face value. In fact, the increased import content of domestic production and consumption brought about by rapid trade liberalization, together with the greater participation of developing countries in importdependent, labour-intensive, low value-added processes in international production networks, implies that such increases in the manufacturing exports of developing countries may have take place without commensurate increases in income and value added. In Mexico, manufactured imports and exports exceeded value added by a large margin. Since 1990 there has been an indubitable boom in manufacturing exports letting the gap between export and imports in this sector to be almost closed. The trick is that these exports have a high direct import contents due to their close involvement in international production networks. In Mexico imports for further processing actually constitute as much as one half to two thirds of the total sales of affiliates of US TNCs in industries such as computers and office equipment, electronic and transport equipment. In this panorama, growth in manufacturing added value, kept low by the maquiladora industry – as shown in figure 30 -, has been negligible compared to the surge in its manufactured imports and exports. 24 Figure 30 MEXICO: value added, exports and imports of 'maquila' manufacturing, 1970-2000 US$ (2000) billion 100 100 v added exports 80 80 imports 60 60 40 40 20 20 0 0 1991 1994 1997 2000 Source: Palma (2002) Thus, the extraordinary increase in the growth of manufacturing exports clearly has not been able to be associated with an improved performance of 25 the manufacture sector as a whole, nor even with one that maintained previous achievements (other than a stable productivity growth). The "assembly" type of operation that characterises many of those export activities (not just in the maquila sector) is an important part of the answer. From a sectoral perspective, the latest official figures reported by government agencies, indicate that the trend seen in the last few years has continued with the bulk of investments going into services (figure 31) - the large increase in flows to the primary sector in 1999 was attributable to the acquisition of YPF stock by REPSOL for US$ 15,168 million. Figure 31 FDI sectoral distribution in LA, 1996-2000 40000 US$ (2000) mln 35000 30000 25000 primario 20000 manifacturas 15000 servicios 10000 5000 0 1996 1997 1998 1999 2000 In the service sector, exports do not play any role and technological spillovers are very little. Foreign Direct Investment in utilities is thus a very secure business (mostly monopolies), where the home country invests very 26 little and the position of the investor is a "rent-seeking" one in a monopoly market. It is interesting to note that in the last couple of years Spain became the main European investor in Latin America. As long as this country was out of the Euro it had a weak currency thus, in order to invest, Spanish companies had to face high exchange rates, pay huge interest rates in a climate of uncertainty. When Spain “entered “ in the Euro system, it suddenly counted on a strong currency and, consequently, low interest rates. This explains the huge amount of Spanish foreign direct investment mainly in services. Spain was in a position of rent seeking on the Euro and rent seeking on low interest rates. 27 Foreign Direct Investment and Growth in Latin America The prevailing paradigm of economic development places emphasis upon the "outward orientation" of countries; especially export growth and attracting direct foreign investment. If "outward-oriented economies do grow faster" (Dollar 1992), one would expect this to be transmitted through exports importing a dynamic to the economy as a whole, and by foreign investment stimulating increased total investment in an economy. The link between exports growth and foreign capital inflows has long being discussed. An early formulation of this idea going back to the 60s was the so-called two-gap approach. This approach emphasises the dependence of capital accumulation and economic growth in developing countries on foreign capital and trade flows through two channels. The first involved resources needed for investment: external capital flows allow developing countries to invest more than they can save thereby closing their saving-gap. The second gap relates to foreign exchange availability and arises because of the dependence of investment and growth in developing countries on imported intermediate capital goods. Even if domestic savings are sufficient to finance all the investment needed, a developing country would still be unable to undertake the investment if it does not earn enough foreign exchange to pay for the imports required. Investments will thus be constrained by the lack of adequate foreign exchange rather than domestic savings. Capital flows, according to this theory, can fill this foreign exchange gap allowing imports, investments, income and savings to be raised above the levels otherwise constrained by export earnings. For developing countries both export and foreign investment grew faster in the 1980s and 1990s than previously, but it does not necessarily follow that faster growth of these implies faster GDP growth. One of the factors on which this faster economic growth depends on is whether foreign investment crowds out or crowd in domestic investment. The two questions are closely related, and much of the discussion of these issues has focussed on the role of foreign investment, both in its investment-enhancing role and its function as a vehicle for export growth. 28 Professional opinion shifted on this issue in the 1990s. For example, the 1992 World Investment Report of UNCTAD expressed some scepticism. After pointing out that FDI as a share of domestic investment in development countries was typically low, below five percent, it went on to observe, "…[T]here may be circumstances in which transnational corporation activities may not contribute to sustained long-term growth…For example, transfer pricing may reduce the potential for growth through trade. Similarly, abuse of market power by transnational corporations can stifle the growth of local entrepreneurs. " (UNCTAD 1992, p. 14) In the abstract, a government can either pursue a neutral policy towards foreign direct investment and international trade or an interventionist one. In practice, all governments intervene to some degree. With regard to FDI, the dichotomy between policy neutrality and intervention became an anachronism in the 1990s. Prior to the debt crisis of the 1980s, most Latin American countries had varying degrees of capital controls, restrictions on external participation in domestic asset and bond markets (which were relatively underdeveloped), and regulations on foreign corporations acquiring domestic firms. In this context, direct foreign investment tended to result in the creation of new assets; indeed, a major motivation for the package of regulations was to ensure this. As a result, until 1980, the balance of payments entry ‘foreign direct investment’ could, for practical purposes, be interpreted as resulting in subsequent capital formation. With the liberalisation of capital accounts and privatisation associated with the so-called Washington Consensus, the nature of FDI underwent substantial change. To varying degrees in all countries privatisation took the form of debt-equity ‘swaps’, in which public assets were sold to foreign firms. This is demonstrated in Table 1 for the first, second, third, and sixth largest economies in