United Nations Conference on Trade and Developmentrade and Developmentrade and Developmentrade and Developmentrade and Development

World Investment Report 1999Foreign Direct Investment and the Challenge of Development United Nations New Y New York and Geneva, 1999 ork and Geneva, 1999... World Investment Report 1999

World Investment Report 1999

Foreign Direct Investment

and the Challenge of Development

United Nations

New Y

New York and Geneva, 1999 ork and Geneva, 1999

The term “country” as used in this study also refers, as appropriate, to territories or areas;the designations employed and the presentation of the material do not imply the expression ofany opinion whatsoever on the part of the Secretariat of the United Nations concerning the legalstatus of any country, territory, city or area or of its authorities, or concerning the delimitation ofits frontiers or boundaries In addition, the designations of country groups are intended solelyfor statistical or analytical convenience and do not necessarily express a judgement about thestage of development reached by a particular country or area in the development process.

The following symbols have been used in the tables:

Two dots ( ) indicate that data are not available or are not separately reported Rows intables have been omitted in those cases where no data are available for any of the elements in therow;

A dash (-) indicates that the item is equal to zero or its value is negligible;

A blank in a table indicates that the item is not applicable, unless otherwise indicated

A slash (/) between dates representing years, e.g., 1994/95, indicates a financial year;Use of a hyphen (-) between dates representing years, e.g., 1994-1995, signifies the fullperiod involved, including the beginning and end years

Reference to “dollars” ($) means United States dollars, unless otherwise indicated.Annual rates of growth or change, unless otherwise stated, refer to annual compoundrates

Details and percentages in tables do not necessarily add to totals because of rounding.The material contained in this study may be freely quoted with appropriateacknowledgement

UNITED NATIONS PUBLICATION

Sales No E.99.II.D.3ISBN 92-1-112440-9Copyright © United Nations, 1999

All rights reservedManufactured in Switzerland

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In 1945 our founders enshrined the promotion of economic development and theimprovement of the quality of life for people in all countries as fundamental objectives of theUnited Nations Since then, countries have worked together to achieve these objectives andmany of them have made great progress Even so, the gap between developing and developedcountries, and between rich and poor within many countries, remains as wide as ever In somerespects, it is growing even larger Achieving sustainable and equitable development thus remainsthe unfinished task of the twentieth century.

The central role in fulfilling this task must be played by the people of each country, throughprivate enterprise and public organization at the local and national levels But a very importantrole can also be played by foreign direct investment (FDI) – increasingly so, as the world economybecomes more global and new technology is ever more essential to economic growth

Each year, the World Investment Report examines issues related to foreign direct investment.This year ’s edition looks specifically at the impact of such investment on key aspects of economicdevelopment – increasing financial resources, enhancing technological capabilities, boostingexport competitiveness, generating and upgrading employment, and protecting the environment.The first message that emerges is that, while FDI can indeed contribute to economic growth anddevelopment, it is not a panacea It can complement and catalyse economic activities and theperformance of domestic enterprises, but in some circumstances it may also hinder them

Another message of the report is, therefore, that public policy does matter, at the nationaland the international levels It is important in creating the conditions that attract foreign directinvestment And it is important for enhancing its benefits To promote the development of theirown countries, Governments need to maximize the positive contribution that foreign directinvestment can make to development, and to minimize any negative effects it may have

While the primary responsibility for development rests with national Governments,corporations also have a responsibility, not only to their shareholders but to society at large One

of the challenges for the future is precisely to encourage firms to assume this responsibility moreforcefully

The report’s focus on foreign direct investment and development is particularly timely,

as it comes shortly before several important events in the year 2000 intended to advance thecause of development: UNCTAD X in February in Bangkok, the South Summit of the Group of

77 in Havana in April, and the United Nations Millennium Summit and Assembly in New York

in the autumn I hope the report will contribute to the deliberations at these events, and help tobring about an improved understanding of development-related processes and policies that areessential if the twenty-first century is to complete – as it must – the unfinished task of the twentieth

Kofi A Annan

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The World Investment Report 1999 was prepared by a team led by Karl P Sauvant and

comprising Victoria Aranda, Bijit Bora, Persephone Economou, Masataka Fujita, BoubacarHassane, Kálmán Kalotay, Gabriele Köhler, Padma Mallampally, Anne Miroux, Ludger Odenthal,Juan Pizarro, Marko Stanovic, James Xiaoning Zhan and Zbigniew Zimny Specific inputs werereceived from Mehmet Arda, Mattheo Bushehri, John Gara, Khalil Hamdani, Mongi Hamdi, AnnaJoubin-Bret, Assad Omer, Olle Östensson, Pedro Roffe, Taffere Tesfachew and Katja Weigl Thework was carried out under the overall direction of Lynn K Mytelka

Principal research assistance was provided by Mohamed Chiraz Baly, Lizanne Martinez,Bradley Boicourt and Janvier Usanase Research assistance was provided by Nelly Berthault andJohn Bolmer A number of interns assisted with the WIR99 at various stages: Skadi Falatik, CarlijnLahaye and Makamona Didier Nsasa The production of the WIR99 was carried out by JeniferTacardon, Irenila Droz, Mary McGee, Florence Hudry, Bartolomeo D’Addario and AtsedeweynAbate Graphics were done by Diego Oyarzun-Reyes It was desktop-published by Teresita Sabico.The Report was edited by Peter Sutcliffe

Sanjaya Lall was the principal consultant and adviser to Part Two of WIR99 Experts fromwithin and outside the United Nations provided inputs for WIR99 Major inputs were receivedfrom Manuel R Agosín, Douglas van den Berghe, Roland Brown, Jaime Crispi, Michel Delapierre,John M Kline, Donald J Lecraw, Robert E Lipsey and Peter Nunnenkamp Inputs were alsoreceived from Thomas G Aquino, Peter Brimble, Jenny Cargill, Daniel Chudnovsky, EdwardDommen, Peter Eigen, Magnus Ericsson, Torbjörn Fredriksson, Roger Frost, Adrian Henriques,Auret van Heerden, Brent Herbert-Copley, Joachim Karl, Georg Kell, Nagesh Kumar, Raymond J.Mataloni Jr., Jacques Morisset, Sarianna Lundan, Sandro Orlando, Terutomo Ozawa, JasonPraetorius, Stephen Pursey, Shahra Razavi, Hans Schenk, Prakash Sethi, Peter de Simone, Devinda

R Subasinghe, Carrie Smith, Meg Voorhes, Alyson Warhurst, Gerald T West, Obie G Whichard,Adrian Wood and Guoming Xian

A number of experts were consulted on various chapters Comments were received duringvarious stages of preparation (including during expert group meetings) from Abebe Abate, LahcenAboutahir, Teresa Andaya, Rasheed Amjad, Charles Arden-Clarke, Marino Baldi, Christian J.Bellak, Emmanuel Boon, Eduardo Borensztein, David Boys, Steven Canner, John A Cantwell,Andrew Cornford, Janelle Diller, William A Dymond, Dieter Ernst, John Evans, Kimberly Evans,Anna Faelth, Arghyrios A Fatouros, Jarko Fidrmuc, Marlies Filbri, Al Frey, Rainer Geiger, MurrayGibbs, Harris Gleckman, Brewster Grace, Edward M Graham, Alicia Greenidge, StephanieHanford, Michael Hansen, Hans Havermann, Katharina Helmstedt, Amy Holman, Kirk F Hudig,Jan Huner, Gábor Hunya, Wee Kee Hwee, Veena Jha, Patrick Juillard, Dwight Justice, HisaoKawabata, Mike Kelly, Stephen J Kobrin, Gloria-Veronica Koch, Ans Kolk, Mark Koulen,Christopher Lewis, Klaus M Leisinger, Klaus Lingner, Nick Mabey, Robert Madelin, ChrisMarsden, Antonio Martins da Cunha Filho, Mina Mashayekhi, Jerry Matthews, Toshiko Matsuki,Thomas McCarthy, Eduardo J Michel, Peter Muchlinski, Victor Ognivtsev, Sven Östberg, AurelioParisotto, Sol Picciotto, Eric D Ramstetter, Mansur Raza, Prasada Reddy, Maryse Robert, DanielRodriguez, Miguel Rodriguez Mendoza, Pierre Sauvé, Mitsuharu Sawaji, Rupert Schlegelmilch,Marinus Sikkel, Anthony G Sims, John M Stopford, Anh Nga Tran-Nguyen, Ann Trebilcock,Rob van Tulder, Peter Utting, René Vossenaar, Douglas C Worth, Mike Wright, Simonetta Zarrilliand Michael Zammit-Cutajar

Numerous officials of central banks, statistical offices, investment promotion agencies andother government offices, and officials of international organizations and non-governmentalorganizations, as well as executives of a number of companies, also contributed to WIR99,especially through the provision of data and other information

The Report benefited from overall advice from John H Dunning, Senior Economic Advisor.The financial support of the Governments of the Netherlands and Norway is gratefullyacknowledged

Contents

Page Preface

Preface iii iii Overview

Overview xxi xxi

P PAR AR ART ONE T ONE TRENDS

I GLOBAL TRENDS GLOBAL TRENDS 3 33

A Trends T rends rends 4 44

1 Geographical patterns of FDI 18

a Regional distribution 18

b FDI among developing countries 21

2 Sectoral and industrial patterns of FDI 26

Notes Notes 30 30 II REGIONAL TRENDS REGIONAL TRENDS 33 33 A Developed countries Developed countries 33 33 1 United States 33

2 European Union 38

3 Japan 42

B Developing countries Developing countries 45 45 1 Africa 45

2 Asia and the Pacific 52

3 Latin America and the Caribbean 61

C Central and Eastern Europe Central and Eastern Europe 69 69 Notes Notes 73 73 III THE LARGEST TRANSNATIONAL THE LARGEST TRANSNA TIONAL TIONAL CORPORA CORPORA CORPORATIONS TIONS AND CORPORA AND CORPORATE STRA TE STRA TE STRATEGIES TEGIES TEGIES 77 77 A The largest transnational corporations The largest transnational corporations 77 77 1 The world’s 100 largest TNCs 77

a Highlights 77

b Degree of transnationality 82

c Weight and economic significance of the 100 largest TNCs 84

2 The 50 largest TNCs from developing countries 85

3 The 25 largest TNCs from Central Europe 89

B Cross-border M&As Cross-border M&As 94 94 1 Trends 94

a Sales 97

b Purchases 98

c Industry composition 99

2 Reasons 100

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3 Impact on development 101

C Strategic partnering, M&As and their implications for the competitive environment for the competitive environment 104 104 1 Concentration and the formation of traditional oligopolies 105

2 Stategic partnerships, M&As and the creation of knowledge-based networked oligopolies 107

Notes Notes 1 11 1112 12 IV IV INVESTMENT POLICY DEVELOPMENTS INVESTMENT POLICY DEVELOPMENTS 1 11 1115 15 A National policies National policies 1 11 1115 15 B Developments at the international level Developments at the international level 1 11 1117 17 1 Bilateral treaties 117

2 Regional developments 121

3 Developments in OECD 126

a Policy developments 126

b The MAI 128

(i) Objectives of the MAI 128

(ii) Main outstanding substantive issues 131

(iii) The broader political context 136

4 Multilateral developments 137

5 Civil society 139

6 Conclusions: lessons 141

Notes Notes 143 143 P PAR AR ART TWO T TWO FOREIGN DIRECT INVESTMENT AND THE CHALLENGE OF DEVELOPMENT V V THE CONTEXT AND ITS CHALLENGE THE CONTEXT AND ITS CHALLENGE 149 149 A The changing context of development The changing context of development 150 150 B The changing context for TNCs The changing context for TNCs 153 153 C The challenge The challenge 154 154 Note Note 156 156 VI INCREASING FINANCIAL RESOURCES AND INVESTMENT VI INCREASING FINANCIAL RESOURCES AND INVESTMENT 157 157 A The importance of investment for development The importance of investment for development 157 157 B The financial behaviour of TNCs The financial behaviour of TNCs 158 158 C The impact of FDI on financial resources and investment The impact of FDI on financial resources and investment 160 160 1 Financial resources 160

