Foreign direct investment in developing countries

According to UNCTAD’s World Investment Report 1998, there was a dramatic increase in the annual global flows of foreign direct investment (FDI) between 1985 and 1995, from around $60 billion to an estimated $315 billion. By 1997, FDI inflows had reached a new high of $400 billion and outflows had climbed to $424 billion.

Developing countries are becoming more important as host and home countries. Their share of global FDI flows increased from 21 per cent in 1991 to an estimated 36 per cent in 1997.

The World Bank (1998) is positive about the medium-term prospects for FDI flows to developing countries. It is likely that strong growth of output and exports in developing countries, increased economic integration and globalization of production and further liberalization of investment rules will bolster FDI flows.

The FDI to GDP ratio in developing countries increased dramatically from 0.8 per cent in 1991 to 2.0 per cent in 1997 according to World Bank (1998) data.

Despite the crisis in financial markets in East Asia in mid-1997, FDI flows into developing Asia remain strong. According to the latest UNCTAD data (April 1999), FDI flows into East, South and South-East Asia in 1998 were US$78 billion, compared to US$84 billion in 1997 – a drop of about 7 per cent . Even so, 1998 flows remained above 1996 inflows of US$76 billion, and well above the average of US$44 billion for 1991-1995.

Regional distribution of FDI inflows and outflows (per cent age)

	Inflows				Outflows
Region/Country	1994	1995	1996	1997	1994	1995	1996	1997
Developed countries	58.2	63.9	57.9	58.2	85.0	86.9	85.1	84.8
Western Europe	32.3	37.1	29.6	28.7	47.0	49.4	50.6	46.2
European Union	29.5	35.3	27.4	27.0	42.4	45.2	45.3	42.4
Other Western Europe	2.8	1.8	2.2	1.7	4.6	4.3	5.3	3.7
United States	18.6	17.7	22.6	22.7	25.8	26.1	22.5	27.0
Japan	0.4	-	0.1	0.8	6.4	6.4	7.0	6.1
Developing countries	39.3	31.9	38.5	37.2	15.0	12.9	14.8	14.4
Africa	2.3	1.6	1.4	1.2	0.2	0.2	0.1	0.3
Latin America and the Caribbean	11.8	9.6	13.0	14.0	1.8	0.7	0.7	2.1
Developing Europe	0.2	0.1	0.3	0.2	-	-	-	0.1
Asia	25.0	20.3	23.7	21.7	12.9	12.1	14.0	12.0
West Asia	0.6	-0.2	0.1	0.5	0.4	0.2	-0.3	0.1
Central Asia	0.4	0.5	0.6	0.7	-	-	-	-
South, East and South-East Asia	24.0	20.1	23.0	20.6	12.5	11.9	14.2	11.8
The Pacific	-	0.2	0.1	0.1	-	-	-	-
Central and Eastern Europe	2.4	4.3	3.7	4.6	0.1	0.1	0.2	0.8
World	100	100	100	100	100	100	100	100

Source: UNCTAD World Investment Report 1998

The Asian financial crisis has, however, provoked several significant changes in the pattern of FDI in the Asia-Pacific region.

• intra-regional investment has declined,
• European MNCs are becoming more active,
• the services sector is receiving an increasingly larger share of FDI, and

mergers and acquisitions are gaining importance as a mode of investment in the region.

Share and distribution of FDI

Statistical evidence collected by UNCTAD and supported by a 1996 WTO study indicates that

• almost one-third of outwards FDI stock is in developing countries; and
• one-third of the top 20 FDI hosts are developing countries.

The main recipients of FDI are middle-income countries, due to their larger markets and rapid economic growth.

In recent years, however, low-income countries apart from China and India have received large amounts of FDI. FDI flows to Vietnam, for instance, increased significantly between 1991-93, when they were worth $380 million per annum, and 1995-97, by which time they had risen to $1.3 billion (World Bank 1998).

Many smaller countries and LDCs, particularly in Africa, received little foreign investment.

FDI flows are highly concentrated. In the period 1985-1997, six developing countries were among the top 20 host economies for FDI (China, Singapore, Hong Kong, Thailand, Argentina and Brazil). With increasing access to FDI this concentration is lessening.

FDI flows to the top ten recipient developing countries
(billions of US dollars)

Country	1991	Country	1994	Country	1997a
Mexico	4.7	China	33.8	China	37.0
China	4.3	Mexico	11.0	Brazil	15.8
Malaysia	4.0	Malaysia	4.3	Mexico	8.1
Argentina	2.4	Peru	3.1	Indonesia	5.8
Thailand	2.0	Brazil	3.1	Poland	4.5
Venezuela	1.9	Argentina	3.1	Malaysia	4.1
Indonesia	1.5	Indonesia	2.1	Argentina	3.8
Hungary	1.5	Nigeria	1.9	Chile	3.5
Brazil	1.1	Poland	1.9	India	3.1
Turkey	0.8	Chile	1.8	Venezuela	2.9
Top ten share in FDI to all developing countries (% )	74.2		76.1		72.3

a. Preliminary
Source: World Bank data and World Bank staff estimates.

Composition of FDI flows

The composition of capital inflows has also differed dramatically across regions. While FDI comprised over 40 per cent of net capital flows to Asia during 1989-94, the majority of flows into Latin American countries have been portfolio investment, with FDI accounting for little more than a quarter of capital flows to that region.

Long-term flows to developing countries

(billions of US dollars)

	1990	1991	1992	1993	1994	1995	1996	1997	1998a)
Net long term resource flows	100.8	123.1	152.3	220.2	223.6	254.9	308.1	338.1	275.0
Official flows	56.9	62.6	54.0	53.3	45.5	53.4	32.2	39.1	47.9
Private flows	43.9	60.5	98.3	167.0	178.1	201.5	275.9	299.0	227.1
International capital marketsb)	19.4	26.2	52.2	100.0	89.6	96.1	149.5	135.5	72.1
Foreign direct investment	24.5	34.4	46.1	67.0	88.5	105.4	126.4	163.4	155.0

Note: Although the Republic of Korea is a high income country, it is included in the developing country aggregate since it is a borrower from the World Bank.
a. Preliminary
b. Bonds, loans and portfolio equity flows
Source: World Bank Debtor Reporting System

According to the World Bank (1998), FDI has been a source of relative stability in capital flows to developing countries, indicating resilience in the face of financial crises. In 1997 no developing region suffered an overall decline in FDI inflow levels, unlike other capital resource inflows.

Trade linkages

Trade policies can affect FDI in many ways.

• Low import protection levels -especially if it is bound - can be a strong magnet for export-oriented FDI.
• High tariffs, in contrast, may induce tariff-jumping FDI to serve the local market.
• So-called quid pro quo FDI may be undertaken for the purpose of defusing a protectionist threat.

The evidence indicates that FDI and host country exports are complementary, but that FDI and host country imports may be either substitutes or complements.

Foreign direct investment is also viewed as a way of increasing the efficiency with which the world's scarce resources are used, for example, in helping to stimulate economic growth in many of the world's poorest countries. FDI, very little of which currently flows to the poorest countries, can be a source not just of badly needed capital, but also of new technology and intangibles such as organizational and managerial skills, and marketing networks.

FDI incentives

Most industrialized countries have very high foreign direct investment incentives that are of concern because they may be offered with little or no knowledge of an investment project's true value to the host country. There is considerable scope for introducing new distortions; and competition among potential host countries in the granting of incentives can drive up the cost of attracting FDI, thereby reducing or even eliminating any net gain for the successful bidder.