Economic aspects of foreign
direct investment
Virtual Institute-St. Petersburg
State University Study Tour
Geneva, 18 April 2007
Michael Lim
UNCTAD-DITE
michael.lim@unctad.org 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 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
Chile 71
ExxonM obil 63
Pakistan 62
General M otors 56
Algeria 53
Peru 53
Czech Republic 51
N ew Zealand 51
U nited Arab Em irates 48
Bangladesh 47
H ungary 46
Ford M otor 44
D aim lerChrysler 42
N igeria 41
Source: UNCTAD 0 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 Key determinants
Natural resource- Abundance of natural resources
seeking FDI Price movements
Market-seeking FDI Market size and purchasing power
(national or regional) Market growth
Tradability of product/service
Need for local adaptation
Structure and openness of markets
Efficiency-seeking, Quality and cost of human resources
export-oriented FDI Physical infrastructure (electricity, transport, ports,
roads, telecoms, etc.)
Technical infrastructure
Trade costs
Quality of suppliers, clusters, etc.
Economic and political stability
Strategic asset- Presence of strategic assets
seeking FDI
Source: UNCTAD 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 17
Transfer pricing (low tax contribution locally)
Socio-cultural effects
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: $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 WORLD INVESTMENT REPORT 21
2006
… 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
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2005
Source: UNCTAD 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 Developing Africa Latin America South, East and West Asia South-East Memorandum:
countries countries and the South-east Asia Europe and CIS LDCs
Caribbean and Oceania
Source: UNCTAD WORLD INVESTMENT REPORT 23
2006
Top 10 recipients of FDI inflows
165
United Kingdom
United States
China
2005
France 2004
Netherlands
Hong Kong, China
Canada
Germany
Belgium
Spain
-20 0 20 40 60 80 100
Source: UNCTAD WORLD INVESTMENT REPORT 24
2006
Largest 10 sources of FDI outflows
119
Netherlands
116
France
101
United Kingdom
Japan 2005
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
2004 2005
5%
16%
5%
32%
32%
56%
According to cross-border 63%
63%
28%
M&As:
The primary sector gained in Primary Manufacturing Tertiary
Primary Manufacturing Services Primary Manufacturing Tertiary
Primary Manufacturing Services
importance
b) Purchases
Services still remain 2004 2005
dominent
5%
Main target industries are: 28%
15%
21%
– Petroleum (oil and gas): 67% 64%
share of 14% of all industries
– Telecommunications: 14%
– Finance: 13% Primary
Primary Manufacturing Tertiary
Manufacturing Services Primary Manufacturing Tertiary
Primary Manufacturing Services
Source: UNCTAD WORLD INVESTMENT REPORT 26
2006
A new wave of cross-border M&As:
close to the previous boom
Cross-border M&As 1999-2001 average 2003 2004 2005
Value ($ billion) 835 297 381 716
Number of deals 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 Economic growth
Pressures to merge Strategic choices
IT dotcom boom New investors (private-equity firms)
Sector No. 1: transport Sector No. 1: natural resources
storage
communications
Source: UNCTAD WORLD INVESTMENT REPORT 27
2006
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
30
15
25
Per cent
$ Billion
12
20
9
15
6
10
5 3
0 0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
South-East Europe CIS FDI inflows as a percentage of gross fixed capital formation
Source: UNCTAD 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,
Three countries (Russian 2004, 2005a
Federation, Ukraine and Romania) (Billions of dollars)
accounted for three quarters of the Federation
Russian 14.6
regional total in 2005. 15.4
In 2005, inflows rose in CIS and Ukraine
7.8
1.7
declined in South-East Europe
Inflows rose in 8 countries Romania
6.4
2005
6.5
2004
(most notably in Ukraine).
2.2
Inflows fell in 11 countries, Bulgaria
3.4
including Azerbaijan, Kazakhstan 1.7
and the Russian Federation Kazakhstan
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
12
7
10 6
$ Billion
Per cent
8 5
6 4
3
4
2
2 1
0 0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Other CIS and South-East Europe Russian Federation FDI outflows as a percentage of gross fixed capital formation
Source: UNCTAD 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, 1980-
2005
(M illions of dollars)
90 000
80 000
70 000
60 000
50 000
40 000
30 000
20 000
10 000
0
- 10 000
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
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)
Economy 2005
Hong Kong (China) 470
British Virgin Islands 123
Russian Fed. 120
Singapore 111
Taiwan POC 97
Brazil 72
China 46
Malaysia 44
South Africa 39
Korea, Rep. of 36
All developing and transition
economies 1 400
Source: UNCTAD WORLD INVESTMENT REPORT 35
2006
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 WORLD INVESTMENT REPORT 36
2006
Outward FDI stock, by source region, developing and
transition economies, 1980-2005
Millions of dollars
614 605 755 520 874 305
350 000
300 000
250 000
200 000
150 000
100 000
50 000
0
1980 1985 1990 1995 2000 2004 2005
Africa Latin America and the Caribbean
Asia and Oceania South-East Europe and the CIS
Source: UNCTAD 37
Mapping South-South FDI: the role of Asia
South-South FDI flows, excl. offshore financial centres, 2002-
2004, 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 39
2006