Investment inflows in 1995 increased by 40 per cent, to an unprecedented $315 billion. Developed countries were the key force behind the record FDI flows, investing $270 billion (an increase of 42 per cent over 1994) and receiving $203 billion (53 per cent higher) (table 1). The spectacular growth of FDI among developed countries was accompanied by a hefty rise in flows into developing countries, which, at $100 billion, set another record in 1995; outward investment from developing countries also rose, reaching $47 billion. Investment flows to Central and Eastern Europe nearly doubled to $12 billion in 1995, after stagnating in 1994. Investment flows are concentrated in a few countries. The ten largest host countries received two thirds of total inflows in 1995 and the smallest 100 recipient countries received only 1 per cent.Read More
World Investment Report 1996
Investment, Trade and International Policy Arrangements
As part of the increasing globalization of economic activities, international production by transnational corporations is growing rapidly. The World Investment Report 1996 provides an analysis of current global and regional trends in international production and looks into the particular theme of the interrelationships between investment and trade. It is a topic of particular interest at this time, given negotiations and discussions on international frameworks for investment in various fora — a topic addressed in WIR 96 in some detail.
More particularly, WIR 96 deals with the following issues:
- What are global and regional trends as regards foreign direct investment and, in particular, such investments in infrastructure?
- What are the linkages between trade and foreign direct investment, their role in development and their implications for national policies, particularly in the context of the changing global environment?
- What are the current international arrangements governing foreign direct investment, the policy options for developing these further and the issues that need to be considered in this respect, especially with a view towards safeguarding development objectives?
In discussing these issues, WIR 96 hopes to contribute to a better understanding of the role of foreign direct investment in the world economy and to the current discussion on the future evolution of international arrangements for foreign direct investment.
Secretary-General of the United Nations
The latest surge in FDI flows reflects the fact that an increasing number of firms, including from developing countries, are becoming more active globally in response to competitive pressures, liberalization and the opening up of new areas for investment. These firms are once again using mergers and acquisitions (M&As) as a central corporate strategy for establishing production facilities abroad to protect, consolidate and advance their international competitiveness. The value of all cross-border M&A transactions (including those involving portfolio investments) doubled between 1988 and 1995, to $229 billion. The value of majority-held M&A transactions (excluding those involving portfolio investment and minority-held FDI) increased by 84 per cent in 1988-1995, to $135 billion.Read More
New investment opportunities in infrastructure, partly because of liberalization and deregulation and partly because governments turn more and more to foreign firms for capital and technology, have aided FDI to reach record levels. Infrastructure, especially communications, attracted FDI flows of around $7 billion annually in the early 1990s. This is but a fraction of the total investment requirements in infrastructure, much of which remains unmet. Investment outflows to infrastructure from the major home countries made up 3-5 per cent of their total outflows in 1995. In many countries, FDI flows account for less than 1 per cent of the gross fixed capital formation in infrastructure. For the United States, the largest outward investor, the shareof infrastructure industries in its outward FDI flows between 1992 and 1994 averaged 4.9 per cent a year. United States TNCs have invested $14 billion in infrastructure as of 1994, 2.3 per cent of its total outward stock. This share is small when compared with the share of FDI in infrastructure in 1940; then, more than a third of the United States FDI stock in Latin America was in infrastructure. Subsequent waves of nationalizations and expropriations, however, led to dramatic declines, a trend that has only recently begun to reverse.Read More
The world’s largest 100 TNCs (excluding banking and financial institutions), ranked by foreign assets, are all based in developed countries. They have roughly $1.4 trillion worth of assets abroad and account for around a third of the global FDI stock. That share has remained stable in the past five years. Royal Dutch Shell (United Kingdom/Netherlands) has topped the list of the top 100 TNCs every year since 1990 (table 3).Read More
The 50 largest TNCs based in developing countries, ranked by foreign assets, accounted for about 10 per cent of the combined outward FDI stock of firms in their countries of origin. These firms’ ratio of foreign to total sales is high (30 per cent), but their ratio of foreign to total assets (9 per cent) is low. Their overall index of transnationality (21 per cent) is low, compared with that of the world’s top 100 TNCs (42 per cent), reflecting their short history as important outward investors; but their plans for expansion suggest that they will become increasingly more transnational. In 1994, Daewoo (Republic of Korea) ranked first among the 50 largest TNCs from developing countries on the basis of the ratio of foreign to total assets (table 4).Read More