2 Investment 167

a Direct impact 167

b Indirect impact: does FDI “crowd out” or “crowd in” domestic investment? 171

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1 The framework 174

a The regulatory framework 174

b Contracts 177

2 Implementation 179

3 Promotion 182

4 Targeting 183

Notes Notes 187 187 Annex to chapter VI Determining crowding in and crowding out ef Annex to chapter VI Determining crowding in and crowding out effects fects fects 189 189 VII VII ENHANCING TECHNOLOGICAL ENHANCING TECHNOLOGICAL ENHANCING TECHNOLOGICAL CAP CAP CAPABILITIES ABILITIES ABILITIES 195 195 A Technology T echnology echnology, learning and development , learning and development , learning and development 195 195 B Technology generation and transfer: the role of TNCs T echnology generation and transfer: the role of TNCs echnology generation and transfer: the role of TNCs 198 198 1 Technology generation 198

2 Technology transfer 203

C FDI and developing countries: technology transfer,,,,, FDI and developing countries: technology transfer dif diffusion and generation fusion and generation fusion and generation 207 207 1 Technology transfer 207

2 Technology dissemination and spillovers 210

a Linked economic agents 211

b Other firms and institutions 213

c Competing firms 214

3 Technology generation 215

D Conclusions and policy implications Conclusions and policy implications 219 219 1 Transfer 223

2 Diffusion 225

3 Generation 226

4 The international dimension 227

Notes Notes 228 228 VIII BOOSTING EXPOR VIII BOOSTING EXPORT COMPETITIVENESS T COMPETITIVENESS T COMPETITIVENESS 229 229 A The competitiveness challenge The competitiveness challenge 229 229 B TNC strategies and role in trade TNC strategies and role in trade 232 232 C The role of FDI in building export competitiveness The role of FDI in building export competitiveness 234 234 1 Technology and trade patterns 234

2 Expanding market access for exports 240

a Advantages of TNCs 240

b Disadvantages of TNCs 241

c Non-equity links: some considerations 242

3 Building dynamic comparative advantages 244

Notes

Notes 255 255

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IX GENERA

IX GENERATING EMPLOYMENT AND STRENGTHENING TING EMPLOYMENT AND STRENGTHENING

THE SKILLS BASE

THE SKILLS BASE 257 257

and skills for development

employment and building skills

1 Employment generation 261

2 Employment quality 269

3 Upgrading skills 273

D Conclusions and policy implications Conclusions and policy implications 277 277 1 Employment policies and instruments 278

a Employment creation 279

b Upgrading employment and skills 280

2 Industrial relations 284

Notes Notes 286 286 X PROTECTING THE ENVIRONMENT PROTECTING THE ENVIRONMENT 289 289 A The importance of the environment for development The importance of the environment for development 289 289 B Environmental strategies of TNCs Environmental strategies of TNCs 292 292 C The impact of FDI on the environment The impact of FDI on the environment in host developing countries in host developing countries in host developing countries 294 294 1 An environmental profile of FDI 294

2 Environmental management and clean technology 299

D Conclusions and policy implications Conclusions and policy implications 306 306 1 Admission and establishment 307

2 Operation 309

3 The international dimension 310

Notes Notes 31 31 311 11 XI ASSESSING FDI AND DEVELOPMENT IN THE NEW COMPETITIVE CONTEXT NEW COMPETITIVE CONTEXT 313 313 A The new competitive context The new competitive context 313 313 B FDI in developing countries FDI in developing countries 315 315 1 Introduction 315

2 What FDI offers 316

3 Policy issues 318

a The international investment process 318

b Domestic enterprise development and FDI 319

c Static versus dynamic effects 322

d Bargaining and regulation 324

4 Policy-making capacity 325

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Note

Note 328 328 Annex to chapter XI The impact of FDI on growth:

an econometric test

Introduction

1 Overview of previous studies 329

a Long-term cross-section studies 329

b Time series studies 331

2 Regression analyses 331

Conclusions Conclusions 335 335 XII THE SOCIAL XII THE SOCIAL RESPONSIBILITY OF TRANSNA RESPONSIBILITY OF TRANSNA RESPONSIBILITY OF TRANSNATIONAL TIONAL TIONAL CORPORA CORPORA CORPORATIONS TIONS 345 A The context for the social responsibility of TNCs The context for the social responsibility of TNCs 345 345 B Meanings of corporate social responsibility Meanings of corporate social responsibility 346 346 1 Beyond philanthropy and compliance with law 346

2 Evolving corporate social contracts and stakeholder interest 347

3 The scope and content of corporate social responsibility 348

4 Business, civil society and government perceptions of corporate social responsibility 349

5 International guidelines and codes of conduct 350

6 International aspects of corporate social responsibility 351

7 Global corporate citizenship 352

C The growing importance of TNC social responsibility The growing importance of TNC social responsibility 354 354 D Recent developments in corporate social responsibility Recent developments in corporate social responsibility 355 355 1 Increased activities by civil society groups 355

2 Business responses 360

3 Government actions 365

Notes

Notes 370 370

References

References 371 371 Annexes

Annexes 401 401 Annex A Additional text tables

Annex A Additional text tables 402 402 Annex B Statistical annex

Annex B Statistical annex 463 463 Selected UNCT

Selected UNCTAD publications on transnational corporations AD publications on transnational corporations

and foreign direct investment

and foreign direct investment 539 539 Questionnaire

Questionnaire 545 545

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PAR AR ART ONE T ONE

Boxes

I.1 The difficulty of relating M&A values to FDI flows 8

I.2 The rise of FDI as a source of finance for developing countries 10

I.3 FDI estimates 11

I.4 Salient features of FDI among developing countries and regions 25

II.1 Policy changes and FDI: the case of Sweden 39

II.2 Effects of FDI on Japan’s trade 44

II.3 The joint UNCTAD/ICC project on investment guides and capacity-building for least developed countries 53

II.4 FDI in the five countries most affected by the financial crisis 56

II.5 Negative effects of the financial crisis on FDI flows to Asian LDCs 59

II.6 A new wave of FDI from developing countries: Latin American TNCs in the 1990s 66

II.7 Regional integration and the internationalization of Argentine companies 68

III.1 Lukoil Oil Company 89

III.2 Why cross-border M&As have become popular in Japan 97

III.3 M&As in the metal mining and refining industries: a record year in 1998 100

III.4 Research joint ventures in the United States 106

III.5 Knowledge-based networks reshape the information and communications technology industries 110

III.6 Lear Seating: becoming a preferred first tier supplier 111

IV.1 BIT negotiations between members of the Group of Fifteen 118

IV.2 The BIT between Bolivia and the United States 119

IV.3 Main features of Framework Agreement on the ASEAN Investment Area 121

IV.4 The OECD Convention on Combating Bribery of Foreign Officials enters into force 127

IV.5 Structure of the MAI 129

IV.6 Checklist of issues suggested for study by the WTO Working Group on the Relationship between Trade and Investment 138

IV.7 Transparency International 142

Figures I.1 Components of FDI inflows, 1990-1997 8

I.2 International financial flows other than FDI outflows to foreign affiliates of United States TNCs and United States FDI outflows, 1986-1996 8

I.3 World FDI inflows and outflows: value and annual growth rates, 1985-1998 9

I.4 FDI inflows as a percentage of gross fixed capital formation, 1980, 1985, 1990, 1995 and 1997 12

I.5 Growth of technology payments and FDI flows, by group of countries,1980-1997 14

I.6 The export propensity of foreign affiliates and domestic firms in manufacturing, latest available year 15

I.7 Value-added per employee of foreign affiliates and domestic firms in manufacturing in selected host economies, latest available year 16

I.8 Transnationality index of host countries, 1996 17

I.9 FDI and trade shares of developing countries in world totals, 1980-1998 18

I.10 Concentration of FDI flows by the largest 10 host/home countries, 1985-1998 19

I.11 FDI stocks among the Triad and the countries in which FDI from the Triad dominates, 1988 and 1997 22

I.12 FDI outflows and exports of goods and non-factor services from developing countries as percentages of the world total, 1980-1998 23

I.13 Inward FDI stock, by sector for the world and developed countries, and inward FDI stock and value added by sector for developing countries, 1988 and 1997 27

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I.14 Outward FDI stock, 1988 and 1997, and value added, 1994,

of developed countries, by sector 28

II.1 Developed countries: FDI inflows, 1997-1998 34

II.2 Developed countries: FDI outflows, 1997-1998 35

II.3 Developed countries: FDI as a percentage of gross fixed capital formation, 1995-1997 36

II.4 United States: employment share of foreign affiliates across states, 1996 37

II.5 FDI projects in the United States, by size of outlays, 1991-1998 38

II.6 FDI inflows to the EU: EMU members of the EU versus non-EMU members of the EU, 1996-1998 40

II.7 Intra-EU and extra-EU FDI flows, 1992-1997 40

II.8 Japanese FDI outflows, by component, 1996-1998 43

II.9 Prospects for Japanese outward FDI in manufacturing, 1999-2001 45

II.10 Number of cross-border M&As in Japan, 1985-1998 45

II.11 FDI inflows into Africa, 1990-1998 46

II.12 Africa: FDI inflows, top 10 countries, 1997 and 1998 46

II.13 Africa: FDI flows as a percentage of gross fixed capital formation, top 20 countries, 1995-1997 47

II.14 Africa: FDI outflows, top 10 countries, 1997 and 1998 48

II.15a African countries ranked according to their attractiveness for FDI in 2000-2003: frequency of replies 49

II.15b African countries ranked according to their progress in creating a business-friendly environment in 2000-2003: frequency of replies 49

II.16a Africa: industries that received considerable FDI inflows in 1996-1998: frequency of replies 50

II.16b Africa: most attractive industries for FDI in 2000-2003: frequency of replies 50

II.17a Africa: most frequently mentioned positive factors for FDI inflows in 2000-2003: frequency of replies 51

II.17b Africa: most important factors affecting FDI inflows in 2000-2003 51

II.17c Africa: most important factors with a negative impact on investment decisions by TNCs: frequency of replies 51

II.18 FDI flows into developing Asia and the Pacific and its share in world and developing countries’ inflows, 1991-1998 53

II.19 Asia and the Pacific: FDI inflows, top 20 economies, 1997 and 1998 54

II.20 Asia: FDI flows as a percentage of gross fixed capital formation, top 20 economies, 1995-1997 55

II.21 FDI flows into developing Asia and the Pacific, by country group, 1991-1998 57

II.22 South, East and South-East Asia: cross-border M&As in relation to FDI inflows, 1991-1998 57

II.23 FDI in developing Asia and the Pacific, by country group, 1991-1998 58

II.24 Cross-border M&As by TNCs headquartered in developing Asia, 1990-1998 60

II.25 Outward FDI flows from developing Asia and the Pacific and its share in world outflows, 1986-1998 60

II.26 Asia and the Pacific: FDI outflows, top 10 economies, 1997 and 1998 60

II.27 The asset value and its growth rate of the top 500 overseas Chinese firms 61

II.28 Latin America and the Caribbean: FDI inflows, top 20 countries,1997 and 1998 62

II.29 Latin America and the Caribbean: FDI flows as a percentage of gross fixed capital formation, top 20 countries, 1995-1997 63

II.30 European Union FDI outflows to Latin America and the Caribbean, 1990-1997 64

II.31 Private net resource flows and current account deficits in Latin America and the Caribbean, 1991-1998 65

II.32 Latin America and the Caribbean: FDI outflows, top 10 countries, 1997 and 1998 66 II.33 Central and Eastern Europe: FDI inflows, 1997 and 1998 69

II.34 Total foreign investment inflows in Central and Eastern Europe, 1993-1998 69

