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M&A driven, world FDI flows will exceed $1 trillion

by Chakravarthi Raghavan

Geneva, 3 Oct 2000 - Fuelled by the hectic pace of cross-border mergers and acquisitions, the latter more than the former, the world’s foreign direct investment flows will exceed $1 trillion in 2000, UNCTAD said Tuesday when launching the 2000 annual World Investment Report.

The report this year focuses on Cross-Border Mergers and Acquisitions (M & A), and reaches some tentative, but contradictory conclusions and policy advises.

UNCTAD Secretary-General Rubens Ricupero who launched the report in Geneva at a press conference underscored the importance of national policies and said policies of countries and the quality of public policies go a long way in explaining the positive and negative implications of Foreign Direct Investment (FDI) in developing countries and their impact on development.

Ricupero in an overview said, “cross-border mergers and acquisitions, including the purchase by foreign investors of privatised state-owned enterprises, are driving the foreign investment volumes to new records.” And in response to questions he remained both cautious and sceptical in making any generalised conclusions or providing advice. But the chief author of the report, Mr. Karl Sauvant spoke in more effusive terms. He told a press briefing in New York (according to an IPS report from there): “A global marketplace for firms is emerging. Companies are being bought and sold across borders on an unprecedented scale.”

The report makes a distinction between FDI coming into developing countries as M&As and ‘Greenfield’ investment, and argues that in the short-term M&As may have problems and in the long-term it benefits developing countries.

It concedes (p 98) that empirical evidence on linkages between cross-border M&As and development, and how they may differ on other modes of entry of FDI, is “still very limited”, and that the analysis in the WIR on this issue “is largely conceptual”, and as a first attempt at assessing the role of cross-border M&As in development.

In trying to make distinctions between portfolio and other types of foreign flows into a developing country, M&As and ‘Greenfield Investment’, and how the effects due to privatizations should be judged, the WIR (p 98), citing its own report of last year, insists: “in any event it needs to be recalled that FDI itself, whatever its mode of entry serves to supplement and complement domestic resources and efforts, which are the key for the development process.”

The report argues that governments recognise the importance of attracting FDI, and value it over portfolio investment and bank lending especially during financial crises.

However, a study by Prof. Gordon Hansen of the University of Michigan and the National Bureau of Economic Research, questions the policies and actions (including various subsidies) to promote FDI as distinct from portfolio investments, and has said developing countries should remain sceptical about claims that promoting FDI will raise national welfare.

Other studies, both for the G-24 as well as the IMF and World Bank staff papers of the last few years, and UNCTAD discussion papers, have clearly brought out the difficulties of really making such distinctions, even about the way brick-and-mortar FDI can be split and spun off into derivatives, making distinctions meaningless.

The study by the US academic was commissioned for the Finance Ministers of the G-24 countries (the developing country grouping at the Fund/Bank institutions) and who met last month at Prague (on the eve of the IMF/World Bank annual meetings), has concluded that “there is weak evidence, at best, that FDI generates positive spillovers for host economies.”

Focusing on the subsidisation (through various tax and policy measures) of inward FDI (in developed and developing countries), Hansen notes that in theory such subsidies are likely to be warranted if transnationals are intensive in the use of elastically-supplied factors, the arrival of TNCs in a market does not lower market share of domestic firms, and FDI generates strong productivity growth.

Empirical research, he says, suggests that the first and third conditions are unlikely to hold.

The Hansen study questions the view that FDI (and the technology and other benefits supposedly coming in with a TNC into a country) “raises the productivity of domestic agents.” While TNCs are attracted to high-productivity countries and industries within them, “there is little evidence at the firm or plant level that FDI raises the productivity of domestic enterprises.”

Indeed says the study, “it appears that plants in industries with a large multinational presence tend to enjoy lower rates of productivity growth.”

“Empirical research thus provides little support for the idea that promoting FDI is warranted on welfare grounds.”

The Hansen study is negative on the benefits, and additions to national welfare of host countries, in the case of FDI in Brazil in respect of the Ford and General Motors plants (where it says the subsidies provided by Brasilia may have actually resulted in loss of national welfare) and of the Intel plant in Costa Rica (where there were no subsidies, but close to zero rate of corporate taxation), there has been neither productivity spillover into the country nor any linkages with domestic firms.

Responding to questions, Ricupero brought up the concerns to developing countries caused by mergers (very few in fact) and acquisitions of domestic firms, and/or former state enterprises, and drew attention to a box in the overview where these concerns of host countries had been highlighted. In particular, he drew attention to the remarks about the areas of concern raised by M&As as transcending the economic and reaching into social, political and cultural realms.

The material in the box says: “More broadly, the transfer of ownership of important enterprises from domestic to foreign hands may be seen as eroding national sovereignty and amounting to recolonization..”

[This last word was first used in an article by the writer (but without claiming or asserting any copyright) in 1985, and then in 1990 as the title of a book, on a new round of trade negotiations including new issues, and with the likely outcome of pushing the economies of developing countries into the type of relationship they had with metropolitan countries during their colonial era.]

It is flattering to see the same terminology in the WIR, but questions of economics cannot be divorced from political, cultural or social elements and their appraisal.