Almost 90 per cent of the 1995 increases in FDI inflows (and outflows) were registered by developed countries. Because of this, the share of developed countries in world inflows increased from 59 per cent in 1994 to 65 per cent in 1995, while outflows rose from 83 to 85 per cent. The growth of developed country FDI was led by a few countries — the United States, United Kingdom, France and Australia, in that order, in the case of inflows, and the United States, United Kingdom and Germany, in that order, in the case of outflows. With large increases in inflows and outflows in 1995, the United States strengthened its position as the largest host and home country. With $60 billion, United States inflows were twice that of the United Kingdom, the second largest recipient among developed countries.Read More
The current boom in FDI flows to developing countries, with inflows reaching $100 billion in 1995, is a reflection of sustained economic growth and continuing liberalization and privatization in these countries, as well as their increasing integration into the investment plans of TNCs. The share of developing countries in the combined outflows of the largest five developed-country outward investors rose from 18 per cent in 1990-1992 to 28 per cent in 1993-1994. Investment from developing countries to other developing countries is also increasing: in 1994, for example, more than half of the FDI flows from Asian developing countries were invested in the same region. South, East and South-East Asia continued to be the largest host developing region, with an estimated $65 billion of inflows in 1995, accounting for two thirds of all developing-country FDI inflows.Read More
Latin America and the Caribbean saw a 5 per cent increase of FDI inflows to $27 billion in 1995. Most, however, was concentrated in individual industries (automobiles in Mexico and Brazil, natural resources in Chile) or privatization-induced (in Argentina and Peru). Investment flows in Latin American countries are therefore susceptible to special circumstances in those industries or to privatization policies. Especially at the country level, investment flows are prone to wide year-toyear fluctuations which makes them “lumpy”. Argentina, Peru and Venezuela provide illustrations of lumpiness in FDI: when some large companies were privatized in the early 1990s, investment inflows soared. In the following years, however, they fell considerably, which was only partially offset by post-privatization investments.Read More
The FDI stock in Africa doubled between 1985 and 1995. Inflows to Africa, however, have not been rising as rapidly as inflows to other regions. In 1995, they were almost the same as in 1994 — $5 billion. The share of Africa in developing-country inflows therefore fell to 4.7 per cent in 1995 (from 5.8 per cent in 1994). But within Africa, there have been significant changes in the geographic pattern of FDI. In the 1980s, southern Africa accounted for more than 40 per cent of Africa’s FDI stock, but its importance has diminished substantially since, and by 1993 it accounted for about a quarter of Africa’s stock. In contrast, North African countries, which in 1980 accounted for a mere 12 per cent of total stock in Africa, have substantially improved their position, accounting for more than 30 per cent by 1993, due mainly to the rising levels of European investments. Investors from the developed countries have displayed uneven interest in Africa.Read More
Driven not only by waves of privatizations, but by economic recovery in some countries (Poland and the Czech Republic), FDI inflows to Central and Eastern Europe have soared to record levels. Having remained stagnant in 1994, inflows almost doubled in 1995, to reach an estimated $12 billion. The region accounted for 5 per cent of world inflows in 1995, compared with only 1 per cent in 1991. Hungary and the Czech Republic accounted for about two thirds of the increase in 1995, with inflows tripling to $3.5 billion and $2.5 billion, respectively. The 1995 FDI flows into the Russian Federation at an estimated $2 billion were double the 1994 level.Read More
Foreign direct investment and trade are of importance for economic performance, growth and development. They are, moreover, increasingly interrelated. These inter-linkages are important for several reasons:
- The role of trade as a positive factor in growth and development has long been recognized and reflected in trade policies. Foreign direct investment, as the principal method of delivering goods and services to foreign markets and the principal factor in the organization of international production, increasingly influences the size, direction and composition of world trade, as do FDI policies.
- The role of FDI as a positive factor in growth and development is being increasingly appreciated and is also increasingly reflected in FDI policies. Trade and trade policies can exert various influences on the size, direction and composition of FDI flows.
- Apart from the autonomous impacts of each on growth and development, interlinkages between trade and FDI must be taken into account if the developmental contribution of each is to be maximized, and if synergies between the two and broader growth and development objectives are to be maximized.
