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					Economic aspects of foreign
    direct investment

Virtual Institute-St. Petersburg
 State University Study Tour

    Geneva, 18 April 2007
               Michael Lim

4 I. Basic concepts
4 II. Determinants and Impacts of FDI
4 III. Recent global and regional FDI trends
4 IV. WIR 2006: FDI from developing

Source: UNCTAD                                 2
I. Basic concepts

   What is foreign direct investment?
4 Balance-of-payments concept
4 Distinguish between portfolio and direct investment
    Ø 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).
    Ø 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).
4 FDI flows comprise three different components:
    Ø Equity capital
    Ø Reinvested earnings
    Ø Intra-company loans

Source: UNCTAD                                                              4
  What is a transnational corporation
4 A TNC consists of:
   Ø A parent company (based in a ‘home country’); and
   Ø One or more foreign affiliates (in ‘host countries’)
4 Foreign affiliates may refer to:
   Ø Subsidiaries (majority-owned)
   Ø Associate (ownership share is>10% but <50%)
   Ø Branch (wholly or jointly unincorporated enterprise)

Source: UNCTAD                                          5
                 Modes of FDI

 4 Greenfield investment
 4 Acquisition
 4 Merger
 4 Joint venture
 4 Expansion investment

Source: UNCTAD                  6
Are TNCs and FDI important to the world

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

Source: UNCTAD                                        8
       The role of TNCs is increasing

4 > 60,000 TNCs
4 > 800,000 foreign affiliates
4 TNCs account for some 2/3 of world exports
4 1/3 of world trade is intra-firm
4 TNCs dominate world industrial R&D
4 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

Source: UNCTAD                                  10
II. Determinants and impacts of FDI

A typology of FDI is useful for analysis

4 FDI is diverse, so a typology is useful to
  create categories of different types of FDI
4 A typology is useful (necessary in fact) as an
  analytical aid

Source: UNCTAD                                     12
          A Typology of types of FDI

4 Natural resource-seeking
    Oil and gas extraction, mining, forestry, fisheries
4 Market-seeking (horizontal FDI)
    Access a domestic or regional (e.g. EU, NAFTA, ASEAN)market
4 Efficiency-seeking (vertical FDI)
    Specialize and divide production in line with the comparative
      advantages of different locations; export-oriented FDI
4 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

Source: UNCTAD                        14
Two analytical perspectives on FDI
impact on host country: financing versus
micro and macro (and broader) impacts
4 Financing (BoP): FDI provides valuable external
       (Simplistic financing version: more FDI = more
  financing; therefore more FDI is good)
4 Micro and macro impacts: FDI may have important
  impacts (positive and negative) on the host economy
  – at both the microeconomic and macroeconomic
  (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
  o Provide access to international markets
Source: UNCTAD                                                           16
Potential negative impacts and concerns
from inward FDI
  Ø Balance of Payments problems (potentially large future
     remittances, possibly high import content of FDI projects)
  Ø Crowding out local enterprises (via unfair competition vs. via
     higher efficiency and better performance)
  Ø Lack of local linkages (enclave activities using few local inputs)
  Ø Low level of local processing (and low local value added)
  Ø Environmental degradation (from certain activities (e.g.
  Ø Limited transfer of technology (an important aspect of
  Ø Employment destruction (M&As)
  Ø Footloose operations (e.g. garments)
  Ø Excessive use of incentives/race to the top (competition for
  Ø Anticompetitive practices (abuse of dominant position)
Source: UNCTAD                                                           17
  Ø Transfer pricing (low tax contribution locally)
Some key points to remember on TNCs
and FDI
4 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.
4 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)
4 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.
4 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.
4 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

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

     4 World FDI inflows:                  $916 billions    (+ 29%)
     4 Developed countries:                $542 billions    (+ 37%)
     4 Developing economies:               $334 billions    (+ 22%)
          –                                $31b             (+ 78%)
          –                                $104b           (+ 3.1%)
          West Asia
          –                                $35b             (+ 85%)
          South, East and SE Asia
          –                                        $165b
          (+ 20%)
     4 SE Europe and CIS                   $40b            (+ 0.3%)
  Source: UNCTAD      WORLD INVESTMENT REPORT                   21
… but remained below the 2000 peak

                    (Billions of dollars)

 Source: UNCTAD                             22
FDI flows by region, 2004-2005

                       (Billions of dollars)

Top 10 recipients of FDI inflows

Largest 10 sources of FDI outflows

      … 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

According to cross-border
§ The primary sector gained in
§ Services still remain
§ Main target industries are:

    – Petroleum (oil and gas):
      share of 14% of all industries
    – Telecommunications: 14%
    – Finance: 13%
  Source: UNCTAD             WORLD INVESTMENT REPORT   26
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).

 Source: UNCTAD         WORLD INVESTMENT REPORT                        27
Regional trends: South-East Europe
and the Commonwealth of Independent
           States (CIS)

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

Source: UNCTAD                                         29
Inflows and their growth uneven by subregion and

4    CIS: two thirds of inflows; South-
     East Europe: one-third.                     FDI inflows, top five economies,
4    Three countries (Russian                              2004, 2005a
     Federation, Ukraine and Romania)                        (Billions of dollars)

     accounted for three quarters of the
     regional total in 2005.
4    In 2005, inflows rose in CIS and
     declined in South-East Europe
4    Inflows rose in 8 countries
     (most notably in Ukraine).
4    Inflows fell in 11 countries,
     including Azerbaijan, Kazakhstan
     and the Russian Federation
     (the latter marginally).
                                           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

 Source: UNCTAD                                        31
         IV. WIR
       2006 Part II:
FDI from Developing and Transition
  Implications for Development

FDI from developing and transition economies has
increased significantly

   4 An acceleration in the 1990s

   4 FDI outflows: $133 billion in 2005 (17% of world total)

   4 Outward FDI stock: $1.4 trillion in 2005 (13% of world total)

   4 Their share in global cross-border M&A purchases rose
       from 4% in 1987 to 13% in 2005

   4 South-North deals: rapid rise in past two years

Source: UNCTAD                                                       33
FDI from developing and transition economies, 1980-
(Millions of dollars)

  Source: UNCTAD                                  34
The largest investors

                  Stock of OFDI from developing
                  and transition economies, 2005
                           (Billions of dollars)

Main features of FDI from Developing and Transition

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

                      Millions of dollars

 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
   4 Main driver today: Globalization process
   4 Major push factors (home country drivers):
        – Limited size of home markets (especially for small
        – 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.
   4 Main pull factors (host country drivers):
        – Markets abroad, natural resources, labour
        – Opportunities arising from liberalization
Source: UNCTAD         WORLD INVESTMENT REPORT                    39

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