An international production system is rapidly emerging with foreign direct investment (FDI)(1) by transnational corporations (TNCs)(2) at its core. The system embraces some 60,000 TNCs with over 500,000 foreign affiliates that account for an estimated 25 per cent of global output. Sales of these foreign affiliates alone amounted to US$11 trillion (well ahead of world exports at US$7 trillion) in 1998.
Meanwhile the world stock of FDI rose by 20 per cent last year to over US$4 trillion, states the United Nations Conference on Trade and Development (UNCTAD) in its new report published today - World Investment Report 1999: Foreign Direct Investment and the Challenge of Development(3).
The world’s largest 100 TNCs, measured in terms of foreign assets, hold a dominant position in the new international production system. They now account for US$4 trillion in total sales and hold a stock of total assets in excess of US$4.2 trillion. General Electric is the world’s largest TNC, closely followed by the Ford Motor Company and the Royal Dutch Shell Group.
|"To promote the development of their own countries, Governments need to maximize the positive contribution that foreign direct investment can make to development, and to minimize any negative effects it may have."
Kofi A. Annan
United Nations Secretary-General
What is striking is that 85 of the top 100 have been on the UNCTAD list for several years. Furthermore only two of the top 100, Petróleos de Venezuela and Daewoo Corporation of the Republic of Korea are from developing countries.
The dynamism of this new international production system is only partly captured by the FDI numbers, stresses UNCTAD, as TNCs are also increasingly forging strategic alliances; among them, international technology partnerships, notably in the information technology, pharmaceutical and automobile industries, are particularly important. Knowledge-based networks, a dimension not captured by the traditional statistics of international production, can be a critical factor of market power in some industries.
|"Formulating and implementing an effective strategy requires above all a development vision, coherence and coordination. It also requires the ability to decide on trade-offs between different objectives of development."
WIR99 reports that FDI in 1998 rose by almost 40 per cent to US$644 billion and UNCTAD expects a new record this year (table 1). The driving engines behind the 1998 and 1999 FDI expansion are cross-border mergers and acquisitions (M&As) among firms, especially between Japan, North America and Western Europe, but also to a rising degree embracing developing countries. Majority-owned cross-border M&As reached US$411 billion in value in 1998, up 74 per cent, after rising by 45 per cent in 1997.
Reasons for increased cross-border M&As include: the opening of markets due to liberalization and deregulation; the pressure of competition between firms brought about by globalization and intensified technological changes; the importance of firm size as a factor in creating synergies and economies of scale, and as a way to keep pace with an evolving technological environment; the desire to strengthen market positions; and also the desire to make immediate financial gain where the opportunity arises.
The magnitude of FDI and foreign-affiliate operations can be captured in a host country transnationality(4) index compiled for the first time by UNCTAD for a number of countries. According to this index, New Zealand is the most transnationalized host country among developed countries and Trinidad and Tobago is the most transnationalized among developing countries. Japan and the Republic of Korea are the least transnationalized host countries.
Challenges to Developing Countries
FDI has become increasingly relevant for many developing countries as a source of international finance: For developing countries as a group it is now the single most important source of external finance, overshadowing inflows from official aid and exceeding net lending by international banks. The share of FDI in total capital flows to developing countries doubled in the 1990s, from 28 per cent in 1991 to 56 per cent in 1998.
Developing countries’ share of total FDI declined from 37 per cent in 1997 to 26 per cent in 1998, as the figures show. This reflects the slight decline of FDI flows to developing countries on account of the performance of Asia on the one hand, and the substantial expansion of FDI flows among developed countries on the other.
Despite financial crises, the overall flow of FDI to developing countries in 1998 remained high at a total of US$166 billion, just US$6.6 billion below the record annual level set in 1997. While TNCs do repatriate earnings, the importance of FDI for developing countries is underscored by UNCTAD’s finding that every dollar of outflow in this form by TNCs is matched by three dollars of inflows. An estimated one fifth of FDI inflows to developing countries consisted of reinvested earnings during the past five years.
In his Preface to WIR99 United Nations Secretary-General Kofi A. Annan asserts: "To promote the development of their own countries, Governments need to maximize the positive contribution that foreign direct investment can make to development, and to minimize any negative effects it may have."
