World Investment Report 1999

Key Messages

Transnational corporations drive international production

International production – the production of goods and services in countries that is controlled and managed by firms headquartered in other countries – is at the core of the process of globalization. TNCs – the firms that engage in international production – now comprise over 500,000 foreign affiliates established by some 60,000 parent companies, many of which also have non-equity relationships with a large number of independent firms. The TNC universe comprises large firms mainly from developed countries, but also firms from developing countries and, more recently, firms from economies in transition, as well as smalland medium-sized firms.

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Which takes place in an increasingly liberal policy framework

The trend towards the liberalization of regulatory regimes for FDI continued in 1998, often complemented with proactive promotional measures. Out of 145 regulatory changes relating to FDI made during that year by 60 countries, 94 per cent were in the direction of creating more favourable conditions for FDI (table 4). The number of bilateral investment agreements also increased further, reaching a total of 1,726 by the end of 1998, of which 434 had been concluded between developing countries. Close to 40 per cent of the 170 treaties signed that year were between developing countries.

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International production has many dimensions

International production involves a package of tangible and intangible assets. Its principal global features (which, of course, differ from country to country) can be captured in various ways (table 5):

  • On the production side, the value of the output under the common governance of TNCs (parent firms and foreign affiliates) amounts to about 25 per cent of global output, one third of it in host countries. Foreign affiliate sales (of goods and services) in domestic and international markets were about $11 trillion in 1998, compared to almost $7 trillion of world exports in the same year. International production is thus more important than international trade in delivering goods and services to foreign markets. In the past decade, both global output and global sales of foreign affiliates have grown faster than world gross domestic product as well as world exports. Judging from data on FDI stock, most international production in developed countries is in services, and most international production in developing countries is in manufacturing (figure 1). For both groups of countries, FDI in the primary sector has declined, while FDI in services in developing countries is gaining in importance. These shifts reflect changes in the structure of the world economy, as well as changing competitive advantages of firms and locational advantages of countries, and the responses of TNCs to globalization and liberalization.Screen Shot 2015-07-29 at 3.52.11 pm
  • Technology flows play an important role in international production. Technology embodied in capital goods exported to foreign affiliates is measured by the value of those exports. Technology provided via contractual agreements is measured by the value of payments and receipts associated with them. And technology transmitted through training is measured by the cost of resources used in the training. Technology payments and receipts of countries in the form of royalty payments and licence fees have risen steadily since the mid- 1980s, and the intra-firm (between parent firm and foreign affiliate) share of these expenditures, already high, has also risen (figure 2). These changes reflect the fact that FDI is increasingly geared to technologically-intensive activities and that technological assets are becoming more and more important for TNCs to maintain and enhance their competitiveness. Much of the increase has taken place in developed countries where royalty payments and receipts have risen faster than FDI flows. These countries accounted for 88 per cent of payments and 98 per cent of receipts of cross-border flows of royalties and licence fees world-wide in 1997.
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That manifest themselves differently in different regions

With the exception of data on FDI (one source of finance for international production), comprehensive data on the global dimensions of international production are not available. Judging from the growth in FDI inflows and outflows (figure 4) as well as in other variables related to the activities of foreign affiliates, however, more and more firms engage increasingly in international production. In 1998, despite adverse economic conditions such as the financial crisis and ensuing recession in several Asian countries, the financial and economic crisis in the Russian Federation and the repercussions of these crises in some Latin American countries, declining world growth, trade, and commodity prices, and reduced bank lending, portfolio investment and privatization activity, FDI inflows increased by 39 per cent globally, the highest rate since 1987.

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Driven by M&As, FDI flows to developed countries register an impressive increase

Record FDI inflows into, and outflows from, developed countries are behind the 1998 surge in global FDI. Developed countries accounted for 92 per cent of global outflows and 72 per cent of global inflows in 1997. The developed country picture is characterized by an intensification of TNC-led links between the United States and the European Union, each of them being the largest source of FDI for the other, and by the emergence of Australia, Canada and Switzerland as significant FDI recipients. The cornerstone of the 1998 surge of FDI was, however, the marked growth of FDI flows into the United States and a few European countries, reflecting their solid economic fundamentals. Most new FDI in 1998, especially between the United States and the European Union, was in the form of M&As. In fact, crossborder M&As drove the large increases in both inflows and outflows for the United States and the strong FDI performance of the developed world as a whole. A new phenomenon is the growth of cross-border M&As in Japan.

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While the developing regions present a diverse picture. FDI flows into Latin America and the Caribbean rose

Despite the turbulence in financial markets, FDI flows into Latin America and the Caribbean in 1998 were more than $71 billion, a five per cent increase over those in 1997. The MERCOSUR countries received almost half of this amount. With more than $28 billion, Brazil was the largest recipient, followed by Mexico with $10 billion. As commodity prices fell sharply, portfolio investment dried up, speculative currency attacks multiplied and positive current account balances turned negative, FDI capital inflows served as a stabilizing force for Latin America and the Caribbean overall. Privatization of service or natural-resource state enterprises is still an important driving force of FDI inflows into Latin America and the Caribbean.

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Compensating partly for a moderate decline in Asia and the Pacific

Although down by 11 per cent to $85 billion in 1998, FDI flows to Asia and the Pacific appeared to have weathered the financial crisis that threw several Asian countries into turmoil and slashed growth rates. It proved to be the most resilient form of private capital flows, even in some of the countries directly hit by the crisis. Contributing to its resilience were the availability of cheap assets due inter alia to currency devaluations, FDI liberalization, especially as regards M&As, intensified efforts to attract FDI, and the still solid long-term prospects of the region.

