Foreign Direct Investment for Development:

Making Globalisation Work for the Poor

Presentation given at the International House of Japan, Tokyo,

18 October 2002

Hans Christiansen
Principal Economist, Division for International Investment and Multinational
Enterprises, OECD
hans.christiansen@oecd.org

1
 Developing countries’ share of global FDI inflows

45

40

35

30

25
Africa
20 Asia
Latin America
15

10

0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

2
 Largest developing country recipients of FDI

China

Mexico

Hong Kong

Brazil

Poland

Singapore

South Africa

Chile

0 5 10 15 20 25 30 35 40 45 50
bn. US$

3
 Inward FDI positions relative to GDP

South and East Asia (*)

Latin America

Africa

North America

Western Europe

World

0 5 10 15 20 25 30 35 40
(*) Excluding Japan

4
 Inward FDI positions of selected Asian countries

Singapore

Malaysia

Vietnam

Indonesia

China

Thailand

Korea

India

0 20 40 60 80 100 120
Per cent of GDP

5
 Japan’s outward FDI 1992-2001: by main regions

Others
1%0%
0%
Asia (*)
19%

Latin America (*)

11%

OECD area
69%

6
 FDI from Japan to selected developing countries

500000
450000
400000
350000
300000 China
250000 Indonesia
200000 Singapore
Thailand
150000
Brazil
100000
50000
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Million Yen

7
Does it matter if direct investment is “foreign”?
What’s the difference?

8
 Does it matter if direct investment is “foreign”?
What’s the difference?

Q Some countries have insufficient domestic savings and little recourse to

foreign borrowing. Others have sufficient funds, but weak domestic
credit intermediation.

9
 Does it matter if direct investment is “foreign”?
What’s the difference?

Q Some countries have insufficient domestic savings and little recourse to

foreign borrowing. Others have sufficient funds, but weak domestic
credit intermediation.

Q Other countries have ample access to borrowed funds, but prefer to

rely on a degree of equity finance. FDI is a more stable source of
external finance than most.

10
 Comparing the volatility of FDI and portfolio investment
(over the last decade)
12

10

8
Coefficient of Variation

FDI
6
Portfolio

0
Argentina Brazil Estonia Indonesia Mexico Morocco Pakistan Philippines Thailand Venezuela

11
 Does it matter if direct investment is “foreign”?
What’s the difference?

Q Some countries have insufficient domestic savings and little recourse to

foreign borrowing. Others have sufficient funds, but weak domestic
credit intermediation.

Q Other countries have ample access to borrowed funds, but prefer to

rely on a degree of equity finance. FDI is a more stable source of
external finance than most.

Q All countries can potentially benefit from foreign corporate presence in

their business sector. The benefits are both direct and indirect. They
occur via three separate channels.

12
The Benefits (and Costs) of FDI for Development: Main Channels

Economic growth (and factor productivity):

Q Integration in international trade. The question is not trade OR

investment. The two reinforce each other.

Q Spillovers due to foreign corporate presence. This includes

technology diffusion and human capital development.

Q Direct impact on corporate efficiency. Competition may be

affected both positively and negatively by foreign entry. The
effect on enterprise development and restructuring is
consistently positive.

13
 FDI and host country integration into international trade

Q Foreign trade and FDI are complementary. In the longer run, increasing
inward investment boosts exports as well as imports.

Q The benefits of FDI are therefore equivalent with the ones that arise from
increased openness to trade.

Q Countries may exploit this through reliance on special entities such as

export processing zones. However, this comes at a non-trivial cost.

Q Policies aimed at harnessing FDI as a tool for limiting imports or boosting

exports have not been generally successful.

14
 Openness to trade and FDI

9
Ave ra g e o f in w a rd a n d o u tw a rd F D I re la tive to G D P (1 9 9 5 -

7 Sweden B.L.E.U.
Netherlands
6

5 U.K.
Switzerland
2001)

4
France Canada
3 Germany
U.S. Spain
2
Australia
Korea
Japan Italy

0
0 10 20 30 40 50 60 70

Average of export and import relative to GDP (1995-2001)

15
 Foreign corporate presence and spillovers to the host economy

Q Technology may be transferred or emulated locally…

– Vertical linkages with suppliers
– Horisontal linkages with competing or complementary companies
– Migration of skilled labour
– Internationalisation of R&D
Q …but not all foreign technologies are equally relevant.
Q Human capital spillovers are common, but not often decisive
– Foreign-owned enterprises offer more training, but the training if often
not widely applicable.
– Demonstration effects vis-à-vis local authorities.
– Migration of managers.
Q Human capital and technology levels are interrelated…
Q …and they are both contingent upon the presence of certain minimum
thresholds in the host economy.

