an overview of fdi

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T.Y. BMS Project Report on

AN OVERVIEW OF FDI

SUBMITTED BY,

CHIRAG NARESH CHAUDHARY

T.Y.BMS [Semester V]

UTTARI BHARTI SABHAS

RAMANANDA ARYA D.A.V. COLLEGE

OF COMMERCE AND SCIENCE,

BHANDUP (E).

SUBMITTED TO,

UNIVERSITY OF MUMBAI

ACADEMIC YEAR

2012-2013

PROJECT GUIDENCE BY

PROF. SRIDHARAN SIR


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DECLARATION

I, Mr. CHAUDHARY CHIRAG NARESH (Seat No. ) of

R.A.DAV College of Science & Commerce of TYBMS [Semester V] hereby

declare that I have completed my project, titled AN OVERVIEW OF FDI in

the Academic Year 2012-2013. The information submitted herein is true and

original to the best of my knowledge.

Signature of Student

[CHIRAG CHAUDHARY]


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UTTARI BHARTI SABHAS,

RAMANANDA ARYA D. A. V. COLLEGE

OF COMMERCE AND SCIENCE,

BHANDUP (E)

CERTIFICATE

OF

PROJECT WORK

This is to certify that

Mr. CHIRAG NARESH CHAUDHARY ofT.Y.B.M.S. Semester V

(Roll No - 352) has undertaken & completed the project work titled AN

OVERVIEW OF FDI during the academic year 2012-13 under the guidance of

Prof. SRIDHARAN SIR submitted in SEPTEMBER, 2012 to this college in

fulfillment of the curriculum ofBACHELOR OF MANAGEMENT STUDIES,

UNIVERSITY OF MUMBAI.

This is a bona fide project work & the information presented is True & original tothe best of our knowledge & belief.

PROJECT GUIDE

(SRIDHARAN SIR)

COURSECOORDINATOR

(CHANDRAKALASHRIVASTAVA)

PRINCIPAL

(DR AJAY BHAMARE)

EXTERNALEXAMINER


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ACKNOWLEDGEMENT

With profound sense of gratitude and regard, I express my sincere thanks to my

project guide Mr. SRIDHARAN SIRfor his valuable guidance and the

confidence he instilled in me, that helped me in the successful completion of this

project report. Without his help, this project would have been a distant affair.

His thorough understanding of the subject and professional guidance was indeed of

immense help to me.

This project helped me a lot in getting more knowledge and experience in the

field of Finance. This project has been very informative and interesting.

Signature of Student

[CHIRAG NARESH CHAUDHARY]


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An Overview of FDIAnalysis of different perspectives of FDI

By: Chirag Chaudhary


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Index

1. Introduction to FDI .....................................................................................................................1

1.1. What is Foreign Direct Investment (FDI?) .............................................................................1

1.2. Composition........................................................................................................................3

1.3. Determinants ......................................................................................................................4

1.4. Classification of Foreign Direct Investments .........................................................................4

1.5. Classification by Motivation ................................................................................................4

2. Current Global Scenario and Trends ............................................................................................8

2.1. Global Overview ..................................................................................................................8

2.2. Sector Highlights ............................................................................................................... 10

2.3. Regional Highlights ............................................................................................................ 11

2.4. Expansions: A Growing Part of FDI ..................................................................................... 20

3. Contribution of FDI towards development ................................................................................. 23

3.1. Trends .............................................................................................................................. 24

3.2. FDI and Growth ................................................................................................................. 25

3.3. FDI and environmental and social concerns ........................................................................ 36

3.4. Net Contribution of FDI to Developments .......................................................................... 38

4. Political Considerations ............................................................................................................ 41

4.1. Literature Review .............................................................................................................. 43

4.2. Discouragement by Political Risk to FDI.............................................................................. 44

5. Social Considerations ................................................................................................................ 56

6. Challenges ................................................................................................................................ 66

6.1. Host country policy measures ............................................................................................ 68

6.2. Home country policy measures .......................................................................................... 72

6.3. The right to regulate .......................................................................................................... 74

7. Corporate Social Responsibility and FDI ..................................................................................... 78

7.1. Legal limitations on corporate accountability ..................................................................... 78

7.2. Power imbalances ............................................................................................................. 79

7.3. FDI liberalization ............................................................................................................... 80

8. Conclusion ........................................................................................Error! Bookmark not defined.

9. Recommendations .................................................................................................................... 84

10. Bibliography ......................................................................................................................... 85


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An Overview of FDI

1. Introduction to FDIForeign Direct Investment (FDI) from the viewpoint of the Balance of Payments

and the International Investment Position (IIP) share a same conceptual

framework given by the International Monetary Fund (IMF). The Balance of

Payments is a statistical statement that systematically summarizes, for a specific

time span, the economic transactions of an Economy with the rest of the world

(transactions between residents and non-residents) and the IIP compiles for a

specific date, such as the end of a year, the value of the stock of each financial

asset and liability as defined in the standard components of the Balance ofPayments.

1.1. What is Foreign Direct Investment (FDI?)According to the IMF and OECD definitions, direct investment reflects the aim of

obtaining a lasting interest by a resident entity of one economy (direct investor) in

an enterprise that is resident in another economy (the direct investment

enterprise). The lasting interest implies the existence of a long-term

relationship between the direct investor and the direct investment enterprise anda significant degree of influence on the management of the latter.

Direct investment involves both the initial transaction establishing the

relationship between the investor and the enterprise and all subsequent capital

transactions between them and among affiliated enterprises4, both incorporated

and unincorporated. It should be noted that capital transactions which do not

give rise to any settlement, e.g. an interchange of shares among affiliated

companies, must also be recorded in the Balance of Payments and in the IIP.

The fifth Edition of the IMFs Balance of Payment Manual definesthe owner of

10% or more of a companys capital as a direct investor. This guideline is not a

fast rule, as It acknowledges that smaller percentage may entail a controlling

interest in the company (and, conversely, that a share of more than 10% may not


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signify control). But the IMF recommends using this percentage as the basic

dividing line between direct investment and portfolio investment in the form of

shareholdings. From this moment, any further capital transactions between these

two companies should be recorded as a direct investment. When a non-resident

holds less than10% of the shares of an enterprise as portfolio investment, and

subsequently acquires additional shares resulting in a direct investment (10% of

more), only the purchase of additional shares is recorded as direct investment in

the Balance of Payments. The holdings that were acquired previously should not

be reclassified from portfolio to direct investment in the Balance of Payments but

the total holdings should be reclassified in the IIP.

Concerning the terms direct investor and direct investment enterprise, the IMF

and the OECD define them as follows. A direct investor may be an individual, an

incorporated or unincorporated private or public enterprise, a government, a

group of related individuals, or a group of related incorporated and/or

unincorporated enterprises which have a direct investment enterprise, operating

in a country other than the country of residence of the direct investor. A direct

investment enterprise is an incorporated or unincorporated enterprise in which a

foreign investor owns 10% or more of the ordinary shares or voting power of an

incorporated enterprise or the equivalent of an unincorporated enterprise.Direct investment enterprises may be subsidiaries, associates or branches. A

subsidiary is an incorporated enterprise in which the foreign investor controls

directly or indirectly (through another subsidiary) more than 50% of the

shareholders voting power. An associate is an enterprise where the direct

investor and its subsidiaries control between 10% and 50% of the voting shares. A

branch is a wholly or jointly owned unincorporated enterprise.

It should be noted that the choice between setting up either asubsidiary/associate or a branch in a foreign country is dependent, among other

factors, upon the existing regulations in the host country (and sometimes in its

own country, too). National regulations are often more restrictive for subsidiaries

than for branches but this is not always the case.


