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FDI
is no panacea for South's economic woes THE TDR-99 notes that with the decline in official financing and instability of private financial flows, FDI has come to be increasingly seen as a solution to the problems of resource gap and external financing. The significant upturn in FDI flows to developing countries in the 1990s, the success of some in attracting large amounts of FDI, and the 'relative stability' of FDI in the aftermath of the East Asia crisis, TDR-99 notes, have led to predictions that FDI is a more stable form of capital flow linked to an emerging international production system, and is likely to offer new and, on some accounts, unprecedented growth opportunities to developing countries. But on a closer examination of recent inflows, including their size, distribution, sources and utilisation, and an assessment of their contribution to the balance of payments (BOP), TDR-99 presents a more sceptical assessment. The report notes that the average annual growth of FDI inflows has risen from 15% in the 1980s to 28% in the 1990s - reflecting in part structural and policy changes in potential southern hosts. And the share of world FDI received by developing countries has risen from around 16% in second half of 1980s to 28% in the 1990s. But, it notes, these flows are increasingly concentrated in a small number of locations - with 10 leading emerging-market economies accounting for three-quarters of all FDI flows to the South and with China, Brazil and Mexico alone accounting for almost one-half of the total flow. Even adjusting the flows to a per capita basis does little to diminish their highly uneven distribution. 'The recent FDI-led integration' of developing countries is thus a highly selective process, TDR-99 says. Data on FDI are not always up-to-date and reliable. FDI flows are usually distinguished under three different sources: equity capital, undistributed profits and loans from parent companies to affiliates. Empirically, equity capital is defined as 'investment made to acquire a lasting management interest (usually at least 10% of voting stock) in an enterprise operating in a country other than that of the investor, whether in a new or existing firm. Acquisitions below 10% are considered portfolio investment. TDR-99 points out these are somewhat arbitrary definitions and raise conceptual problems - nor do the definitions always accurately reflect national practices in classifying FDI. Thus defined, while total FDI inflows into developing countries have been growing steadily, total portfolio equity inflows have shown considerable instability since their emergence in the mid-1980s. Undistributed profits are a relatively important proportion of measurable FDI flows - though the share of reinvested earnings in total FDI in developing countries has been declining in favour of equity and loans during the 1990s. For example, more than half the total outflow of what is labelled FDI from the US consists of earnings of foreign subsidiaries retained by them and not remitted to the US. Some studies have questioned the validity of contending that such FDI is functionally indistinguishable from fresh capital inflows, as if these reinvested earnings are a flow of foreign resources crossing the borders of two countries. TDR-99 says that clearly such reinvestments do not involve any cross-border flows and their treatment as a one-way inflow item in the capital account of the BOP is not admissible. But the difficulty is resolved by showing the profit as a payment abroad on the current account, and the reinvested profits as an FDI inflow on the capital account. Difficult to evaluate However, existing statistical measures cannot always distinguish between retained earnings being used for investment in equity capital, on the one hand, and for acquisition of other financial assets such as government bonds, on the other. Together with many other changes in global financial markets that have facilitated capital mobility, such features of FDI make it difficult to evaluate its stability. Another issue that has a bearing on stability and sustainability and on the impact on the BOP of FDI relates to whether the inflows are utilised for mergers and acquisitions (M&A) or so-called greenfield investment. While conventional analysis has usually treated FDI as if it consists essentially of additions to the real capital stock of the host country, and though long-term considerations may play a role, M&A may also be greatly influenced by prospects of quick capital gains, particularly during periods of crisis. In practice, TDR-99 points out, data do not allow independent estimation of these two components of FDI. But since the data on cross-border M&A are available, greenfield investments can be estimated as a 'residual' - the difference between total FDI and M&A. Cross-border M&A has accounted for between one-half and two- thirds of total world FDI flows Ð a figure that is higher for developed countries and lesser for developing, probably mainly because of the smaller role for M&A in China. If China is excluded, the share of M&A in cumulative FDI in 1992- 1997 turns out to be 72%, up from 22% during 1988-1991. And when the residual is treated as the greenfield component of FDI, its absolute annual level during 1992-1997 was consistently below the level reached in 1991. 