In this essay I am asked to analyze the pattern of global FDI flows by recipient countries in 1990-2011. Firstly, I will define foreign direct investment. Secondly, I will examine the trends of the figure over the years. The third section of my essay will include the theoretical background and empirical evidence which help me explain the trends. Least but not last, I will illustrate some of the problems of analyzing FDI in this period.
Foreign direct investment is defined as a term investment in the business of a domestic market of a foreign country. FDI is one of the most important factors in modern economies and is intertwined with the existence of multinationals enterprises. According to IMF's "Balance of Payments" (1993) "FDI reflects the aim of obtaining a lasting interest by a resident entity of one economy in an enterprise that is resident in another economy."
Trends
Figure 1
10000201000003E2000002840E5F6771
In this section I will interpret the trends of the graph from 1990-2011. The graph shows us the FDI inflows by countries and regions. As it is illustrated, there are two big dips, in 2002 and 2008. In order to analyse the graph effectively, I divided it into three periods
1990-2000
2000-2007
2007-2011
2.1 FDI Inflows 1990-2000
Foreign Direct Investments (FDI) were increased rapidly in this decade (Figure 1) while a large number of countries had abolition the restrictions related to FDI and adopted policies and incentives to attract foreign investors. According to UNCTAD (2004), the annual inflows from $ 208 billion that were in 1990, reached $1400 billion in 2000.
There are many differences between regions. The capital accumulation of FDI was asymmetric between industrialized countries (USA, JAPAN and Europe) and developing countries (Brazil, India, Russia and China).In developing countries, the share of incoming FDI jumped from 24.6% in the period 1990-1993 to over 40% in 1992-1997 and then fall back to 21.33% after the Asian crisis. As illustrated by Velde (2006 p6), the four important developing economies, China, Brazil, Russia, India contributed for three quarters of inflow FDI in 1990s. These FDI were directed mainly to China and Latin America. Furthermore, EU was a main recipient for Asian Firms and UK was an attractive country for Indian firms. In 2000 India was considered as the biggest receiver in South Asia. The UNCTAD (2003) indicated that the factors that investors were attracted by India can be found in the improvement of economy and information technology as well as in the liberalisation of trade.
Figure 2: World FDI Inflows by Sectors - Percentage of Total FDI Inflows
http://ars.els-cdn.com/content/image/1-s2.0-S0305750X12000289-gr7.jpg
Source: UNCTAD/DITE (2010)
In Figure 2, we can see that the share of services in 1990s increases over time in total stock of FDI, while decreasing that of industry and agriculture. This shift towards services corresponds to the fact that the tri-sedimentary sector contributes more than 70% over the GDP of developed countries, and that most of the services were not included in international exchanges and thus must be produced at the time and place of consumption. Moreover, the liberalization of the regime applicable to services in different countries led to the increasing flows in areas that were closed to foreign capital. In particular, the privatization of public enterprises in Latin America but also in Central and Eastern Europe were of particular importance. In addition, trends by sector differ from country to country. Asian countries have attracted efficiency-seeking FDI in textiles and electronics. India and China through their cheap labour attracted many multinational companies. On the other hand, Brazil inward stock was based in natural resources, services through privatisation and efficiency-seeking in manufacturing. In addition, Russia was attracted by many firms due to the rich natural resources and the size of the market. As illustrated in UNCTAD (2003), it has been a host for market-seeking firms in foods and beverages (Cadbury, Liggett). Besides that, efficiency-seeking programs were created in the automobile industry during 1999.
As stated by Adjei (2007) the "The major changes in the FDI inflows was the rapidly increased of Brownfield investment instead of Greenfield investment which started at 1994 and completed in 2000." The majority of FDI was done through mergers which were increased by 76.2% in the period 1998-2000. In addition, most mergers and acquisitions were between developed economies such as Japan, USA and Europe. Many companies were moved from resources seeking to efficiency seeking and asset seeking. But if we compare based on the stock of capital, sales subsidiaries exceed exports sometimes. For example, industrial sales products from American subsidiaries in the EU are about 3.8 times the US exports to the EU, respectively for the EU is 3.6 times.
It is worthy noted that many firms created international production networks as part of the "asset seeking strategy", in which different stages of production of a product was made ​​in another country. A worthy example is the "American car". As illustrated in WTO (1998 p36) ," 30% of the car's value goes to Korea for assembly, 17.5% in Japan for components and advanced technology, 7.5% in Germany for design, 4% in Taiwan and Singapore for small parts, 2.5% in Great Britain for advertising services and marketing, 1.5% in Ireland and Barbados for data processing. Only 37% of the value production takes place in the U.S."
