prospects for trade and capital flows in the developing ......prospects for trade and capital flows...

PROSPECTS FOR TRADE AND CAPITAL FLOWS IN THE DEVELOPING COUNTRIES

New Sources and Directions for Investment

Sheila Page and Iftikhar Hussain

OverseasDevelopmentInstitute

Overseas Development Institut

PROSPECTS FOR TRADEAND CAPITAL FLOWS

IN THE DEVELOPING COUNTRIES

New Sources and Directions for Investment

Sheila Page and Iftikhar Hussain Overseas Development Institute

Report prepared for discussion Not to be quoted without permission

23 May 1995

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CONTENTS

PartiProspects for Trade and Capital Flows

1. Turning points and trends

2. Output in the industrial countries

3. Prospects for trade

4. Prices in world trade

5. Forecasting capital flows

6. Interest rates

7. Output in the developing countries

8. Special topics

9. Conclusions and questions

Sheila Page

1

5

8

12

15

20

21

25

26

Part IIRecent Trends in Foreign Direct Investmentin Developing Countries

New sources and directions

Future prospects

Iftikhar Hussain

29

36

Appendix

Reports discussed

Definitions and country groups

39

39

40

TABLES

Table 1: Geographical structure of OECD tradeTable 2: Industrial countriesTable 3: Export and import volumes, developing countriesTable 4: Prices and interest ratesTable 5: Capital flows to developing countriesTable 6: Output in developing countriesTable 7: Selected developing countries: real GDPTable 8: Foreign direct investment inflows by countryTable 9: Geographical breakdown of foreign direct investment, 1992Table 10: Foreign direct investment outflows by country

369

13162224313335

BOX

Box 1: Problems with data on foreign direct investment 30

Parti

Prospects for Trade and Capital Flows

1. Turning points and trends

Perhaps forecasters, like lenders to emerging markets, never learn. In the early 1990s, as in the early 1980s, after a period in which the outturn had been persistently disappointing, the potential for a strong revival was not recognised. Forecasters did not expect the strong performance of 1994 and they remain cautious (for all areas except Africa) about the future. The argument that uncertainties (about national policies; about the outcome of the Uruguay Round of GATT talks; about the outcome of various regional negotiations; about the durability of the rise seen in private capital flows; about the resolution of particular conflicts, most notably in southern Africa . . .) were reducing confidence and holding growth back should have signalled a recovery in 1994 when many of these problems had been resolved, and a long-lasting improvement in performance. Output and trade growth in 1994 proved to be better than expected, in total and in most areas.

Some of the change in world totals may be misleading. In particular, estimates for the former centrally planned economies, particularly for the former members of the USSR, remain highly uncertain (an alternative method of measuring their output is discussed in the next chapter on output forecasts). Differences on how much their economies have contracted, exactly when this contraction will end (or if it has ended), and how rapid any resumed growth may be, help to explain some of the divergences among the forecasters. In particular, the continued improvement in world output in 1995 expected by the IMF1 stems entirely from a turnaround from negative to positive changes in output by these countries, with industrial country growth unchanged and a decrease in the rate for developing countries. Within areas there are also examples of single important countries whose performance is not representative of the total. Much of the deterioration now expected for Latin America can be explained by Mexico. But in broad terms, both industrial and developing countries are expected to maintain their growth in 1995, with perhaps some slowing in the medium term.

The forecasters react differently to the errors and uncertainties. The IMF emphasises (p. 1) the 'speed with which perceptions about a country's situation can change', although its example, the Mexican crisis, seems a doubtful one. It was identifiable (and identified) as a risk because of Mexico's current deficit and over-valued exchange rate at least a year before the crisis of December 1994. The need to find a rapid way for the international system to react to balance of payments crises is now on the international agenda (literally so, at the spring 1995 meetings of the IMF and World Bank). This was identified as a priority in

1. The publications used in the comparisons of forecasts are listed at the end, as are other publications cited in the text. The principal report by each forecaster is referred to simply by its name. Other publications by the forecasting organisations are referred to by short titles.

1973-4, with the imbalances caused by the rise in oil prices (met first by a series of bilateral measures, then an emergency measure in the form of the special oil facility) and in 1982 following a previous Mexican crisis (met first by a series of bilateral measures, then a series of special measures and debt initiatives).