II.35 Actual FDI inflows and FDI commitments into Poland, 1995-1998 70

II.36 Central and Eastern Europe: FDI flows as a percentage of gross fixed capital formation, 1995-1997 71

II.37 Central and Eastern Europe: geographical sources of inward FDI stock, 1998 72

II.38 Central and Eastern Europe: industry composition of inward FDI stock, 1998 73

II.39 Central and Eastern Europe: FDI outflows, 1997 and 1998 73

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III.1 Average transnationality index of the world’s 100 largest TNCs, 1990-1997 83

III.2 Transnationalization trends of the top 50 TNCs from developing countries, 1993 to 1997 88

III.3 Foreign assets of biggest investors from developing countries, 1997 88

III.4 Cross-border M&As as a percentage of all M&As in the world, 1980-1998 95

III.5 Share of M&As in investment expenditures by foreign direct investors 95

in United States businesses, 1980-1998 95

III.6 Number of inter-firm technology agreements, by selected industry, 1980-1996 104

III.7 Concentration ratios of the top four and top 10 companies in the information technology and automotive industries 105

III.8 A comparison of the principal characteristics of a traditional and a knowledge-based networked oligopoly: the electrical and the information technology industries 108

III.9 The main nodes in the data processing networked oligopoly during the 1990s 109

IV.1 Types of changes in FDI laws and regulations, 1998 116

IV.2 BITs concluded in 1998, by country group 117

IV.3 DTTs concluded in 1998, by country group 120

T Tables ables I.1 Number of parent corporations and foreign affiliates, by area and economy, latest available year 5

I.2 Selected indicators of FDI and international production, 1986-1998 9

I.3 Regional distribution of FDI inflows and outflows, 1995-1998 20

I.4 Outward FDI directed to other developing countries from South, East and South-East Asia and Latin America 24

II.1 United States: possible determinants of the employment impact of FDI across states, 1996, correlation results 37

II.2 Sectoral distribution of intra-EU and extra-EU FDI inflows, 1995-1996 41

II.3 The top three source countries of inward FDI stock in Central and Eastern Europe, 1998 72

III.1 The world’s top 100 TNCs, ranked by foreign assets, 1997 78

III.2a Newcomers to the world’s top 100 TNCs, ranked by foreign assets, 1997 81

III.2b Departures from the world’s top 100 TNCs, ranked by foreign assets, 1997 81

III.3 Snapshot of the world’s 100 largest TNCs, 1997 81

III.4 Country breakdown of the world’s top 100 TNCs, by transnationality index, foreign assets, foreign sales and foreign employment, 1996 and 1997 82

III.5 Industry composition of top 100 TNCs, 1996 and 1997 83

III.6 The world’s top TNCs in terms of degree of transnationality, 1997 83

III.7 Comparison of the top 100 TNCs with Fortune Global 500, 1997 84

III.8 The top 50 TNCs from developing countries, ranked by foreign assets, 1997 86

III.9 The top five TNCs from developing countries in terms of degree of transnationality, 1997 89

III.10 Snapshot of the top 50 TNCs from developing countries, 1997 89

III.11 The top 50 TNCs from developing countries: industry composition and transnationality index, 1997 89

III.12 The top 25 TNCs based in Central Europe, ranked by foreign assets, 1997 90

III.13 The top 25 TNCs based in Central Europe, ranked by foreign assets, 1998 91

III.14 Countries of origin of the top 25 TNCs based in Central Europe, 1997 and 1998 92

III.15 Top TNCs of the Russian Federation, Estonia, Lithuania, TFYR Macedonia and Ukraine, ranked by foreign assets, 1997 and 1998 93

III.16 Snapshot of the top 25 TNCs from Central Europe, 1997 and 1998 94

III.17 The industry composition of the top 25 TNCs based in Central Europe, 1997 and 1998 94

III.18 The 10 largest cross-border M&A deals, announced in 1998 and 1999 96

III.19 The significance of M&As as a mode of entry for Japanese FDI, by region, 1983 and 1995 99

III.20 Employment cuts in selected cross-border M&As 103

IV.1 National regulatory changes, 1991-1998 115

IV.2 International investment policy trends: developments in 1997-1998 116

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PAR AR ART TWO T TWO Boxes

V.1 Evolution of approaches to development 150

V.2 Why have governments changed their attitudes to TNCs? 152

VI.1 Testing the volatility of capital flows 162

VI.2 Evidence for crowding in and crowding out 172

VI.3 UNCTAD’s Investment Policy Reviews 176

VI.4 Funding contractual negotiation with TNCs 178

VI.5 Administrative barriers to FDI: the red tape analysis 180

VI.6 Changing the image of Africa 182

VI.7 Attracting high technology investment: Intel’s Costa Rica plant 184

VII.1 Ten features of technological learning 197

VII.2 Technological activity by foreign affiliates in developed countries 201

VII.3 Downgrading of local innovatory capacity: examples from Brazil 202

VII.4 Differing technology content in TNC transfers 205

VII.5 TNCs and the restructuring of Argentine industry 208

VII.6 Promoting TNC technology spillovers in Taiwan Province of China and Singapore 211 VII.7 Strategic R&D by TNCs in developing countries 216

VII.8 The role of industry-based research consortia 217

VII.9 FDI and technology development strategies in the Republic of Korea 220

VII.10 Transfer of technology in multilateral fora 222

VII.11 Singapore’s strategy to upgrade foreign affiliate technology 224

VIII.1 The changing technology composition of world exports and exports from developing countries 230

VIII.2 The ownership structure of United States exports 233

VIII.3 Boosting export competitiveness with EPZs 237

VIII.4 Technological learning through OEM: Daewoo and NEC 241

VIII.5 TNCs and the evolution of modern agri-business 243

VIII.6 FDI and manufactured export performance: some statistical relations 246

VIII.7 FDI and upgrading competitiveness in the Indian software industry 250

VIII.8 Targeting export-related FDI 253

VIII.9 TRIMs and developing countries: questions for consideration 254

IX.1 Employment in foreign affiliates of TNCs from the United States and Japan: recent trends 266

IX.2 Home work and TNC distribution channels 267

IX.3 FDI and the employment of women 268

IX.4 New forms of work organization and training needs 270

IX.5 Enhancing labour productivity in EPZs: recent trends 271

IX.6 Falling “co-operation costs” and global production 275

IX.7 Training initiatives in Malaysia 276

IX.8 FDI in business education: recent trends and considerations 282

IX.9 Core labour standards and FDI 285

X.1 TNCs and the new context in the mining industry 291

X.2 Testing the “pollution haven” hypothesis 298

X.3 Key factors in the diffusion of clean technologies 300

X.4 The "greening" of the pulp and paper industry 301

X.5 Foreign investment and environmental management: evidence from the Chilean pulp and paper industry 301

X.6 ISO 14001 standards for environmental management 302

X.7 Combining environmental management with eco-efficiency in the hotel industry: the Taj Group of Hotels in India 305

X.8 Assisting developing countries’ SMEs with environmental impact studies for outward FDI 308

XI.1 Flexibility in international investment agreements 326

XII.1 Towards a global compact for the new century 353

XII.2 Comparative codes of conduct and their auditing and follow-up procedures 357

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XII.3 Royal Dutch/Shell: an illustration 362

XII.4 Mattel: monitoring the Global Manufacturing Principles 363

Figures V.1 Number of parent TNCs in selected major home developed countries, 1968/1969 and 1998 153

VI.I The ratio of FDI inflows to gross fixed capital formation, by region, annual average, 1971-1980, 1981-1990 and 1991-1997 167

VII.1 Growth rates of total and high-technology production and exports, 1980-1995 195

VII.2 Shares of large foreign firms in national patents and production, 1992-1996 201

VII.3 Determinants of the mode of technology transfer 204

VIII.1 Shares of technologically-complex products in world trade, 1980, 1996 231

VIII.2 Shares of TNCs in primary and manufactured exports, latest available year 245

VIII.3 The share of foreign affiliates in total manufacturing exports: Czech Republic and Hungary, 1995 246

IX.1 Factors influencing the effects of inward FDI on employment quantity 262

X.1 Share of pollution-intensive manufacturing production in total manufacturing production: United States and for United States majority foreign-owned affiliates 296

X.2 Share of pollution-intensive manufacturing production in total manufacturing production: United States majority-owned foreign affiliates, by region, 1982-1996 297

T Tables ables VI.1 Sources of financing of foreign affiliates of Japanese TNCs, 1989, 1992 and 1995 159

VI.2 Sources of financing of foreign affiliates of United States TNCs, on a stock basis, 1994 161

VI.3 The financial cost of sources of foreign financing: FDI and long-term international bank loans, 1983-1997 164

VI.4 Comparison of repatriated earnings and FDI inflows, 1991-1997 165

VI.5 The relative importance of FDI inflows in gross fixed capital formation, by countries, 1971-1997 168

VI.6 Foreign affiliates of United States TNCs: total investment and FDI flows, 1989 and 1996 169

VI.7 Illustrative list of transaction costs related to the legal and regulatory environment 179

VI.A.1 Developing country regions: effects of FDI on investment 192

VI.A.2 Effects of FDI on investment in individual countries, 1970-1996 192

VI.A.3 Panel estimations with FDI as a dependent variable and growth lagged once and twice as explanatory variables, 1970-1996 193

VII.1 Leading United States R&D spenders, 1996 199

VII.2 Share of United States patents registered by the world’s largest firms attributable to research in foreign locations, 1969-1995 200

VII.3 Collaboration of Indian research centres with TNCs: R&D contracts awarded by TNCs to Indian publicly funded R&D institutes in the early 1990s 213

VII.4 Recorded R&D expenditures by foreign affiliates of United States TNCs, 1994 216

VII.5 Illustrative cases of global R&D centres and R&D joint ventures in India 218

VIII.1 Possible contributions of inward FDI to competitive advantages of host countries 235

IX.1 Labour force evaluation index for selected economies 264

IX.2 Estimated employment in TNCs 265

IX.3 Employees in foreign affiliates as a percentage of total employment in selected developing economies 265

Page

IX.4 Women’s employment in selected export processing zones in

developing economies 268X.1 Environmental impacts of selected industries 294X.2 The share of pollution-intensive industries in outward FDI stock and

gross fixed capital formation, selected developed countries, 1990 and 1996 296X.3 The share of pollution-intensive industries in inward FDI stock and

gross fixed capital formation, selected economies, 1990 and 1996 297XI.A.1 Equations relating FDI inflows to past FDI inflows,

five one-year periods, 1971-1995 337XI.A.2 Equations relating FDI inflows to past FDI inflows and past and present

growth in per capita GDP, five-year periods, 1971-1995 338XI.A.3 Equations relating FDI inflows to past FDI inflows and past ratios of fixed

capital formation to GDP, five-year periods, 1971-1995 338XI.A.4 Equations relating investment ratios to past ratios and

past FDI inflows, five-year periods, 1971-1990 339XI.A.5 Equations relating trade ratios to past trade ratios

and past FDI inflows, five-year periods, 1965-1995 339XI.A.6 Equations relating to FDI inflows to past inflows and to

trade ratios, five-year periods, 1971-1995 340XI.A.7 Equations relating real per capita growth to past growth,

five-year periods, 1965-1995 340XI.A.8 Equations relating real per capita growth to past growth,

past investment ratio and past FDI, five-year periods, 1971-1995 341XI.A.9 Equations relating real per capita growth to past growth

and other past variables, five-year periods, 1971-1995 342XI.A.10 Pooled equation relating per capita growth to past growth and other variables

including price level and income relative to the United States 342XI.A.11 Equations relating per capita growth to past growth and

other variables including FDI-schooling cross product,

five-year periods, 1971-1995 343

The momentum for the expansion of international production continues to hold, thoughthe world economy is currently affected by a number of factors that could discourage investment,including FDI by TNCs FDI flows to developing countries declined in 1998, but that declinewas confined to a few countries Technology flows, as measured by technology payments,

continued to grow, partly reflecting the increasing importance of technology in the production

process Cross-border M&As among developed countries have driven the expansion of FDI flowsand international production capacity in 1998 This suggests that, in the face of diminishedfinancing and reduced market prospects world-wide, TNCs in the Triad are concentrating onconsolidating their assets and activities so as to strengthen their readiness for global expansion

or survival once the health of the world economy, including countries affected by the recentfinancial crises and their aftermath, is fully restored

