Economic aspects of foreign direct investment Virtual Institute-St. Petersburg State University Study Tour Geneva, 18 A

1. Economic aspects of foreign direct investmentVirtual Institute-St. Petersburg State University Study TourGeneva, 18 April 2007 Michael Lim UNCTAD-DITE michael.lim@unctad.org

2. Outline • I. Basic concepts • II. Determinants and Impacts of FDI • III. Recentglobal and regional FDI trends • IV. WIR 2006: FDI from developing economies

3. I. Basic concepts

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

5. 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)

6. Modes of FDI • Greenfield investment • Acquisition • Merger • Joint venture • Expansion investment

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.

8. FDI constitutes the largest component of resource flows to developing countries Billions of dollars

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

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

11. II. Determinants and impacts of FDI

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

13. 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

14. Economic determinants of FDI

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)

16. Potential benefits from inward FDI • Provide external financing • Transfer of hard technology • Transfer of “soft technology” (knowledge, management skills, organizational methods – spillovers) • Promote exports (efficiency-seeking, export platform FDI) • Employment creation (M&As vs. greenfield FDI) • Promote local skills development through training • Improve quality of local services • Introduce new goods and services • Competitive spur to local economy (spillover – but may crowd out!) • Contribute to local enterprise development (via spillovers and directly) • Provide access to international markets

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 outlocal 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

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.

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

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%) WORLD INVESTMENT REPORT 2006

22. … but remained below the 2000 peak (Billions of dollars)

23. FDI flows by region, 2004-2005 (Billions of dollars) WORLD INVESTMENT REPORT 2006

24. Top 10 recipients of FDI inflows WORLD INVESTMENT REPORT 2006

25. Largest 10 sources of FDI outflows … but developing economies are becoming emerging sources … Hong Kong (China) 10th and China 17th

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% WORLD INVESTMENT REPORT 2006

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). WORLD INVESTMENT REPORT 2006

28. Regional trends: South-East Europe and the Commonwealth of Independent States (CIS)

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

30. 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 FDI inflows, top five economies, 2004, 2005a (Billions of dollars) Ranked on the basis of the magnitude of 2005 FDI flows.

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

32. IV. WIR 2006 Part II: FDI from Developing and Transition Economies:Implications for Development

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

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

35. The largest investors Stock of OFDI from developing and transition economies, 2005 (Billions of dollars) WORLD INVESTMENT REPORT 2006

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 WORLD INVESTMENT REPORT 2006

37. Outward FDI stock, by source region, developing and transition economies, 1980-2005 Millions of dollars

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 WORLD INVESTMENT REPORT 2006