1 Economic aspects of foreign direct investment Virtual Institute-St. Petersburg State University Study Tour Geneva, 18 April 2007 Michael Lim UNCTAD-DITE

1

Economic aspects of foreign direct investment

Virtual Institute-St. Petersburg State University

Study Tour

Geneva, 18 April 2007

Michael LimUNCTAD-DITE

[email protected]

Source: UNCTAD 2

Outline

I. Basic concepts II. Determinants and Impacts of FDI III. Recent global and regional FDI

trends IV. WIR 2006: FDI from developing

economies

3

I. Basic concepts

Source: UNCTAD 4

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 5

What is a transnational corporation (TNC)?

A TNC consists of:A parent company (based in a ‘home

country’); andOne 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 6

Modes of FDI

Greenfield investment Acquisition Merger Joint venture Expansion investment

Source: UNCTAD 7

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 8

FDI constitutes the largest component of

resource flows to developing countries

Billions of dollars

Total Resource f low s

FDI inflow s

Portfolio f low sCommercial banks loans

Official f low s

-50

0

50

100

150

200

250

300

350

400

450

500

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: UNCTAD 9

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 10

Some TNCs are very bigValue added or GDP, 2000, USD billions

41

42

44

46

47

48

51

51

53

53

56

62

63

71

0 10 20 30 40 50 60 70 80

Nigeria

DaimlerChrysler

Ford Motor

Hungary

Bangladesh

United Arab Emirates

New Zealand

Czech Republic

Peru

Algeria

General Motors

Pakistan

ExxonMobil

Chile

11

II. Determinants and impacts of FDI

Source: UNCTAD 12

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 13

A Typology of types of FDI

Natural resource-seekingOil 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 14

Economic determinants of FDI

Type of FDI Key determinants Natural resource-seeking FDI

Abundance of natural resources Price movements

Market-seeking FDI (national or regional)

Market size and purchasing power Market growth Tradability of product/service Need for local adaptation Structure and openness of markets

Efficiency-seeking, export-oriented FDI

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

Strategic asset-seeking FDI

Presence of strategic assets

Source: UNCTAD 15

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 16

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 17

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) Transfer pricing (low tax contribution locally) Socio-cultural effects

Source: UNCTAD 18

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 19

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.)

20

III. Recent global and regional FDI trends

Source: UNCTAD WORLD INVESTMENT REPORT 2006

21

FDI inflows grew in 2005 for the second consecutive year …and it was a worldwide phenomenon

World FDI inflows: $916 billions (+ 29%) Developed countries: $542 billions (+ 37%) Developing economies: $334 billions (+ 22%)

– Africa $31b (+ 78%)– LAC $104b (+ 3.1%)– West Asia $35b (+ 85%)– South, East and SE Asia $165b (+ 20%)

SE Europe and CIS $40b (+ 0.3%)

Source: UNCTAD 22

… but remained below the 2000 peak

(Billions of dollars)

0

200

400

600

800

1 000

1 200

1 400

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

05

World total

Developing economies

Developed economies

South-East Europe and CIS


23

FDI flows by region, 2004-2005

0

50

100

150

200

250

300

Developedcountries

Developingcountries

Africa Latin Americaand the

Caribbean

South, East andSouth-east Asia

and Oceania

West Asia South-EastEurope and CIS

Memorandum: LDCs

2004

2005

Developing countries

396 542 334



24

Top 10 recipients of FDI inflows

-20 0 20 40 60 80 100

Spain

Belgium

Germany

Canada

Hong Kong, China

Netherlands

France

China

United States

United Kingdom

2005

2004

165

Source: UNCTAD 25

Largest 10 sources of FDI outflows

… but developing economies are becoming emerging sources … Hong Kong (China) 10th and China 17th

-20 0 20 40 60 80 100

Hong Kong, China

Canada

Spain

Italy

Switzerland

Germany

Japan

United Kingdom

France

Netherlands

2005

2004

119

116

101


26

Sectoral analysis: the revival of FDI in natural resources

According to cross-border

M&As: The primary sector gained

in importance Services still remain

dominent Main target industries are:

– Petroleum (oil and gas): share of 14% of all industries

– Telecommunications: 14%– Finance: 13%

a) Sales

b) Purchases

2004

63%

5%

32%

Primary Manufacturing Tertiary

2005

56% 28%

16%


2004

67%

28%

5%


2005

21%

64%

15%


2004

63%

5%

32%

Primary Manufacturing Services

2005

56% 28%

16%


2004

67%

28%

5%


2005

21%

64%

15%



27

A new wave of cross-border M&As:close to the previous boom

… and an increasing number of mega deals (75 in 2004; 141 in 2005).

