It stimulates production improvements, contributes to technological advancement, boosts manufacturing employment, and generates exports
Foreign direct investment flows to developing countries have increased at a rapid pace, reaching an estimated US$38 billion in 1992, a fourfold increase since the mid-1980s and a 50% increase over the past two years. FDI now is the dominant form of resource flows to developing economies and the primary source of private capital for low-income countries, accounting for more than a quarter of aggregate net flows and exceeding total long-term debt flows.[1]
FDI is a large and growing source of equity investment that brings with it considerable benefits: technology transfer, management know-how, and export marketing access. Many developing countries will need to be more effective in attracting FDI flows if they are to close the technology gap with high-income countries, upgrade managerial skills, and develop their export markets.
After a spectacular growth in the second half of the 1980s, global FDI flows have declined over the past two years from their peak of nearly US$200 billion in 1989. By contrast, FDI flows to developing countries have increased, reflecting improved macroeconomic performance (particularly in some Latin American countries, following debt reduction agreements), more welcoming regulatory regimes (as in Thailand), and active privatization and debt conversion programs. The share of FDI going to developing countries increased from a low point of less than 12% in 1987 to 22% in 1991.
Two countries---the United States and Japan---accounted for nearly 70% of the entire FDI flows to developing countries in 1990. A consequence of source country concen- tration is the so-called triad pattern of FDI flows (with its regional associations), which appears to be growing more accentuated. U.S. multinationals favor Latin America, whereas Japan and the Asian newly industrialized economies (NIEs) are the main source of FDI in Asia. There has also been some growth in intradeveloping country flows, for example from Korea to China. For Eastern Europe, the European Community is the major source of FDI.
The concentration is less marked by receiving country. The share of absolute flows in 1991 was 35% for the top three recipient countries and 71% for the top 10. This apparent concentration largely disappears when FDI is scaled by recipient gross domestic product or investment (see table). Top recipients' ratios of FDI to GDP and to GDI (gross domestic investment) were often not very different from the averages for all developing countries---1.1% and 4.5%, respectively. Exceptions were Argentina, Malaysia, and Venezuela, with high FDI-GDI ratios, and Malaysia, with a high FDI-GDP ratio. If the ratios of FDI to GDI for all developing countries rose to the level of the highest individual ratio, the increase in aggregate net flows would be huge---about US$120 billion a year, more than three times the current level.
FDI in East Asia tends to contribute to new fixed capital formation (especially power and infrastructure), while the bulk of flows in Latin America has been directed to the purchase of existing companies. Often these companies are capital hungry (Argentina's and Venezuela's telecommunications industries) and can be expected to attract future flows to support investment in excess of initial outlays.
In the 1980s and 1990s, FDI flows have shifted from manufacturing and extraction to services, particularly the new capital-intensive service industries, such as telecommunications, transportation, banking, and public utilities, which are being privatized and opened to FDI in several developing countries. During 1988-92, privatization transactions in developing countries amounted to US$56 billion. About US$14 billion, or 25%, of the privatization proceeds were financed by external capital flows, with the balance financed by debt-equity conversions and local financing. Infrastructure and financial services accounted for three-quarters of these transactions.
FDI contributes to the growth of host economies through various channels in addition to physical capital formation, including technology transfer, human capital (managerial skills) development, and promotion of foreign trade. But its benefits will be lost if the host economy is heavily distorted.
One benefit is that foreign-owned firms may stimulate local productivity through backward linkages to service suppliers and the labor force---and by serving as a model of working practices and management techniques. It has been argued that the best measure of FDI's impact is not simply the initial balance of payments transaction but also the foreign firm's local purchases from suppliers and sales to customers in the host market, because these are analogous to exports and imports. For the United States, total 1987 exports were less than half the sales by U.S.-owned firms abroad.
Foreign affiliates of transnational corporations can contribute directly to technological advancement in developing countries through a stimulus to research and development expenditures, changes in product and export composition, and higher factor productivity. During the past decade, the share of R&D expenditures in sales for U.S. majority-owned affiliates in developing countries, albeit small, has increased. Technology can also be transferred through nonequity channels, such as licensing and subcontracting.
Although direct employment by foreign-owned corporations in developing countries is small (less than 1% of the work force), foreign affiliates accounted for more than a quarter of employment in manufacturing in more than half of a sample of developing countries. Much of this employment was in production with high technological and industrial know-how, such as electrical and electronic equipment, nonelectrical machinery, and chemicals.
The presence of foreign firms in manufacturing has also enabled them to generate a high share of manufactured exports. For example, foreign firms account for more than half the manufactured exports in Malaysia, Mexico, and the Philippines, and a recent survey of firms in Thailand found the share to be nearly three-quarters.
The macroeconomic impact of FDI varies considerably by region and country. Outside the Pacific Basin developing countries, FDI has tended to substitute for other capital flows, whereas in the Pacific Basin countries, it has been additional to domestic investment and has not, therefore, financed the balance of payments (that is, both domestic investment and the current account deficit have increased). Coupled with the observation that profits on FDI often climb quite steeply after an initial period of unprofitability, this suggests that FDI should not generally be viewed as a means of financing balance of payments needs over the medium term.
