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Economic aspects of foreign direct investment Virtual Institute-St. Petersburg State University Study Tour Geneva, 18 April 2007 Michael Lim UNCTAD-DITE [email protected] 1 Outline I. Basic concepts II. Determinants and Impacts of FDI III. Recent global and regional FDI trends IV. WIR 2006: FDI from developing economies Source: UNCTAD 2 I. Basic concepts 3 What is foreign direct investment? Balance-of-payments concept Distinguish between portfolio and direct investment Direct investment: investment of a resident in a foreign company resulting in a lasting and significant management interest (more than 10 per cent of the equity or voting shares). Portfolio investment: investment of a resident in a foreign company without a lasting and significant management interest (less than 10 per cent of the equity or voting shares). FDI flows comprise three different components: Equity capital Reinvested earnings Intra-company loans Source: UNCTAD 4 What is a transnational corporation (TNC)? A TNC consists of: A parent company (based in a ‘home country’); and One or more foreign affiliates (in ‘host countries’) Foreign affiliates may refer to: Subsidiaries (majority-owned) Associate (ownership share is>10% but <50%) Branch (wholly or jointly unincorporated enterprise) Source: UNCTAD 5 Modes of FDI Greenfield investment Acquisition Merger Joint venture Expansion investment Source: UNCTAD 6 Are TNCs and FDI important to the world economy? Yes because: 1. TNCs together account for a significant part of international economic activity (eg international trade, generation of technology) 2. FDI is the largest single source of private finance for developing countries 3. Their role in the world economy is likely to grow further. Source: UNCTAD 7 FDI constitutes the largest component of resource flows to developing countries Billions of dollars 500 Total Resource flow s 450 400 350 300 250 FDI inflow s 200 150 Commercial banks loans Portfolio flow s 100 50 0 Official flow s -50 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: UNCTAD 8 The role of TNCs is increasing > 60,000 TNCs > 800,000 foreign affiliates TNCs account for some 2/3 of world exports 1/3 of world trade is intra-firm TNCs dominate world industrial R&D FDI is the largest source of external finance for developing countries Source: UNCTAD 9 Some TNCs are very big Value added or GDP, 2000, USD billions 71 Chile ExxonM obil 63 Pakistan 62 General M otors 56 Algeria 53 Peru 53 Czech Republic 51 N ew Zealand 51 48 U nited Arab Em irates Bangladesh 47 H ungary 46 Ford M otor 44 42 D aim lerChrysler N igeria Source: UNCTAD 0 41 10 20 30 40 50 60 70 80 10 II. Determinants and impacts of FDI 11 A typology of FDI is useful for analysis FDI is diverse, so a typology is useful to create categories of different types of FDI A typology is useful (necessary in fact) as an analytical aid Source: UNCTAD 12 A Typology of types of FDI Natural resource-seeking Oil and gas extraction, mining, forestry, fisheries Market-seeking (horizontal FDI) Access a domestic or regional (e.g. EU, NAFTA, ASEAN)market Efficiency-seeking (vertical FDI) Specialize and divide production in line with the comparative advantages of different locations; export-oriented FDI Strategic-asset seeking (primarily through M&As) Access specific (created) assets such as technology, brand name, specialized skills Source: UNCTAD 13 Economic determinants of FDI Type of FDI Natural resourceseeking FDI Market-seeking FDI (national or regional) Efficiency-seeking, export-oriented FDI Strategic assetseeking FDI Source: UNCTAD Key determinants Abundance of natural resources Price movements Market size and purchasing power Market growth Tradability of product/service Need for local adaptation Structure and openness of markets Quality and cost of human resources Physical infrastructure (electricity, transport, ports, roads, telecoms, etc.) Technical infrastructure Trade costs Quality of suppliers, clusters, etc. Economic and political stability Presence of strategic assets 14 Two analytical perspectives on FDI impact on host country: financing versus micro and macro (and broader) impacts Financing (BoP): FDI provides valuable external financing (Simplistic financing version: more FDI = more financing; therefore more FDI is good) versus Micro and macro impacts: FDI may have important impacts (positive and negative) on the host economy – at both the microeconomic and macroeconomic level (A broad analysis could include social, environmental, cultural and political in addition to economic impacts) Source: UNCTAD 15 Potential benefits from inward FDI o Provide external financing o Transfer of hard technology o Transfer of “soft technology” (knowledge, management skills, organizational