Value ($ billion) 835 297 381 716

Number of deals 6 974 4 562 5 113 6 134

20051999-2001 averageCross-border M&As 2003 2004

Caracteristics of cross-border M&AsCurrent wave

Financial market boom Economic growthPressures to merge Strategic choicesIT dotcom boom New investors (private-equity firms)Sector No. 1: transport Sector No. 1: natural resources storage

communications

Previous wave

28

Regional trends: South-East Europe and the Commonwealth of

Independent States (CIS)

Source: UNCTAD 29

FDI flows to South-East Europe and CIS in 2005:steady after the large increase in the previous year

0

5

10

15

20

25

30

35

40

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

$ B

illi

on

0

3

6

9

12

15

18

21

Per

cen

t

South-East Europe CIS FDI inflows as a percentage of gross fixed capital formation

Source: UNCTAD 30

FDI inflows, top five economies, 2004, 2005a


Ranked on the basis of the magnitude of 2005 FDI flows.

CIS: two thirds of inflows; South-East Europe: one-third.

Three countries (Russian Federation, Ukraine and Romania) accounted for three quarters of the regional total in 2005.

In 2005, inflows rose in CIS and declined in South-East Europe

Inflows rose in 8 countries (most notably in Ukraine).

Inflows fell in 11 countries, including Azerbaijan, Kazakhstan and the Russian Federation (the latter marginally).

Inflows and their growth uneven by subregion and country

4.1

3.4

6.5

1.7

1.7

2.2

6.4

7.8

14.6

15.4

0 2 4 6 8 10 12 14 16

Kazakhstan

Bulgaria

Romania

Ukraine

RussianFederation

2005

2004

Source: UNCTAD 31

FDI outflows from South-East Europe and CIS in 2005:fourth year of growth

0

2

4

6

8

10

12

14

16

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

$ B

illi

on

0

1

2

3

4

5

6

7

8

9

10

Per

cen

t

Other CIS and South-East Europe Russian Federation FDI outflows as a percentage of gross fixed capital formation

32

FDI from Developing and Transition Economies:

Implications for Development

IV. WIR 2006 Part II:

Source: UNCTAD 33

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 34

- 10 000

0

10 000

20 000

30 000

40 000

50 000

60 000

70 000

80 000

90 000

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

Offshore financial centres

Hong Kong (China)Other developing and transition economies

FDI from developing and transition economies, 1980-2005(Millions of dollars)


35

The largest investors

Stock of OFDI from developing and transition economies, 2005


Economy 2005Hong Kong (China) 470British Virgin Islands 123Russian Fed. 120Singapore 111Taiwan POC 97Brazil 72China 46Malaysia 44South Africa 39Korea, Rep. of 36

All developing and transition economies 1 400


36

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, low-income economies (including some LDCs) have OFDI - however, on a much smaller scale

Source: UNCTAD 37

Outward FDI stock, by source region, developing and transition economies, 1980-2005

874 305 755 520 614 605

0

50 000

100 000

150 000

200 000

250 000

300 000

350 000

1980 1985 1990 1995 2000 2004 2005

Africa Latin America and the Caribbean

Asia and Oceania South-East Europe and the CIS

Millions of dollars

Source: UNCTAD 38

Mapping South-South FDI: the role of Asia

South-South FDI flows, excl. offshore financial centres, 2002-2004, millions of dollars


39

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

Documents

1 Economic aspects of foreign direct investment Virtual Institute-St. Petersburg State University Study Tour Geneva, 18 April 2007 Michael Lim UNCTAD-DITE