Global Policy Forum

By Caroline Lambert

After catching its breath in 1998, foreign direct investment is on the rise again in developing countries. This is good news, as FDI remains the largest and most stable source of external finance for these countries. But FDI also carries inherent risks which need to be addressed if globalization is to benefit the poorer parts of the world.

The United Nations Conference on Trade and Development (UNCTAD) has just provided yet another glowing picture of the increasing pace of globalization. According to the World Investment Report (WIR), foreign direct investment flows totaled $865bn in 1999 and could well pass the $1trn mark in 2000. Developing countries have benefited from this investment surge. After stagnating in 1998, in response to the Asian crisis and the Russian debt hiccup, FDI flowed back to emerging markets with a vengeance, increasing by over 16% to reach $208bn in 1999. In part, this is because of more favorable overall economic conditions. It is also related to further liberalization of FDI regimes, regional integration and continued privatizations. In 1999, new bilateral investment treaties and double taxation treaties were signed on average every two working days. In addition, new free trade and investment agreements, such as the ones between Chile and Mexico and between the EU and Mexico, have had a favorable impact on FDI.

Despite a decline from 1998, foreign acquisitions of companies from developing countries have increased dramatically since 1996, reaching $63.4bn in 1999 compared to less than $16bn in 1995. Developing countries have also become more aggressive foreign investors, with outward FDI reaching $66bn in 1999, $41bn of which was spent on acquiring foreign firms. This is good news for developing countries. As the IMF recently pointed out, FDI has consistently been the largest and most stable source of foreign capital inflows. Over the past decade, private external financing, including FDI, portfolio investment and commercial bank loans, has gradually dwarfed official flows. Since 1997, however, developing countries' overall private external financing has been declining, mostly due to a reduction in portfolio investment and commercial bank loans following crises in Asia and Russia. FDI, on the other hand, has proved remarkably resilient, stagnating in 1998 before resuming its progression in 1999. Unlike other forms of private capital, FDI is more influenced by economic fundamentals than short-term financial considerations and is therefore a stabilizing factor in times of crisis.

So is FDI an unconditional blessing for developing countries? Not quite. First, global FDI is becoming increasingly concentrated. Despite an increase in absolute value, the share of FDI landing in developing countries has actually been declining - from 34% in 1995 to 24% in 1999. And within the developing world, 80% of FDI flows to only 10 countries, with China, Brazil and Argentina leading the flock or attractive investment destinations. In other words, foreign investment largely bypasses poorer countries. So attracting more and higher-quality FDI remains a challenge for most developing countries.

In addition, not all FDI is equally beneficial for host countries. According to UNCTAD, mergers and acquisitions, in the short term, yield fewer benefits than greenfield foreign investment. Acquisitions usually do not add to host countries' capital stock, as they only transfer ownership from a local to a foreign investor. In addition, as they take over existing operations, they are less likely to transfer new or better technologies compared to greenfield investments. Their impact on employment is not as beneficial as start up operations, as they rarely create new employment in the short term and may even resort to lay-offs. Acquisitions may increase concentration in host countries and therefore undermine the competitive situation.

Over the longer term, however, acquisitions and greenfield FDI are likely to result in similar advantages, as incremental investment usually follows an original acquisition. In addition, the alternative to acquisition is sometimes closure, which bears much higher costs in terms of lost employment and impact on capital stock. So acquisitions can play a crucial role in local economic restructuring and the survival of local companies. The fact remains, however, that TNCs' commercial objectives and the development needs of host economies do not necessarily coincide. Host countries' FDI and sectoral policies are therefore crucial in mitigating FDI's potential negative side effects. According to UNCTAD, host countries must assess trade-offs related to efficiency, output growth, distribution of income, access to market and non-economic objectives such as national sovereignty and employment preservation, and design adequate FDI policies. These can include sectoral reservations, ownership regulations, size criteria, FDI screening and FDI incentives.

The most important policy instrument, however, remains competition regulation, as the threat of monopoly or tight oligopoly is potentially the single most important negative effect of cross-border acquisitions. Today, some 90 countries have introduced antitrust laws, but more needs to be done to ensure that the benefits of increased FDI are not wiped out by anticompetitive practices. That's where international cooperation comes into the picture. Cooperation between competition authorities is essential to allow nations to respond effectively to cross-border acquisitions with global implications. In addition, the increasing internationalization of transnational corporations has blurred the picture and made them less accountable to any particular national control and scrutiny. Taxes are a particularly sensitive issue, as transfer pricing on intra-group trade can be used to minimize corporations' overall tax bills. In 1995, 61% of US-controlled and 67% of non US-controlled transnational corporations paid no income tax. So if developing countries are to reap the full benefits of FDI, globalization needs to rhyme better with global regulation.

More analysis of the World Investment Report 2000 by eCountries: http://www.Ecountries.com/global/1554375.

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