FDI Inflows 2000-2007
FDI global flows from the upper level of 1387 billion in 2000 have decreased significantly in 2001. It was the first big dip in FDI. Developing countries were affected by 14% decrease in inflows. Africa reached $12 billion in 2002 and had an increase of 28% in 2002, which was attributed to natural resources projects. However, not all developing countries were affected the same in the crisis period. China and India due to their attractiveness didn't face severe problems in that period. China dealt with a range of manufacturing services. In addition, India was dealing with services, engineering and electronic industries. Conversely, as reported in UNCTAD (2003), USA which was the highest in the ranking of FDI till 2001, reached very low inflows in 2003. EU and Japan recorded also low flows. EU's FDI inflows fell to $21 billion in 2003 compare to $31 billion in 2002. In Russia the inflows dropped also to $1.1 in 2003. The sectors and industries were affected in vulnerable countries where the lack of policies to attract foreign investors was obvious. The value and rate of border mergers and acquisitions were decreased also. The reasons may be attributed to the increased intra-European investments due to the common currency and the increase of price in shares.
After 2004, the FDI inflows rose again and it was called the pre-crisis period. The services were increased rapidly in developed economies mainly. Also, in 2006 was recorded the second highest FDI flow, $1306 billion. The rise was attributed mostly to increasing cross-border multinational activities such as acquisitions, mergers and strategic alliances.
FDI inflows 2007-2011
The financial crisis started in 2008 caused the reduction on FDI flows globally. Some regions were affected more than other with losses more than half of the total flows. Developed countries flows dropped to 44% in 2009 while developing countries declined a 24% in FDI flows. According to UNCTAD (2010), "FDI shares were increasing in services and primary sectors. Whereas, industries vulnerable to business cycles affected along with companies that were elastic to the recession. " As reported in UNCTAD (2010), "the fall of profits in 2009 for developed economies followed lower reinvesting earnings and intra-company loans. Meanwhile, the M&As were decreasing. " As a result, developing economies these years attracted more FDI in Greenfield investments (Figure 3). The UNCTAD (2010) observed that developing economies were responsible for nearly half of the worldwide FDI inflows in 2010-2011.
Figure 3: Value of cross-border M&A sales and Greenfield investment projects
500
450
400
350
billion
300
250
$
200
150
100
50
0
Q1
Q2 Q3
Q4 Q1 Q2 Q3 Q4
Q1
Q2
Q3
Q4
Q1 Q2 Q3 Q4 Q1
Q2 Q3
Q4
2007
2008
2009
2010
2011
M&A value
Greenfield value
Source: UNCTAD
In 2011 it was observed an increase of 16% in the total FDI inflows compared to 2010. As illustrated by UNCTAD (2012), "The increasing flow of FDI was an outcome of high reinvested earnings." The FDI flows were leading by emerging markets, Asia and Latin America. As stated by ECLAC (2011 p28) Japan was attributed as the second largest investor in Brazil with 13.6% inflows. The increasing Greenfield projects attributed "A record level of $777 billion FDI to developing countries", UNCTAD (2012). After three years of crisis, developed countries FDI flows was 21% higher due to cross-border mergers and acquisitions dealing mainly in Europe. The increase in developed economies was "due to the sale of non-core assets" GITM (2012 p3). Europe was very vulnerable to crisis and Greenfield investment projects dropped to 3% in 2011, TWN (2012). As In Russia, the FDI inflows reached 31% after the recession due to the financial deals made in energy industry. As showed in TWN (2012), "China has increased non-financial services by $116 billion in 2011". Also in 2011, China reported an increase of 8% whereas India's FDI inflow rose to 31%. These two countries along with the large market of Brazil are considered as the strongest and most promising economies for FDI flows. The rapidly increase of FDI in developing countries was because these economies were not affected by financial crisis in the last five years and offered higher revenues in investments.
3.0 Theoretical Background
The purpose of this section is to introduce the theoretical background developed from the 50s and the later efforts interpreting the trends of FDI. The theories of FDI attempt to explain the causes that lead companies of a country in moving production to another country.
3.1 Stephen Hymer: The pioneer
Stephen Hymer, in his doctoral thesis gave a new impetus to the analysis of FDI and drastically affected almost all subsequent theories Pitelis(2002).
Hymer argued that market imperfections exist and are transaction costs, lack of information and imperfect competition. These factors are influencing business strategy for FDI. Hence, he developed a theory called "Market power theory" whose goal was to enhance its monopoly power in the market. The basic idea was that MNEs increase their share in domestic markets through mergers or expansion and as industrial concentration increases, so as market power and profits. Thus, profits from the increased degree of monopoly power in the domestic environment were invested in foreign domestic enterprises.
As stated from Dunning and Rugman(1985) the theory of Hymer had some problems as it focuses on the power of market. More researchers also extended this thesis, and considered that Hymer investigates why and how business invests overseas, rather than how a business operates productive in foreign countries.
3.2 Vernon's Theory
The theory of the cycle product of Vernon in 1966 was the first attempt to interpret the relationship between international trade and foreign production. As Vintila (2010 p55) stated "in Vernon's theory there are four stages of production cycle: innovation, growth, maturity and decline."