TRENDS

T

Transnational corporations drive international pr ransnational corporations drive international pr ransnational corporations drive international production … oduction …

International production – the production of goods and services in countries that iscontrolled and managed by firms headquartered in other countries – is at the core of the process

of globalization Transnational corporations (TNCs) – the firms that engage in internationalproduction – now comprise over 500,000 foreign affiliates established by some 60,000 parentcompanies, many of which also have non-equity relationships with a large number ofindependent 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 small- and medium-sized firms A small number of TNCs, ranking at the top, arenoteworthy for their role and relative importance in international production:

• The world’s 100 largest non-financial TNCs together held $1.8 trillion in foreign assets,sold products worth $2.1 trillion abroad and employed some six million persons in theirforeign affiliates in 1997 They accounted for an estimated 15 per cent of the foreign assets

of all TNCs and 22 per cent of their sales General Electric is the largest among these TNCsranked by foreign assets, holding the top place for the second consecutive year Close to

90 per cent of the top 100 TNCs are from Triad countries (European Union, Japan andUnited States), while only two developing-country firms - Petroleos de Venezuela andDaewoo - figure in the list While company rankings may change from year to year,membership in the list of the 100 largest TNCs has not changed much since 1990: aboutthree-quarters of the TNCs in the list in 1997 were already part of the world’s 100 largestTNCs in 1990 Even the ranking of the top TNCs by their degree of transnationality (anindex reflecting the combined importance of foreign assets, sales and employment as shares

of their respective totals) has been fairly stable Automotive, electronics/electrical

• The list of the 25 largest TNCs based in Central Europe (not including the RussianFederation) - published for the first time in this year ’s World Investment Report — identifies

a new nascent group of investors which, together, held $2.3 billion in assets abroad in

1998 and had foreign sales worth $3.7 billion Employment in their foreign affiliates,however, is low, a factor that reduces the value of the transnationality index for thesefirms Most of the top TNCs from Central Europe are active in transportation, chemicalsand pharmaceuticals, and natural resources

The largest TNCs as described above are determined on the basis of the value of assetsthat they control abroad Control of assets is usually achieved by a minimum share in equity orownership, which defines foreign direct investment (FDI) Increasingly, however, TNCs are alsooperating internationally through non-equity arrangements, including strategic partnerships

A rising number of technology partnerships have been formed, in particular in the informationtechnology, pharmaceutical and automobile industries in the 1990s Such partnerships assistfirms in their search for ways to reduce costs and risks, and provide them with the flexibilityrequired in an uncertain and constantly changing technological environment Knowledge-basednetworks, a dimension not captured by the traditional measures of international production,can be a crucial factor of market power in some industries

… which takes place in an incr

… which takes place in an increasingly liberal policy framework easingly liberal policy framework.

The trend towards the liberalization of regulatory regimes for foreign direct investment(FDI) continued in 1998, often complemented with proactive promotional measures Out of 145regulatory changes relating to FDI made during that year by 60 countries, 94 per cent were inthe direction of creating more favourable conditions for FDI The number of bilateral investmentagreements also increased further, reaching a total of 1,726 by the end of 1998, of which 434 hadbeen concluded between developing countries Close to 40 per cent of the 170 treaties signedthat year were between developing countries By the end of 1998, the number of treaties for theavoidance of double taxation had reached a total of 1,871

At the regional and interregional levels, rule-making activity on FDI continued to beintense in all regions, mainly in connection with the creation or expansion of regional integrationschemes, and typically involving rules for the liberalization and protection of FDI The mostimportant development in 1998 was that the negotiations on a Multilateral Agreement onInvestment within the OECD were discontinued; however, work in the OECD continued inseveral other investment-related areas Overall, the question of governance in internationalbusiness transactions has been a recurrent subject in discussions and work related to internationalinstruments in recent years

International pr

International production has many dimensions … oduction has many dimensions …

International production involves a package of tangible and intangible assets Its principalglobal features (which, of course, differ from country to country) can be captured in variousways:

• 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

Overview

third of it in host countries Foreign affiliate sales (of goods and services) in domestic andinternational markets were about $11 trillion in 1998, compared to almost $7 trillion ofworld exports in the same year International production is thus more important thaninternational 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 worldgross domestic product as well as world exports Judging from data on FDI stock, mostinternational production in developed countries is in services, and most internationalproduction in developing countries is in manufacturing For both groups of countries,FDI in the primary sector has declined, while FDI in services in developing countries isgaining 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

• 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 paymentsand receipts associated with them And technology transmitted through training ismeasured 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 themid-1980s, and the intra-firm (between parent firm and foreign affiliate) share of theseexpenditures, already high, has also risen These changes reflect the fact that FDI isincreasingly geared to technologically-intensive activities and that technological assetsare becoming more and more important for TNCs to maintain and enhance theircompetitiveness Much of the increase has taken place in developed countries where royaltypayments and receipts have risen faster than FDI flows These countries accounted for 88per cent of payments and 98 per cent of receipts of cross-border flows of royalties andlicence fees world-wide in 1997

• Innovation and research and development (R&D) are at the heart of the ownershipadvantages that propel firms to engage in international production On the basis of datafor Japanese and United States TNCs, it seems that the bulk of R&D expenditure isundertaken by parent firms in their home countries and, when located abroad, mostly indeveloped countries Affiliates tend to spend much less on R&D, especially in comparison

to the R&D expenditures of the host countries in which they are located, notable exceptionsbeing Ireland and Singapore

• International trade is stimulated by international production because of the tradingactivities of TNCs At the same time, international production takes place because trade

is not possible in some cases, such as in the case of certain services that are location-boundbecause of the need for proximity between buyers and sellers Trade within TNCs and

arm’s-length trade associated with TNCs are estimated to account, together, for about

two-thirds of world trade, and intra-firm trade, alone, for one-third High propensities toexport on the part of foreign affiliates may be accompanied by high propensities to import,which can lead to trade deficits

• International production generates employment opportunities that are particularlywelcome in host countries with high rates of unemployment In recent years, employment

in foreign affiliates has been rising despite stagnating employment growth in TNC systems

as a whole, i.e when parent firms are also taken into account The trend towards increasingemployment is more pronounced for foreign affiliates in developing countries However,employment in foreign affiliates is typically a small share of total paid employment inthese countries, amounting to not more than two per cent of the workforce In themanufacturing sector, which receives the bulk of FDI, this share is higher

• Financial flows associated with international production consist of funds for financingthe establishment, acquisition or expansion of foreign affiliates The source of these fundscan be the TNC itself – new equity from parent firms, loans, and/or earnings of foreignaffiliates that are reinvested, together defined as FDI There are also sources of funds

external to a TNC, raised by foreign affiliates in host countries and international capitalmarkets The expenditure of TNCs on establishing, acquiring or expanding internationalproduction facilities is therefore higher in value than the amount normally captured byFDI flows

• The capital base of international production, regardless of how it is financed, is reflected

in the value of assets of foreign affiliates This is about four times the value of the FDIstock in the case of developed countries, but only marginally higher than the value of theFDI stock in the case of developing countries

The extent to which a particular host country is involved in international production can

be measured by an index of transnationality It captures the average of the following four ratios:FDI inflows as a percentage of gross fixed capital formation for the past three years; inward FDIstock as a percentage of GDP; value added of foreign affiliates as a percentage of GDP; andemployment of foreign affiliates as a percentage of total employment Among developedcountries, New Zealand has the highest transnationality index and Japan, the lowest Amongdeveloping countries, Trinidad and Tobago has the highest index and the Republic of Korea, thelowest Small host countries tend to score high in terms of the transnationality index

… that manifest themselves dif

… that manifest themselves differ fer ferently in dif ently in dif ently in differ fer ferent r ent r ent regions egions.

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 as well as in other variables related to theactivities of foreign affiliates, however, more and more firms engage increasingly in internationalproduction In 1998, despite adverse economic conditions such as the financial crisis and ensuingrecession in several Asian countries, the financial and economic crisis in the Russian Federationand the repercussions of these crises in some Latin American countries, declining world growth,trade, and commodity prices, and reduced bank lending, portfolio investment and privatizationactivity, FDI inflows increased by 39 per cent globally, the highest rate since 1987 In 1998, FDIinflows reached $644 billion, and are projected to increase in 1999 as well Mergers andacquisitions (M&As) have fuelled the increases in FDI, with a rise of more than $202 billion inthe value of M&As transacted in 1998 as compared with that in 1997 The importance of M&As

as modes of expansion of international production implies that the net addition to total physicalproduction capabilities annually is less than that implied by the value of annual FDI flows,since most of the additions may well be created by simply a change in ownership

The record level reached by world FDI flows in 1998 despite the prevailing gloomyeconomic environment also masks a high concentration of FDI: the largest 10 home countriesaccounted for four-fifths of global FDI outflows It also masks divergent trends for developedand developing countries In the former, economic growth remained stable, largely unaffected

by the recession in Japan or the financial crisis FDI inflows to and outflows from developed

countries soared to new heights – to about $460 billion and $595 billion, respectively, in 1998.

Economic growth rates in developing countries in Asia plummeted due to the financial crisisand recession, but FDI flows there declined only moderately, cushioned by the impact of currencydepreciation, policy liberalization and a more accommodating attitude towards M&As.Nevertheless, largely because of reduced inflows into a few Asian economies, FDI flows todeveloping countries as a group declined from $173 billion to $166 billion Moreover, the FDIgap among developing countries widened further, with the top five countries receiving 55 percent of all the developing-country inflows in 1998 and the 48 least developed countries receiving

less then one per cent.

Most FDI is located in the developed world, although the developing countries’ share hadbeen growing steadily until 1997, when it reached 37 per cent The subsequent decline (to 28per cent) in that share in 1998 reflects the strong FDI performance of developed countries in thatyear Among developed countries, most FDI is located — and originates — in the Triad, whichaccounted for almost two-thirds of the outward stock of developed countries in 1997

Overview

Differences in the size as measured by gross domestic product of host economies are animportant factor accounting for the differences observed in the shares of various regions and

countries in world FDI flows However, developing countries as a group receive more FDI per

dollar of gross domestic product than do developed countries Furthermore, if differences ineconomies’ size are taken into account, the FDI gap among groups of developing regionsdiminishes This is not surprising since FDI is attracted to developing countries also by factors(such as natural resources) not directly related to the size of their economies; it also suggeststhat the significance of a given amount of FDI for a country depends upon the country’s incomelevel However, even when differences in gross domestic product are controlled for, developedcountries remain more important as regards FDI outflows, although the gap between them anddeveloping countries diminishes Moreover, on a per capita basis developing countries receive(and invest abroad) less FDI than do developed countries, reflecting the concentration ofpopulation in the former and the concentration of FDI in the latter

FDI flows from developing countries accounted for 14 per cent of global outflows in 1997,but only eight per cent in 1998 Despite the sharp dip in 1998, the overall trend remains positive:more and more TNCs from developing countries are becoming competitive internationally andpossess ownership advantages that allow them to invest abroad, mainly in other developingcountries However, only a handful of developing countries account for the bulk of developingcountry FDI outflows Most intra-developing country FDI activity is recorded in East and South-East Asia, especially among ASEAN countries, and recently in Latin America, especially amongMERCOSUR members There are signs that FDI flows from East and South-East Asia to LatinAmerica and Africa are picking up One way to assist South-South FDI flows is to help firmsfrom developing countries to obtain insurance from MIGA for their investments abroad Assuch insurance often depends on the preparation of environmental assessment studies (which,for many firms, especially smaller ones, are quite expensive), the establishment of a trust fundthat would provide assistance in this respect should be considered

Driven by M&As, FDI flows to developed countries

rrrrregister an impr egister an impr egister an impressive incr essive incr essive increase … ease …

Record FDI inflows into, and outflows from, developed countries are behind the 1998surge in global FDI Developed countries accounted for 92 per cent of global outflows and 72per cent of global inflows in 1997 The developed country picture is characterized by anintensification of TNC-led links between the United States and the European Union, each ofthem being the largest source of FDI for the other, and by the emergence of Australia, Canadaand 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, cross-border M&As drove the large increases in both inflows andoutflows for the United States and the strong FDI performance of the developed world as awhole A new phenomenon is the growth of cross-border M&As in Japan For developed

countries, the value of cross-border M&A sales reached a record $468 billion in 1998.

