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Wednesday, 10 September 2008 20:23

Everyone likes investment.  It creates jobs, economic activity and opportunity.

But many people start raising questions about investment coming from foreigners.  Could it be politically motivated?  Witness the dramatic rise of investments from sovereign wealth funds, and state-owned enterprises.  Could it damage our environment?  The recent oil spills in the Gulf of Mexico pale into insignificance compared with those in Nigeria.  Could it rip off excessive profits?  Resource nationalism, especially in Latin America, might suggest "yes".

Could foreign investment result in mistreatment of workers?  Suicides and strikes in China are not a good sign.  Is foreign ownership of parts of the economy a threat to national sovereignty, especially when it is a company from a rich country investing in a poorer country?  Perhaps not, but it can seem so in the eyes of citizens.  And when we offshore invest to a developing country, it can seem like exporting jobs, especially if it is your job which is lost!

Foreign direct investment (FDI) has however been perhaps the most dynamic aspect of globalization over the past few decades, as barriers to investment have been reduced most everywhere.  And most countries that have received waves of FDI have also experienced very strong economic growth.  China and many other Asian countries are good examples.

What exactly is FDI?  It's when an investment is made to acquire a lasting interest in an enterprise operating outside of the economy of the investor.  One of the objectives is to gain an effective voice in the management of the enterprise.  This means that direct investors are able to influence the management of an enterprise, but does not necessarily imply that they have absolute control.

According to the statisticians, a threshold of 10 per cent of equity ownership usually qualifies an investor as a foreign direct investor.  So, it is quite different from the "portfolio investor" who might buy a few shares on the stock market.  

The direct investor can acquire his lasting interest in a company in different ways.  He might buy shares in an existing enterprise -- "mergers and acquisitions".  Or he might create a new enterprise or investment activity -- "greenfield investment".  When a multinational enterprise (MNE) reinvests profits in a foreign investment affiliate, this also counts as FDI.

FDI brings many obvious benefits, such as growth in economic activity and employment, and improved efficiency through competition with local enterprises.  But it can do more than that.  It can also lead to transfers of technology and best practice working methods to local enterprises with which it interacts.  It can stimulate human capital development of workers employed by the MNE affiliate.  It goes without saying that the ability to realise these benefits depends on the "absorptive capacity" of the local economy -- here the key element is the level of education of the local workers.  FDI in natural resource activities can also generate important taxation and/or royalty revenues.

Recent decades have witnessed major waves in FDI.  From 1980 to 1990, FDI quadrupled in value to over $200 billion, before easing back a little.  The next wave then peaked at $1400 billion in 2000, before crashing down to less than $600 billion in 2003.  A new wave came to an historic peak in 2007 at over $1800 driven by cross-border mergers and acquisitions (M&As).  Reinvested earnings accounted for about 30% of total FDI flows as a result of increased profits of foreign affiliates, notably in developing countries.  But now, because of the financial crisis, FDI is in free fall again.  For 2008, FDI is estimated by UNCTAD at $1400 billion (a fall of more than 20%), and it will likely fall again in 2009.

Two-thirds of inflows of FDI go to developed countries.  Close to one-third goes to developing countries.  While the US is the biggest recipient, about 2/3 of inflows go to Europe (with UK, France, the Netherlnds, Spain, Germany, Belgium and Switzerland being the leading recipients).

There has also been a globalization in FDI with the rise of developing economies as an FDI destination.  Nevertheless, FDI flows to the developing world are highly concentrated in a handful of countries.  In 2007, China was the world's sixth most important destination for FDI, followed by Hong Kong at 7th and Russia at 9th.  Also in the top 20 were Brazil (14th), Mexico (17th), Saudi Arabia (18th), Singapore (19th) and India (20th).  FDI flows to South, East and South-East Asia account for half of all flows going to developing countries.

No African countries figure in the top 20, and Africa's share of global FDI is only 3%.  Nevetheless, FDI into Africa in 2007 reached a new record of $53 billion thanks to booming commodity markets, the rising profitability of investments and improved policy environments.  A large proportion of FDI projects in Africa are linked to the extraction of natural resources.  MNEs from the US and EU are the main investors, followed by African investors (particularly from South Africa).  African investments by Asian MNEs are mainly concentrated on oil and gas extraction, and infrastructure.