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An Overview of FDI

To establish the basic concepts related to FDI, following points should benoted:

When a firm controls (or have a strong say in) another firm located abroad,e.g. by owing more than 0% of its equity, the former is said "parent enterprise"

(or "investor") and the latter "foreign affiliate".

Foreign Direct Investment (FDI) is the financial investment giving rise andsustaining over time the investor's significant degree of influence on the

management of the affiliate.

The initial investment can be the purchase of an existing firm (by acquisition orby merger, the so-called "M&A") as well as the foundation of a new legal

entity who usually - but not necessarily - makes a green-field real investment

(e.g. building a factory) in the foreign country [1]. In a broader definition, FDI consists of the acquisition or creation of assets (e.g.

firm equity, land, houses, oil-drilling rigs) undertaken by foreigners. If in these

enterprises they are not alone but act together with local firms and/or

governments, one talk of "joint ventures".

A country outflows of FDI means that it is "exporting money" to "buy" or"build" foreign productive capacity, whose ownership will remain in the first

country's hands.

For a country, attracting an inflow of FDI strengthen the connection to worldtrade networks and finance its development path. However, unilateral massive

FDI to a country can make it dependent on the external pressure that foreign

owners might exert on it.

Since it is through FDI that a firm becomes a multinational, one could say thatit's the FDI process that generates MNC (multinational companies). The

reverse is also true: firms that are already multinational generate the majority

of FDI flows.

1.2. CompositionFDI has three components:

Equity capital;


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reinvested earnings, the investor's share of earning not distributed asdividends by affiliates, in proportion to its share in the equity (say for instance

50% in a certain joint venture);

Intra-company loans, when the investor borrows funds to the affiliate, usuallywithout the intention of asking the money back.

1.3. DeterminantsAt investor's level, a firm can decide to make a foreign investment because of

many factors, including:

Upstream integration, by purchasing a provider, whose input will now be soldcheaper (or exclusively) to it or be differentiated along particular features;

Horizontal integration, by purchasing a firm making the same product, toexpand its production, reduces costs, improving logistics;

Downstream integration, by purchasing a firm using or distributing itsproducts, to get higher value added along the chain and to aggressively push

distribution;

Diversification, by purchasing a firm doing somewhat different activities thanthe purchaser, to seize new opportunities.

1.4. Classification of Foreign Direct InvestmentsThere is no single definition that applies to all types of FDI, and TNCs certainly do

not label their activities in this way. Instead, it is principally the academic

community that has set out to define the varieties of FDI. One view breaks foreign

investment into four distinct types: resource seeking, market seeking, efficiency

seeking, and strategic asset seeking. Having a clear understanding of the

investor's motivation helps you to target more effectively particular varieties of

investors for your location.

1.5. Classification by MotivationResource seeking

FDI in natural resources (minerals, raw materials, and agricultural products)

FDI seeking low-cost or specialized labor


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Market Seeking

FDI into markets previously served by exports, or into closed markets protected

by high import

FDI by supplier companies following their customers overseas

FDI that aims to adapt products to local tastes and needs, and to use localresources

Efficiency seeking

Rationalized or integrated operations leading to cross-border product or process

specialization

Strategic asset seeking

Acquisitions and alliances to promote long-term corporate objectives

Most FDI in developing and transition economies is resource seeking. This type of

investment aims to exploit a country's comparative advantage. For instance,

countries rich in primary materials, such as oil or minerals, will attract companies

seeking to develop these resources. Low-cost or specialized labor is two other

factors that attract resource-seeking FDI. Resource-seeking FDI is generally used

to produce goods for export.

In contrast, market-seeking investment is aimed at reaching local or regional

markets, often including neighboring countries. Companies making this type of

investment typically manufacture a wide variety of household consumer products

or other types of industrial goods in response to actual or future demand for their

products. In some cases, market-seeking FDI occurs as supplier companies follow

their customers overseas. For example, an auto components manufacturer may

follow a car producer. Market-seeking investment is often defensive and is used

by companies to try to circumvent real or threatened import barriers. A liberal

trade regime is essential if the investor wishes to serve neighboring or overseas

markets.

Efficiency-seeking FDI frequently occurs as a follow-on form of investment. A TNC

may make a number of resource- or market-seeking investments, and over time,

it may decide to consolidate these operations on a product or process basis.

Companies are able to do this, however, only if cross-border markets are open


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and well developed. As a result, this form of FDI is most common in regionally

integrated markets, most notably in Europe and Asia.

TNCs also may undertake smaller-scale product rationalization among a few

neighboring countries. This type of investment is illustrated by Nestl's North

African and Middle Eastern affiliates. Each affiliate produces a specialized product

for the regional market. Each affiliate also imports other products from sister

affiliates in neighboring countries. Taken together, the region has access to a full

spectrum of products, but each affiliate is responsible for the production of only a

small segment.

Strategic asset-seeking FDI occurs when companies undertake investments,

acquisitions or alliances to promote their long-term strategic objectives. For

example, a TNC may form a strategic alliance with a company based in another

country to jointly undertake mutually beneficial R&D. Strategic asset-seeking FDI

is common in industrialized countries.

By contrast to the classification according to the institutional sector, the OECD

Benchmark definition favors an industrial breakdown, which includes nine

economic sectors. The OECD specifically recommends, for the purpose of thisclassification, that FDI carried out via a resident holding company be classified

according to the industrial sector to which the parent company belongs. Under

this criterion, when the parent company is a bank, FDI transactions carried out by

a non-banking holding company would be attributed to the Banks


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An Overview of FDI

Institutional sector (IMF) Economic or industry sector (OECD)

Monetary Authority Agriculture, hunting, forestry and

fishing

Banks Mining and quarryingGeneral Government Manufacturing

Other Resident Sector Electricity, gas and water

Construction

Wholesale and retail trade and

restaurants

Transport, storage and communications

Financing, real estate and business

services

Community, social and personal

services

The topics touched upon above, will be discussed in detail in coming chapters.


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2. Current Global Scenario and TrendsThe year 2011 was a challenging one for the global FDI market. Natural disastersin Asia-Pacific and economic and political instability in Europe, north Africa and

the Middle East led many companies to put on hold their FDI plans, leading to a

sharp decline in FDI in many countries. North America, with brighter economic

prospects and a shale rush, achieved solid FDI growth. Likewise, companies

continued to be attracted to the investment opportunities in Africa and Latin

America, with 20%-plus growth in FDI in each region. Brazil was again the star

performer, with a 38% increase in FDI projects.

Renewable energy was the fastest growing sector for FDI in 2011, despite the

challenges facing the sector which are discussed in our sector focus. Renewable

energy became the leading sector for capital investment in Europe in 2011, and

was the second largest sector in North America.

The following data uncovers how expansions are becoming a much more

important element of the FDI market. In recent times, almost one in five FDI

projects was an expansion project, and the data further shows that expansions

are particularly important for extraction, manufacturing, and front- and back-

office projects.

2.1. Global Overview(Source: Financial Times)


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Against the backdrop of another tumultuous year for the world economy, foreign

investors have remained cautiously optimistic with slow but solid growth in FDI.

The number of FDI projects increased by 5.6% in 2011, faster than the 3%increase in 2010. In total FDI Markets recorded 13,718 FDI projects in 2011. After

declining by 14.5% in 2010, the estimated capital investment associated with FDI

projects grew by 1.2% in 2011 to $860bn, indicating the beginning of a recovery in

more capital-intensive sectors. The same pattern was seen in employment, with

estimated direct job creation from FDI increasing by 2.5% in 2011 to 2.27 million,

following a 3.5% decline in 2010.

Despite the political upheaval in North Africa, Africa as a whole was the growth

hotspot in 2011, with a 24% increase in FDI projects recorded. In contrast, Europe

was the only region to experience a decline in the number of FDI projects in 2011.

