Download FDI : WHAT IS IT

FDI : WHAT IS IT ?
Focus :
Does “FDI”, like domestic direct investment, represent
“gross fixed capital formation”, i.e. additions to the (value
of the) physical capital stock ?
- In the general public’s eye – YES
- Officially – NO
Re official FDI : part of it may effectively be transformed
into additional consumption spending and imports; turned
into additional capital outflows; or remain in domestic
financial markets as savings – for long periods.
From a growth perspective, FDI may also entail the
adoption of new / improved technologies ; as well as
additions to the stock of human capital.
Outline :
1. FDI : OECD / IMF Definition
2. Transmission Channels
3. SA Example
4. Theoretical Observations
- Physical Factor Augmentation
- Skills / Knowledge Transfer / Production
- “Crowding-in Effects”
5. Implications for Empirical Research
6. Conclusion
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1. FDI : OECD / IMF DEFINITION
 When a foreign company acquires more than 10 % of the
ordinary shares or voting rights of a local business entity.
+ “lasting interest” + “a significant influence on management”
(IMF; OECD)
But :
- What if it acquires 9 % and it is used for ∆ K?
- What if it acquires 51 % with no ∆ K – merely a
transfer of ownership? E.g. cross-border acquisitions
& mergers (A & Ms).
 Re A & Ms: they constitute a significant share of FDI flows,
both in developed and developing countries (Mody, 2004).
FDI in SA in the 1990s “(mostly) involved the acquisition of
existing operations rather than the setting up of new
enterprises” (Gelb & Black, 2004).
Advantages: new technologies; skills transfer; risk spreading;
gaining market share, both locally and globally; etc.
But :
- How should these be valued?
 In the public eye FDI is (wrongly) assumed to be “greenfield”
investments, i.e. creation of new facilities or expansion of
existing facilities – gross fixed capital formation by foreigners.
And yet only a small portion of official FDI may actually
constitute greenfield investments.
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2. TRANSMISSION CHANNELS
Equity
K Outflows
K
Inflows
(FDI)
M
Fixed
Assets
C
+
Fixed Capital
Formation
Technology Transfer;
Knowledge Production
Etc.
 Official FDI may directly lead to fixed capital formation (e.g. a
new residence, new hotel); or they may work their way through
the equity markets and through foreign purchases of fixed
assets, some of which may give rise to direct investment / FDI.
 Alternatively, the money received may be (i) used for
consumption purposes (C), (ii) spent on imports (M), or (iii)
leave the country as capital outflows. It may also (iv) remain
within the domestic financial and property markets in the
relevant period (t). The latter amount may eventually (period
t+1) be spent abroad or locally – as above.
Thus, let total spending or demand,
Y d = ( C ) (1+f c ) – M (1+f
m)
+ I (1+f i ) + X
where fc is the fraction by which official FDI boosts private and
public consumption, and fm is fraction by which it boosts imports.
Likewise, fi is the fraction by which official FDI boosts investment, or
“ gross fixed capital formation”; with fi(I) being greenfield
investments.
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3. SA EXAMPLE
 Barclays acquired ownership of ABSA and its capital stock in
2005 – without necessarily enhancing it.
 The Barclays bid came to about R 30 billion; was settled in
July 2005; and was (presumably) recorded as FDI in 2005 : Q3
– see Tables 1 and 2 below:
Table 1: Financial account (2003:Q04 to 2005:Q03)
04
Direct
investment
Liabilities
Assets
Net
direct
investment
Portfolio
investment
Liabilities
Assets
Net portfolio
investment
Other
investment
Liabilities
Assets
Net
other
investment
2003
2003
01
02
2004
03
04
2004
01
2005
02
03
3 021
-1 017
2 004
5 550
-4 275
1 275
8,630
237
8,867
-1 605
-9 785
-11
390
2 007
-380
1 627
-3 877
1 207
-2 670
5 155
-8 721
-3 566
1 369
-633
736
1 371
3 161
4 532
32 175
-1 700
30 475
-6 107
-555
-6 662
7 548
-1 001
6 547
5,105
-18
5,087
14 095
-1 493
12 602
2 984
-1 279
1 705
22 691
-3 156
19 535
44 875
-5 946
38 929
7 808
2 264
10 072
25 281
-1 541
23 740
7 296
-3 225
4 071
9 263
-17
762
-8 499
14 594
-36
919
-22
325
4 899
-11
102
-6 203
5 112
3 251
-2 888
1 589
3 758
4 099
10 881
-2 163
22 291
-6 343
-2 416
746
8 363
-1 299
7 857
8 718
15 948
-1 670
1 938
-26
375
-24
437
Source: SARB 2005
Table 2: Foreign Liabilities : Direct Investment
Banking Sector:
2003
2004
2005
2006
165
1640
31 134
268
 The Barclays-ABSA transaction did not constitute “direct
investment”, or “greenfield” investments – at least not in 2005.