The World Bank puts more weight on changes in underlying conditions, emphasising particularly (p. 1) 'the new opportunities in trade and external finance offered by globalization'. It discusses in detail three related examples of this:

the growing share of developing countries in the world economy, and consequently their effect on industrial countries through stimulating trade, investment, and perhaps also commodity prices;

the potential effects of the Uruguay Round of trade negotiations;

and the new need to maintain the confidence of international financial markets.

The last is a difficult concept to quantify and apply in forecasting. The World Bank discussion does not distinguish between the alternative interpretations, that confidence is based on performance, past or expected, or that it is based on policies perceived to be 'good'. It is also unclear why it should be important to the majority of developing countries which do not receive and cannot realistically expect private capital inflows. The second part of this report surveys recent trends in direct foreign investment. It makes it clear how concentrated this is on a few countries, as it has always been, while the evidence on portfolio investment (even if the IMF's comments are not taken as a warning against it) is also that it tends to be available for only a limited range. The changes in this and in total capital flows are discussed in Chapter 5.

The World Bank's own emphasis is increasingly on policies. It argues that the progress on removing barriers (and preferences) for developing country trade means that their own policies are more important. It is necessarily the case in any analysis that removing any one influence increases the relative importance of all those remaining. It has modified the presentation of its forecasts in the direction of making the Global Economic Prospects publication more explicitly one of advocacy of specific types of policy, rather than the more technical presentation of forecasts and variants which it has been in the past.2 In this, it is following the World Bank's original forecast publication, the World Development Report, now devoted to a special topic. It now has a 'central message', that 'the increasing integration of developing countries into the global economy represents a major - perhaps the most important opportunity for raising the welfare of both developing and industrial countries over the long term' (p. 2), and much of its discussion of alternative scenarios (discussed in Chapter 7 on output in developing countries), like its definition of confidence, is based on policies.

It considers trade to be the 'engine of growth' (reminiscent of the mid-1970s image of locomotives to pull the OECD countries out of their post-oil crisis recession). But its analysis of the two examples which it offers does not entirely support this. Its estimates of the effects

2. It must be admitted that this is a tendency in any report prepared over a period of years.

of the Uruguay Round (discussed in detail in Chapter 3 on trade forecasts) are now much more conservative than when it was pressing for a settlement, and the outcome appears to have had no effect on its forecasts for trade. Its arguments that the growing share of developing countries in international trade and investment increases the opportunities for growth on both sides seem to be directed principally at countering arguments that it can damage the interests of some groups, in particular unskilled workers, in the industrial. On this point, it now accepts the possibility that the transition effects can be especially strong on such labour, making the (theoretically and historically correct) reply, not that it does not happen or is too small to be significant, but that it can be and is offset by the benefits to other workers. (It could also mention the direct welfare effects on consumers.)

Beyond noting that the share of industrial countries' exports going to developing countries rose between the 'late 1980s' and 'today' (pp. 1-2), it does not analyse here how globalisation may have increased the effect of the developing on the developed. The OECD present a much more detailed analysis (reproduced in Table 1) to support the opposite point of view: that OECD trade with the rest of the world has changed little since 1962. In the 1980s, the importance of the industrialising Asian economies has increased, but this has been partially offset by a decline in that of OPEC. Overall, the share of exports to (or imports from) the rest of the world has increased from 2.5% of OECD countries' GDP to 3.5%, with most of the increase concentrated on the US. This should not necessarily be interpreted to

Table 1: Geographical structure of OECD tradepercentage of nominal GDP

Area or Source/destination country

OECD Non-OECDof which DAEsN-

China OPEC

USA Non-OECDof which DAEsa+

China OPEC

Japan Non-OECDof which DAEs"+

China OPEC

Europe Non-OECDof which DAEsN-

China OPEC

Source of imports Destination of exports

1962 1972 1982 1992 1993 1962 1972 1982 1992 1993

2.53 2.61 5.22 3.55 2.55 2.53 4.69 3.43

0.190.68

0.360.83

0.882.21

1.440.74

0.260.34

0.420.42

0.87 1.361.46 0.57

1.02 1.12 2.83 3.13 3.23 1.55 1.18 2.56 2.39 2.42

0.08 0.33 0.87 1.74 1.83 0.11 0.22 0.67 1.08 1.130.26 0.22 0.99 0.55 0.53 0.18 0.23 0.73 0.37 0.33

3.88 3.72 7.67 3.26 2.96 4.13 4.17 6.49 4.15 4.04

0.841.12

0.731.50

1.614.45

1.52 1.461.06 0.89

4.38 3.94 6.64 3.96

1.29 1.67 2.39 2.81 2.840.52 0.61 2.00 0.52 0.41

3.61 3.43 5.94 3.80

0.241.19

0.281.37

0.632.68

1.090.76

0.260.55

0.260.61

0.48 0.802.14 0.76

* DAEs are the Dynamic Asian Economies (Hong Kong, Korea, Malaysia, Singapore, Taiwan, Thailand).