With Europe holding back recovery, the FDI market still has some way to go to

reach the pre-recession peak of 15,489 FDI projects.


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A big winner for FDI in 2011 was Brazil and its neighbors in Latin America. A long-

touted success story, Brazil has been steadily attracting more FDI projects since

2007. Last year was a record year for FDI projects in Brazil, and capital investment

also grew by 48%. However, as a source country for FDI, Brazil still accounts for

less than 1% of global FDI projects and 0.5% of global capital invested.

Brazils neighbors are also benefiting from the growing interest in the region:

Argentina Colombia and Uruguay each achieved growth in FDI project numbers in

2011. Overall, the number of FDI projects in Latin America grew by 22% in 2011,

just behind the 24% growth in Africa, and accounted for 10% of global FDI

projects.

India and China also had a strong performance in 2011, achieving an increase in

capital investment of 15% and 3%, respectively, as well as an increase in project

numbers.

Russia experienced a small decrease in FDI project numbers and capital

investment, although outward FDI projects from Russia grew marginally by 3%.

Ranked sixth in the world as a source of FDI, Canada is growing rapidly in

importance as a global investor, establishing 41.9% more projects overseas in

2011 than in 2010. Capital investment from Canadian companies overseas greweven more, by an estimated 59.4% in 2011. Australian companies also ramped up

their investment overseas, establishing 20.5% more FDI projects in 2011 than in

2010, with a 52.8% growth in job creation overseas compared to 2010.

2.2. Sector HighlightsThe top five sectors in terms of project numbers all experienced growth in 2011.

Software and IT remained the leading sector for global FDI projects, with a very

strong 18% increase in project numbers. The top three sectors, which also include

business and financial services, accounted for 34.7% of global FDI projects in

2011.

Metals were the leading sector worldwide when ranked by capital investment,

with an estimated $111.65bn of FDI in 2011. Metals replaced the coal, oil and

natural gas sector in the number one spot a position it had maintained since FDI


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An Overview of FDI1

Markets began tracking FDI in 2003. The number of FDI projects in the metals

sector grew by 17.8% in 2011. Renewable energy was one of the fastest growing

sectors in 2011, with the number of FDI projects increasing by 20% and with

capital investment increasing by 40.7%. Renewable energy was the third largest

sector for capital investment, after metals and coal, oil and natural gas.

The automotive sector also had a good year in 2011, with FDI project numbers

growing by 12.8%. Capital investment associated with these projects reached an

estimated $63bn in 2011 and job creation accounted for 13% of the global total.

China, India and the US attracted more than 38% of these projects. The real

estate sector continued to stagnate, with an 11.5% decline in FDI project numbers

in 2011, ranking 15th its weakest performance since 2005. Capital investment

and jobs also continued to fall in the sector in 2011.

Why the market did not recover in 2012?

The global economy experienced four major shocks in 2011, which had a negative

impact on corporate investment plans. First, the Arab Spring created high levels of

political uncertainty and investment risk in several countries in North Africa and

subsequently the Middle East.

Second, the earthquake, tsunami and nuclear disaster in Japan had a major

impact on the Japanese economy and global supply chains.Third, the massive flooding in Thailand, a leading country for FDI, forced many

companies to postpone their investment plans in the country and also disrupted

global supply chains. Fourth, the European debt crisis added to global risk and

uncertainty and reduced economic growth in Europe to near zero. The outcome

of these four shocks can be clearly seen in FDI statistics for 2011. FDI Markets

recorded a 29% decline in the number of FDI projects investing in Egypt, a 25%

decline in Japan, a 35% decline in Thailand and a 22% decline in projects investing

in Italy. With production and supply chains severely damaged domestically, Japanand Thailand-based companies accelerated their outward FDI overseas with

growth in outward FDI projects in 2011 of 6% and 45%, respectively.

2.3. Regional HighlightsAsia Pacific


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FDI projects into Asia Pacific:

China, India and Singapore attracted 57% of FDI projects in Asia- Pacific in 2011.

India was the strongest performing country with a 21% growth in FDI projects in

2011, following just 1% growth in 2010. The impact of the natural disasters in

Japan and Thailand is clearly evident in the sharp decline in FDI in both countries.

Hong Kong had a strong year, with its number of projects growing by 6%, after a

21% drop in 2010.

In terms of the size of projects, Indonesia, Pakistan and South Korea and each

recorded growth in capital investment in 2011 of more than 70% after securing

large-scale investment projects. Examples include Cyprus-based Solvay Group

announcing a $3bn nickel smelting plant in Indonesia, and United Arab Emirates

based Al Ghurair Group announcing plans to develop a $700m oil refinery inPakistan. The top-performing country for attracting new jobs was China, which

saw just over 340,000 jobs created as a result of inward FDI.

FDI Projects out of Asia Pacific

Analyzing FDI overseas, Japan, India and China accounted for more than 60% of

FDI projects from Asia-Pacific countries in 2011. Japan remained the dominant

outward investor, establishing more FDI projects overseas than India and China

combined. Japans position is even more important when the size of projects isconsidered, with Japanese companies creating nearly 300,000 jobs overseas; 40%

of total overseas job creation generated by Asia-Pacific countries.


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An Overview of FDI1

Of the major investing countries, Hong Kong and Australia recorded the fastestgrowth in outward FDI projects, with percentage growth rates of 23% and 21%,

respectively. In Thailand, flooding over the monsoon season seems to have

encouraged domestic companies to invest overseas. In terms of capital

investment overseas, Indian, Hong Kong and Vietnamese companies each

increased their outward FDI by more than 70% in 2011.

This map shows % change from 2011


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An Overview of FDI1

Capital investment by sector in 2011:

Metals and minerals was the largest sector for FDI, with an estimated $46bn of

capital investment tracked by FDI Markets in Asia-Pacific in 2011. With a 54%

decline in capital investment in coal, oil and natural gas, the sector moved down

into second place. In contrast, FDI in renewable energy grew rapidly, with a 59%

in project numbers and 77% increase in jobs creation in the sector in 2011. In

total, an estimated $6.93bn of FDI was announced in Asia-Pacifics renewable

energy sector in 2011. Software and IT services, while not appearing in the top

sectors in terms of capital investment, had a strong year in terms of project

numbers, with a 27% increase, and in job creation with nearly 60,000 new

software and IT services jobs created by FDI in the region in 2011.

Europe

FDI projects into Europe:

The number of FDI projects in Europe declined by 3% in 2011, with a mixed

performance across countries. The UK experienced solid growth in FDI, reinforcing


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An Overview of FDI1

its position as the leading FDI location in Europe. As well as a 13% increase in

recorded FDI project numbers, capital investment in the UK increased by 48% and

FDI job creation by 33%. However, in terms of total job creation, FDI in Russia

generated the highest number of new jobs, with 89,047 jobs created in 2011

compared to 66,817 in the UK. This was despite a decline in FDI in Russia in 2011.

A selection of small and medium-sized economies in Europe performed strongly.

Ireland, the Netherlands, Serbia and Romania all achieved a significant growth in

inward FDI. While the Netherlands was the best performer, with 29% growth in

FDI projects in 2011, estimated job creation from FDI in the Netherlands actually

fell by 13% as the average project size declined. In contrast, job creation in Ireland

grew by 13% and capital investment by 78%. Positioned outside the top 10,

Belgium was among the countries that experienced a contrast, with a 43% decline

in the number of recorded FDI projects in 2011.

FDI Projects Out of Europe:This map shows % change from 2011


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An Overview of FDI1

In terms of investment overseas, the UK retained its position as the leading

European investor measured by the number of FDI projects established overseas

in 2011, closely followed by Germany. German companies, however, created a

higher number of jobs overseas, with 180,830 created by German companies in

2011 and 155,987 by UK companies. The number of FDI projects overseas from

France and Russia increased slightly in 2011. FDI from Spain created 19% fewer

jobs and 28% lower capital investment than in 2010. Ireland and Denmark also

saw growth in the number of outward FDI projects by 20% and 21%, respectively.