'Thus,' says TDR-99, 'the recent boom in FDI flows to developing countries has, with the exception of China, consisted predominantly of M&A, largely in the services sector.' The surge in M&A, especially in the services sector, is closely linked to privatisation programmes adopted in 1990s in which transnational corporations (TNCs) have played a prominent role. According to World Bank data, during 1990-1997, privatisation via foreign investors amounted to 12% of total FDI inflows into the developing world except China. Owing to consequent, frequently drastic, falls of exchange rates and declines in asset prices, financial crises in emerging markets have also created opportunities for highly profitable M&A. In 1998, for example, while total FDI flows to the five Asian countries affected by the crisis declined by $1.5 billion, cross-border M&A in those countries is estimated to have risen to more than $3 billion. The shift of FDI towards acquisition of ownership rights over existing assets is associated with changes in sectoral composition. FDI in the primary sector has been declining for some time, though still a relatively more important component of total FDI in developing than in developed countries. The secondary sector still accounts for the largest share of total FDI in many developing countries, but the pattern in the 1990s has definitely involved a shift away from manufacturing to tertiary sectors where much M&A activity has taken place. 'Not a sound basis' There has been a rising share of non-tradable sectors in total FDI flows. But clearly the stocks of assets of the host country, in the public and private sectors, for M&A are finite and their limits are even tighter in poorer countries. FDI attracted by privatisation of public assets is of a one-off nature. As for FDI involving acquisition of existing private equity, the presence of non-residents in the stock markets of many emerging markets is already at high levels, and for foreign acquisitions to grow, the stock market equities have to grow too. 'These considerations suggest that any simple projection of recent FDI trends may not be a sound basis to assess the sustainability of such flows.' As for the BOP impact, the issue could be viewed in terms of net transfers (comparing FDI inflows with associated payments abroad, including profit remittances, royalties, licence fees and wage remittances as well as interest paid on net loans of parent company to subsidiary). This was a prominent issue in the early literature on FDI, but is no longer so. Countries with long history of TNC involvement Ð hence a large stock of foreign capital Ð usually had negative net transfers, which remained negative until 1988, when China was excluded. 'But it is the boom in FDI, rather than stagnation in profit remittances, that has reversed the situation in favour of developing countries in the 1990s. In fact, profit remittances continued to increase at an average rate of 10% per annum from 1988 to 1998.' Data limitations prevent any comprehensive analysis covering all developing countries of the broader concept of net transfers - taking account of royalties, licence fees and interest payments to parent companies. But UNCTAD estimations of royalties and licence fees for Argentina (1986-1996), Mexico and Thailand (1987-1996) give a total outflow of $9.9 billion for these items, or over 10% of FDI inflow for these countries. Viewing it in a broader approach, and including the effect of FDI on exports and imports in addition to net transfers, UNCTAD has some conclusions from a few country studies available. In the case of Malaysia, the total impact of the trade balance of foreign firms and their income flows on Malaysia's current account had been negative in every year during 1980-1992. The impact on the trade balance became positive during the late 1980s owing to a strong export expansion. But as exports became more import-intensive, this effect diminished. And the net foreign exchange outflows on the current account were offset by new FDI inflows on the capital account only after the late 1980s, but the cumulative payments impact during the whole period was negative. A similar picture emerges for Thailand, where FDI, particularly from Japan, surged after 1986. It had a positive impact on investment and growth, and partly explained the rise in the export/GDP ratio from 29% in 1987 to 36% in 1992. But it was also the cause of a stronger rise in imports because the associated investment and production was import-intensive. It has been estimated that 90% of all machinery and equipment used for FDI projects and 50% of raw materials were imported and thus FDI had a negative impact on the trade balance in the late 1980s and early 1990s. This was reinforced by the rising payments abroad for royalty and licence fees and rising profit remittances. 