16
 FDI and efficiency gains: competition and enterprise restructuring

Q Market concentration has increased significantly in response to M&As…

Q …but this does not necessarily imply that competition suffers...
Q …especially not where the appropriate (foreign trade, anti-trust) policies
are in place.

Q Foreign-orchestrated takeovers generally result in better management and

corporate governance practices…
Q …and efficiency gains more generally, especially in sectors with
economies of scale.
Q Foreign participation in privatisation has generally been successful, but
often also politically controversial.

17
 Environmental and social concerns

Q MNEs are well placed to apply environmentally sound practices, and they
generally obey host country laws and regulations…
Q …but they have little incentive to take the lead. Appropriate domestic
regulation is hence very important.

Q There is very little systematic evidence of “pollution havens” and “race to

the bottom”…
Q …whereas some anecdotal evidence remains subject to dispute.

Q FDI generally helps raising social standards in the host country…

Q …and there are signs of a positive correlation between FDI and core labour
standards…
Q …but some controversy continues to surround export processing zones.

18
 Poverty and inward FDI stock (in 60 developing countries)

80

70
Share of population living below 1 USD per day

60

50

40

30

20

10

0
0 5 10 15 20 25 30 35 40 45 50
FDI stock as percentage of GDP, 1995

19
 Poverty and inward FDI stock (in 60 developing countries)

80

70
Share of population living below 1 USD per day

60

50

40

30

20

10

0
0 5 10 15 20 25 30 35 40 45 50
FDI stock as percentage of GDP, 1995

20
 What may host countries do about it?

Overall: Every aspect of host countries’ economic and governance practices

affects the investment climate. The following policy action toward
macroeconomic stability and institutional predictability should be priority:

Q Pursue sound macroeconomic policies geared to sustained high economic

growth and employment, price stability and sustainable external accounts.

Q Promote medium-term fiscal discipline, efficient and socially just tax

systems and prudent public-sector debt management.

Q Strengthen domestic financial systems in order to make domestic financial

resources available to supplement and complement foreign investment.

21
 What may host countries do about it?

Investment climate: FDI is unlikely unless investors have a reasonable

understanding of the environment in which they will be operating. Moreover,
foreign-owned enterprises need to be able to deal with domestic business
sector as well as related enterprises abroad in a fair and rational manner.
Authorities need to consider the following challenges:

Q Strengthen ongoing efforts to consolidate the rule of law and good

governance.

Q Work toward increased openness to foreign trade so that the domestic

enterprise sector can participate fully in the global economy.

Q Enshrine the principle of non-discrimination in national legislation and

implement procedures to enforce it through all levels of government and
public administration.

22
 Attracting FDI: Relative Importance of Key Factors

Q Confidence in the rule of law

Q Quality of macroeconomic environment
Q Political stability
Q Quality and clarity of business legislation
Q Sector/industry specifics
Q Administrative burden
Q Social coherence and infrastructure
Q Local labour market conditions
Q Social network (e.g. for expatriates)
Q Business infrastructure

23
 Attracting FDI: Relative importance of key factors

Q Confidence in the rule of law

Q Quality of macroeconomic environment
Q Political stability
Q Quality and clarity of business legislation
Q Sector/industry specifics
Q Administrative burden
Q Social coherence and infrastructure
Q Local labour market conditions
Q Social network (e.g. for expatriates)
Q Business infrastructure

24
 Inward FDI and the quality of institutional governance

1,00

0,90
R2 = 0,4492
0,80

0,70
Institutional Governance

0,60

0,50

0,40

0,30

0,20

0,10

0,00
0 10 000 20 000 30 000 40 000 50 000 60 000
FDI inflows, 1995-2000 ($ million)

25
 What may host countries do about it?

Investment climate: FDI is unlikely unless investors have a reasonable

understanding of the environment in which they will be operating. Moreover,
foreign-owned enterprises need to be able to deal with domestic business
sector as well as related enterprises abroad in a fair and rational manner.
Authorities need to consider the following challenges:

Q Strengthen ongoing efforts to consolidate the rule of law and good

governance.

Q Work toward increased openness to foreign trade so that the domestic

enterprise sector can participate fully in the global economy.

Q Enshrine the principle of non-discrimination in national legislation and

implement procedures to enforce it through all levels of government and
public administration.

26
 What may host countries do about it?

Encouraging spillovers: Domestic competences, technologies and

infrastructures need to be sufficiently well developed to allow nationals to
take full advantage of the spillovers foreign-owned generate. Hence, host
country authorities should consider undertaking certain measures:

Q Put in place, and raise the quality of, relevant physical and technological
infrastructure.

Q Raise the basic level of education of national workforces.

Q Implement internationally agreed standards in areas such as child labour,

workplace discrimination and impediments to collective bargaining.

27