Source: OECD

imply that the influence of developing countries on industrial countries is unimportant. In 1974-6 the fact that developing countries contracted much less than industrial countries in response to the first oil price rise was already an important influence in reducing, if not in turning around, the recession in the industrial: their importance to forecasts of industrial countries was underestimated then as well. But the OECD data, combined with the growing share of developing country trade in total world trade, offer evidence of a different change in trend: the much greater importance of developing countries as markets for each other, helping to explain their recent and continuing ability to achieve rapid growth in spite of performance by the industrial countries. Some forecasters, in particular the OECD and the IMF, implicitly now recognise this by publishing individual country forecasts for the major developing countries (discussed in Chapter 7 and presented in Table 7). The OECD also question the significance now of a traditional effect from developing countries on industrial, through demand for commodities and hence to prices and inflation. The developing countries' own demand for commodities is now a more important part of total purchases. Failure to allow for this may help to explain failure to anticipate the 1994 rise in prices. The reduced share of these products in industrial country output and demand, however, necessarily means that the impact of any commodity price rise is less than it was 20 years ago. This is discussed in detail in Chapter 4 on prices.

The final potential source of new linkages cited by the World Bank, growing foreign investment, is also capable of more than one interpretation. As is shown in the section on investment, an increase in gross flows to developing countries should no longer be assumed to be reflected entirely in net flows. It is in accord with the logic of globalisation and the experience of investment and trade among industrial countries that flows to developing countries should become increasingly offset by flows from them to the industrial, where developing country firms see the same type of opportunities either for specialisation or to be nearer markets as those from industrial countries. At the same time, the growing economic importance of developing countries to each other has meant that much of the increase in flows is among developing countries. The new sources and uses of capital are also discussed in connection with the current, and expected, high level of interest rates (Chapter 6).

Several of the forecasters discuss the growth of regional groups and of trade and investment among them, but it is not clear whether the forecasts are using more differentiated approaches, or whether they should. If the growth in trade simply reflects normal output growth or competitiveness effects, traditional aggregate models should remain valid. If, however, there are special influences within a region, or special advantages from current trading partners, implied by the old type of constant-market-share-matrix model for forecasting, then some modifications need to be made, especially as all the forecasters continue to expect very different outcomes in different areas. The OECD has included relevant to this, on export markets weighted by existing trade shares to help explain past and expected future performance, for at least a decade.

The forecasts available to analyse this year are more limited than in the past because the latest available from UNCTAD and the area development banks are those of the second half of 1994. The major revisions made since then in those which have been published more recently, the unexpectedly good performance of output and trade in 1994, and the monetary and exchange rate turbulence of the end of 1994 and early 1995, all suggest that these would now also be revised. UNCTAD's analysis was largely confined to 1994. Some country

forecasts for 1995 from the Asian Development Bank are included. Some additional new forecasts, in particular by individual country forecasters for the US and Germany, have been included to give a greater range of recent points of view.

2. Output in the industrial countries

In 1994, the US and the European countries (especially Germany) grew significantly faster than the forecasters had expected at the beginning of the year, with the US above long run trends, and Germany at or slightly below, not in continuing recession as had been feared. Only Japan saw slow and below expectation growth. In 1995, the total growth for industrial countries is expected to remain about the same, or slightly higher (Table 2). The OECD expresses more optimism, emphasising that 'economic prospects for the OECD area are at present better than they have been for several years' (p. 1), but this is not reflected in its numerical forecasts. The recovery in the European countries will be maintained; the US will fall back, but not into recession; and Japan will recover. Most of the forecasts for Japan were published and probably all were made before the two shocks of the earthquake and the continuing rise in the yen. Allowing for these may not modify the picture greatly. Japanese forecasters expect reconstruction to add slightly to demand, while the rise in the yen may only confirm the position that Japanese growth is now mainly based on internal rather than external demand. A strong rise in imports, whether because of the yen or any opening in the Japanese economy because of the Uruguay Round could put such expectations at risk, but none of the forecasters suggests that this is likely. The latest JCER forecast for 1995 is 2.5%.

