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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
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39
Web Sites
UNCTAD
www.unctad.org
United Nation Conference on Trade and Development
IMF
www.imf.org
International Monetary Fund
OECD
www.oecd.org
Organisation for Economic Co-operation and Development,
World Bank
www.worldbank.org
World Bank, Washington D.C.,
ECLAC
www.eclac.cl
Economic Commission for Latin America and the Caribbean
40