The European Union was the largest source of FDI, registering $386 billion in outflows in

1998 The United Kingdom, with about $114 billion, was the lead European Union investor Incontrast to the boost to intra- and extra-European Union investment in the late 1980s and early1990s that resulted from anticipation of the Single Market Programme, steps towards monetaryintegration manifested by the adoption of a single currency have so far had only little effect onFDI Flows to members of the European Monetary Union (EMU) increased only slightly morethan those to non-members in 1998, and the share of EMU members in total FDI inflows to the

EU was still lower than in 1996 This could change in 1999 and beyond, as, with theimplementation of the monetary union, its advantages and disadvantages for the location ofFDI are understood better

Japan’s outflows declined from $26 billion in 1997 to $24 billion in 1998, while inflowsremained at almost the same level as in 1997, i.e $3.2 billion Economic recession at home and inneighbouring Asia (translating into fewer sales and lower profits) has reduced both themotivation and the ability of Japanese TNCs to invest abroad This was manifested by loweroutflows of new equity and reinvested profits Japanese TNCs were hard hit in Asia, sufferinglosses and having to shift to export-oriented production to the extent possible To alleviate theirdifficulties, Japanese TNCs are restructuring their overseas operations On the other hand, despitethe recession in Japan, investment opportunities in Japan, particularly for M&As, are leading to

an increase in inflows Although lower FDI outflows and higher FDI inflows are reducing thegap between FDI inflows to and outflows from Japan, the low level of the former may affectJapan’s trade structure

As this brief review shows, cross-border M&As were the driving force of increased FDIflows in 1998 There are many factors that explain the current wave of M&A – a wave that doesnot seem to be deterred by the relatively poor results that have been observed with respect toM&As, particularly in some industries These include the opening of markets due to theliberalization of trade, investments and capital markets and to deregulation in a number ofindustries, and fiercer competitive pressures brought about by globalization and technological

changes Under these conditions, expanding firm size and managing a portfolio of locational

assets becomes more important for firms, as it enables them to take advantage of resources andmarkets world-wide The search for size is also driven by the search for financial, managerialand operational synergies, as well as economies of scale Finally, size puts firms in a betterposition to keep pace with an uncertain and rapidly evolving technological environment, a crucialrequirement in an increasingly knowledge-intensive world economy, and to face soaring costs

of research Other motivations include efforts to attain a dominant market position as well as

short-term financial gains in terms of stock value In many instances, furthermore, the dynamics

of the process feeds upon itself, as firms fear that, if they do not find suitable partners, they maynot survive, at least in the long run

… while the developing r

… while the developing regions pr egions pr egions present a diverse pictur esent a diverse pictur esent a diverse picture FDI flows into Latin e FDI flows into Latin America and the Caribbean r

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 MERCOSURcountries received almost half of this amount With more than $28 billion, Brazil was the largestrecipient, followed by Mexico with $10 billion As commodity prices fell sharply, portfolioinvestment 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 Large markets,especially those of NAFTA and MERCOSUR, also provided lucrative investment destinations

To the extent that FDI is concentrated in services and other non-tradable industries, profit anddividend remittances, as well as expectation regarding remittances, could have implications forthe balance-of-payments of the host countries In Brazil, for instance, profit and dividendremittances increased by about 18 per cent to an estimated $7.7 billion in 1998

The United States remains the largest investor in Latin America and the Caribbean TheEuropean Union, however, has made significant gains as a source of FDI to that region, and isbeginning to challenge the traditional dominance of the United States Spain in particular hasbeen a significant investor, accounting for one third of all European Union FDI in Latin Americaand the Caribbean in 1997 FDI outflows from Latin America and the Caribbean rose to morethan $15 billion 1998 – but more than two-fifths of that originated from offshore financial centresand cannot therefore be attributed solely to Latin American and Caribbean TNCs An estimated

$8 billion was invested within the region; Argentinian, Brazilian and Chilean TNCs wereespecially active in intra-regional FDI

Overview

… 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 Pacificappeared to have weathered the financial crisis that threw several Asian countries into turmoiland slashed growth rates It proved to be the most resilient form of private capital flows, even insome 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 regardsM&As, intensified efforts to attract FDI, and the still solid long-term prospects of the region.China remains the largest FDI host country in the developing Asian region, receiving $45billion in 1998 The Republic of Korea saw a dramatic increase in inflows (from less than $3billion in 1997 to $5 billion in 1998) and became a net FDI recipient with FDI inflows exceedingoutflows for the first time in the 1990s Thailand also experienced a dramatic increase in inflows(by 87 per cent in 1998), as a number of weakened financial institutions were acquired by foreigninvestors The Philippines also registered large gains By contrast, Hong Kong (China), Indonesia,Singapore, Taiwan Province of China and Viet Nam suffered declines

South Asian economies received small FDI flows; India for example was unable to sustainthe high rate of FDI growth it had enjoyed in the recent past

Continuing earlier trends, the Pacific Island economies received about $175 million in

1998, mostly from Australia, Japan and New Zealand FDI flows to West Asia remained at alevel similar to those of 1997, a year that registered a sharp increase This was due largely to thelow oil prices prevailing in 1998 For the same reason, FDI flows to oil-exporting Central Asianeconomies lost their growth momentum, but that was partly compensated by increases in thenon-oil based economies of Armenia and Georgia

United States TNCs have been active investors in Asia during the crisis, followed byEuropean TNCs

Plagued by financing difficulties, TNCs from developing Asian countries decreased theiroverseas FDI (especially in other Asian countries) by a quarter, investing altogether $36 billion

in 1998 Financing shortages led many companies, especially TNCs based in the Republic ofKorea, to slow down the acquisition of foreign companies and even to divest some of theirassets abroad

… Africa is still awaiting the r

… Africa is still awaiting the realization of its potential … ealization of its potential …

FDI inflows to Africa (including South Africa) — at $8.3 billion in 1998 — were downfrom the record $9.4 billion registered in 1997 This was largely accounted for by a decrease offlows into South Africa where privatization-related FDI — which had reached an unprecedentedpeak 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, butgrowth in FDI flows to the region was much less than that in FDI flows to other developingcountries, leaving much of Africa’s potential for FDI unutilized

A survey of African investment promotion agencies, undertaken by UNCTAD in 1999,indicates where this potential lies, at least in the eyes of those who seek to attract FDI: during1996-1998, the leading industries that attracted FDI were telecommunications, food andbeverages, tourism, textiles and clothing, as well as mining and quarrying For the years 2000-

2003, they are expected to be tourism, food and beverages, telecommunications as well as textileand leather Independently of specific industries, the five countries that were ranked mostattractive to foreign investors in Africa for the period 2000-2003 were South Africa, Nigeria,Botswana, Côte d’Ivoire and Tunisia The countries that were most frequently mentioned asregards the creation of a business-friendly environment were Botswana, South Africa, Nigeria,Uganda and Côte d’Ivoire Among the countries that were ranked as the top 10 according to thecriterion of a business-friendly environment, six countries - Botswana, Ghana, Mozambique,Namibia, Tunisia and Uganda — had been identified as FDI front-runners in WIR98 (out of

seven front-runners) The survey, however, also indicated that, in spite of the reforms that havetaken place and the progress expected in a number of African countries in terms of improvingthe business environment, further work is needed to change the image of Africa and to developamong foreign investors a more differentiated view of the continent and its opportunities

… and flows into Central and Eastern Eur

… and flows into Central and Eastern Europe, except the Russian Federation, ope, except the Russian Federation, rrrrreached new highs eached new highs.

Excluding the Russian Federation, Central and Eastern European countries received recordFDI 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 onmarket-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 Europeancountries, FDI is still privatization-led, although a few countries have started a switch to non-privatization-generated investment

FOREIGN DIRECT INVESTMENT AND THE

CHALLENGE OF DEVELOPMENT

The

The new competitive context raises new challenges for governments and TNCs … new competitive context raises new challenges for governments and TNCs …

The development priorities of developing countries include achieving sustained incomegrowth for their economies by raising investment rates, strengthening technological capacitiesand skills, and improving the competitiveness of their exports in world markets; distributingthe benefits of growth equitably by creating more and better employment opportunities; andprotecting and conserving the physical environment for future generations The new, morecompetitive, context of a liberalizing and globalizing world economy in which economic activitytakes place imposes considerable pressures on developing countries to upgrade their resourcesand 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 competitiveconditions, evolving attitudes and policies, and more vocal (and influential) stakeholders

A vital part of the new context is the need to improve competitiveness, defined as theability to sustain income growth in an open setting In a liberalizing and globalizing world,growth can be sustained only if countries can foster new, higher value-added activities, to producegoods and services that hold their own in open markets

FDI and international production by TNCs can play an important role in complementingthe efforts of national firms in this respect However, the objectives of TNCs differ from those ofhost governments: governments seek to spur national development, while TNCs seek to enhancetheir own competitiveness in an international context In the new context, TNCs’ ownershipadvantages are also changing In particular, rapid innovation and deployment of newtechnologies, in line with logistic and market demands, are more important than ever before.Thus, TNCs have to change their relations with suppliers, buyers and competitors to managebetter the processes of technical change and innovation And they have to strike closer linkswith institutions dealing with science, technology, skills and information The spread oftechnology to, and growth of skills in, different countries means that new TNCs are constantlyentering the arena to challenge established ones

A striking feature of the new environment is how TNCs shift their portfolios of mobileassets across the globe to find the best match with the immobile assets of different locations Inthe process, they also shift some corporate functions to different locations within internationallyintegrated production and marketing systems (intensifying the process of “deep integration”).The ability to provide the necessary immobile assets thus becomes a critical part of an FDI —

Overview

and competitiveness — strategy for developing countries While a large domestic market remains

a powerful magnet for investors, TNCs serving global markets increasingly look for world-classinfrastructure, skilled and productive labour, innovatory capacities and an agglomeration ofefficient suppliers, competitors, support institutions and services In addition, they may alsoseek to acquire created assets embodied in competitive host country firms, which may lead to arestructuring of these firms not necessarily beneficial for host countries Low-cost labour remains

a source of competitive advantage for countries, but its importance is diminishing; moreover, itdoes not provide a base for sustainable growth since rising incomes erode the edge it provides.The same applies to natural resources

… and meeting them r

… and meeting them requir equir equires policy intervention es policy intervention.