For the major European countries, as well, domestic demand is likely to be the principal source of growth. The EU emphasises this for Germany and the UK, although suggesting that other countries, particularly those which have devalued, could also see growth in external demand. The Hamburg (HWWA) forecast emphasises monetary policy in the past for all the industrial countries as a source of growth. If the recent growth is principally because of domestic factors, and if, as discussed in Chapters 5 and 6 on capital flows and interest rates, monetary and fiscal policies may tighten, this would be a risk to current rates of growth, but none of the forecasters (in their base forecasts) expects this to be strong. This gives the pattern in Table 2, of slight slowing in the medium term (although 1996, for those which give it, is little different from 1995), but little change from the average rate of 3% or just under of 1994-5. Several forecasts are slightly more pessimistic for the US, but most of the forecasters see a convergence among the industrial countries. Neither the continued high (in historical terms) real interest rates nor attempts to achieve convergence among the EU countries to meet the Maastricht criteria are expected to have strong negative effects, and the possibility of positive effects from the external forces which should increase confidence or from trading opportunities stemming from the trade agreement or the new importance of developing countries is not mentioned. The most recent official forecasts for the US are an exception. These suggest a much better performance for the US (3%), based on world output rising 3.5%, because of increasing trade opportunities, not only because of rapid growth in the industrialising countries, but because of the Uruguay Round, NAFTA, and other

Table 2: Industrial countriespercentages

IMF HWWA

1994World OutputIndustrial Countries

United StatesJapan

European CommunityGermanyUK

Former Centrally PlannedEastern EuropeFormer USSR

Import VolumeUS Import Volume

Export VolumeWorld Trade Volume

1995World OutputIndustrial Countries

United StatesJapan



Import VolumeUS Imports

ExportWorld Trade Volume

Medium Term

(May)

3.73.04.10.62.82.93.8

-9.42.7

-15.0

10.5

8.69.4

3.83.03.21.83.23.23.2

-3.83.6

-9.07.8

8.08.0

IMF1996 1996

(Jan)

2.841

2.83.5

3.03

2.5

33

OECD1997

-2000

UN(Dec)

2.22.63.80.62.42.43.5

-10.32.4

5.57.56.27.1

3.02.752.75

2333

-53.5

6.08.5

67

EC1996

WB OECD(Apr) (Dec)

2.82.9 2.8

3.91.02.52.83.5

-9.1

-15

8.913.2

98.9

3.03.12.53.02.83.1

-77.48.28.18.2

NIER1996 1998

-2002

EC(Dec)

3.90.72.62.53.8

-3.2

8

2.72.22.9

32.70.4

6.5

World1995-1996

Base Low

World OutputIndustrial Countries

United StatesJapan



Import VolumeExport VolumeWorld Trade Volume

4.22.7 2.91.9 2.03.5 3.43.1 3.23.3 3.52.8 3.03.53.54.35.04.86.8

2.92.23.83.03.12.9

06.97.47.8

2.32.73.23.42.8

3.0 2.72.5 2.23.7 3.02.9 2.73.2 2.62.5 2.6

6.4 6.1

3.22.9 4.2

0.1

6.6 9.5

7.1 9.5

NIER(Feb)

2.84

0.82.52.34.0

15.2

9

3.03.22.22.82.93.2

10.8

8

Bank1995-2000

WT(Ma

3,

Base Low

3.32.8

3.5

4.9

6.1

1.2

1.4

3.7

liberalisation measures in Latin American trade. If the numbers and the analysis are well- founded, the other forecasts could prove pessimistic.

On the data used by all the forecasters, the performance of the former centrally planned countries continues to be poor, and outcomes and forecasts continue to be revised down. Eastern European countries appear to have grown for the first time since 1989, and are expected to continue to do so, although at a moderate rate. In contrast, the ex-USSR and Russia in particular are still contracting (some forecasters had expected this to end in 1994 or 1995). The estimates and forecasts of other forecasters (for example, the Vienna Institute for Comparative Economic Studies, which specialises in this area) support these figures. As well as its purely statistical effect on the measurement of changes in world output, this is important for both industrial and developing countries in the medium term because taken together the area could have a major effect on trade. If there is the possibility of a turnaround even to slow rates of growth or at least of an end to the fall, the effect on trade could be significant. If, however, the fall in output proves to have been exaggerated, the potential effects of ending it are correspondingly reduced.