Capital investment made by Danish companies overseas increased from an

estimated $3.4bn in 2010 to nearly $8bn in 2011. Major Danish investors included

Grundfos, a manufacturer of pipes and pumps, investing in a 50m manufacturing

facility in Serbia, and Lego announcing plans to boost capacity at its Nyiregyhaza

plant in Hungary with an investment of $94m.

The largest sector for FDI in Europe in 2011 was renewable energy. Capital

investment in renewable energy almost doubled in 2011, reaching an estimated

$40bn and accounting for one-third of estimated capital investment in Europe. In

contrast, capital investment in the coal, oil and natural gas sector fell by 36%, with

estimated investment of $13bn. The transport equipment sector also saw a large

decline in FDI in 2011 with a 25% drop in capital investment.


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An Overview of FDI1

North America

FDI projects into North America:

Four states/provinces attracted 33 % of FDI into North America in 2011. California

was the leading state for FDI in North America, attracting 12% of inward FDI

projects in 2011, followed by New York (8%), Ontario (7%) and Texas (6%). The

fastest growing of the top 15 states/provinces for FDI in 2011 were Alberta, New

Jersey, Massachusetts and Pennsylvania.

FDI projects out of North America:

While California was the leading state in North America for outward FDI, with 629

projects in 2011, of the top 15 outward investors; Ontario recorded the fastest

growth in outward FDI in 2011, with a 50% growth in project numbers. Quebec

also saw a substantial increase in outward FDI with a 33% increase in FDI projects

in 2011. Washington, Georgia, Florida, Texas and New Jersey also all saw strong

growth in outward FDI.

Capital investment by sector in 2011:


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An Overview of FDI1

Coal, oil and natural gas and renewable energy were the top two sectors for FDI in

2011, accounting for 34% of capital investment in North America. The ranking is

reversed from 2010, when renewable energy was the leading sector followed by

coal, oiling natural gas. Focus on investment opportunities in shale gas and oil is

the main factor behind the change in ranking, which saw the sector increase its

capital investment in North America by nearly 300% in 2011.

Middle East and Africa

FDI projects into Middle East and Africa:

The number of FDI projects in the Middle East and Africa (MEA) region grew by

16% in 2011. Capital investment was down slightly by 1% and job creation up by

3%. The top 10 countries for FDI attracted 64% of projects and capital investment,

and 54% of jobs created. The United Arab Emirates attracted the highest number

of projects, while Saudi Arabia attracted the most capital investment, which grew

by 40% in 2011 to just over $14bn. However, this is still far below the $42bn in

capital investment recorded in Saudi Arabia in 2008. South Africa was the best

performing country in the region in 2011, with a 57% increase in project numbers,

87% growth in capital investment, and a 28% rise in jobs created, making it the

leading country in the region for job creation. The political turmoil of 2011 led to

some dramatic changes in the volume of FDI in the countrys most affected by the

Arab Spring uprisings. The number of FDI projects in Libya and Yemen declined by80%, in Egypt by 29%, in Syria by 26% and in Tunisia the number of FDI projects

fell by 14%.

FDI projects out of Middle East and Africa:

Companies from the MEA region invested in 10% more projects overseas in 2011

than 2010, accounting for 4% of global FDI projects. Despite the growth, the

number of overseas FDI projects from MEA companies was still only 71% of the

volume recorded in 2008. The growth in projects led to a small increase in capital

investment of 0.4% but a decline in the number of jobs created by 6%. UAE based

companies remained most active in FDI overseas, although the number of their

projects declined by 3% in 2011 and capital investment overseas declined by 43%.

This was largely due to continued decline in real estate FDI, with UAE companies

investing in 57% fewer real estate projects in 2011 than 2010. South African


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An Overview of FDI1

companies were the second most active in investing, with a strong growth of 25%

more projects overseas, 93% more capital investment and 65% more job creation

in 2011.

Capital investment by sector in 2011:Given the vast natural resources of the MEA region, coal, oil and natural gas was

the leading sector for FDI, with an estimated $35bn capital investment in 2011.

However, capital investment growth declined by 17% during 2011. The second

leading sector in 2011 was the metals and minerals sector, with $27bn of

investment, a 67% increase on 2010.

In terms of project numbers, financial and business services were the top sector,

accounting for 33% of all projects recorded in the MEA region, with growth of 3%

in 2011. In terms of jobs created, metals and minerals was the leading sector with

an estimated 57,000 jobs created and with very strong jobs growth of 38% in

2011. The sector accounted for more than one-quarter of all jobs created by FDI

in the MEA region in 2011.

The fastest growing sector for FDI in the region was the food, beverages and

tobacco sector, with a 49% increase in FDI project numbers, a 140% increase in

jobs created, and a 200% increase in capital investment.

The weakest performing sector in 2011 was again the real estate, hotels and

tourism sector, with a 36% decline in FDI projects and 40% decline in capital

investment in 2011.


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2.4. Expansions: A Growing Part of FDIGlobal trends in expansions:

When making an investment decision to develop its operations through organic

growth, a company has two main choices: set up a new operation or expand an

existing one. Over the period 2004-08, expansions declined in importance from

17% of capital investment in 2004 to just 11% in 2008. This was a period of rapidgrowth in the FDI market, with many companies establishing their first operations

in fast-growing emerging markets. Emerging market companies were also rapidly

expanding and building their global footprints. As a result, expansions became

relatively less important in global FDI. Since 2008, the start of the global economic

crisis, the reverse trend has been seen with expansions becoming more important


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for global FDI. In 2011, expansions accounted for 23% of global capital investment

from FDI. In the period of global economic crisis, investors have shown a much

stronger preference for expanding existing operations than at any time since FDI

Markets began collating FDI data in 2003. Expanding existing operations has been

seen as a lower-risk and lower-cost FDI strategy than establishing a new presence.

Role of expansions for different FDI project types:

Expansions were most important for extraction projects, which are very capital-

intensive projects requiring substantial re-investment over a period of many years

for most projects. Expansions were also very important for manufacturing

projects, with 39% of projects in 2011 being expansions. Manufacturing

expansions accounted for 10% of all global FDI projects in 2011. Expansions were

also of high importance for front and back offices, indicating that many

companies have already established their regional or global back- and front-office

operations, with future investment decisions often involving expansion of existing

operations. The business functions where expansions are least important are

construction, electricity, and sales, marketing and support; where up to 95% of

FDI involves new investment projects.

Importance of expansions by country:

The role of expansions varies significantly across countries. Ireland has one of the

highest proportions of expansions, as does Hungary. Both countries act as

regional hubs for the manufacturing operations of global companies, which

typically results in a higher proportion of expansions in FDI. Countries with a long

track record in attracting FDI, or with a high level of foreign acquisitions, also

resulted in a higher share of expansions. Expansions in the US, the UK, Mexico

and Canada accounted for around one-quarter of FDI projects. Countries which

are relatively new to FDI and which are rapidly growing tended to have a smallshare of expansions in FDI. Indonesia, Turkey, Russia and Kenya all have below-

average levels of expansions in FDI. Low-tax and entry point economies, including

Switzerland, UAE, Singapore and Hong Kong, also had a very low proportion of

expansion in FDI, most likely due to their attractiveness for new companies due to

low tax.


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To summarize, the shift of FDI to emerging markets continued to gather pace in

2011, with Africa and Latin America and the Caribbean recording the fastest

growth in inward FDI. From a global perspective, FDI is largely market-seeking,

which explains why the economic regions with the best economic growth

prospects are attracting a larger share of global FDI. This trend is amplified by

resource-seeking FDI, with Africa, Latin America and resource-rich countries in

Asia attracting more investment.