the region in 1990. For the four countries together, well over forty percent of foreign direct investment involved acquisition of domestic assets through privatisation. Acquisition by international corporations of domestic private sector firms represented a second major change in the form 29 of FDI in Latin America after 1980, though its extent was more difficult to quantify. These changes in mode of entry of FDI had important consequences. With regard to statistics, after 1980 FDI balance of payments flows must be read differently than before: was no longer valid to infer that the FDI balance of payments entry in a given year would result in capital formation in a subsequent year. Specifically, it could no longer be assumed that all or even most FDI resulted in net creation of assets (see Brazil in Table 1). From the perspective of neoclassical theory, to find that FDI was not net asset creating would not be interpreted as a problem requiring action. If an economy is in full employment general equilibrium (would it ever be the case in a developing country?), the typical starting point of neoclassical ‘stories’, then an ex-post inflow of capital to construct physical capital would necessarily reduce some form of expenditure by an equal amount. If government expenditure and exports were constant in real terms, the capital inflow would result in 100 percent ‘crowding out’ of domestic private investment or domestic consumption. If the capital inflow prompted a rise in the real interest rate, the crowding out could be greater than 100 percent (total investment could fall). This analysis is not consistent with the empirical evidence, which indicates that for most countries and decades the relationship between FDI and domestic investment was non-significant, and significantly positive almost as frequently as it was negative. In practice the empirical evidence supports 30 the primary motivation of Latin American governments for their FDI policies in during 1960-1980: to ensure that foreign investment would bring a net addition to domestic investment, either by entering into sectors domestic capital was incapable of efficiently developing, or by creating complementary linkages to domestic capital. With capital account deregulation and its associated domestic asset acquisition by international firms, new growth theories came up (namely the theory of endogenous growth) which incorporate the role of knowledge of technology endogenously as a factor of production in its own right and provide for the possibility of non diminishing returns to capital (See Romer 1994). The emphasis on the advantages of FDI shifted from the straightforward contribution to capital accumulation to more speculative outcomes and the recognition of the role of knowledge in economic growth has led to a renewed interest in the analysis of the role of FDI in growth. These include the possibility that FDI: 1) might provide technologies and skills not otherwise available; 2) access to new export markets; and 3) generate spread affects within an industry that raises the managerial or technical efficiency of domestic firms (UNCTAD WIR 1999). Romer (1993:548) has argued that by bringing new knowledge to their host countries, TNCs may help to reduce "idea gaps" between developed and developing countries which are sources of growth. Thus FDI effect on growth in host countries could be more valuable than its direct generation of output by complementing the domestic investments. The indirect effect of FDI on growth in the host countries could be more valuable than its direct generation of output by complementing the domestic investments. The indirect effect of FDI on growth in the host country may comprise a sum total of its externalities on domestic investments through knowledge spillovers and vertical linkages. Empirical evidence suggests that no general conclusion could be drawn about these outcomes, which seemed to depend on the specifics of each country. An argument sometimes encountered is that the inflow of FDI resulting deregulation of capital flows can substitute for policy interventions to generate more competition in domestic markets. This is an empirical assertion about which no general conclusion can be drawn, and expert opinion is mixed. 31 One can conclude that the most general argument in favor of FDI, both analytically and empirically, is that it fosters economic growth in as far as it increases total investment, and, slightly weaker, that its total effect is more likely to be positive if it does not reduce domestic investment. The study by two Latin American economists, Manuel Agosin and Ricardo Mayer, in showing either a crowding out or at best a neutral effect, challenges one of the central thesis of the neo-liberal economics, namely that FDI and TNC presence in an economy, and liberalization policies to bring this about, has a positive effect on the host. In this study of some 32 countries in Africa, Asia and Latin American and Caribbean, published in UNCTAD's Discussion papers series, the two authors specify conditions favorable to CI the term "Crowding in" is used when the presence of the FDI by a TNC stimulates new downstream and upstream investments that would not have taken place in their absence. In developing country setting, foreign investment that introduces goods and services new to the domestic economy, be they for export or domestic markets, are more likely to have ore favorable effects on capital formation than foreign investments in areas where there are already domestic producers. Again, the impact of FDI on investment is greater when it is greenfield investments rather than when it is M&A. In several acquisitions in Latin America, the acquisition of domestic firms were almost akin to portfolio investments, with the TNC doing nothing to improve the operation of the domestic company. Large M&A like large portfolio inflows, might have adverse macro-economic externalities. When of a size no longer considered marginal, they tend to appreciate the exchange rate and discourage investment for export markets, and indeed for the production of importable as well. In their econometric exercise, Agosin-Mayer show that over the period 1970-1996, FDI had a CI effect in three countries of Africa, a neutral effect on 5 African countries and a crowding out (CO) effect on four others. In Asia, there was a CI effect in three cases and a neutral effect on five others. There was no country in Asia that experienced CO. In Latin America, there was a neutral effect on seven countries and e CO effect on five others. There was no case of CI effect in the region. 32 All this suggests that over a long period of time (1970-1996), CI has been strong in Asia and CO has been the norm in Latin America. In Africa, FDI increased overall investment one-to-one. The following table summarizes the obtained results. 