The EBRD publishes similar estimates (for 1994, 3% for eastern Europe; -13% for the former Soviet Union), but notes (p. 145) that the official data 'exaggerate the fall in output'. The principal reason suggested is that the data on old companies tend to be better than on new, especially private sector, companies, while it is the latter which are more likely to be growing. It discusses in an appendix alternative approaches, in particular suggesting that the method used frequently by UK forecasters and official statistics, of making three estimates, from data on output, demand, and income, would provide useful checks.

The World Bank (Transition), however, has recently published alternative estimates based on electricity power consumption. It points out that both individual plants and the countries have an interest in underestimating output, in order to reduce targets and increase the probability of assistance, and that the old statistical methods of the USSR were not designed to produce the type of data used in GDP measures, even if they were working well. Even in more advanced countries, where factory output is not as important a share of the total, there is a strong correlation between power consumption and GDP (it has been suggested as a useful rapid indicator of output in the UK, for example). In the eastern European countries the decline in power consumption (22%) mirrored closely the decline estimated in GDP (24%). In contrast, it finds that for the ex-USSR the falls are 15% and 54% respectively, and argues that 'The huge differences . . . cannot be explained rationally'. For Russia, the falls are 15% and 40%. If the power-based estimates are correct, output has fallen less in these countries than in Eastern Europe. If such estimates are closer to reality than official data, the possibility of a turnaround may be greater, but its potential magnitude is reduced.

Several forecasters, including the UN and the IMF, note that even the continued growth at 3% which they are expecting will have little or no effect in reducing unemployment in the industrial countries. This is one of the factors explaining concern about possible protectionist pressures in the industrial countries which could blunt the effects of the trade liberalisation which has been achieved. It is, in some ways, a circular argument: if the effects of the Uruguay Round were as significant as pre-1994 estimates suggested, they would be increasing trade and growth, and blunting the protectionist pressures. It suggests that the forecasters remain seriously handicapped by inability to allow for the effects of international policy

8

changes on economic variables, or of changes in economic variables on national policy. The forecasts which depend heavily on assumptions about policy are most conspicuously vulnerable to these uncertainties, but those which ignore them or explicitly choose not to forecast them are equally unreliable.

3. Prospects for trade

According to the World Trade Organization (WTO), world trade increased in volume terms by 9% in 1994 (Table 2). Although, as it points out, this was the largest rise since 1976, such an increase is unusual more because it is exceptionally high relative to the growth of output and because it was completely outside the range of forecasts than because of its absolute size. It is striking that none of the forecasters attributes the growth to the world or the regional trade agreements of 1993 and 1994, either directly or through confidence effects, and none expects the rate to remain that high. The effects of the turnaround in the industrial countries on the composition of demand are part of the explanation. Several forecasters point to these, particularly the recovery in demand in Europe. The rapid rise in Japan could be attributed to a delayed response to its growth in output in 1992-3. It is, however, notable that among developing countries the liberalising Latin American countries showed the most rapid growth rates of trade relative to output (13.5%, Table 3, compared to around 4%, Table 6). US imports, particularly from Latin America, thus including its NAFTA partner Mexico, also rose very strongly. In value, Brazil, Mexico, Argentina, and Colombia, all liberalising both unilaterally and as members of regional groups, were all above 20%. Although some of the trade rises by the Asian countries were equally high, this was less surprising in the context of their strong growth in output (15% for trade, 7% for output for the NICs). China, in value terms, had a rise of only 11%, much less than its output rise (which was 10-12% even in volume) should explain.

On exports, both Latin American countries (to the US) and Asian NICs showed strong rises, although the NIC performance was only just equal to its imports. Even at the WTO's estimate of more than 10%, the rise for Latin American exports was less than for imports. The other Asian countries, particularly China, also saw exports expanding less than imports. Although US exports rose strongly, they were not as rapid as its imports. The US, Latin America and Japan were making a net contribution to world demand, which was being met by eastern Europe, China, and western Europe. There, export growth was slightly greater than import growth, although data problems for intra-European trade make estimates uncertain. Excluding intra-EU trade, the WTO finds little difference between import and export growth. Both were at 13% in value. The high growth estimated for Eastern European and ex-USSR trade by the WTO, 11.5% for exports and 10% for imports lends support for a sceptical view of the low estimates of their output performance. This pattern of area demand has significant implications for the forecasts.