 Of course, the acquisition could have entailed efficiency gains,
etc.
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4. THEORETICAL OBSERVATIONS
FDI is generally perceived to be a means of supplementing
domestic savings and augmenting the physical capital stock.
 E.g. re Factor Augmentation a-la Solow-Swan:
Y = A K  N1-
Or in growth terms,
y = a +  k + ( 1 - ) n
Now, allowing for FDI,
k = s+ kf
where s is the (domestic) savings ratio,  is the output :
capital ratio, and k f is the growth rate of FDI (which can be
positive or negative).
All of k f is assumed to add to the (value of) the physical
capital stock, i.e. gross fixed capital formation.
 Similarly, technology transfer (e.g. Blomstrom & Kokko, 1998;
also Stokke et al, 2007)
a = f ( kf )
 Re Skills / Knowledge Transfer: e.g. Romer’s goods &
knowledge production sectors:
Y = K y ( A N y ) 1 - 
.
A = B(Ka)

( N a )π Aθ
So, as before :
k a = sa  a + k af
(e.g. Gorg & Greenaway, 2004)
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 Also, “Crowding-in Effects” :
Let I d and I f represent capital investments undertaken by
domestic institutions and foreigners, respectively. Then
with I d  ( I f )  0
I d = I d ( I f , ......)
with S higher and C lower
( e.g. Mody & Murshid, 2002 )
Similarly for exports and imports ; e.g.
with X  ( I f )  0
X = X ( I f , ......)
(e.g. Eichengreen, 2000; Ozturk, 2007)
Also, domestic investment may be seen as a prerequisite for
FDI ; e.g.
with I f  ( I d )  0
I f = I f ( I d , ......)
Important issues:
Causality issue : growth
FDI (e.g. Chakraborty & Basu, 2002)
“Minimum threshold stock of human capital” (Borensztein, 1995)
Domestic country’s financial system (Hermes & Lensink, 2003)
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5. IMPLICATIONS FOR EMPIRICAL RESEARCH
Let official or broadlydefined FDI be given by
FDI b = f i (I k + I h) + ( f c C ) + ( f
m
M) + (f
w
CWO ) + ( f k o KO)
[1]
where f i now represents the fraction by which FDI boosts physical
and human capital ( I h ); f w is the fraction by which FDI contributes
to “changes in (domestic) wealth ownership”, CWO (or “saving”);
and f k o is the fraction by which it boosts capital outflows, KO.
 Impact of FDI on GDP
Y = α b + β b FDI b + ….. + ε b
where Y is real GDP (growth), with α b and β
estimated coefficients and ε b the error term.
[2]
b
being the
Now, the equivalent econometric equation for that part of FDI
constituting fixed and human capital formation,
Y = α i + β i [f i (I k + I h)] + ….. + ε i
[3]
is likely to yield different results from those generated by
equation (2) with β b ≠ β i . Clearly, this difference will depend
on the extent to which FDI b varies over time relative to f i (I k +
I h).
 Impact of GDP on FDI
FDI b = α b + β b Y + …..
[4]
f i (I k + I h) = α i + β i Y + …..
[5]
where, as before, β b ≠ β i
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6. CONCLUSION
 Official FDI ≠ gross fixed capital formation :
- Part is transformed into additional consumption, imports
and capital outflows.
- Another part remains in the financial and fixed property
markets as savings – for long periods.
- A part is transformed into gross fixed capital formation.
 Can one assume that official FDI does somehow equal
additions to the capital stock – broadly defined ? E.g. that
FDI = GFKF + HKF + TT + I n
with TT being technology transfers (or increases in the value of
technologies used); and In represents induced investment
(e.g. I d = f ( I f )) ?
How would one measure these components?
E.g. impact of FDI on GDP growth :
a
GFKF
b
Growth
HKF
c
TT
d
In
Similarly re impact of GDP growth on FDI
 Your problem – not mine !
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