33 Savings and Investments no unconditional panacea for growth Savings and investment are not an unconditional panacea for development and growth, and they can perform the role of engine only in an healthy macro-economic environment and coherent and consistent long - term policy. The widespread agreement about mobilisation of domestic resources is a crucial one for raising economic growth and promoting development, as well as the common sense view that capital investment is a powerful engine of growth and higher levels of savings are associated with higher levels of investments. But while foreign investment may be important, its role is essentially complementary, and is usually subsequent to domestic efforts. Historically, domestic private savings have played a major role in supporting investment in the industrialized countries. In looking at the linkages between savings, investment and growth, and the growth models, it is important to point out that these models are all based on assumptions of perfect markets which clear instantaneously through adjustment in prices, a tendency towards full utilization of factors of production, social endowments of production factors etc, and generally focus on the supply side, assuming that output is determined by supply conditions alone. Neoclassical economic models based on these, or earlier models have a key underlying assumption that both domestic and foreign savings are fully channelled into productive investment –“a strong but not realistic assumption, especially as regards developing economies” (Economic Survey of Europe 2001:1). This assumption has in fact to be tested against the absorptive capacity of developing countries – a capacity constrained by institutional bottlenecks or lack of profitable investment opportunities. Common sense would suggest if domestic savings and investment are low, an approach to accelerating development would be to complement domestic resources through foreign savings, possibly through international 34 finance assistance programmes – the implied logic of many development aid programmes. But inherent problems and unresolved issues, and lack of analytical tools and models used of this purpose, have proved inadequate and ex-post performance of recipient countries have not validated either the prescriptions of the models or amounts of resources allocated for assistance. While there are many explanations and elements, the main conclusion is that there are no “easy fixes” to deep developmental problems that many countries are facing, and there is a need for a comprehensive, long-term policy approach to these problems, in which external assistance should be an integral part. Attracting external resources has been important for development and growth, but for this to happen on a massive scale, capital inflows have to be attracted by gainful investment opportunities. But most developing countries do not have the administrative capacity to implement effective screening policies to ensure that FDI does not displace domestic firms or that TNCs contribute new technologies or introduce new products to the country’s export basket . “Latin America”, Agosin and Mayer conclude, “is the great disappointment. One reason for the crowding out in that region is that overall investment has been much weaker in Latin America than in Asia. It could also be that Latin America countries have been much less choosy about FDI than Asian countries, either in the sense of prior screening or attempting to attract desirable firms”. There is indeed a considerable scope for a proper industrial policy for foreign direct investment in the manufacture sector in order to deepen the industrialization process, making much more use of domestic inputs rather than foreign ones. A stronger competition policy and a more regulated environment is also necessary for foreign inflows directed to the service sector, to force these investment to be more efficient keeping lower prices and able to discriminate in favour of foreign investments that have positive effects on total investments. 35 List of figures Figure 1 ......................................................................................................................... 2 Figure 2 ......................................................................................................................... 3 Figure 3 ......................................................................................................................... 3 Figure 4 ......................................................................................................................... 4 Figure 5 ......................................................................................................................... 5 Figure 6 ......................................................................................................................... 5 Figure 7 ......................................................................................................................... 6 Figure 8 ......................................................................................................................... 6 Figure 9 ......................................................................................................................... 6 Figure 10 ....................................................................................................................... 7 Figure 11 ....................................................................................................................... 8 Figure 12 ....................................................................................................................... 8 Figure 13 ....................................................................................................................... 9 Figure 14 ....................................................................................................................... 9 Figure 15 ....................................................................................................................... 9 Figure 16 ..................................................................................................................... 10 Figure 17 ..................................................................................................................... 12 Figure 18 ..................................................................................................................... 12 Figure 19 ..................................................................................................................... 13 Figure 20 ..................................................................................................................... 14 Figure 21 ..................................................................................................................... 14 Figure 22 ..................................................................................................................... 15 Figure 23 ..................................................................................................................... 17 Figure 24 ..................................................................................................................... 17 Figure 25 ..................................................................................................................... 18 Figure 26 ..................................................................................................................... 18 Figure 27 ..................................................................................................................... 19 Figure 28 ..................................................................................................................... 20 Figure 29 ..................................................................................................................... 23 Figure 30 ..................................................................................................................... 25 Figure 31 ..................................................................................................................... 26 36 References Agosin M, Trade Specialisation and Economic Growth in Latin Ffrench-Davis R. 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