In what Ricupero called in the overview ‘a postscript’ and the parallel between the current wave of mergers and acquisitions and the concentration of ownership and rise of monopolies and oligopolies and that which happened in the United States during the last decade of the 19th century which resulted in the anti-trust laws (the Clayton and Sherman Acts), the WIR also suggested that a similar challenge as that faced by the US in that period was arising.

“This could mean,” says the WIR, “that what is already happening may only be the beginning of a massive consolidation process at the regional and global levels.  If so, it is all the more important to put in place the necessary policy instruments to deal with this process. Among these policy instruments, competition policy has pride of place. In the end a global market for firms may need a global approach to competition policy, an approach that takes the interests and conditions of developing countries fully into account.”

This however does not address the real parallels and their absence and hence the dangers of a ‘global’ competition policy.

It is now questionable even in the US as to how effective the Clayton and Sherman anti-trust laws and their enforcement are, and how subjective the decisions are (depending on the campaign financing of parties and successful candidates).

But it is difficult to separate the reach and effectiveness of these laws and policies, from the fact of a Federal State, and a Supreme Court, and the enforcement mechanisms that come with a court of record and ability to visit with criminal and civil penalty offenders. How can such a role be discharged at the global level to warrant developing countries accepting such a global competition policy?

Could or should any developing country trust the WTO and its dispute settlement process. And with conflicts and differences between equally placed economic powers like the EU and the US on the issues of when market power becomes a threat to competition, could a global norm suffice in small economies where even a corporation having just 20 percent of market power in the face of innumerable decentralised small-scale suppliers could be an oligopoly and/or an olipsony?

These are serious issues of political economy that the WIR does not or cannot address - given its approach to FDI, TNCs and their activities, involving acceptance more on faith than facts.

In its survey of FDI and developments, the WIR says that FDI flows into the developed countries rose to $636 billion in 1999 (up from $481 billion in 1998), while FDI to developing countries rose to $208 billion compared to $179 billion in 1998.

According to the WIR, global FDI outflows rose 16% to $800 billion last year, with the UK with $199 billion, being the largest outward investor. Large M&As and the continuing strength of its economy made it the largest recipient of FDI, $276 billion or one-third of the world total.

FDI into Latin America and the Caribbean rose steeply last year to exceed $90 billion. FDI inflows into all countries of Asia grew to $106 billion. But those to Central and Eastern Europe and Africa however remained ‘quite modest’ at $21 and $9 billion respectively.

As in the past, the WIR throws in a considerable, and confusing amount of data, anecdotal examples, and several ‘may-s’, ‘could-s’ etc to suggest conceptually positive spillover effects of FDI (technology transfers, productivity growth, exports etc), and of M&As.

Several academics and economic experts in this area (Prof Bob Sutcliff, Prof Epstein, Prof Nadal, and Prof Yash Tandon) in reviews of earlier year WIRs and articles on FDI issues, have raised questions about the difficulties of comparing and analysing the statistical and other data in WIRs, either with other sources or the WIR itself.

Part of the problem is in the statistics themselves - which often are estimates and thus not reliable—and the very clever ways that the inflows and outflows are disguised for various reasons (including tax avoidance, if not evasion by major TNCs), and each organisation adapts its own yardsticks and standards.

However, part of the problem is also due to the way the WIR is prepared and produced, with little time left for any one to really sit back and look at the entire document with a dispassionate eye to catch internal contradictions and contradictions with other policy conclusions of UNCTAD itself, even in other documents also signed by the Secretary-General and/or issued under his authority.

Part of the problem too lies in the way the IMF decides on the organization of national data and reporting for its balance-of-payments purposes, where the cash flow, and the net flow and the balance-sheet for countries get mixed up for ideological considerations, and even the goal-post keeps changing.

In pages 267-282 (at the beginning of the Annex B, statistical annex), the WIR explains or explains away contradictions that anyone trying to look at the facts and make a policy conclusion or judgement seems to come up against in terms of the data problems, and how they are gathered and verified—reliance on the IMF’s BOP data, and the latest Fifth Edition of the IMF manual and its ‘arbitrary’ classifications about FDI, and other flows.

For e.g. what is the real basis to decide that a 10% equity interest or holding of a resident entity of one economy in an entity of another qualifies for the term ‘foreign direct investment’ and implies “a lasting interest”, and the investor exercises significant degree of influence on the management of the enterprise?

Examples are easy to cite (but don’t suffice to draw any generalized conclusion), of cases in joint ventures or partnerships where even 49% would not suffice, others where even a 5-6 % equity (with very widely scattered shareholding) provides management control, and cases where even a 100% ownership can easily be spun into derivatives and packaged and sold off to others for the original owners who have already ‘exited’.

The annex also gives as in earlier editions the list of countries where one or the other of the components of FDI used in IMF-BOP data are not available, and those where for one year or another it was supplemented by contacting national authorities.

Perhaps of no particular significance, in terms of weight of the missing component or data in terms of the global economy, GDP etc, neverthless one is intrigued by mention of Somalia—a country where by most international reckoning there is no functioning state - or several of the former soviet republics and east european economies where again the data collection process implies a really functioning state and government apparatus, reaching into public or private sectors.-SUNS4753

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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