There is no conflict between exploiting static sources of comparative advantage anddeveloping new, dynamic ones; existing advantages provide the means by which new advantagescan 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 growthaccelerates, or economic development reaches a certain level; it merely changes its form andfocus This is why competitiveness remains a concern of governments in developing anddeveloped countries alike The starting point for this concern is that providing a level playingfield and letting firms respond to market signals is sufficient only to the extent that marketswork efficiently The very existence of TNCs is a manifestation that this is not always the case

In the presence of market failures, e.g when markets fail to exploit existing endowments fully,fail to develop new competitive advantages, or do not give the correct signals to economic agents

so that they can make proper investment decisions, intervention is necessary — providedgovernments have the capabilities to design, monitor and implement policies that overcomemarket failures

More specifically, government policies on FDI need to counter two sets of market failures.The first arises from information or coordination failures in the investment process, which canlead a country to attract insufficient FDI, or the wrong quality of FDI The second arises whenprivate interests of investors diverge from the economic interests of host countries This canlead FDI to have negative effects on development, or it may lead to positive, but static benefitsthat are not sustainable over time Private and social interests may, of course, diverge for anyinvestment, local or foreign: policies are then needed to remove the divergence for all investors.However, some divergence may be specific to foreign investment FDI may differ from localinvestment because the locus of decision-making and sources of competitiveness in the formerlie abroad, because TNCs pursue regional or global competitiveness-enhancing strategies, orbecause foreign investors are less committed to host economies and are relatively mobile Thus,the case for intervening with FDI policies may have a sound economic basis In addition, countriesconsider that foreign ownership has to be controlled on non-economic grounds — for instance,

to keep cultural or strategic activities in national hands

The role of FDI in countries’ processes and efforts to meet development objectives candiffer greatly across countries, depending on the nature of the economy and the government

One vision — pursued, for example, by Malaysia, Singapore and Thailand — was to rely

substantially on FDI, integrating the economy into TNC production networks and promotingcompetitiveness by upgrading within those networks Another vision — pursued by the Republic

of Korea and Taiwan Province of China — was to develop domestic enterprises and autonomousinnovative capabilities, relying on TNCs mainly as sources of technology, primarily at arm’slength Yet another, that of the administration of Hong Kong (China), was to leave resourceallocation largely to market forces, while providing infrastructure and governance There is noideal development strategy with respect to the use of FDI that is common for all countries at alltimes Any good strategy must be context specific, reflecting a country’s level of economicdevelopment, the resource base, the specific technological context, the competitive setting, and

a government’s capabilities to implement policies

FDI comprises a package of r

FDI comprises a package of resour esour esources … ces …

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 tomeasure with precision Each TNC represents a complex package of firm-level attributes thatare dispersed in varying quantities and quality from one host country to another These attributesare difficult to separate and quantify Where their presence has widespread effects, measurement

is even more difficult There is no precise method of specifying a counter-factual – what wouldhave happened if a TNC had not made a particular investment Thus, the assessment of thedevelopment effects of FDI has to resort either to an econometric analysis of the relationshipsbetween inward FDI and various measures of economic performance, the results of which areoften inconclusive, or to a qualitative analysis of particular aspects of the contribution of TNCs

to development, without any attempt at measuring costs and benefits quantitatively

FDI comprises a bundle of assets, some proprietary to the investor The proprietary assets,the “ownership advantages” of TNCs, can be obtained only from the firms that create them.They can be copied or reproduced by others, but the cost of doing that can be very high,particularly in developing countries and where advanced technologies are involved Non-proprietary assets – finance, many capital goods, intermediate inputs and the like – can usually

be obtained from the market also

The most prized proprietary asset is probably technology Others are brand names,specialized skills, and the ability to organize and integrate production across countries, toestablish marketing networks, or to have privileged access to the market for non-proprietaryassets (e.g funds, equipment) Taken together, these advantages mean that TNCs can contributesignificantly to economic development in host countries – if the host country can induce them

to transfer their advantages in appropriate forms and has the capacity to make good use ofthem The assets in the FDI bundle are:

• Capital: FDI brings in investible financial resources to host countries FDI inflows aremore stable and easier to service than commercial debt or portfolio investment Indistinction to other sources of capital, TNCs typically invest in long-term projects

• Technology: TNCs can bring modern technologies, some of them not available in theabsence of FDI, and they can raise the efficiency with which existing technologies areused They can adapt technologies to local conditions, drawing upon their experience inother developing countries They may, in some cases, set up local R&D facilities They canupgrade technologies as innovations emerge and consumption patterns change They canstimulate technical efficiency and technical change in local firms, suppliers, clients andcompetitors, by providing assistance, by acting as role models and by intensifyingcompetition

• Market access: TNCs can provide access to export markets, both for goods (and someservices) that are already produced in host countries, helping them switch from domestic

to international markets; and for new activities that exploit a host economy’s comparativeadvantages The growth of exports itself offers benefits in terms of technological learning,realization of scale economies, competitive stimulus and market intelligence

• Skills and management techniques: TNCs employ and have world-wide access toindividuals with advanced skills and knowledge and can transfer such skills andknowledge to their foreign affiliates by bringing in experts and by setting up state-of-the-art training facilities Improved and adaptable skills and new organizational practices andmanagement techniques can yield competitive benefits for firms as well as help sustainemployment as economic and technological conditions change

• Environment: TNCs are in the lead in developing clean technologies and modernenvironmental management systems They can use them in countries in which they operate

Overview

Spillovers of technologies and management methods can potentially enhance

environmental management in local firms within the industries that host foreign affiliates.While TNCs offer the potential for developing countries to access these assets in a package,this does not necessarily mean that simply opening up to FDI is the best way of obtaining orbenefiting from them The occurence of market failures mentioned above means that governmentsmay have to intervene in the process of attracting FDI with measures to promote FDI generally

or measures to promote specific types of FDI Furthermore, the complexity of the FDI packagemeans that governments face trade-offs between different benefits and objectives For instance,they may have to choose between investments that offer short as opposed to long-term benefits;the former may lead to static gains, but not necessarily to dynamic ones

The principal issues to be addressed by governments fall into the following four groups:

• Information and coordination failures in the international investment process

• Infant industry considerations in the development of local enterprises, which can bejeopardized when inward FDI crowds out those enterprises

• The static nature of advantages transferred by TNCs where domestic capabilities are lowand do not improve over time, or where TNCs fail to invest sufficiently in raising therelevant capabilities

• Weak bargaining and regulatory capabilities on the part of host country governments,which can result in an unequal distribution of benefits or abuse of market power by TNCs

… the benefits of which can be r

… the benefits of which can be reaped thr eaped thr eaped through policy measur ough policy measur ough policy measures … es …

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

FDI-• 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 FDIapproval process can take several times longer, and entail costs many times greater in onecountry than in another with similar policies After approval, the costs of setting upfacilities, operating them, importing and exporting goods, paying taxes and generallydealing with the authorities can differ enormously

• Such costs can, other things being equal, affect significantly the competitive position of ahost 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, foreigninvestors have a much wider set of options before them, and are able to compare transactioncosts in different countries Thus, attracting TNCs requires not just that transaction costs

be lowered, but also, increasingly, that they be benchmarked against those of competinghost countries One important measure that many countries take to ensure that internationalinvestors face minimal costs is to set up one-stop promotion agencies able to guide andassist them in getting necessary approvals However, unless the agencies have the authorityneeded to provide truly one-stop services, and unless the rules themselves are clear andstraightforward, this may not help

• Despite their size and international exposure, TNCs face market failures in information Theirinformation base is far from perfect, and the decision-making process can be subjectiveand biased Taking economic fundamentals as given, it may be worthwhile for a country

that receives lower FDI than desired to invest in establishing a distinct image of its ownand, if necessary, attempt to alter the perception of potential investors by providing moreand better information Such promotion efforts are highly skill-intensive and potentiallyexpensive, and they need to be mounted carefully to maximize their impact Investortargeting — general, industry-specific or company specific – could be a cost-effectiveapproach in some cases Targeting or information provision is not the same as givingfinancial or fiscal incentives In general, incentives play a relatively minor role in a goodpromotion programme, and good, long-term investors are not the ones most susceptible

to short-term inducements The experiences of Ireland, Singapore - and, more recently,Costa Rica — suggest that promotion and targeting can be quite effective in raising theinflow of investment and its quality

Effective promotion should go beyond simply “marketing a country”, into coordinatingthe supply of a country’s immobile assets with the specific needs of targeted investors Thisaddresses potential failures in markets and institutions — for skills, technical services orinfrastructure — in relation to the specific needs of new activities targeted via FDI A developingcountry may not be able to meet, without special effort, such needs, particularly in activitieswith advanced skill and technology requirements The attraction of FDI into such industries can

be greatly helped if a host government discovers the needs of TNCs and takes steps to cater tothem The information and skill needs of such coordination and targeting exceed those ofinvestment promotion per se, requiring investment promotion agencies to have detailedknowledge of the technologies involved (skill, logistical, infrastructural, supply and institutionalneeds), as well as of the strategies of the relevant TNCs

… that also minimize the adverse ef

… that also minimize the adverse effects on domestic enterprise development fects 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 ofconcern Crowding out due to FDI could occur in two ways: first, in the product market, byadversely 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 costsfor local firms, or both

The first issue reflects “infant industry” considerations, but without the usual connotation

of protecting new activities against import competition It concerns the fostering of learning indomestic firms vis-à-vis foreign firms FDI can abort or distort the growth of domestic capabilities

in competing firms when direct exposure to foreign competition prevents local enterprises fromundertaking lengthy and costly learning processes Foreign affiliates also undergo learning locally

to master and adapt technologies and train employees in new skills However, they have muchgreater resources to undertake this learning, and considerably more experience of how to goabout learning in different conditions In these cases, “crowding out” can be said to occur ifpotentially competitive local firms cannot compete with affiliates at a given point in time.The case for domestic enterprise protection differs from the infant industry argument fortrade protection When trade protection is eliminated, consumers benefit from cheaper importsand greater product variety; but some domestic production and employment can be lost Incontrast, in the case of local enterprise protection, the absence of such protection from FDIcompetition does not lead to loss of domestic production and employment in exchange forenhancing consumer benefits; but, indigenous entrepreneurial development may be hampered,particularly in sophisticated activities The net cost of this is that linkages may be fewer andtechnological deepening may be inhibited As with all infant industry arguments, crowding out

is economically undesirable if three conditions are met First, infant local enterprises are able tomature to full competitiveness if sheltered against foreign competition that takes place through(in this case) FDI Second, the maturing process does not take so long that the discounted presentsocial costs outweigh the social benefits Third, even if there are social costs, there must be externalbenefits that outweigh them

Overview

Crowding out can impose a long-term cost on the host economy if it holds back thedevelopment of domestic capabilities or retards the growth of a local innovative base This canmake technological upgrading and deepening dependent on decisions taken by TNCs, and insome cases hold back the host economy at lower technological levels than would otherwise bethe case However, it is important to distinguish between affiliates crowding out potentiallyefficient domestic enterprises and affiliates out-competing inefficient local firms that cannotachieve full competitiveness One of the benefits of FDI can be the injection of new technologiesand competition that leads to the exit of inefficient enterprises and the raising of efficiency inothers Without such a process, the economy can lack dynamism and flexibility, and can losecompetitiveness over time, unless competition between local firms in the domestic market isintense, or they face international competition (say, in export markets)

TNCs, however, can also “crowd in” local firms if they strike up strong linkages withdomestic suppliers, subcontractors and institutions Crowding in can take place when foreignentry increases business opportunities and local linkages, raises investible resources or makesfactor markets more efficient Such stimulating effects are most likely when FDI concentrates inindustries that are undeveloped in (or new to) host countries Where local firms are welldeveloped, but still face difficulties in competing with foreign affiliates, there can be harmfulcrowding out However, local firms can also become suppliers to TNCs, or be taken over bythem, as discussed below

A second variety of crowding out reflects an uneven playing field for domestic firmsbecause of a segmentation in local factor markets: TNCs may have privileged access to factorssuch as finance (which may give them a special advantage especially vis-à-vis local firms) andskilled personnel because of their reputation and size They can thus raise entry costs for localfirms, or simply deprive them of the best factor inputs

Both forms of crowding out raise policy concerns Most governments wish to promotelocal enterprises, particularly in complex and dynamic industrial activities Many feel that thedeepening of capabilities in local firms yields greater benefits than receiving the sametechnologies from TNCs: linkages with local suppliers are stronger, there is more interactionwith local institutions, and where innovatory activities take place, knowledge developed withinfirms is not “exported” to parent companies and exploited abroad, and so on The few developingeconomies that have developed advanced indigenous technological capabilities have restrictedthe entry of FDI (generally, or into specific activities) The possession of a strong indigenoustechnology base is vital not just for building the competitiveness of local enterprises – it is alsoimportant for attracting high-technology FDI and for R&D investments by TNCs

At the same time, there are risks in restricting FDI per se to promote local enterprises Forone thing, it is very difficult in practice to draw the distinction between crowding out andlegitimate competition If policy makers cannot make this distinction, they may prop upuneconomic local firms for a long period, at heavy cost to domestic consumers and economicgrowth The danger of technological lags if TNCs are kept out of sophisticated activities in acountry is much greater now than, say, several decades ago So is the risk of being unable toenter export markets for activities with high product differentiation and internationally integratedproduction processes It is important however, to strengthen the opportunities for domestic firms

to crowd in after the entry of FDI by building up local capabilities and a strong group of and medium-sized domestic firms that could develop linkages with foreign affiliates

small-The right balance of policies between regulating foreign entry and permitting competitiondepends on the context Only a few developing countries have built impressive domesticcapabilities and world-class innovative systems while restricting the access of TNCs Some othershave restricted foreign entry, but have not succeeded in promoting competitive domesticenterprises in high-technology manufacturing activities Success clearly depends on many otherthings apart from sheltering learning, including the availability of complementary resourcesand inputs, the size of the domestic market and the competitive climate in which learning takesplace In sum, the infant enterprise argument remains valid, and can provide a case for policy

on employment M&As can also have anti-competitive effects if they reduce substantially thenumber of competitors in a domestic market, especially for non-tradable products such as mostservices.

