World Investment Report 2005

Key Messages

Led by developing countries, global FDI flows resumed growth in 2004

On account of a strong increase in foreign direct investment (FDI) flows to developing countries, 2004 saw a slight rebound in global FDI after three years of declining flows. At $648 billion, world FDI inflows were 2% higher in 2004 than in 2003. Inflows to developing countries surged by 40%, to $233 billion, but developed countries as a group experienced a 14% drop in their inward FDI. As a result, the share of developing countries in world FDI inflows was 36% (table 1), the highest level since 1997. The United States retained its position as the number one recipient of FDI, followed by the United Kingdom and China.

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With the Asia and Oceania region the largest recipient as well as source of FDI among developing countries

The upturn in global FDI was marked by significant differences between countries and regions (figure 2 and table 1). Asia and Oceania (for definition, see box 1) was again the top destination of FDI flows to developing regions. It attracted $148 billion of FDI, $46 billion more than in 2003, marking the largest increase ever. East Asia saw a 46% increase in inflows, to reach $105 billion, driven largely by a significant increase in flows to Hong Kong (China). In South-East Asia, FDI surged by 48% to $26 billion, while South Asia, with India at the forefront, received $7 billion, corresponding to a 30% rise. FDI inflows to West Asia grew even more, rising from $6.5 billion to $9.8 billion, of which more than half was concentrated in Saudi Arabia, the Syrian Arab Republic and Turkey. China continued to be the largest developing-country recipient with $61 billion in FDI inflows.

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FDI rebounded in Latin America following four years of decline

Following four years of continuous decline, FDI flows to Latin America and the Caribbean registered a significant upsurge in 2004, reaching $68 billion — 44% above the level attained in 2003. Economic recovery in the region, stronger growth in the world economy and higher commodity prices were contributing factors. Brazil and Mexico were the largest recipients, with inflows of $18 billion and $17 billion respectively. Together with Chile and Argentina they accounted for two-thirds of all FDI flows into the region in 2004. However, FDI inflows did not increase in all the countries of Latin America. There were notable declines in Bolivia and Venezuela, mainly linked to uncertainty regarding legislation related to oil and gas production. In Ecuador the completion of the crude oil pipeline construction explained the decrease in FDI inflows. A number of countries modified their legislation and tax regimes to increase the State’s share in revenues from non-renewable natural resources. It is still too early to assess the impact of these changes on the volume of FDI. Significant projects remain under development and additional ones were announced during 2004.

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Remained stable in Africa

FDI flows to Africa remained at almost the same level — $18 billion — as in 2003. FDI in natural resources was particularly strong, reflecting the high prices of minerals and oil and the increased profitability of investment in the primary sector. High and rising prices of petroleum, metals and minerals induced TNCs to maintain relatively high levels of investment in new exploration projects or to escalate existing production. Several large cross-border M&As were concluded in the mining industry last year. Despite these developments Africa’s share in FDI flows worldwide remains low, at 3%.

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And increased in South-East Europe and the CIS for the fourth consecutive year

FDI inflows to South-East Europe and the CIS, a new group of conomies under the United Nations reclassification (box 1), recorded a fourth year of growth in 2004, reaching an all-time high of $35 billion. This was the only region to escape the three-year decline (2001-2003) in world FDI flows, and it maintained robust growth in inward FDI in 2004 (more than 40%). Trends in inward FDI to the two subregions have differed somewhat, however, reflecting the influence of various factors. In South-East Europe, FDI inflows started to grow only in 2003. Led by large privatization deals, these inflows nearly tripled, to $11 billion in 2004. In the CIS, inflows grew from $5 billion in 2000 to $24 billion in 2004, benefiting largely from the high prices of petroleum and natural gas. The Russian Federation is the largest recipient of FDI inflows in the region.

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By contrast, FDI inflows to developed countries continued to decline

FDI flows into developed countries, which now include the 10 new EU members (see box 1), fell to $380 billion in 2004. The decline was less sharp than in 2003, possibly suggesting a bottoming out of the downward trend that started in 2001. The decline pertained to many major host countries in the developed world. However, there were some significant exceptions; the United States and the United Kingdom recorded substantial increases in inflows mainly as a result of cross-border M&As. Meanwhile, investment outflows from developed countries turned upwards again in 2004 to reach $637 billion.

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Further increases in FDI are expected

Prospects for FDI worldwide appear to be favourable for 2005. For 2006, global FDI flows can be expected to rise further if economic growth is consolidated and becomes more widespread, corporate restructuring takes hold, profit growth persists and the pursuit of new markets continues. The continued need of firms to improve their competitiveness by expanding into new markets, reducing costs and accessing natural resources and strategic assets abroad provides strong incentives for further FDI in developing countries in particular. Also, the improved profitability of TNCs is likely to trigger greater M&A activity, which should also push up the levels of FDI in developed countries.