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Africa is still awaiting the realization of its potential

FDI inflows to Africa (including South Africa) — at $8.3 billion in 1998 — were down from the record $9.4 billion registered in 1997 (figure 5). This was largely accounted for by a decrease of flows into South Africa where privatization-related FDI — which had reached an unprecedented peak in 1997 — fell back in 1998 to levels of previous years. The rest of the continent registered a modest increase. Overall, Africa benefited from a rise in inward FDI since the early 1990s, but growth in FDI flows to the region was much less than that in FDI flows to other developing countries, leaving much of Africa’s potential for FDI unutilized.

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And flows into Central and Eastern Europe, except the Russian Federation, reached new highs

Excluding the Russian Federation, Central and Eastern European countries received record FDI inflows of $16 billion in 1998 — 25 per cent higher than in 1997. The Russian Federation, plagued by low investor confidence, a stagnant privatization programme and dependence on market-oriented investment that suffered a blow from devaluation and economic uncertainty, received only $2 billion, 60 per cent less than in 1997. In most Central and Eastern European countries, FDI is still privatizationled, although a few countries have started a switch to nonprivatization-generated investment.

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The new competitive context raises new challenges for governments and TNCs

The development priorities of developing countries include achieving sustained income growth for their economies by raising investment rates, strengthening technological capacities and skills, and improving the competitiveness of their exports in world markets; distributing the benefits of growth equitably by creating more and better employment opportunities; and protecting and conserving the physical environment for future generations. The new, more competitive, context of a liberalizing and globalizing world economy in which economic activity takes place imposes considerable pressures on developing countries to upgrade their resources and capabilities if they are to achieve these objectives. This new global context is characterized by rapid advances in knowledge, shrinking economic space and rapid changes in competitive conditions, evolving attitudes and policies, and more vocal (and influential) stakeholders.

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And meeting them requires policy intervention

There is no conflict between exploiting static sources of comparative advantage and developing new, dynamic ones; existing advantages provide the means by which new advantages can be developed. A steady evolution from one to the other is the basis for sustained growth. What is needed is a policy framework to facilitate and accelerate the process: this is the essence of a competitiveness strategy. The need for such strategy does not disappear once growth accelerates, or economic development reaches a certain level; it merely changes its form and focus. This is why competitiveness remains a concern of governments in developing and developed countries alike.

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FDI comprises a package of resources

Most developing countries today consider FDI an important channel for obtaining access to resources for development. However, the economic effects of FDI are almost impossible to measure with precision. Each TNC represents a complex package of firm-level attributes that are dispersed in varying quantities and quality from one host country to another. These attributes are difficult to separate and quantify. Where their presence has widespread effects, measurement is even more difficult.

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The benefits of which can be reaped through policy measures

While the ultimate attraction for FDI lies in the economic base of a host country and FDI-attracting efforts by themselves cannot compensate for the lack of such a base, there remains a strong case for proactive policies to attract FDI. Countries may not be able to attract FDI in the volume and quality that they desire and that their economic base merits, for one or more of the following principal reasons:

  • High transaction costs. While most FDI regimes are converging on a similar set of rules and incentives, there remain large differences in how these rules are implemented. The FDI approval process can take several times longer, and entail costs many times greater in one country than in another with similar policies. After approval, the costs of setting up facilities, operating them, importing and exporting goods, paying taxes and generally dealing with the authorities can differ enormously.
  • Such costs can, other things being equal, affect significantly the competitive position of a host economy. An important part of a competitiveness strategy thus consists of reducing unnecessary, distorting and wasteful business costs, including, among others, administrative and bureaucratic costs. This affects both local and foreign enterprises. However, foreign investors have a much wider set of options before them, and are able to compare transaction costs in different countries. Thus, attracting TNCs requires not just that transaction costs be lowered, but also, increasingly, that they be benchmarked against those of competing host countries. One important measure that many countries take to ensure that international investors face minimal costs is to set up one-stop promotion agencies able to guide and assist them in getting necessary approvals. However, unless the agencies have the authority needed to provide truly one-stop services, and unless the rules themselves are clear and straightforward, this may not help.
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That also minimize the adverse effects on domestic enterprise development

Domestic enterprise development is a priority for all developing countries. In this regard, the possible ”crowding out” of domestic firms by foreign affiliates is frequently an issue of concern. Crowding out due to FDI could occur in two ways: first, in the product market, by adversely affecting learning and growth by local firms in competing activities; second, in financial or other factor markets, by reducing the availability of finance or other factors, or raising costs for local firms, or both.

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Positive dynamic FDI effects on host countries require appropriate skills and policies

Many important issues concerning the benefits of FDI for technology acquisition and technological capacity-building, skills development and competitiveness revolve around its static versus dynamic effects. TNCs can be efficient vehicles for the transfer of technologies and skills suited to existing factor endowments in host economies. They provide technology at very different levels of scale and complexity in different locations, depending on market orientation and size, labour skills available, technical capabilities and supplier networks. Where the trade regime in host (and home) countries is conducive (and infrastructure is adequate), they can use local endowments effectively to expand exports from host countries. This can create new capabilities in the host economies and can have beneficial spillover effects.

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As well as strong bargaining capabilities, regulatory regimes and policy-making capacity

In some cases, the outcome of FDI depends significantly on how well a host economy bargains with international investors. However, the capacity of developing host countries to negotiate with TNCs is often limited. The negotiating skills and information available to TNCs tend to be of better quality. With growing competition for TNC resources, the need of many developing countries for the assets TNCs possess is often more acute than the need of TNCs for the locational advantages offered by a specific country. In many cases, particularly in export-oriented investment projects where natural resources are not a prime consideration, TNCs have several alternative locations. Host countries may also have alternative foreign investors, but they are often unaware of them. Where the outcome of an FDI project depends on astute bargaining, developing host countries may sometimes do rather poorly compared to TNCs.

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