The uncertain economic outlook led transnational corporations (TNCs) in developed countries to maintain their wait-and-see approach towards new investments or to divest foreign assets, rather than undertake major international expansion. In 2012, 22 of the 38 developed countries experienced a decline in outward FDI, leading to a 23 per cent overall decline.

Africa bucked the trend with a 5 per cent increase in FDI inflows to $50 billion. This growth was driven partly by FDI in extractive industries, but investment in consumer-oriented manufacturing and service industries is also expanding. FDI flows to developing Asia fell 7 per cent, to $407 billion, but remained at a high level. Driven by continued intraregional restructuring, lower-income countries such as Cambodia, Myanmar and Viet Nam are bright spots for labour-intensive FDI. In Latin America and the Caribbean, FDI inflows decreased 2 per cent to $244 billion due to a decline in Central America and the Caribbean. This decline was masked by an increase of 12 per cent in South America, where FDI inflows were a mix of natural-resource-seeking and market-seeking activity.

FDI inflows to least developed countries (LDCs) hit a record high, an increase led by developing-country TNCs, especially from India. A modest increase in FDI flows to landlocked developing countries (LLDCs) occurred, thanks to rising flows to African and Latin American LLDCs and several economies in Central Asia. FDI flows into small island developing States (SIDS) continued to recover for the second consecutive year, driven by investments in natural-resource-rich countries.

A slump in cross-border mergers and acquisitions (M&As) sales caused inward FDI flows to transition economies to fall by 9 per cent to $87 billion; $51 billion of this went to the Russian Federation, but a large part of it was “round-tripping”.

Most governments are keen to attract and facilitate foreign investment as a means for productive capacity-building and sustainable development. At the same time, numerous countries are reinforcing the regulatory environment for foreign investment, making more use of industrial policies in strategic sectors, tightening screening and monitoring procedures, and closely scrutinizing cross-border M&As. There is an ongoing risk that some of these measures are undertaken for protectionist purposes.

By the end of 2012, the regime of international investment agreements (IIAs) consisted of 3,196 treaties. Today, countries increasingly favour a regional over a bilateral approach to IIA rule making and take into account sustainable development elements. More than 1,300 of today’s 2,857 bilateral investment treaties (BITs) will have reached their “anytime termination phase” by the end of 2013, opening a window of opportunity to address inconsistencies and overlaps in the multi-faceted and multi-layered IIA regime, and to strengthen its development dimension.

This responds to the debate about the pros and cons of the investment arbitration regime, spurred by an increasing number of cases and persistent concerns about the regime’s systemic deficiencies. The five options for reform are: promoting alternative dispute resolution, modifying the existing ISDS system through individual IIAs, limiting investors’ access to ISDS, introducing an appeals facility and creating a standing international investment court. Collective efforts at the multilateral level can help develop a consensus on the preferred course of action.

Today’s global economy is characterized by global value chains (GVCs), in which intermediate goods and services are traded in fragmented and internationally dispersed production processes. GVCs are typically coordinated by TNCs, with cross-border trade of inputs and outputs taking place within their networks of affiliates, contractual partners and arm’s-length suppliers. TNC-coordinated GVCs account for some 80 per cent of global trade.

About 28 per cent or $5 trillion of the $19 trillion in global gross exports in 2010 – because intermediates are counted several times in world exports, but should be counted only once as “value added in trade”. Patterns of value added trade in GVCs determine the distribution of actual economic gains from trade between individual economies and are shaped to a significant extent by the investment decisions of TNCs. Countries with a greater presence of FDI relative to the size of their economies tend to have a higher level of participation in GVCs and to generate relatively more domestic value added from trade.

In developing countries, value added trade contributes nearly 30 per cent to countries’ GDP on average, as compared with 18 per cent in developed countries. And there is a positive correlation between participation in GVCs and growth rates of GDP per capita. GVCs have a direct economic impact on value added, jobs and income. They can also be an important avenue for developing countries to build productive capacity, including through technology dissemination and skill building, thus opening up opportunities for longer-term industrial upgrading.

The GDP contribution of GVCs can be limited if countries capture only a small share of the value added created in the chain. Also, technology dissemination, skill building and upgrading are not automatic. Developing countries face the risk of remaining locked into relatively low value added activities. In addition, environmental impacts and social effects, including on working conditions, occupational safety and health, and job security, can be negative. The potential “footlooseness” of GVC activities and increased vulnerability to external shocks pose further risks.

They need to carefully weigh the pros and cons of GVC participation and the costs and benefits of proactive policies to promote GVCs or GVC-led development strategies, in line with their specific situation and factor endowments. Some countries may decide not to promote it; others may not have a choice. In reality, most are already involved in GVCs to a degree. Promoting GVC participation implies targeting specific GVC segments; i.e. GVC promotion can be selective. Moreover, GVC participation is only one aspect of a country’s overall development strategy.

If countries decide to actively promote GVC participation, policymakers should first determine where their countries’ trade profiles and industrial capabilities stand and then evaluate realistic GVC development paths for strategic positioning. Gaining access to GVCs and realizing upgrading opportunities requires a structured approach that includes embedding GVCs in industrial development policies (e.g. targeting GVC tasks and activities); enabling GVC growth by creating a conducive environment for trade and investment and by putting in place infrastructural prerequisites; and building productive capacities in local firms and skills in the local workforce. To mitigate the risks involved in GVC participation, these efforts should take place within a strong environmental, social and governance framework, with strengthened regulation and enforcement and capacity-building support to local firms for compliance.

• Synergistic trade and investment policies and institutions. Trade and investment policies often work in silos. In the context of GVCs they can have unintended and counterproductive reciprocal effects. To avoid this, policymakers – where necessary, with the help of international organizations – should carefully review those policy instruments that simultaneously affect investment and trade in GVCs; i.e. trade measures affecting investment and investment measures affecting trade. Furthermore, at the institutional level, the trade and investment links in GVCs call for closer coordination and collaboration between trade and investment promotion agencies.
• “Regional industrial development compacts”. The relevance of regional value chains underscores the importance of regional cooperation. Regional industrial development compacts could encompass integrated regional trade and investment agreements focusing on liberalization and facilitation, and establishing joint trade and investment promotion mechanisms and institutions. They could also aim to create cross-border industrial clusters through joint financing for GVC-enabling infrastructure and joint productive capacity-building. Establishing such compacts requires working in partnership between governments in the region, between governments and international organizations, and between the public and private sectors.
• Sustainable export processing zones (EPZs). Sustainability is becoming an important factor for attracting GVC activities. EPZs have become significant GVC hubs by offering benefits to TNCs and suppliers in GVCs. They could also offer – in addition to or in lieu of some existing benefits – expanded support services for corporate social responsibility (CSR) efforts to become catalysts for CSR implementation. Policymakers could consider setting up relevant services, including technical assistance for certification and reporting, support on occupational safety and health issues, and recycling or alternative energy facilities, transforming EPZs into centres of excellence for sustainable business. International organizations can help through the establishment of benchmarks, exchanges of best practices and capacity-building programmes.