The main argument of Vernon (1966) was that the competitive advantages of U.S. firms - particularly their ability to innovate in new products and processes - was determined by the structure of the U.S. market, from high-income and inelastic demand. This gave the companies' a competitive advantage which originally took place through exports to European countries with the same demand characteristics. As the product was becoming matured, the competitive advantage was determined not by the technological capability but the ability to minimize production costs. Moreover, since competitors were beginning to enter the market and copy the product, demand becomes more elastic and markets expanded. Lastly, the subsidiary company exported to the origin company or in developing countries.
As Sosukpaibul (2007 p20) said that Vernon changed his theory few years later and focused in the desire of business to sustain an oligopolistic market formation by establishing barriers to entry.
3.3 The Eclectic theory
According to Dunning (1988), the most successful businesses are not those that have significant competitive advantages, but those who have the ability to combine these resources in a foreign location.
The basic assumption of the eclectic paradigm is that a firm will engage in FDI if the three following conditions are satisfied:
MNEs must possess ownership-specific advantage that guarantees them a monopoly power in the market of a foreign country. The advantages are physical inputs like labour, capital, natural resources and intangible inputs like technology, information, business and organizational skills.
MNEs must have a reason for wanting to put the production in a new location than in the country of origin. Some of them are costs of transport, productivity, market size, government policies and culture diversity.
The imperfections of markets, leads MNEs to internalize their operations and exploiting their advantages.
As stated by Dunning (2001 p187) "The recent technological and economic events and the emergence of new explanations of MNE activity sustained the power of the paradigm and did not reduce it". New paradigms such as "technologically and network related paradigms" tried to explain FDI but didn't clarify FDI in emerging economies and also several service sectors Dunning (2001).
4.0 Empirical Evidence: The Determinants
Before deciding to invest abroad, potential investors consider the current situation and future prospects of the host economy. In this section, I will examine the major determinants of FDI over the years that cannot be interpreted by theories.
By these determinants we can understand why FDI was higher in some economies than others
The political stability of a country offers investors security. Potential fluctuations in prices and exchange rates causes limited FDI in countries. A worthy example is the recent situations in Greece and Spain. As noted in Third World Network (2011), firms don't prefer developed countries such as Greece because of the unpredictability of their economies and the contagions that might follow.
The market size which we measure by GDP per capita is considered as the most important determinant, Demirhan et al (2008 p358). As indicated by Jordaan (2005 p40) "FDI will jump to outsized and expanding markets, where industries can earn higher profits and receive bigger returns on their capitals."
The infrastructure of an economy in all dimensions plays a vital role in investments. The technological infrastructure of the businesses leads to improvement of productivity and competitiveness. Equally important to firms is the quality of physical infrastructure of a region. This contributes to reducing business costs as well as the rapid and safe movement of people and goods to more markets.
The labour costs of the host economy and their productivity is considered as the most contentious according to Charkrabarti (2001). In developing countries the wages are lower and labour is willing to work in any conditions. Theoretically, the undervalue rates attract firms to operate FDI in emerging economies. However, there is no unanimity among researches for the importance of wages in attracting FDI, Masca (2008).
The most common form of competition between national governments to attract investment in fixed capital is the tax regime for the taxation of business. Tax competition leads to a lower taxation per unit of investment, but also allows countries to attract more FDI inflows.
5.0 Complications in Data
In this section I will illustrate some complications in the trends which cannot be explained through any theories and determinants.
FDI Statistics cannot be accurate completely in many ways. MNEs and countries are searching for tax havens before they invest in an economy. For example, Cyprus a tiny island with political and deficits problems is a major host country for Russia. The reason can be attributed to the 10% corporate tax that Cyprus offers. In 2011 tax haven countries contributed for 4% in the total flows. The funds do not stay in the tax havens countries but redirected to other countries.
Furthermore, FDI statistics are considered the most unreliable data of economics. Flows are calculated in the balance of payments and supplemented with statistics "FDI stocks" which is also calculated by central banks but with methodologies that are not as harmonized as it is for the flows. In addition, we observe differerences between UNCTAD and IMF data causing complications and disputes to the world.
Least but not last, the indicators might flow in a specific way after the "suggestions" of some countries. It is worthy to note that West Midlands in 2009 recorded the highest FDI inflows. As illustrated in figure 4, India, China and Taiwan which are considered emerging markets invested in a developed country, Hornsey (2009). In my opinion, MNEs in developing countries are political guided from well-built economies offering an attractive framework.
Figure 4http://wmro.files.wordpress.com/2009/07/foreign-direct-investment-into-west-midlands-1991-2009-full-size.jpg
Source: http://wmro.wordpress.com/2009/07/28/inward-investment-record-high-for-the-west-midlands/
6.0 Conclusion
The benefits from FDI are manifold. The most important include the contribution of FDI to economic growth, diffusion of expertise and knowledge, increase employment and improvement of entrepreneurship. After 2011, countries systematically amend their regulations of FDI and change their liberalization policies working towards confidence. According to GITM (2012), the prospects for FDI flows in 2012 are $1.6 trillion. But the uncertainty of the euro and the fear of contagions in developed economies will affect FDI growth in 2012.