M&As may also yield economic benefits, however Where the investor makes a long-termcommitment to the acquired firm and invests in upgrading and restructuring its technology andmanagement, the impact is very similar to a greenfield investment In Thailand, for instance, inthe context of the recent financial crisis, a number of M&As in the automobile industry areleading to restructuring and increased competitiveness, manifested by increases in commercialvehicle exports FDI related to M&As can play an important role in modernizing privatizedutilities such as telecommunications and public utilities, as is the case in some instances in LatinAmerica Foreign acquisitions can prevent viable assets of local firms from being wiped out;this can be particularly important in economies in transition and financially distressed developingcountries

The benefits of M&As (including in the context of privatization) depend on thecircumstances of a country and the conditions under which enterprises are acquired andsubsequently operated However, there may be value in monitoring M&As, instituting effectivecompetition policies, and placing limits on them when the macroeconomic situation justifies it.This raises the question of the effects of FDI on market structure in host countries Therehas been a long-standing concern that the entry of large TNCs raises concentration levels within

an economy and can lead to the abuse of market power TNCs tend to congregate in concentratedindustries Whether this leads to the abuse of market power is an empirical question requiringfurther research If host economies have liberal trade regimes, the danger of anti-competitivebehaviour in such structures is largely mitigated However, it remains true that effectivecompetition policy becomes more and more important in a world in which large TNCs can easilydominate an industry in a host country

Positive dynamic FDI ef

Positive dynamic FDI effects on host countries r fects on host countries r fects on host countries requir equir equire appr e appr e appropriate skills opriate skills and policies, …

Many important issues concerning the benefits of FDI for technology acquisition andtechnological capacity-building, skills development and competitiveness revolve around its staticversus dynamic effects TNCs can be efficient vehicles for the transfer of technologies and skillssuited to existing factor endowments in host economies They provide technology at very differentlevels 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 inhost (and home) countries is conducive (and infrastructure is adequate), they can use localendowments effectively to expand exports from host countries This can create new capabilities

Overview

in the host economies and can have beneficial spillover effects In low-technology assemblyactivities, the skills and linkage benefits may be low; in high-technology activities, however,they may be considerable Unless they operate in highly protected regimes, pay particularlylow wages (as in some export processing zones in low-skill assembly), or benefit from expensiveinfrastructure while paying no taxes, there is a strong presumption that FDI contributes positively

to using host country resources efficiently and productively

In this context, one of the main benefits of TNCs to export growth is not simply theirability to provide the technology and skills to complement local resources, or labour to producefor export, but to provide access to foreign markets TNCs are increasingly important players inworld trade They have large internal (intra-firm) markets for some of the most dynamic andtechnology-intensive products, access to which is available only to affiliates They haveestablished brand names and distribution channels with supply facilities spread over severalnational locations They can influence the granting of trade privileges in their home (or in third)markets All these factors mean that they might offer considerable advantages in creating aninitial export base for new entrants

The development impact of FDI, however, also depends on the dynamics of the transfer oftechnology and skills by TNCs: how much upgrading of local capabilities takes place over time,how far local linkages deepen, and how closely affiliates integrate themselves in the local learningsystem TNCs may simply exploit the existing advantages of a host economy and move on asthose advantages erode Static advantages may not automatically transmute into dynamicadvantages This possibility looms particularly large where a host economy’s main advantage islow-cost unskilled labour, and the main TNC export activity is low-technology assembly.The extent to which TNCs dynamically upgrade their technology and skills transfer andraise local capabilities and linkages depends on the interaction of the trade and competitionpolicy regime, government policies on the operations of foreign affiliates, the corporate strategiesand resources of TNCs, and the state of development and responsiveness of local factor markets,firms and institutions

• The trade and competition policy regime in a host economy may provide the encouragementfor enterprises, local and foreign, to invest in developing local capabilities In general, themore competitive and outward-oriented a regime, the more dynamic is the upgradingprocess A highly protected regime, or a regime with stringent constraints on local entryand exit, discourages technological upgrading, isolating the economy from internationaltrends This is not to say that completely free trade is the best setting Infant industryconsiderations suggest that some protection of new activities can promote technologicallearning and deepening However, even protected infants must be subjected to the rigours

of international competition fairly quickly – otherwise they will never grow up This applies

to foreign affiliates, as well as to local firms A strongly export-oriented setting withappropriate incentives provides the best setting for rapid technological upgrading

• The second factor concerns policies regarding the operations of foreign affiliates, includinglocal-content requirements, incentives for local training or R&D, and pressures to diffusetechnologies The results of the use of such policies have often been poor when they werenot integrated into a wider strategy for upgrading capabilities However, where countrieshave used them as part of a coherent strategy, as in the mature newly-industrializingeconomies, the results have often been quite beneficial: foreign affiliates enhanced thetechnology content of their activities and of their linkages to local firms, which weresupported in raising their efficiency and competitiveness Much of the effort by foreignaffiliates to upgrade local capabilities involves extra cost, and affiliates will not necessarilyundertake this effort unless it is cost effective and suits their long-term objectives For thehost economy, it is worth doing so only if it leads to efficient outcomes If upgrading isforced beyond a country’s capabilities, it will not survive in a competitive and openenvironment

• The third factor involves TNC strategies Corporate strategies differ in the extent to whichthey assign responsibility to different affiliates and decide their position in the corporatenetwork TNCs are changing their strategies in response to technological change and policyliberalization, and much of this is outside the scope of influence of developing hostcountries Nevertheless, host country governments can influence aspects of TNC locationdecisions by measures such as targeting investors, inducing upgrading by specific toolsand incentives and improving local factors and institutions This requires them to have aclear understanding of TNC strategies and their evolution

• The fourth factor, the state and responsiveness of local factor markets, firms and institutions,

is probably the most important one TNCs upgrade their affiliates where it is cost-efficient

to do so Moreover, since firms in most industries prefer their suppliers to be nearby, theywill deepen local linkages if local suppliers can respond to new demands efficiently Bothdepend upon the efficacy and development of local skills and technological capabilities,supplier networks and support institutions Without improvements in factor markets, TNCscan improve the skills and capabilities of their employees only to a limited extent They

do not compensate for weaknesses in the local education, training and technology system

In the absence of rising skills and capabilities generally, it would be too costly for them toimport advanced technologies and complex, linkage-intensive operations

At the same time, there are risks that the presence of TNCs inhibits technologicaldevelopment in a host economy TNCs are highly efficient in transferring the results ofinnovation performed in developed countries, but less so in transferring the innovationprocess itself While there are some notable exceptions, foreign affiliates tend to do relativelylittle R&D This may be acceptable for a while in the case of countries at low levels ofindustrial development, but can soon become a constraint on capability building ascountries need to develop autonomous innovative capabilities Once host countries buildstrong local capabilities, TNCs can contribute positively by setting up R&D facilities.However, at the intermediate stage, the entry of large TNCs with ready-made technologiescan inhibit local technology development, especially when local competitors are too farbehind to gain from their presence Where a host economy adopts a proactive strategy todevelop local skills and technology institutions, it may be able to induce TNCs to invest inlocal R&D even if there is little research capability in local firms The appropriate policyresponse is not to rule out FDI, but to channel it selectively so that local learning is protectedand promoted In countries that do not restrict FDI, it is possible to induce advanced TNCtechnological activity by building skills and institutions

Overview

To strengthen developing countries’ bargaining capabilities, legal advice is often required,but the costs of obtaining such advice are usually prohibitive, especially for least developedcountries Establishing a pilot facility that would help ensure that expert advice in contractnegotiations is more readily available to developing countries is worth considering Such a facilitywould benefit not only developing host countries, but also TNCs by reducing specific transactioncosts in the process of negotiations (for instance, by reducing the risk of delays) and, moregenerally, by leading to more stable and lasting contracts

To return to the regulatory framework: with liberalization and globalization, there arefewer policy tools available to countries left to influence the conduct of foreign and local firms.The capacities of host developing countries to regulate enterprises in terms of competition policyand environment policy are emerging as the most active policy-making areas An effectivecompetition policy is therefore an absolute necessity However, most developing countries lacksuch policy Mounting a competition policy is a complex task requiring specialized skills andexpertise that are often scarce in developing countries It is important for host countries to startthe process of developing these skills and expertise, especially if large TNCs with significantmarket power are attracted to their markets

Similar concerns arise with respect to the environment Many developing host countrieshave only limited regulations on the environment, and often lack the capacity to enforce themeffectively TNCs are often accused of exploiting these in order to evade tougher controls in thedeveloped world Some host developing countries are accused of using lax enforcement to attractFDI in pollution-intensive activities The evidence on the propensity of TNCs to locate theirinvestments in order to evade environmental regulations is, however, not conclusive TNCs areusually under growing pressure to conform to high environmental standards from home countryenvironmental regulations, consumers, environment groups and other “drivers” in the developedand developing world Many see environment management not only as necessary, but also ascommercially desirable However, it is up to host governments to ensure that all TNCs anddomestic firms follow the examples set by the “green” TNCs

Another important regulatory problem is that of transfer pricing to evade taxes orrestrictions on profit remission TNCs can use transfer pricing over large volumes of trade andservice transactions The problem is not restricted to dealings between affiliates; it may alsoarise in joint ventures However, it may well be that the deliberate abuse of transfer pricing hasdeclined as tax rates have fallen and full profit remittances are allowed in much of the developingworld Double-taxation treaties between host and home countries have also lowered the risk oftransfer-pricing abuses However, this problem still remains a widespread concern amongdeveloped and developing countries Tackling it needs considerable expertise and information.Developing country tax authorities are generally poorly equipped to do this, and can benefitgreatly from technical assistance and information from developed-country governments in thisarea

Managing FDI policy effectively in the context of a broader competitiveness strategy is ademanding task A passive, laissez faire approach is unlikely to be sufficient because of failures

in markets and deficiencies in existing institutions Such an approach may not attract sufficientFDI, extract all the potential benefits that FDI offers, or induce TNCs to operate by best-practicesstandards However, a laissez faire FDI strategy may yield benefits in host countries that haveunder-performed in terms of competitiveness and investment attraction because of past policies.Such a strategy sends a strong signal to the investment community that the economy is open forbusiness FDI will be attracted into areas of existing comparative advantage However, thereare two problems First, if attractive locational assets are limited, or their use is held back bypoor infrastructure or non-economic risk, there will be little FDI response Second, even if FDIenters, its benefits are likely to be static and will run out when existing advantages are used up