Over 80% of outflows come from developed countries, while about 12% come from developing countries.  The US is again number one in terms of outflows, but again Europe as a whole leads the way (with UK, France, Germany, Spain and Italy being the leading investors).  The developing world is much less represented on the outflow side -- Hong Kong (9th), Russia (13th), British Virgin Islands (18th) and China (19th).  Despite the great publicity given to China's overseas investments, in reality its aggregate investments are not extremely high.

In addition to rising dramatically, FDI has been changing very much in nature.

First, FDI has been a key driver in the establishment supply chain production systems, especially in East Asia.  In that way, FDI is also a key driver of trade.  Capital equipment may be exported for the establishment of new production facilities.  Then, components are shipped to various destinations.  And then the final assembled product is sent to its consumption destination.

Second, as the demand for commodities has been rising, some countries have become concerned about the security of supply of the commodities.  This is leading to growing investments in natural resources to secure their safe and stable supply.  The case of China's natural resource investments in Africa has attracted the most attention, but it is far from the being the only case.

Third, current surplus countries like China and oil exporters have been establishing sovereign wealth funds (SWFs) which are making all sorts of investments.  Although the history of SWFs dates back to the 1950s, they have attracted much attention only in recent years.  Recpient countries fear that SWF investments might have political motivations, and adversely affect the enterprises which receive their investments.

Fourth, FDI coming from developing country MNEs is rising in importance.  Nevertheless, only one developing country MNE makes it into the world top 25, being Hutchison Whampoa from Hong Kong, which ranks 23.  Other leading MNEs from the developing world are: Petronas (Malaysia), Samsung (Korea), Cemex (Mexico), Hyundai (Korea), Singtel (Singapore), CITIC (China), Formosa Plastic Group (Taiwan), Jardine Matheson (Hong Kong) and LG (Korea).  MNEs from advanced OECD countries are still top of the heap.  The world's leading non-financial MNEs are: General Electric, BP, Toyota, Shell, Exxonmobil, Ford, Vodaphone, Total, Electricite de France and Walmart.

Fifth, MNEs are subject to much criticism by NGOs which question how responsibly they behave in developing countries, particularly from a social, environmental and ethical point of view.  For example, should Total leave Burma?  This has led to the movement of corporate social responsibility.  Many companies now claim that their mission is not only to make profits, but that now have a broader responsibility to society, the environment and and to have ethical behaviour.  Some people are cynical about this.  But there are many arguments that suggest that ultimately it is good business for a company to be responsible.  The United Nations is involved in corporate responsibility through the Global Compact, and the OECD through its "Guidelines for Multinational Enterprises".

Countries that received large inflows of FDI have generally experienced very strong economic growth.  And yet, many concerns are still expressed, often concerns of a nationalistic nature.

Some of the paradoxes of investment globalization are:

.  Investment protectionism is ever present, especially in oil producing countries.  They are concerned that Western companies will control strategic resources, and will make excessive profits.  In many oil producing countries, oil production is by companies owned by the national government, which provides the government a good source of revenue.  The ultimate effect of this is that there is an under-investment in oil exploration and production, in part because these countries do not have the technological knowhow to develop their resources.

.  Many recipient countries do not benefit very much from knowledge spillovers from FDI.  This is in part because such investments may be located in special economic zones or export processing zones which have weak linkages with the rest of the economy.  Also, stronger investments in education which enable the work force to better absorb knowledge spillovers. 

.  Although many countries have opened up to FDI, a great many have not.  FDI to the developing world is mainly concentrated in East Asia.  Further, there are very many restrictions in most countries to FDI in the service sector.  This is an enormous break on innovation and dynamism for countries like Japan which need a boost of energy.

Reference:

World Investment Report, 2008, UNCTAD -- www.unctad.org

Report of the World Commission on the Social Dimension of Globalization -- www.ilo.org


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