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TNCs are internationalizing R&D, including in developing countries

WIR05 focuses on the internationalization of research and development (R&D) by TNCs. This is not a new phenomenon. When expanding internationally, firms have always needed to adapt technologies locally to sell successfully in host countries. In many cases, some internationalization of R&D has been necessary to accomplish this. However, it was traditionally the case that R&D was reserved for the home countries of the TNCs. By contrast, now a number of new features are emerging in the internationalization process. In particular, for the first time, TNCs are setting up R&D facilities outside developed countries that go beyond adaptation for local markets; increasingly, in some developing and South-East European and CIS countries, TNCs’ R&D is targeting global markets and is integrated into the core innovation efforts of TNCs.

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With important implications for innovation and development

Innovative activity is essential for economic growth and development. Moreover, sustainable economic development requires more than simply “opening up” and waiting for new technologies to flow in. It demands continuous technological effort by domestic enterprises, along with supportive government policies. With the increasing knowledgeintensity of production, the need to develop technological capabilities is growing. Greater openness to trade and capital flows does not reduce the imperative of local technological effort. On the contrary, liberalization, and the open market environment associated with it, have made it necessary for firms — be they large or small, in developed or developing countries — to acquire the technological and innovative capabilities needed to become or stay competitive.

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TNCs are the drivers of global R&D

Global R&D expenditure has grown rapidly over the past decade to reach some $677 billion in 2002. It is highly concentrated. The top ten countries by such expenditure, led by the United States, account for more than four-fifths of the world total. Only two developing countries (China and the Republic of Korea) feature among the top ten. However, the share of developed countries fell from 97% in 1991 to 91% in 2002, while that of developing Asia rose from 2% to 6%. Similarly, there has been a rise in innovation outputs (as measured by the number of patents issued). For example, between the two time periods of 1991-1993 and 2001-2003, the share of foreign patent applications from developing countries, South-East Europe and the CIS to the United States Patent and Trademark Office, jumped from 7% to 17%.

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Their R&D is growing particularly fast, though unevenly, in developing countries

The share of host developing countries in the global R&D systems of TNCs is rising, but unevenly. Only a few economies have attracted the bulk of the R&D activity. Developing Asia is the most dynamic recipient. In the case of R&D expenditures by majority-owned foreign affiliates of United States TNCs, for example, the share of developing Asia soared from 3% in 1994 to 10% in 2002. The increase was particularly noticeable for China, Singapore, Hong Kong (China) and Malaysia. In the foreign R&D activities of Swedish TNCs the share of countries outside the Triad more than doubled, from 2.5% in 1995 to 7% in 2003. Survey findings and other data for Germany and Japan support the growing importance of developing countries and some economies in transition as locations for TNCs’ R&D.

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And the type of R&;D undertaken varies by region

The R&D conducted in different locations varies considerably by region and economy. For example, in 2002, three-quarters of the R&D of United States majority-owned foreign affiliates in developing Asia were related to computers and electronic products, while in India over threequarters of their R&D expenditure went into services (notably related to software development). In Brazil and Mexico, chemicals and transport equipment together accounted for over half of all R&D by United States foreign affiliates.

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The process is driven by new push and pull factors, and is facilitated by enabling technologies and policies

The need to adapt products and processes to key host-country markets has always been an important motive for TNCs to internationalize R&D. The need to tap into knowledge centres abroad to source new technologies, recruit the best skills and monitor the activities of competitors is also well known in the literature. However, the recent surge of R&D by TNCs in selected developing host economies also reflects the quest for cost reduction and for accessing expanding pools of talent in these locations. It can be seen as a logical next step in the globalization of TNC production networks. It also resembles the international restructuring that has taken place in export-oriented manufacturing and ICT-based services through which TNCs seek to improve their competitiveness by exploiting the strengths of different locations.

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And has important implications for both host and home countries

The creation of knowledge is a driver of economic growth, but no single country can produce all the knowledge needed to stay competitive and to grow in a sustained manner. Countries are therefore eager to connect with international networks of innovation. Outward and inward FDI in R&D are two ways of doing so. R&D internationalization opens up new opportunities for developing countries to access technology, build highvalue-added products and services, develop new skills and foster a culture of innovation through spillovers to local firms and institutions. FDI in R&D can help countries strengthen their innovation systems and upgrade industrially and technologically, enabling them to perform more demanding functions, handle more advanced equipment and make more complex products.

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Appropriate policy responses are needed at the national level

Enterprises are the principal agents of innovation. However, they do not innovate and learn in isolation, but in interaction with competitors, suppliers and clients, with public research institutions, universities and other knowledge-creating bodies like standards and metrology institutes. The nature of these interactions, in turn, is shaped by the surrounding institutional framework. The complex web within which innovation occurs is commonly referred to as the “national innovation system”. Its strength can be influenced by government intervention.

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Taking developments at the international level into account

Policy-making at the national level also has to consider developments in international investment agreements at various levels. Many international agreements give special attention to investment in R&D activities. Key issues relate to the entry and establishment of R&D-related FDI, the treatment of R&D performance requirements (whether by restricting or explicitly permitting them), incentives encouraging investment in R&D activities, and the movement of key personnel.

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