Historically, the relationship between FDI and trade for a given product has been characterized by a linear, step-by-step sequential process of internationalization, running from trade to FDI or from FDI to trade. In manufacturing, market-seeking firms typically begin with domestic production and sales. They internationalize via exports, licensing and other contractual arrangements and by establishing foreign trading affiliates before they engage in FDI. As a result of this linear sequence, FDI in manufacturing is often viewed as an activity replacing trade. This perception has been strengthened, moreover, by the notion of a product cycle in which FDI takes place only when an innovating firm no longer finds exporting as profitable as producing abroad.Read More
Apart from product-specific FDI and trade impacts of sequential trade-FDI interlinkages, there are also impacts from associated trade and associated FDI. The former include, for example, additions to exports of the home country due to intra-firm sales of services and intangible assets by parent firms to foreign affiliates, whether in manufacturing, natural resources or services. They also include additions to home country exports due to intra-firm sales of machinery and intermediate products by parent firms to their foreign affiliates. Similar exports from the parent firm occur in low cost inputseeking manufacturing FDI and in natural resource FDI. In addition, there could be further effects on trade due to exports by other firms in the same or other industries (or even sectors) of goods and services required by foreign affiliates. Foreign affiliates in the services sector may also have an indirect impact on trade, as they may create demand for machinery and equipment necessary and/or for information-intensive support services provided either by headquarters personnel or services provided via communication lines.Read More
The overall impact of market-seeking direct investment on the volume and composition of trade of a home or host country at the industry or aggregate level depends on the relative importance of these various direct and indirect effects. In general, FDI that follows trade can replace trade in a single product, but it is unlikely to do so — and, in fact, is often complementary to trade — at the sectoral and national levels. Some empirical studies suggest, indeed, that the trade-creating effect of FDI in manufacturing tends to outweigh the trade-replacing effect for the home country. Moreover, FDI seems to shift the composition of home country exports to host countries towards intermediate products and away from final products. In natural resources, the impact of the FDI trade linkage was, and still is, trade creating.Read More
The linear interrelationship between trade and investment continues to characterize a good part of FDI. But something new is happening. In the past 30 years or so, and particularly since the mid- 1980s, the environment for FDI and trade has changed significantly. The most important changes relate to the reduction of technological and policy-related barriers to the movement of goods, services, capital, professional and skilled workers, and firms. More specifically, technological developments have greatly enhanced the ease with which goods, services, intangible assets and people can be transported, and tasks related to the organization and management of firms implemented over distances. The liberalization of rules and regulations governing trade, investment and technology flows has meant that the new possibilities created by technology can actually be realized. As a result, international production has grown substantially, as many firms have become TNCs.Read More
The principal effect of the new environment is that firms are freer to choose how to serve foreign markets: by producing at home and exporting, by producing in a foreign country for local sale, or by producing in a foreign country for export. They also have greater freedom to obtain foreign resources and inputs for production by importing them from foreign producers or by establishing production facilities that enable them to access resources where they are located, for producing raw, intermediate or final products for use elsewhere or sale in national, regional or global markets.Read More
But the changes brought about by the new environment go further. As firms seize new regional and global opportunities, they combine ownership advantages with the locational advantages of host countries, and so strengthen their own competitive positions. With this purpose in view, firms — particularly those that are already TNCs — are increasingly organizing or reorganizing their crossborder production activities in an efficiency-oriented, integrated fashion, capitalizing on the tangible and intangible assets available throughout the corporate system. In the resulting international division of labour within firms, any part of the value-added chain can be located wherever it contributes most to a company’s overall performance. As a result, the simple, sequential relationship characteristic of TNCs in manufacturing gives way to a more complex relationship, in which intra-firm trade flows between parent firms and affiliates and among affiliates assume considerable and increasing importance.Read More
The decision to locate any part of the value-added chain wherever it is best for a firm — be it transnational or national — to convert global inputs into outputs for global markets means that FDI and trade flows are determined simultaneously. They are both immediate consequences of the same locational decision. As a result, the issue is no longer whether trade leads to FDI or FDI to trade; whether FDI substitutes for trade or trade substitutes for FDI; or whether they complement each other.Read More
Reduced obstacles to trade and FDI and the possibilities that they open up for TNCs to disperse production activities within integrated international production systems create new opportunities for countries. The challenge is to attract FDI and then to maximize the benefits associated with it in order to realize the opportunities arising from the new environment.Read More