To ensure that FDI is sustained over time and enters new activities requires policy intervention,both to target investors and to raise the quality of local factors Needless to say, for the greatmajority of countries the form of intervention has to be different from traditional patterns ofheavy inward-orientation and market-unfriendly policies – it has to be aimed at competitiveness

What all this suggests is that there is no ideal universal strategy on FDI Any strategy has

to suit the particular conditions of a country at any particular time, and evolve as the country’sneeds and its competitive position in the world change Increasingly, it also has to take intoaccount the fact that international investment agreements set parameters for domestic policymaking Governments of developing countries need to ensure, therefore, that such agreements

do leave them the policy space they require to pursue their development strategies Formulatingand implementing an effective strategy requires above all a development vision, coherence andcoordination It also requires the ability to decide on trade-offs between different objectives ofdevelopment In a typical structure of policy making, this requires the FDI strategy-makingbody to be placed near the head of government so that a strategic view of national needs andpriorities can be formed and enforced

* * *

In conclusion, TNCs are principal drivers of the globalization process, which defines thenew context for development In this context, there is more space for firms to pursue theircorporate strategies, and enjoy more rights than before The obvious question is: should theseincreased rights be complemented by firms' assuming greater social responsibility? The notion

of social responsibility of TNCs encompasses a broad range of issues of which environmental,human and labour rights have attracted most attention in recent years In a liberalizing andglobalizing world economy, this question is likely to be asked with increasing frequency andinsistence In his Davos speech in January 1999, the Secretary-General of the United Nationsinitiated the discussions on this question by proposing a global compact Perhaps they could beintensified in the framework of a more structured dialogue between all parties concerned.Development would have to be central to this dialogue, as this is the overriding concern of themajority of humankind and because it is, in any event, intimately linked to the social,environmental and human rights objectives that lead the agenda in this area The dialogue couldbuild on the proposal of a global compact made by the Secretary-General, with a view towardsexamining how, concretely, the core principles already identified, as well as developmentconsiderations, could be translated into corporate practices After all, companies can best promotetheir social responsibilities by the way they conduct their own businesses and by the spread ofgood corporate practices

The world today is more closely knit, using different means of organization, communicationand production, and is more subject to rapid change than ever before At the same time, the past

30 years show striking – and growing – differences between countries in their ability to competeand grow They also show how markets by themselves are not enough to promote sustainedand rapid growth: policies matter, as do the institutions that formulate and implement them.There is an important role for government policies, but not in the earlier mould of widespreadintervention behind protective barriers Rather, in a globalizing world economy, governmentsincreasingly need to address the challenge of development in an open environment FDI canplay a role in meeting this challenge Indeed, expectations are high, perhaps too high, as towhat FDI can do But it seems clear that if TNCs contribute to development – and do sosignificantly and visibly – the relationship that has emerged between host country governments,particularly in developing countries, and TNCs over the past 15-20 years can develop furtherwith potential benefits for all concerned

Rubens Ricupero

Part One Trends

CHAPTER I

GLOB

The growth of international production is an important part of the process ofglobalization “International production” refers to that part of the production of goods andservices of countries that is controlled and managed by firms headquartered in other countries.Firms can exercise control of production in countries (“host countries”) other than their own(“home country”) either through the ownership of a minimum share of equity – that is, aminimum share in the capital stock or assets – of the enterprises in which the production takesplace, or through contractual (non-equity) arrangements that confer control upon them.Exercising control and having a voice in the management of an enterprise located abroad(“foreign affiliate”) – whether through capital investment or through contractual arrangement– leads to international production

Firms that engage in international production – transnational corporations (TNCs) –establish, under the common governance of their headquarters, international production systems

in which factors of production move, to a greater or lesser extent, among units located in differentcountries These systems increasingly cover a variety of activities, ranging from research anddevelopment (R&D) to manufacturing to service functions such as accounting, advertising,marketing and training, dispersed over host-country locations and integrated to produce finalgoods or services They are also increasingly being established, especially in developed countries,through mergers between existing firms from different countries or the acquisition of existingenterprises in countries by firms from others Once internationally dispersed production unitsunder common governance are established, mobile and location-bound factors of production towhich a TNC has access in home and host countries (and sometimes even third countries) are

combined in each unit in ways and for production that contribute the most to the firm’s economic

and strategic objectives From the perspective of factor use – as distinct from that of location ashost or home country for enterprises engaged in international production – all of the production

that takes place in these TNC production systems (in parent firms or home -country units as well

as foreign affiliates or host-country units) constitutes international production Viewed fromthe perspective of home and host countries, however, it is, respectively, the production in foreignlocations by a country’s own firms, and the production by foreign firms in a country’s ownlocations, that constitute international production It is this latter concept of production in foreignlocations, or production by foreign affiliates, that is most commonly used and that is used in

systems between home and host countries, the assets accumulated to create the basis for

international production, and the output, sales, trade and employment that internationalproduction generates Section B focuses then on the geographical and industrial patterns ofinternational production, as indicated by the distribution of FDI

A T

The extent and spread of international production activity may be gauged from thenumber of enterprises that are involved in it and their location Over 500,000 foreign affiliatesare in operation world-wide, established by about 60,000 parent companies (table I.1), spanningvirtually every country in the world To this, an (unknown) number of firms would have to beadded that are linked to each other through non-equity relationships While a number of theseparent corporations fit the traditional notion of TNCs as big and dominant (chapter III), manyare small- and medium-sized enterprises (SMEs).1 To illustrate, in 1996, small- and medium-sized TNCs accounted for four-fifths of all Swedish TNCs, while in Italy they accounted forthree-fifths (UNCTAD, forthcoming a); in the case of Japan, small- and medium-sized TNCsaccounted for 55 per cent of new foreign affiliates by Japanese firms in 1996 (Fujita, 1998, p 70)

In today’s globalizing world economy, the increasing competitive pressures faced by firms of allsizes impel more and more of them to establish an international portfolio of locational assets toremain competitive (UNCTAD, 1995) However small parent firms and their foreign affiliatesmay be, they are part of an increasing network of production linkages across borders

The establishment of foreign affiliates involves costs – in cash or kind, tangible andintangible Some of the funds required are made available by parent firms in the form of equity(often in a package comprising capital as well as other resources such as technology,organizational and managerial practices and marketing expertise), intra-company loans, andreinvested earnings (which accounted for about one fifth of total FDI flows in 1994-1997 (figureI.1)),2 together defined as foreign direct investment (FDI).3 In addition, foreign affiliates canalso be financed from funds that they raise in the domestic capital markets of host countries or

in international capital markets in forms such as loans and bonds Flows of funds frominternational capital markets may in fact sometimes be higher than FDI flows; this was the case

in 1988, 1990, 1993 and 1996 in respect to international funds other than FDI channelled to foreignaffiliates of United States TNCs (and, therefore, not recorded under FDI (figure I.2)) The relativeimportance of non-FDI finance for foreign affiliates is, however, likely to be lower in the case ofaffiliates in developing countries Financing also comes from equity shares contributed by localpartners or shareholders in the case of foreign affiliates that are not wholly owned by theirparent companies Total investment expenditure in foreign affiliates is, therefore, typicallyhigher than the value captured by FDI data (see chapter VI) In the case of foreign affiliates set

up through mergers and acquisitions (M&As) (which also include assets acquired in the context

of privatization, a special case of M&A), it is not known whether cross-border M&As are beingfinanced by FDI only They too can be financed from domestic capital markets or frominternational capital markets In addition, it is often not known to the user of data whether thepayment for an M&A is made in the year of the M&A, or phased over several years (box I.1).Therefore, there is not necessarily a direct correspondence between the value of cross-borderM&As and that of FDI flows; in other words, it cannot be taken for granted that the total value

of cross-border M&As actually represents FDI inflows.4

b

by area and econom y area and econom y area and economy yy yy,,,,, latest a latest a latest av vv vvailab ailab ailable y le y le year ear

(Number)

T Tab ab ab ab able I.1 le I.1 le I.1 Number of parent corporations and f Number of parent corporations and f Number of parent corporations and foreign affiliates, oreign affiliates, b

by area and econom y area and econom y area and economy yy yy,,,,, latest a latest a latest av vv vvailab ailab ailable y le y le year (contin ear (contin ear (continued) ued)

(Number)

South, East and South-East Asia 6 067 b 206 148

Central and Eastern Eur

Central and Eastern Europe ope 850 b 174 710

Source: UNCTAD estimates.

a Represents the number of parent companies/foreign affiliates in the economy shown, as defined by that economy Deviations from the definition adopted in the World Investment Repor t (see section on definitions and sources in the annex B) are noted below.

b Includes data for only the countries shown below.

c Provisional figures by Banque Nationale de Belgique.

d Of this number, 1,517 are majority-owned foreign affiliates.

e Directly and indirectly owned foreign affiliates.

f Does not include the number of foreign-owned holding companies in Germany which, in turn, hold participating interests in Germany (indirect foreign participating interests).

g As of October 1993.

h Includes those Spanish parent enterprises which, at the same time, are controlled by a direct investor.

Chapter I

%

Global T

i Data provided by Sveriges Riksbank Includes non-active firms (i.e firms that are not in operation) If the Swedish enterprises owning majority-owned foreign affiliates are considered, the number of Swedish TNCs was 1,833 Similarly, the number of majority- owned foreign affiliates operating in Sweden was 3,953 The survey on majority-owned foreign affiliates is conducted by NUTEK (Swedish National Board for Industrial and Technical Development).

j Data on the number of parent companies based in the United Kingdom, and the number of foreign affiliates in the United Kingdom, are based on the register of companies held for inquiries on the United Kingdom FDI abroad, and FDI into the United Kingdom conducted by the Central Statistical Office On that basis, the numbers are probably understated because of the lags in identifying investment in greenfield sites and because some companies with small presence in the United Kingdom and abroad have not yet been identified.

k Represents a total of 27 bank parent companies and 1,058 non-bank parent companies.

l Represents 453 foreign affiliates in banking and 2,072 non-bank foreign affiliates.

p Represents a total of 12,226 bank and non-bank affiliates in 1996 whose assets, sales or net income exceeded $1 million, and 5,551 bank and non-bank affiliates in 1992 with assets, sales and net income under $1 million, and 534 United States affiliates that are depository institutions Each affiliate represents a fully consolidated United States business enterprise, which may consist of a number of individual companies.

q Represents the number of foreign affiliates that received permission to invest during 1992-May 1998.

r As of April 1999.

s Estimated by Comite de Inversiones Extranjeras.

t Number of foreign companies registered under DL600.

u Less than 10.

v Out of this number, 811 are majority-owned foreign affiliates, while 159 affiliates have less than 10 per cent equity share.

w An equity stake of 25 per cent or more of the ordinary shares or voting power.

x Estimates by the Board of Investment.

y As of 1989.

z As of 1991.

aa As of October 1993.

ab As of May 1995.

ac Wholly-owned foreign affiliates only.

ad The number of companies receiving foreign investment that are registered with the Foreign Investment and Foreign Trade Agency.

ae This number covers all firms with foreign equity, i.e., equity ownership by non-resident corporations and/or non-resident individuals, registered with the Securities Exchange Commission from 1989 to 1995.

af Data are for the number of investment projects.

ag The number of firms that are registered with the National Bank of Kyrgyz Republic The actual number of firms that are in operation was three.

ah The number of firms that are registered with the National Bank of Kyrgyz Republic The actual number of firms that are in operation was 387.

ai As of March 1999.

aj The number refers to the firms that are in operation The total number of foreign affiliates registered is 1,299.

ak As of 1997.

al Out of this number 53,775 are are fully-owned foreign affiliates Includes joint ventures.

am As of 15 March 1999 Only registered affiliates with the Estonian Commercial Register.

an As of 1994.

ao Number of firms with foreign capital.

ap The number of affiliates established during December 1990-December 1998.

aq Includes joint ventures with local firms.

definitions change, or as older data are updated.