methods – spillovers) o Promote exports (efficiency-seeking, export platform FDI) o Employment creation (M&As vs. greenfield FDI) o Promote local skills development through training o Improve quality of local services o Introduce new goods and services o Competitive spur to local economy (spillover – but may crowd out!) o Contribute to local enterprise development (via spillovers and directly) o Provide access to international markets Source: UNCTAD 16 Potential negative impacts and concerns from inward FDI Balance of Payments problems (potentially large future remittances, possibly high import content of FDI projects) Crowding out local enterprises (via unfair competition vs. via higher efficiency and better performance) Lack of local linkages (enclave activities using few local inputs) Low level of local processing (and low local value added) Environmental degradation (from certain activities (e.g. mining)) Limited transfer of technology (an important aspect of linkages) Employment destruction (M&As) Footloose operations (e.g. garments) Excessive use of incentives/race to the top (competition for FDI) Anticompetitive practices (abuse of dominant position) Source: UNCTAD Transfer pricing (low tax contribution locally) Socio-cultural effects 17 Some key points to remember on TNCs and FDI The impact of FDI on host countries is not homogenous, but rather depends, inter alia, upon (i) country-specific conditions (notably the level of income, economic development, country size, domestic firms’ development in the industry in question, technological development and human capital and infrastructure development), (ii) the specific TNC investing, their motives and the specific industry in question and (iii) host country policies. Benefits from FDI are generally not automatic and may depend upon the active use of government policies to promote them. Source: UNCTAD 18 Some key points to remember on TNCs and FDI (continued) TNCs are a diverse group and include huge global firms (e.g. General Motors, Citigroup, Exxon-Mobil) as well as small firms with few foreign affiliates. Government’s should attempt to integrate their policies on FDI into a broader strategy of economic development (comprised of a set of consistent policies) taking into account their specific conditions (advantages and disadvantages) and priorities. Given the extreme diversity among countries and TNCs, policy recommendations on FDI should in general be country-specific. (But some observations may hold for many countries.) Source: UNCTAD 19 III. Recent global and regional FDI trends 20 FDI inflows grew in 2005 for the second consecutive year … and it was a worldwide phenomenon World FDI inflows: Developed countries: Developing economies: – – – – Africa LAC West Asia South, East and SE Asia (+ 20%) SE Europe and CIS Source: UNCTAD $916 billions $542 billions $334 billions $31b $104b $35b $165b (+ 29%) (+ 37%) (+ 22%) (+ 78%) (+ 3.1%) (+ 85%) $40b (+ 0.3%) WORLD INVESTMENT REPORT 2006 21 … but remained below the 2000 peak (Billions of dollars) World total 1 400 1 200 Developing economies 1 000 Developed economies 800 600 South-East Europe and CIS 400 200 Source: UNCTAD 2005 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 0 22 FDI flows by region, 2004-2005 (Billions of dollars) 396 542 334 300 Developing countries 2004 2005 250 200 150 100 50 0 Developed countries Source: UNCTAD Developing countries Africa Latin America and the Caribbean South, East and South-east Asia and Oceania West Asia WORLD INVESTMENT REPORT 2006 South-East Europe and CIS Memorandum: LDCs 23 Top 10 recipients of FDI inflows 165 United Kingdom United States China 2005 2004 France Netherlands Hong Kong, China Canada Germany Belgium Spain -20 Source: UNCTAD 0 20 40 60 80 WORLD INVESTMENT REPORT 2006 100 24 Largest 10 sources of FDI outflows 119 Netherlands 116 France 101 United Kingdom 2005 Japan 2004 Germany Switzerland Italy Spain Canada Hong Kong, China -20 0 20 40 60 80 100 … but developing economies are becoming emerging sources … Hong Kong (China) 10th and China 17th Source: UNCTAD 25 Sectoral analysis: the revival of FDI in natural resources a) Sales 2005 2004 5% 5% 16% 32% 32% According to cross-border 56% 63% 63% 28% M&As: The primary sector gained in Primary Manufacturing Tertiary Primary Manufacturing Services Primary Primary Manufacturing Manufacturing Services Tertiary importance b) Purchases Services still remain 2004 dominent 5% Main target industries are: – Petroleum (oil and gas): share of 14% of all industries – Telecommunications: 14% – Finance: 13% Source: UNCTAD 2005 15% 28% 21% 67% Primary Primary 64% Manufacturing Manufacturing Services Tertiary WORLD INVESTMENT REPORT 2006 Primary Primary Manufacturing Manufacturing Services Tertiary 26 A new wave of cross-border