The intertwining of FDI and trade presents new challenges for national policy makers. The need for coordinated policy approaches acquires greater importance with the emergence of integrated international production systems, as investment and trade flows are the life-blood of such systems. Transnational corporations internally integrate the trade and investment functions that most national governments still tend to view and address separately, sometimes creating a disjuncture between national policy instruments and integrated corporate transactions.Read More
Foreign direct investment and trade are inextricably intertwined, both at the microeconomic level of firms’ strategies and operations and at the macroeconomic level of national economies. They contribute not only individually and directly to the development process, but also jointly and indirectly, through linkages with one another. Governments are increasingly establishing national policy frameworks to create a framework within which FDI and trade can flourish, knowing full well that, once an appropriate enabling framework is created, other factors determine FDI and trade flows.Read More
At the bilateral level, key investment concepts, principles and standards have been developed through the conclusion of treaties for the protection and promotion of FDI (bilateral investment treaties or BITs). Their distinctive feature is their exclusive concern with investment. Introduced years ago, these treaties have remained virtually unchanged in their format, and the issues they address continue to be among the most important for investors. They contain mostly general standards of treatment after entry and establishment and specific protection standards on particular key issues. As far as development is concerned, BITs emphasize the importance of FDI for development and therefore seek to promote it; they generally recognize the effect of national laws and policies on FDI; and they contain various exceptions or qualifications, e.g., exceptions for balance-of-payments considerations in relation to the principle of free transfer of funds.Read More
At the regional level, the mix of investment issues covered is broader than that found at the bilateral level, and the operational approaches to deal with them are less uniform. This reflects, among other things, differences in interests and needs, levels of development, perspectives of future development and that investment issues are typically only one of the issues covered in a regional agreement. Most regional instruments are legally binding, although there are exceptions and the definition of investment varies considerably, depending on the purpose and context of an agreement.Read More
At the multilateral level, most agreements relate to sectoral or to specific issues, moving in on central FDI concerns from the outside. Particularly important among them are services, performance requirements, intellectual property rights, insurance, settlement of disputes and employment and labour relations. Attention is also being paid to restrictive business practices, competition policy, incentives and consumer protection. It is at the multilateral level that concern for development is most apparent. This is particularly so in the case of the GATS, TRIPS and TRIMs agreements, as well as the (non-binding) Restrictive Business Practices Set, where special provisions are made that explicitly recognize the needs of developing countries.Read More
In the 1980s, the earlier post-war approaches to investment, which often stressed restrictions, controls and conditions on entry and establishment of FDI, were reversed, mainly as a result of the debt crisis (which made FDI a more desirable alternative to bank lending) and of the changing perceptions of the role that FDI can play in growth and development. As a result, laws and policies in many developing countries began to change dramatically in the direction of liberalization, protection and promotion of FDI. Liberalization also expanded and deepened in developed countries. These changes are now being reflected in regional instruments, and in sectoral or issue-specific multilateral agreements.Read More
With the growing appreciation of the role of FDI in development and the convergence of national attitudes in favour of market-oriented policies, some issues have moved from the national to the international arena and have become standard substantive items in international discussions on FDI (even though the extent to which these are at present incorporated in specific international instruments varies considerably, as does the strength with which they are addressed).Read More
Regarding the functional characteristics of present arrangements, there are, with many variations, also some common features. Thus, restrictions are eliminated gradually (in the case of the OECD, for example, it took 25 years from the adoption of the Liberalisation Codes until the right of establishment was confirmed). Transparency is increased through the reporting of investment measures and relevant normative changes and monitoring, follow-up and dispute-settlement mechanisms of varying degrees of strength and binding force are set up. A key lesson from these functional approaches is that implementing and strengthening standards is a lengthy process. But it may well be that globalization pressures and changing corporate strategies will require faster normative responsiveness in the future.Read More
The Uruguay Round of Multilateral Trade Negotiations was the first time that some investment issues were directly introduced as part of the disciplines of the multilateral trading system. This occurred most markedly in the negotiations of GATS which defines trade in services as including the provision of services through commercial presence. The TRIMs Agreement, in fact, focuses on one aspect of the policy interrelationship between trade and investment (performance requirements). Possible future work on investment and competition may lead to even deeper policy integration. A major question is the extent to which this new trend should be accommodated through the development of concepts designed to capture the relationships between investment and trade.Read More
It was observed earlier that, for international agreements to be effective and stable, they need to take into account the interests of all parties, incorporate a balance of interests and allow for common advantage. This applies particularly to developing countries and, more generally, to agreements between countries at different levels of development. In particular, any agreement involving developed and developing countries must take into account the special importance of development policies and objectives. The development dimension can be addressed in international investment accords at all levels and in several ways.Read More