The UN attributes the recent pattern to the different timing of industrial cycles among the industrial countries. It points to the importance of intra-Asian trade in raising the total rate

Table 3: Export and import volumes, developing countries 9percentages

WTO EU IMF UN OECD World Bank (Mar) (Dec) (May) (Dec) (Dec) (April) 1995-1996

Base Low1994

Exports 10.4Oil exporters 5.5Non-fuel exporters 10.2Asia 10.0

NICs 15.0 11.1Western Hemisphere 10.5

Imports 1.7Oil exporters -1.9Non-fuel exporters 13.8Asia 13.5

NICs 15.0 12.6 12.0South Asia 13.5

1995

Exports 9.1 10.25 Oil exporters 5.6 4.5 Non-fuel exporters 10.0 Africa 4.75

Sub-Saharan 5.2 7.9 Asia 12.75

NICs 11.6 11.3 14.1 Western Hemisphere 8.25 7.6 10.5

8.6 9 Imports

Oil exporters -6.5 0 Non-fuel exporters 11.9 Africa

Sub-Saharan 6.5 Asia 11.75

NICs 12.4 12.0South Asia 8.2 10.9

Western Hemisphere 8

Medium Term IMF EU World Bank OECD1996 1996 1995-2000 1996

Base LowExports 10.7

AfricaSub-Saharan 3.4 0.6

AsiaNICs 9.0 7.1 11.4 South Asia 6.7 4.7

Western Hemisphere 6.1 3.4 Imports 11.2

NICs 12.2 12.3

10

of growth of world trade, suggesting that it explained most of the recorded increase in trade in 1991-3. It thus, like the OECD, appears to be emphasising the role of the developing countries in improving their own and world performance, not the direct effects which they might have on industrial countries through trade demand.

The Bank for International Settlements (BIS) compares the share of Asia to Europe and North America, grouping the Asian old and new NICs, China and India, with Japan. Its charts (p. 73) show manufacturing output shifting to Asia, suggesting that Asia took first place in the mid-1980s. Although it emphasises the simultaneous growth in its share of extra-regional trade in manufactures (to 40% of the world total compared to about 25% each for the other areas), most of this growth according to the BIS data appears to have been before Asia took the lead in output, with the share holding level since then. These different ways of viewing the growing importance of Asia to the world economy have important implications for analysing the consequences of the faster growth for the region which all the forecasters expect.

The WTO also indicates important changes in the composition of trade which should be taken into account. 'Office machinery and telecommunications', the category in which computers are found, is now 11 % of the total, greater than the traditional categories of food, car products, chemicals, fuels, and clothing, which have been central to trade and trade negotiations in the past. Although this sector remains rapidly growing, it would be surprising if it could maintain the recent rate of rise, particularly if it owes part of its recent position in trade to a step increase in technology or shift of investment to new areas, as suggested by some theories behind 'globalisation'.

The forecasts, however, seem to be based principally on changes in growth and cyclical changes in the relationship of trade to growth, rather than to the more policy-based or structural changes which the reports discuss. All expect slower growth in trade in 1995 than in 1994, in spite of the same or more rapid growth in output and the potential for liberalisation following the implementation of the Uruguay Round agreements (staged from 1 January 1995 to end-2004), NAFTA (also staged from 1994 to 2003), MERCOSUR, in South America (in force from 1 January 1995), and the plethora of proposals for Asia and the Pacific. The OECD, with one of the highest forecasts at about 8% in both 1995 and 1996, expects industrial countries' demand to be sustained by the rest of the world, as export growth slightly exceeds that of imports, with some groups seeing faster growth in the medium term (notably the Asian economies). The World Bank expects a slowing to 7% in the immediate future, then to 6%, suggesting that it considers the trade-output relationship of 1994 to be exceptional as output does not grow more slowly. (Although it quotes the WTO's estimates of an addition of 0.5 to 1.4 percentage points to the rate of growth of trade during the next 10 years from the Uruguay Round, it does not seem to use this in its forecast, and its own discussion implies a lower gain.) The IMF expects a slowing only in the medium term, and only to about 7%. Other forecasts agree on this basic pattern of a return towards around 6-7%, the normal ratio of about 2 between trade and output growth.