As the case of North America shows, the shift in FDI to economic growth poles

and resource-rich countries does not necessarily result in less FDI in the advanced

economies; FDI in North America continued to grow in 2011. However, without

strong economic growth or natural resources (such as vast shale oil and gas

reserves in North America), there are fewer investment opportunities, leading toa decline in FDI. With limited natural resources, Europe is unlikely to achieve

growth in FDI without solid economic growth.

The FDI forecasting unit at FDI Intelligence is predicting 4.4% growth in global FDI

in 2012 as its positive scenario. This assumes that there are no major economic

and political crises (for example, a Greek default), that Europe does not fall into

recession, and that Chinas economic growth does not slow down below 7.5%. If

any of these events take place, then our revised forecast for 2012 is a 1% to 2%growth in FDI. If multiple events take place, then the FDI market is likely to decline

in 2012.

In the context of market uncertainty and, at best, slow growth in FDI in 2012, the

focus on renewable energy and expansions are of particular importance.

Renewable energy has become one the largest and fastest growing sectors for

FDI. With the right government policies, environmental conditions and industry

competitiveness, there continues to be very strong opportunities to attract FDI in

this sector. With rapid take-up of cloud-based services, social media and mobile

devices, we also expect strong growth of FDI in data centers in 2012, in particular

green data centers, which utilize renewable energy for their power requirements.


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3. Contribution of FDI towards developmentForeign direct investment (FDI) is an integral part of an open and effective

international economic system and a major catalyst to development. Yet, thebenefits of FDI do not accrue automatically and evenly across countries, sectors

and local communities. National policies and the international investment

architecture matter for attracting FDI to a larger number of developing countries

and for reaping the full benefits of FDI for development. The challenges primarily

address host countries, which need to establish a transparent, broad and effective

enabling policy environment for investment and to build the human and

institutional capacities to implement them.

With most FDI flows originating from OECD countries, developed countries can

contribute to advancing this agenda. They can facilitate developing countries

access to international markets and technology, and ensure policy coherence for

development more generally; use overseas development assistance (ODA) to

leverage public/private investment projects; encourage non-OECD countries to

integrate further into rules-based international frameworks for investment;

actively promote the OECD Guidelines for Multinational Enterprises, together

with other elements of the OECD Declaration on International Investment; andshare with non-members the OECD peer review-based approach to building

investment capacity.

Developing countries, emerging economies and countries in transition have come

increasingly to see FDI as a source of economic development and modernization,

income growth and employment. Countries have liberalized their FDI regimes and

pursued other policies to attract investment. They have addressed the issue of

how best to pursue domestic policies to maximize the benefits of foreign

presence in the domestic economy. The study Foreign Direct Investment for

Development attempts primarily to shed light on the second issue, by focusing on

the overall effect of FDI on macroeconomic growth and other welfare-enhancing

processes, and on the channels through which these benefits take effect.


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The overall benefits of FDI for developing country economies are well

documented. Given the appropriate host-country policies and a basic level of

development, a preponderance of studies shows that FDI triggers technology

spillovers, assists human capital formation, contributes to international trade

integration, helps create a more competitive business environment and enhances

enterprise development. All of these contribute to higher economic growth,

which is the most potent tool for alleviating poverty in developing countries.

Moreover, beyond the strictly economic benefits, FDI may help improve

environmental and social conditions in the host country by, for example,

transferring cleaner technologies and leading to more socially responsible

corporate policies

3.1. TrendsThe magnitude of FDI flows continued to set records through the last decade,

before falling back in 2001. In 2000, world total inflows reached 1.3 trillion US

dollars (USD) or four times the levels of five years earlier. More than 80% of the

recipients of these inflows, and more than 90% of the initiators of the outflows,

were located in developed countries.

The limited share of FDI that goes to developing countries is spread very

unevenly, with two-thirds of total FDI flows from OECD members to non-OECD

countries going to Asia and Latin America. Within regions there are some strong

concentrations on a few countries, such as China and Singapore in the case of

Asia. Even so, FDI inflows represent significant sums for many developing

countries, several of them recording levels of FDI, relative to the size of the

domestic economy, that overshadow the largest OECD economies . Moreover, the

flow of FDI to developing countries worldwide currently overshadows official

development assistance by a wide margin, further highlighting the need to

address the use of FDI as a tool for economic development.

OECD FDI Outflows by Region


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In recent years, an increasingly large share of FDI flows has been through mergers

and acquisitions (M&A). This partly reflects a flurry of transatlantic corporate

takeovers, and partly the large-scale privatization programs that were

implemented throughout much of the world in the 1990s. In developing

countries, however, Greenfield investment has remained the predominant mode

of entry for direct investors, followed by foreign companies participation in

privatizations.

3.2. FDI and GrowthBeyond the initial macroeconomic stimulus from the actual investment, FDI

influences growth by raising total factor productivity and, more generally, the

efficiency of resource use in the recipient economy. This works through three

channels: the linkages between FDI and foreign trade flows, the spillovers and

other externalities vis--vis the host country business sector, and the direct

impact on structural factors in the host economy.

Most empirical studies conclude that FDI contributes to both factor productivity

and income growth in host countries, beyond what domestic investment normally

would trigger. It is more difficult, however, to assess the magnitude of this

impact, not least because large FDI inflows to developing countries often concur

with unusually high growth rates triggered by unrelated factors. Whether, as


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sometimes asserted, the positive effects of FDI are mitigated by a partial

crowding out of domestic investment is far from clear. Some researchers have

found evidence of crowding out, while others conclude that FDI may actually

serve to increase domestic investment. Regardless, even where crowding out

does take place, the net effect generally remains beneficial, not least as the

replacement tends to result in the release of scarce domestic funds for other

investment purposes.

In the least developed economies, FDI seems to have a somewhat smaller effect

on growth, which has been attributed to the presence of threshold

externalities. Apparently, developing countries need to have reached a certain

level of development in education, technology, infrastructure and health before

being able to benefit from a foreign presence in their markets. Imperfect andunderdeveloped financial markets may also prevent a country from reaping the

full benefits of FDI. Weak financial intermediation hits domestic enterprises much

harder than it does multinational enterprises (MNEs). In some cases it may lead to

a scarcity of financial resources that precludes them from seizing the business

opportunities arising from the foreign presence. Foreign investors participation in

physical infrastructure and in the financial sectors (subject to adequate regulatory

frameworks) can help on these two grounds.

a. Trade and InvestmentWhile the empirical evidence of FDIs effects on host-country foreign trade

differs significantly across countries and economic sectors, a consensus is

nevertheless emerging that the FDI-trade linkage must be seen in a broader

context than the direct impact of investment on imports and exports. The

main trade-related benefit of FDI for developing countries lies in its long-

term contribution to integrating the host economy more closely into the

world economy in a process likely to include higher imports as well asexports. In other words, trade and investment are increasingly recognized

as mutually reinforcing channels for cross-border activities. However, host-

country authorities need to consider the short and medium-term impacts

of FDI on foreign trade as well, particularly when faced with current-

account pressures, and they sometimes have to face the question of


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whether some of the foreign-owned enterprises transactions with their

mother companies could diminish foreign reserves.

As countries develop and approach industrialized nation status, inward FDI

contributes to their further integration into the global economy by

engendering and boosting foreign trade flows (the link between openness

to trade and investment is illustrated by figure below). Apparently, several

factors are at play. They include the development and strengthening of

international networks of related enterprises and an increasing importance

of foreign subsidiaries in MNEs strategies for distribution, sales and

marketing. In both cases, this leads to an important policy conclusion,

namely that a developing countrys ability to attract FDI is influenced

significantly by the entrants subsequent access to engage in importing and

exporting activities. This, in turn, implies that would-be host countries

should consider a policy of openness to international trade as central in

their strategies to benefit from FDI, and that, by restricting imports from

developing countries, home countries effectively curtail these countries

ability to attract foreign direct investment. Host countries could consider a

strategy of attracting FDI through raising the size of the relevant market by

pursuing policies of regional trade liberalization and integration.