M&As: close to the previous boom Cross-border M&As Value ($ billion) Number of deals 1999-2001 average 2003 2004 2005 835 297 381 716 6 974 4 562 5 113 6 134 … and an increasing number of mega deals (75 in 2004; 141 in 2005). Caracteristics of cross-border M&As Previous wave Current wave Financial market boom Pressures to merge IT dotcom boom Sector No. 1: transport storage communications Source: UNCTAD Economic growth Strategic choices New investors (private-equity firms) Sector No. 1: natural resources WORLD INVESTMENT REPORT 2006 27 Regional trends: South-East Europe and the Commonwealth of Independent States (CIS) 28 FDI flows to South-East Europe and CIS in 2005: steady after the large increase in the previous year 40 21 35 18 15 25 12 20 9 15 Per cent $ Billion 30 6 10 5 3 0 0 1995 1996 1997 South-East Europe Source: UNCTAD 1998 CIS 1999 2000 2001 2002 2003 2004 2005 FDI inflows as a percentage of gross fixed capital formation 29 Inflows and their growth uneven by subregion and country CIS: two thirds of inflows; South East Europe: one-third. FDI inflows, top five economies, 2004, 2005a Three countries (Russian (Billions of dollars) Federation, Ukraine and Romania) 14.6 accounted for three quarters of the Russian Federation 15.4 regional total in 2005. 7.8 In 2005, inflows rose in CIS and Ukraine 1.7 declined in South-East Europe 6.4 Inflows rose in 8 countries Romania 2005 6.5 2004 (most notably in Ukraine). 2.2 Bulgaria Inflows fell in 11 countries, 3.4 including Azerbaijan, Kazakhstan 1.7 Kazakhstan and the Russian Federation 4.1 (the latter marginally). 0 2 4 6 8 10 12 14 16 Ranked on the basis of the magnitude of 2005 FDI flows. Source: UNCTAD 30 FDI outflows from South-East Europe and CIS in 2005: fourth year of growth 16 10 14 9 8 7 10 6 8 5 6 4 Per cent $ Billion 12 3 4 2 2 1 0 0 1995 1996 1997 Other CIS and South-East Europe Source: UNCTAD 1998 1999 2000 Russian Federation 2001 2002 2003 2004 2005 FDI outflows as a percentage of gross fixed capital formation 31 IV. WIR 2006 Part II: FDI from Developing and Transition Economies: Implications for Development 32 FDI from developing and transition economies has increased significantly An acceleration in the 1990s FDI outflows: $133 billion in 2005 (17% of world total) Outward FDI stock: $1.4 trillion in 2005 (13% of world total) Their share in global cross-border M&A purchases rose from 4% in 1987 to 13% in 2005 South-North deals: rapid rise in past two years Source: UNCTAD 33 FDI from developing and transition economies, 19802005 (Millions of dollars) 90 000 80 000 70 000 60 000 50 000 40 000 30 000 20 000 10 000 0 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 - 10 000 Offshore financial centres Hong Kong (China) Other developing and transition economies Source: UNCTAD 34 The largest investors Stock of OFDI from developing and transition economies, 2005 (Billions of dollars) Source: UNCTAD Economy Hong Kong (China) British Virgin Islands Russian Fed. Singapore Taiwan POC Brazil China Malaysia South Africa Korea, Rep. of 2005 470 123 120 111 97 72 46 44 39 36 All developing and transition economies 1 400 WORLD INVESTMENT REPORT 2006 35 Main features of FDI from Developing and Transition Economies Concentrated (top 10 sources = 83% of FDI stock) but a number of countries are joining in Asia has grown in importance Services sector dominates Developing countries invest primarily in other developing countries (the bulk of their flows) (i.e. large South-South FDI flows) Larger developing economies along with Russia dominate the numbers, but some smaller, lowincome economies (including some LDCs) have OFDI - however, on a much smaller scale Source: UNCTAD WORLD INVESTMENT REPORT 2006 36 Outward FDI stock, by source region, developing and transition economies, 1980-2005 Millions of dollars 350 000 614 605 755 520 874 305 2000 2004 2005 300 000 250 000 200 000 150 000 100 000 50 000 0 1980 Source: UNCTAD 1985 1990 1995 Africa Latin America and the Caribbean Asia and Oceania South-East Europe and the CIS 37 Mapping South-South FDI: the role of Asia South-South FDI flows, excl. offshore financial centres, 20022004, millions of dollars Source: UNCTAD 38 Main drivers and motives of developing and transition economy TNCs Main driver today: Globalization process Major push factors (home country drivers): – Limited size of home markets (especially for small economies) – Rising costs of production in the home economy (rising wages, exchange rate changes) – Rising competition in the home and foreign markets (notably via globalization), which intensifies the impact of the above two drivers. Main pull factors (host country drivers): – Markets abroad, natural resources, labour – Opportunities arising from liberalization Source: UNCTAD WORLD INVESTMENT REPORT 2006 39