For analytical purposes, two basic approaches, two ideal types, regarding the further evolution of international arrangements for FDI can be distinguished. One approach involves allowing current arrangements to evolve organically, while improving them actively by deepening and expanding them, as appropriate. The overarching rationale for this approach is that current arrangements are working well in providing an enabling framework that allows FDI to contribute to growth and development and are supporting high and growing volumes of FDI. Moreover, such arrangements allow for groups of countries to enter into agreements having the degree of “strength” that is suitable to their circumstances.Read More
Another approach involves the construction, through negotiation, of a comprehensive multilateral framework for FDI. The overarching rationale for this approach is that the globalization of business, increased volumes and the growing importance of FDI, intertwined of FDI and trade and the emergence of an integrated international production system require a similarly global policy framework. In brief, in this view a global economy requires a global policy approach to create a stable, predictable and transparent enabling framework for FDI.Read More
These two policy approaches have been presented for expositional purposes as stylized alternatives, to highlight differences, even at the risk of oversimplification. In reality, even the proponents of each option seldom make such a clear distinction. Those in favour of an approach that allows current arrangements to evolve organically include a diverse range of governments; their support for this approach, however, does not necessarily preclude support for an eventual multilateral framework. Conversely, governments seeking a comprehensive multilateral framework are actively strengthening bilateral, regional, interregional and specific multilateral agreements on FDI. There appears, indeed, to be a consensus that greater international cooperation on FDI issues is desirable. This underlying consensus is reflected in both of the policy approaches. The differences among governments and others in their support for either of the above options — or some combination of the two — lie more in their opinions on how best to achieve greater cooperation. In this perspective, the two approaches can be seen as coexisting and, indeed, developing in a complementary manner.Read More
Since the further development of international FDI arrangements is being pursued at all levels, it is important to identify and analyse issues that need to be considered, especially with a view towards their implications for development. An examination of investment instruments provides a list of key issues that could reasonably be expected to be addressed:
- Scope. In any instrument on FDI, the forms and types of transactions and operations to which it applies need to be determined.
- Investment measures that affect entry and operations of foreign investors. Particularly relevant are issues relating to admission and establishment, ownership and control, operations, incentives and investment-related trade measures.
- Application, with respect to FDI, of certain standards of treatment. Particularly relevant are issues of national treatment, most-favoured-nation treatment, and fair and equitable treatment.
Because the activities of TNCs have such pervasive consequences for the development prospects of all countries, and in particular those of developing countries and economies in transition, any international arrangement involving the latter groups of countries has to be particularly sensitive to development needs. Broadly speaking, the development objective needs to be:
- safeguarded by allowing countries in need of a transition period — through exclusions, exemptions and temporary measures — the time to adjust to more stringent standards of investment liberalization, it being recognized that many developing countries have already gone far on their own initiative;
- advanced by agreeing that developing countries can take appropriate measures to increase the benefits that they can reap from FDI, without infringing on the essential interests of foreign investors;
- supported by home country governments committing themselves to help developing countries attract FDI, in particular FDI that is most consonant with their development needs (e.g., because it embodies appropriate technology or is export-oriented). Governments of home countries can promote FDI flows to developing countries, e.g., through the provision of information and technical assistance; direct financial support and fiscal incentives; and investment insurance and tax-sparing provisions. While many home countries have already many measures in place in this respect, and some international instruments address this issue, not all do, and those that do, can be strengthened.
Investment issues are currently the subject of discussion or negotiation in a number of regional and interregional fora. One important recent initiative was the launching, in May 1995, of negotiations aimed at the conclusion of a Multilateral Agreement on Investment among the members of the OECD in time for the Organization’s ministerial meeting in 1997. The main aim of these negotiations is to eliminate discrimination between foreign and domestic investors. The agreement is intended to provide a broad framework for international investment, with high standards for the liberalization of investment regimes and the protection of investment, and with effective disputesettlement procedures.Read More
Although multilateral rules on FDI could be established in an independent agreement, recent proposals aim at the negotiation of such rules in the framework of international organizations with global, or potentially global, membership. In particular, the WTO has been mentioned as an appropriate forum for such negotiations. An important consideration underlying this suggestion is that the intertwining of investment and trade requires a more integrated approach to international rulemaking.Read More