WIR99 shows that FDI flows are highly uneven among developing countries and many of the very poorest countries are becoming increasingly marginalized in an era of globalization because they are being bypassed by TNCs. For example, although several African countries have attracted considerable FDI, most African countries still receive limited investment by TNCs. In 1998, for example, the 33 least developed countries in Africa experienced a modest gain in FDI inflows for the sixth consecutive year, but their total FDI inflows were only US$2.2 billion - less than 1.5 per cent of total inflows to all developing countries.
The 10 largest countries in terms of hosting inward FDI flows account for well over two-thirds of overall FDI. The five largest host developing countries alone account for more than one-half of the total FDI inflows to developing countries, with the biggest recipients last year led again by China, with an inflow of US$45 billion, and Brazil, attracting US$29 billion.
Policies make a Difference
TNCs and governments have common objectives, but as UNCTAD notes there are also important differences, making the formulation of appropriate policy crucial. Governments seek to spur development within a national context, while TNCs seek to enhance their competitiveness in an international context. As the report states: "Not all FDI is automatically in the best interest of host countries. Some can have an adverse effect on development."
In 1998 a total of 145 regulatory changes relating to FDI were introduced by 60 countries; 94 per cent of them were in the direction of creating more favourable conditions for FDI (table 2).
However, UNCTAD Secretary-General Rubens Ricupero stresses in WIR’99 that expectations are possibly too high about the benefits that rising flows of FDI can yield for developing countries. TNCs can make major positive contributions, but only if effective government policies are in place. He notes that: "In a liberalizing and globalizing world, growth can be sustained only if countries can foster new, higher value-added activities, to produce goods and services that hold their own in open markets."
Countries are in competition to attract FDI and must have effective policies to maximize the results. But, they must also formulate policies for TNCs which ensure that FDI contributes to growth and competitiveness, strengthens the balance of payments, creates jobs and transfers technology. Governments must also ensure that actions by TNCs do not damage the environment, crowd out existing domestic enterprises and undermine the potential of infant domestic industries.
Social Responsibilities of Corporations
The report examines the mounting importance of social responsibility issues for TNCs. Building on a statement made at the World Economic Forum in Davos by Secretary-General Annan earlier this year, it notes the mounting societal interest in policies adopted by TNCs, in particular with regard to the environment, human rights and labour issues. At the same time the report notes the imperative for governments to pursue policies of good governance and curb corruption and red tape as they seek to attract FDI.
According to Mr. Annan, "While the prime 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 more forcefully."
International Agreements and Negotiations
As globalization proceeds, the number of international agreements on investment has increased. At the bilateral level, the total number of bilateral investment treaties reached 1,726 involving 174 countries by the end of 1998, 170 more than at the end of 1997. Similarly the number of bilateral treaties for the avoidance of double taxation increased from 1,792 in 1997 to 1,871 in 1998. UNCTAD notes that a number of agreements are being or have been negotiated at the regional level, and in some special multilateral areas, such as the WTO Agreement on Trade-related Investment Measures (TRIMs).
But, experience shows the intense complexity of forging broader multilateral agreements. The failure of negotiating a comprehensive and high-standard Multilateral Agreement on Investment at the OECD testified to this. "Too ambitious investment negotiating agendas at the international level have a lesser likelihood of success than more modest and incremental propositions," suggests WIR’99.
Negotiating with TNCs
This year’s WIR notes that the approaches governments take to attract FDI and channel it most productively will vary from one country to another and that there is no single strategy that fits all circumstances. Securing the right balance that maximizes the benefits of TNC investment, while encouraging the growth of domestic industries and building technological strengths, may depend on how well host developing countries can negotiate with TNCs. As the report says in terms of regulating TNCs: "with liberalization and globalization, there are fewer policy tools available to countries left to influence the conduct of foreign and local firms."
The report adds that the capacities of host developing countries to regulate enterprises in terms of competition policy and environment policy are emerging as the most active policy-making areas. An effective competition policy is therefore an absolute necessity. However, most developing countries lack such a policy.
Mr. Ricupero states that: "Formulating and implementing an effective strategy requires above all a development vision, coherence and coordination. It also requires the ability to decide on trade-offs between different objectives of development."