Implicitly, therefore, the forecasters expect no dynamic effect from trade liberalisation or globalisation on the relationship between trade and output and in fact seem to assume that any adjustment or efficiency effects have largely come through, with perhaps a little to come in the next year or two. This seems very surprising given the magnitude of the changes which

11they have discussed, and the staged nature of both the policy changes and globalisation. It could be explained if they were assuming that the areas of the world with relatively low trade elasticities were going to be growing faster than those with high, thus increasing their weight in the total. On 1994 relationships, there could be an argument for this interpretation: the sources of rapid import growth, the US, Japan, and Latin America are all less likely to expand rapidly than southeast Asia or China. As the Asian NICs at least could be argued to have already made the liberalisation gains from trade, it could be argued that they are unlikely to become more integrated into the world economy, while the slow, less liberal countries will be adapting slowly and therefore contributing little. On a more dynamic view of specialisation, as suggested in the 'globalisation' arguments, or in those for regional linkages, it seems unlikely that the fastest growing areas have little more to gain from trade.

The gains from the Uruguay Round seem now to be accepted as small, and the distribution uneven. The IMF does not mention it in its forecasts for developing or industrial countries, in the short or medium term. The World Bank does have a chapter on this 'important source of the new dynamism in trade' (p. 29), but as indicated above it does not appear to have modified its forecast to take account of it, or of the estimates which it quotes for NAFTA or for successful Asian regionalism. It suggests that extending NAFTA to the whole of the western hemisphere could add 0.2 percentage points to world trade growth, and complete Asian-Pacific free trade could add 0.5 points, but does not expect either of these regionalisations to occur. It does not specify what it does expect or quantify what has already happened. Some of its results on where regionalism is likely to be effective could be the result of its method of estimating current complementarity by matching imports and exports of potential members of groups. This does not allow either for future changes in industrial structures, particularly important among developing countries, or for any distortions in trade composition which are themselves the result of trade restrictions. These methods must have a tendency to give underestimates of potential effects.

The quantifiable effects of the Uruguay Round have been widely discussed. 3 The main gains that would affect forecasts for trade are directly on exports by some agricultural exporters (among developing countries, southern South America and some southeast Asia), and on clothing exporters (China, South Asia, Asian NICs), and in higher imports by the industrial countries because of the lowering of their import barriers, and the consequent effects on both the level of their income and the share of demand going to imports. The forecasts do not appear to reflect the implied higher exports by Latin America and some Asian countries or higher imports relative to output by the industrial countries. In addition, the effects from stronger and more predictable regulation of trade through the 'binding' of import tariffs, move away from non-tariff barriers, regulation of anti-dumping, subsidies, and rules on protection of intellectual property, as well as simply the achievement of a settlement should reduce the risks of trade relative to domestic suppliers and markets for all countries, and therefore increase all trade elasticities. Although the reduction in the importance of preferences for developing countries relative to barriers to industrial countries may be estimated to be small, any effect would be on increasing industrial countries' share of trade,

3. The ODI estimates were presented briefly in the report prepared for the 1994 Conference and in more detail in Page and Davenport, World Trade Reform.

12

or growth in trade. None of these effects can be seen in the forecasts, or in the textual discussion of them.

The World Bank, the OECD and the BIS all (perhaps rather belatedly) discuss the importance of trade in services. The World Bank puts a strong emphasis on its increase in the share of total trade, identifying it as a major area for growth in the future. It points to the growth recorded in its share of world trade from 17% in 1980 to 22% on the most recent data. (There must be a possibility that some of the increase is better data collection.) The WTO, which made the first major quantitative assessment of services in its 1989 report, gives data for total trade in services, and trade by the major exporters and importers. It estimates that in 1994 services grew only half as rapidly as goods, leading to a fall to 21% from 22% in 1992 and 1993. The World Bank particular stresses the service sector's high share in foreign direct investment. This, however, appears to hold mainly in developed countries, and it has always been true that foreign investment has been relatively high in services. This is not surprising as even with the growth in the share of those services which are likely to be traded, stemming from technological improvements in communications and transportation, the share of services which are difficult to trade remains higher than the comparable share for goods, so that the choice for an efficient foreign supplier of services between using investment and trade is much more likely to fall on investment.