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Host countries ability to use FDI as a means to increase exports in the short

and medium term depends on the context. The clearest examples of FDI

boosting exports are found where inward investment helps host countries

that had been financially constrained make use either of their resource

endowment (e.g. foreign investment in mineral extraction) or their

geographical location (e.g. investment in some transition economies).

Targeted measures to harness the benefits of FDI for integrating host

economies more closely into international trade flows, notably by

establishing export-processing zones (EPZs), have attracted increasing

attention. In many cases they have contributed to a rising of imports as well

as exports of developing countries. However, it is not clear whether the

benefits to the domestic economy justify drawbacks such as the cost to the

public purse of maintaining EPZs or the risks of creating an uneven playing

field between domestic and foreign enterprises and of triggering

international bidding wars.

Recent studies do not support the presumption that lesser developed

countries may use inward FDI as a substitute for imports. Rather, FDI tends

to lead to an upsurge in imports, which is often gradually reduced as local

companies acquire the skills to serve as subcontractors to the entrantMNEs.

b. Technology TransfersEconomic literature identifies technology transfers as perhaps the most

important channel through which foreign corporate presence may produce

positive externalities in the host developing economy. MNEs are the

developed worlds most important source of corporate research and

development (R&D) activity, and they generally possess a higher level of

technology than is available in developing countries, so they have thepotential to generate considerable technological spillovers. However,

whether and to what extent MNEs facilitate such spillovers varies according

to context and sectors.

Technology transfer and diffusion work via four interrelated channels:

vertical linkages with suppliers or purchasers in the host countries;


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horizontal linkages with competing or complementary companies in the

same industry; migration of skilled labor; and the internationalization of

R&D. The evidence of positive spillovers is strongest and most consistent in

the case of vertical linkages, in particular, the backward linkages with

local suppliers in developing countries. MNEs generally are found to

provide technical assistance, training and other information to raise the

quality of the suppliers products. Many MNEs assist local suppliers in

purchasing raw materials and intermediate goods and in modernizing or

upgrading production facilities.

Reliable empirical evidence on horizontal spillovers is hard to obtain,

because the entry of an MNE into a less developed economy affects the

local market structure in ways for which researchers cannot easily control.

The relatively few studies on the horizontal dimension of spillovers have

found mixed results. One reason for this could be efforts by foreign

enterprises to avoid a spillover of knowhow to their immediate

competition. Some recent evidence appears to indicate that horizontal

spillovers are more important between enterprises operating in unrelated

sectors.

A proviso relates to the relevance of the technologies transferred. For

technology transfer to generate externalities, the technologies need to berelevant to the host-country business sector beyond the company that

receives them first. The technological level of the host countrys business

sector is of great importance. Evidence suggests that for FDI to have a more

positive impact than domestic investment on productivity, the technology

gap between domestic enterprises and foreign investors must be relatively

limited. Where important differences prevail, or where the absolute

technological level in the host country is low, local enterprises are unlikely

to be able to absorb foreign technologies transferred via MNEs.c. Human Capital Enhancement

The major impact of FDI on human capital in developing countries appears

to be indirect, occurring not principally through the efforts of MNEs, but

rather from government policies seeking to attract FDI via enhanced human

capital. Once individuals are employed by MNE subsidiaries, their human


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capital may be enhanced further through training and on-the-job learning.

Those subsidiaries may also have a positive influence on human capital

enhancement in other enterprises with which they develop links, including

suppliers. Such enhancement can have further effects as that labor moves

to other firms and as some employees become entrepreneurs. Thus, the

issue of human capital development is intimately related with other,

broader development issues.

Investment in general education and other generic human capital is of the

utmost importance in creating an enabling environment for FDI. Achieving a

certain minimum level of educational attainment is paramount to a

countrys ability both to attract FDI and to maximize the human capital

spillovers from foreign enterprise presence. The minimum level differs

between industries and according to other characteristics of the host

countrys enabling environment; education in itself is unlikely to make a

country attractive to foreign direct investors. However, where a significant

knowledge gap is allowed to persist between foreign entry and the rest of

the host economy, no significant spillovers are likely.

Among the other important elements of the enabling environment are the

host countrys labor market standards. By taking steps against

discrimination and abuse, the authorities bolster employees opportunitiesto upgrade their human capital, and strengthen their incentives for doing

so. Also, a labor market where participants have access to a certain degree

of security and social acceptance lends itself more readily to the flexibility

that is a key to the success of economic strategies based on human capital.

It provides an environment in which MNEs based in OECD countries can

more easily operate, applying their home country standards and

contributing to human capital development. One strategy to further this

goal is a wider adherence to the OECD Declaration on InternationalInvestment and Multinational Enterprises, which would further the

acceptance of the principles laid down in the Guidelines for Multinational

Enterprises.

While the benefits of MNE presence for human capital enhancement are

commonly accepted, it is equally clear that their magnitude is significantly


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smaller than that of general (public) education. The beneficial effects of

training provided by FDI can supplement, but not replace, a generic

increase in skill levels. The presence of MNEs may, however, provide a

useful demonstration effect, as the demand for skilled labor by these

enterprises provides host-country authorities with an early indication of

what skills are in demand. The challenge for the authorities is to meet this

demand in a timely manner while providing education that is of such

general usefulness that it does not implicitly favor specific enterprises.

Empirical and anecdotal evidence indicates that, while considerable

national and sectors discrepancies persist, MNEs tend to provide more

training and other upgrading of human capital than do domestic

enterprises. However, evidence that the human capital thus created spills

over to the rest of the host economy is much weaker. Policies to enhance

labor-market flexibility and encourage entrepreneurship, among other

strategies, could help buttress such spillovers.

Human capital levels and spillovers are closely interrelated with technology

transfers. In particular, technologically advanced sectors and host countries

are more likely to see human capital spillovers and, conversely, economies

with a high human capital component lend themselves more easily to

technology spillovers. The implication of this is that efforts to reap thebenefits of technology and human capital spillovers could gain

effectiveness when policies of technological and educational improvement

are undertaken conjointly.

d. CompetitionFDI and the presence of MNEs may exert a significant influence on

competition in host-country markets. However, since there is no commonly

accepted way of measuring the degree of competition in a given market,

few firm conclusions may be drawn from empirical evidence. The presenceof foreign enterprises may greatly assist economic development by spurring

domestic competition and thereby leading eventually to higher

productivity, lower prices and more efficient resource allocation.

Conversely, the entry of MNEs also tends to raise the levels of

concentration in host-country markets, which can hurt competition. This


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risk is exacerbated by any of several factors: if the host country constitutes

a separate geographic market, the barriers to entry are high, the host

country is small, the entrant has an important international market

position, or the host-country competition law framework is weak or weakly

enforced.

Market concentration worldwide has increased significantly since the early

1990s due to a wave of mergers and acquisitions that has reshaped the

global corporate landscape. At the same time, a surge in the number of

strategic alliances has changed the way in which formally independent

corporate entities interact. Alliances are generally thought to limit direct

competition while generating efficiency gains, but evidence of this is not

firmly established. There has also been a wave of privatizations that has

attracted considerable foreign direct investment (mainly in developing and

emerging countries), and this, too, could have important effects on

competition.

Empirical studies suggest that the effect of FDI on host-country

concentration is, if anything, stronger in developing countries than in more

mature economies. This could raise the concern that MNE entry into less-

developed countries can be anti-competitive. Moreover, while ample

evidence shows MNE entry raising productivity levels among host-countryincumbents in developed countries, the evidence from developing

countries is weaker. Where such spillovers are found, the magnitude and

dispersion of their effects are linked positively to prevailing levels of

competition.