'These features appear to have contributed to the external imbalances that played an important role in the subsequent crisis'. As for the recent surge in FDI into Brazil, TDR-99 cites UN Economic Commission for Latin America and the Caribbean (ECLAC) studies that because of an upward trend in associated remittances, increased concentration of FDI in non-tradeable sectors and gradual exhaustion of privatisation-linked FDI, in the near future there will be a significant deterioration in BOP (due to activities) of TNCs in the Brazilian economy. According to ECLAC, the TNC-led restructuring of the automotive sector has been an important factor behind the renewed FDI flows into the region, and has worsened the trade balance in both Argentina and Brazil because of the import dependence of such FDI - whereas in Mexico the impact has been strongly positive. However, even when FDI-linked activities may incur foreign-exchange deficits, such investments may still improve the BOP if they create significant externalities enhancing the export potential of the economy, TDR-99 says. There may be net benefits still if there are significant technological spillovers from FDI and the presence of TNCs. 'Nevertheless, such benefits are not spontaneous and may not compensate for additional foreign-exchange deficits if FDI predominantly takes the form of M&A in non-traded sectors. 'In any case if the payments outcome of TNC-related activities is constantly a deficit, the economy would need to generate net foreign exchange elsewhere, since meeting such a deficit by simply relying on a new inflow of FDI would mean engaging in an unsustainable process of Ponzi financing.' 'Weakening' Examining and comparing the relationship between export growth and FDI inflows during the 1980s and 1990s in South and East Asian countries, the Bank for International Settlements has singled out 'significant weakening of the relationship between FDI and the growth of exports in the 1990s' as a factor contributing to the factor payment problems and the crisis in East Asia. The BIS also notes that prospects had become 'dimmer that the initial deterioration of the current account, brought about by the imports of capital goods associated with foreign direct investment, would eventually be corrected by new export activity generated by the increase in capacity.' UNCTAD notes that the same comparison for a larger number of developing countries, including several in Latin America, shows that this weakening of the link between FDI and exports is widespread in the developing world. The same inflows of FDI were associated with less rapid expansion in exports during 1991-1996 than in 1985-1990 in both Asia and Latin America. 'Notwithstanding other possible influences originating from global economic conditions, such as increased competition in world markets, slow growth and adverse price movements, the increasing concentration of FDI in services sectors seems likely to have played an important role in the weakening of the link between FDI and export growth.' While TDR-99 refrains from drawing the necessary conclusion, this line of reasoning based on empirical evidence raises the question whether developing countries, in further negotiations on services, should call a halt to opening up their markets for service exports from the North through capital and investment as a mode of supply or in further financial services liberalisation of their banking and insurance sectors and stock markets. In a final chapter, devoted to 'Rethinking Policies for Development', TDR-99 says that attracting FDI to obtain foreign technologies and secure other advantages associated with the international production network of TNCs can offer a faster route to establishment of competitive industries. 'However, the benefits from hosting TNCs are not automatic, and the policy objectives of the host country in such matters as local content, technological upgrading and BOP stability may clash with the commercial interests of corporations.... replacing the high import content of TNC activities in manufacturing with domestic production remains an important objective in many countries. Equally, the potential technological and other spillovers, particularly for middle-income economies and in sectors where specific knowledge and capital equipment are closely knit together, still require that host governments preserve their ability to bargain effectively with TNCs.' The TDR analysis presents perhaps the most effective case against any negotiations for a multilateral framework of rules on investment at the WTO, even one providing for post-establishment MFN and national treatment and other privileges for foreign investors. Perhaps the UNCTAD analysis of FDI could be summed up as: FDI is an acronym for foreign direct investment that may be foreign but could also be round-tripping domestic capital (that flows out legitimately or illegally and then brought back); not always direct inflows as it could be reinvestment and loan capital that is debt-creating; and not necessarily investment and capital accumulation but consumption. - (Oct/Nov 99) The above article first appeared in the South-North Development Monitor (SUNS- issue no. 4513) of which Chakravarthi Raghavan is the Chief Editor.
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