However, the direct impact of rising concentration on competition, if any,

appears to vary by sector and host country. There are relatively few

industries where global concentration has reached levels causing real

concern for competition, especially if relevant markets are global in scope.In addition, high levels of concentration in properly defined markets may

not result in reduced competition if barriers to entry and exit are low or

buyers are in a good position to protect themselves from higher prices.

While it is economically desirable that strongly performing foreign

competitors be allowed to replace less productive domestic enterprises,


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policies to safeguard a healthy degree of competition must be in place.

Arguably the best way of achieving this is by expanding the relevant

market by increasing the host economys openness to international trade.

In addition, efficiency-enhancing national competition laws and

enforcement agencies are advisable to minimize the anti-competitive

effects of weaker firms exiting the market. When mergers are being

reviewed and when possible abuses of dominance cases are being

assessed, the accent should be on protecting competition rather than

competitors. Modern competition policy focuses on efficiency and

protecting consumers; any other approach may lead to competition policy

being reduced to an industrial policy that may fail to deliver long term

benefits to consumers.

e. Enterprise DevelopmentFDI has the potential significantly to spur enterprise development in host

countries. The direct impact on the targeted enterprise includes the

achievement of synergies within the acquiring MNE, efforts to raise

efficiency and reduce costs in the targeted enterprise, and the

development of new activities. In addition, efficiency gains may occur in

unrelated enterprises through demonstration effects and other spillovers

akin to those that lead to technology and human capital spillovers.Available evidence points to a significant improvement in economic

efficiency in enterprises acquired by MNEs, albeit to degrees that vary by

country and sector. The strongest evidence of improvement is found in

industries with economies of scale. Here, the submersion of an individual

enterprise into a larger corporate entity generally gives rise to important

efficiency gains.

Foreign-orchestrated takeovers lead to changes in management and

corporate governance. MNEs generally impose their own company policies,internal reporting systems and principles of information disclosure on

acquired enterprises (although cases of learning from subsidiaries have also

been seen), and a number of foreign managers normally come with the

takeover. Insofar as foreign corporate practices are superior to the ones

prevailing in the host economy, this may boost corporate efficiency,


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empirical studies have found. However, to the extent that country specific

competences are an asset for managers in subsidiaries, MNEs need to strive

toward an optimal mix of local and foreign management.

An important special case relates to foreign participation in the

privatization of government-owned enterprises. Experiences, many of them

from the transition economies in East and Central Europe, have been

largely positive; participation by MNEs in privatizations has consistently

improved the efficiency of the acquired enterprises. Some political

controversies have, however, occurred because the efficiency gains were

often associated with sizeable near term job losses. Moreover, the value of

FDI in connection with privatization in transition economies could partly

reflect the fact that few domestic strategic investors have access to

sufficient finance. In those few cases where domestic private investors

were brought into previously publicly owned enterprises, important

efficiency gains resulted.

The privatization of utilities is often particularly sensitive, as these

enterprises often enjoy monopolistic market power, at least within

segments of the local economy. The first-best privatization strategy is

arguably to link privatization with an opening of markets to greater

competition. But where the privatized entity remains largelyunreconstructed prior to privatization, local authorities often resort to

attracting foreign investors by promising them protection from competition

for a designated period. In this case there is a heightened need for strong,

independent domestic regulatory oversight.

Overall, the picture of the effects of FDI on enterprise restructuring that we

can derive from recent experience may be too positive, because investors

will have picked their targets among enterprises with a potential for

achieving efficiency gains. However, from a policy perspective, this makeslittle difference, as long as foreign investors differ from domestic investors

in their ability or willingness to improve efficiency or realize new business

opportunities. Authorities aiming to improve the economic efficiency of

their domestic business sectors have incentives to encourage FDI as a

vehicle for enterprise restructuring.


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3.3. FDI and environmental and social concernsFDI has the potential to bring social and environmental benefits to host

economies through the dissemination of good practices and technologies within

MNEs, and through their subsequent spillovers to domestic enterprises. There is arisk, however, that foreign-owned enterprises could use FDI to export

production no longer approved in their home countries. In this case, and

especially where host-country authorities are keen to attract FDI, there would be

a risk of a lowering or a freezing of regulatory standards. In fact, there is little

empirical evidence to support the risk scenario.

The direct environmental impact of FDI is generally positive, at least where host-

country environmental policies are adequate. There are, however, examples to

the contrary, especially in particular industries and sectors. Most importantly, to

reap the full environmental benefits of inward FDI, adequate local capacities are

needed, as regards environmental practices and the broader technological

capabilities of host-country enterprises.

The technologies that are transferred to developing countries in connection with

foreign direct investment tend to be more modern, and environmentally

cleaner, than what is locally available. Moreover, positive externalities have

been observed where local imitation, employment turnover and supply-chain

requirements led to more general environmental improvements in the host

economy. There have been some instances, however, of MNEs moving equipment

deemed environmentally unsuitable in the home country to their affiliates in

developing countries.

The use of such inferior technology will usually not be in the better interest of a

company; this demonstrates the sort of environmental risk associated with FDI.

Empirical studies have found little support for the assertion that policy makers

efforts to attract FDI may lead to pollution havens or a race to the bottom.

The possibility of a regulatory chill, however, is harder to refute forth lack of a

counterfactual scenario. Apparently, the cost of environmental compliance is so

limited (and the cost to a firms reputation of being seen to try to avoid them so


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great) that most MNEs allocate production to developing countries regardless of

these countries environmental regulations. The evidence supporting this

argument seems to depend on the wealth and the degree of environmental

concern in the MNEs other countries of operation.

Empirical evidence of the social consequences of FDI is far from abundant.

Overall, however, it supports the notion that foreign investment may help reduce

poverty and improve social conditions. The general effects of FDI on growth are

essential. Studies have found that higher incomes in developing countries

generally benefit the poorest segments of the population proportionately. The

beneficial effects of FDI on poverty reduction are potentially stronger when FDI is

employed as a tool to develop labor-intensive industries and where it is

anchored in the adherence of MNEs to national labor law and internationallyaccepted labor standards.


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There is little evidence that foreign corporate presence in developing countries

leads to a general deterioration of basic social values, such as core labor

standards. On the contrary, empirical studies have found a positive relationship

between FDI and workers rights. Low labor standards may, in some cases, even

act as a deterrent to FDI, due to investors concerns about their reputation

elsewhere in the world and their fears of social unrest in the host country.

Problems may, however, arise in specific contexts. For example, the non-trivial

role that EPZs play in many developing countries could, some have argued, raise

concerns regarding the respect for basic social values.

3.4. Net Contribution of FDI to DevelopmentsThe main policy conclusion that can be drawn from the study is that the economic

benefits of FDI are real, but they do not accrue automatically. To reap the

maximum benefits from foreign corporate presence a healthy enabling

environment for business is paramount, which encourages domestic as well as

foreign investment, provides incentives for innovation and improvements of skills

and contributes to a competitive corporate climate. The net benefits from FDI do

not accrue automatically, and their magnitude differs according to host country

and context. The factors that hold back the full benefits of FDI in some developing

countries include the level of general education and health, the technologicallevel of host-country enterprises, insufficient openness to trade, and weak

competition and inadequate regulatory frameworks. Conversely, a level of

technological, educational and infrastructure achievement in a developing

country does, other things being equal, equip it better to benefit from a foreign

presence in its markets.

Yet even countries at levels of economic development that do not lend

themselves to positive externalities from foreign presence may benefit from

inward FDI through the limited access to international funding. By easing financial

restraint, FDI enables host countries to achieve the higher growth rates that

generally emanate from a faster pace of gross fixed capital formation. The

eventual economic effect of FDI on economies with little other recourse to

finance depends crucially on the policies pursued by host-country authorities.


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These sectors composition of an economy can also make a difference. While the

service sectors of many developing countries may be underdeveloped and hence

unable to attract large inflows of FDI, extractive industries in countries with

abundant natural resources can be developed beneficially with the aid of foreign

investors.

In addition to the potential drawbacks of inward FDI mentioned earlier, some

micro-oriented problems could arise. For instance, while the overall impact of FDI

on enterprise development and productivity is almost always positive, it generally

also brings distributional changes and a need for industrial restructuring in the

host economy. Changes give rise to adjustment costs and are resisted by social

groups that do not expect to be among the beneficiaries. Structural rigidities in

the host economy exacerbate such costs, not least where labor markets are tooslow to provide new opportunities for individuals touched by restructuring.

Overall, the costs are best mitigated when appropriate practices are pursued

toward flexibility, coupled with macroeconomic stability and the implementation

of adequate legal and regulatory frameworks. While the responsibility for this lies

largely with host-country authorities, home countries, MNEs and international

forums also have important roles to play.

In cases where domestic legal, competition and environmental frameworks areweak or weakly enforced, the presence of financially strong foreign enterprises

may not be sufficient to assist economic development although there are

examples (notably in finance) where the entry of MNEs based in OECD member

countries has contributed to an upgrading of industry standards. Where economic

and legal structures create a healthy environment for business, the entry of

strong foreign corporate contenders tends to stimulate the host-country business

sector, whether through competition, vertical linkages or demonstration effects.

FDI can be said to act as a catalyst for underlying strengths and weaknesses in thehost countries corporate environments, possibly exacerbating the problems in

no governance zones, while eliciting the advantages in countries with a more

benign business climate and better governance. This reinforces the point made

above about the need for host (and home) countries to work to improve


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regulatory and legal frameworks and other elements that help enable the

business sector.

Finally, FDI like official development aid cannot be the main source for solving

poor countries development problems. With average inward FDI stocksrepresenting around 15 % of gross domestic capital formation in developing

countries, foreign investment acts as a valuable supplement to domestically

provided fixed capital rather than a primary source of finance. Countries

incapable of raising funds for investment locally are unlikely beneficiaries of FDI.

Likewise, while FDI may contribute significantly to human capital formation, the

transfer of state-of-the-art technologies, enterprise restructuring and increased

competition, it is the host country authorities that must undertake basic efforts to

raise education levels, invest in infrastructure and improve the health of domesticbusiness sectors. Domestic subsidiaries of MNEs have the potential to supplement

such efforts, and foreign or international agencies may assist, for example

through measures to build capacity. But the benign effects of FDI remain

contingent upon timely and appropriate policy action by the relevant national

authorities.


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4. Political ConsiderationsDo political risks discourage Foreign Direct Investment (FDI) in both developing

and developed economies in a similar manner? In this chapter, we examinewhether and in what manner political risks affect FDI and compare its different

effects in developing and developed economies. Using the 12 category Political

Risk Index compiled by the International Country Risk Guide (ICRG), we find the

following: First, political risk is a significant determinant of FDI in both

industrialized and developing nations. Second, not all aspects of political risk

affect FDI stocks in industrialized and developing countries in the same way.

When we compare the effects of different political risk component, we find that

since the 9/11 attacks, political risks have become more important and significant

determinants of FDI flows, especially in industrialized nations.

Do political risks discourage Foreign Direct Investment (FDI) in both developing

and developed economies in a similar manner? Which particular aspect of

political riskspolitical, societal, and economic risks at the domestic level and

international problemsaffect FDI flows and stocks more significantly in

developing and developed countries? Already fierce competition for FDI among

nations has become more intense due to the recent global economic downturn.Many economic determinants of FDI a large domestic market , sustainable

growth , sufficient economic and infrastructure development or high natural

resources endowmentare beyond the control of government. Stable political and

policy environments are also attractive investment determinants. Host countries

can turn domestic economies into more attractive investment environments by

reducing political risk and promoting stable and liberal policy to attract more

foreign investment, although these are long-term changes. Thus, the goal of this

paper is to provide a microscopic look at the effect of individual political riskcomponents on FDI in both developed and developing markets. This, we believe,

will provide a blueprint for long-term policy directions to shape a friendlier and

favorable investment environment: what works and what doesnt when it comes

to attracting FDI. Our paper will inform policy makers on which particular aspect

of political risk has significant effect on attracting FDI and provide an outline on


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the long-term political and institutional development favorable for attracting

more foreign investors.

As the literature on the determinants of FDI informs, political and institutional risk

is one of the major concerns for foreign investors, especially in developingnations. Some political risks, e.g., a resurgence of resource nationalism and

unfavorable annulment or change of the terms of foreign investment, continue to

pose a great challenge to foreign investors in developing markets. In addition,

recent high profile and massive casualty terrorist attacks not only stress the

prevalence of political violence and the importance of political risk as a challenge

to foreign investors, but also highlight that even developed countries are not

immune to political risk and violence. A question, thus, arises, how does political

risk affect FDI flows in developed nations in the face of such a volatile politicalenvironment? How does a high profile incident of political violence affect how

political risk shapes FDI flows and stocks?

Let us examine whether and in what manner political risk affects FDI and compare

its different effects in developing and developed economies. We also examine

how political risk affects FDI since the 9/11 attacks, especially in developed

nations, as we deem that the 9/11 attacks marked a watershed moment. The

attacks were catastrophic events that shaped not only world politics but also theglobal economy dramatically. They had devastating effects on global FDI flows

and stocks shortly after, although Enders et al. (2006) do not find any significant

lasting effects of the 9/11 attacks on the global economy. Thus, we divide our

analysis into before and after the 9/11 and compare the effects of political risk

between these two different periods. We find the following: First, political risk is a

significant determinant of FDI in both industrialized and developing nations.

Second, not all aspects of political risk affect FDI stocks in industrialized and

developing countries in the same way. A host economy with good democraticaccountability (DEMO) and a good investment profile (INVT) can attract

significantly more FDI in both industrialized and developing countries. On one

hand, other political risk components, such as ethnic tensions (ETHC) and military

in politics (MLTY), significantly impact FDI in industrialized countries, but they do

not have significant effects on FDI in developing nations. On the other hand, in


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developing nations, markets with better law and order (Law), low religious

tension (RLGN), and more stable government (GORN) tend to attract more FDI.

Third, since the 9/11 attacks, political risks have become more important and

significant determinants of FDI flows, especially in industrialized nations. Since the

9/11 attacks, democratic accountability (DEMO), investment profile (INVM), and

military in politics (MLTY) have significant positive effects on FDI, while ethnic

tensions (ETHC) has a significant negative effect on FDI stocks.

Considerations to political risk to FDI are threefold: first, we investigate and

compare the effects of political risks by using a larger and more comprehensive

sample than previous studies, and our analysis includes both developing and

developed nations over the period of 1984-2003; second, we investigate how

high-profile and catastrophic terrorist attacks, especially the 9/11 attacks in theUS, shape the importance of political risk as a determinant of FDI in industrialized

countries afterwards; third, we use a more complete and comprehensive measure

of political risk to better understand how each aspect of political risk affects FDI

stocks in both developing and developed nations. We use a 12 category Political

Risk Index compiled by the International Country Risk Guide (ICRG) to investigate

the individual effect of each political risk component on FDI in both developing

and industrialized countries.

4.1. Literature ReviewFDI is a driving force behind the economic growth of a host economy and the

rapid economic globalization of the global economy1: To a hosting economy, FDI

is an engine of employment, technological progress, productivity improvements

and ultimately econo

an overview of fdi

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