The effect of the Uruguay Round on trade in services was probably to liberalise it, and certainly to improve information about both flows and the rules which govern it. All of these would tend to reduce the risks and increase the attractiveness of trading in them. The technological and other changes which the World Bank and the OECD cite could have additional effect on some services, and therefore on the countries which could supply them. It would be helpful if the forecasters could make explicit allowance for these, but they are not forecast.

4. Prices in world trade

1994 saw an exceptionally large and unexpected rise in the prices of commodities other than oil (Table 4). Although there are differences among the estimates, these are largely the result of what are normally minor differences in the product-weighting of the indices (the differences in price changes among commodities were unusually large) or in the point at which prices are measured (affecting the timing between 1994 and 1995). Neither the extent of the rise nor the perception that it is temporary is in dispute. The forecasters are now in agreement on the Singer-Prebisch hypothesis that the long run trend is down,4 and differ only in the timing and steepness of the downturn which they forecast. The World Bank (p. 19) illustrates the course of prices since 1948. Although its forecast suggests a further rise in 1995-6, this occurs in 1995, and is the result of the high level at the end of 1994, with a fall

4. A recent article by Sapsford and Balasubramanyam (1994) gives an extensive review of the evidence which now supports this and the arguments behind it.

Table 4: Prices and interest ratespercentages 13

1994

Consumer prices developed6 Months LIBOR6 Months LIBOR Deflated

Prices US$Manufactured ExportsOilOil (real)Primary Commodities

FoodTropical BeveragesAgricultural Raw Materials

Minerals, Ores, Metals Developing Country Exports Developing Country Imports

1995

IMF(May)

2.4 5.1 2.7

-6.5 12.3

1.1 1.5

UN (Dec)

2.3

WB(April)

2.1 5.1

3.2-2.0-5.0 18.8

81.023.010.0

OECD(Dec)

2.2

3-5-8 15 10 68 12 11

EC NIER Estimates (Dec) (Feb)

2.2

3.8-0.4-4.2

2.35.07

2.6

32.27.3

13.8

19.615.771.5

9.6

Consumer prices developed6 months LIBOR6 months LIBOR Deflated




2.6 6.8 4.2

9.3

8.0

7.0 6.3

2.5 3.1 7.4 4.2

2.8 7.5 4.6

1.32.00.78.8

19.011.513.0

67140

-141213

5.69.4 5.2

-0.46.25

)) 2.8

-0.326.1

Medium Term IMF World1996 Bank

1996

World Bank 1995-1996

World Bank 1995-2004

Base Low Base Low

EC

Consumer prices developed6 Months LIBOR6 Months LIBOR Deflated




2.70

-1.1

0.61.0

1.82.50.7

-3.1

-6.0-4.4-2.5

1.72.60.92.7

2.28.96.74.9

2.6 4.03.7 1.0 4.01.0 -3.2

-2.0 3.5

-2.52.03.0

3.04.01.0

))-26.3

-1.0-11.4

3.35.01.7

))-2.2

0.71.1

22012

-523

14

of 4% implied in 1996, and a fall, relative to manufactures, of 1% a year after that. (Some of the details of the forecast are derived from a separate World Bank publication on commodity prices.) There is therefore a deterioration in developing countries' terms of trade throughout the forecast period. Some other forecasters, notably the National Institute, have larger terms of trade losses, because of more rapid inflation in the industrial countries. What is not expected is the possibility of a very rapid fall in commodity prices.

Part of the recent rise is attributed to the rapidity of the cyclical recovery in the industrial countries (consistent with the explanations for the unusual rise in world trade), and also to problems of supply in some commodities (coffee, timber). The UN mentions the possibility of a shift of speculative activity from equity markets (perceived to be overvalued in 1994) to commodity markets, while private commentators have seen a parallel shift within commodity markets, from price rises in those in genuine short supply to speculation in related products, then in unrelated commodities, by force of example. But there are at least two reasons for expecting a longer-lasting upward shift in the trend (in addition to forecasters' normal reluctance to forecast large reversals). The reduction in subsidies to agricultural production in the EU and the US required by the Uruguay Round is estimated to have some effect on raising food prices. Because of the timing of agricultural reforms, much of this shift should already have affected prices, possibly helping to explain the strength of prices in 1994. As it will not be reversed, it will have a lasting effect on their level. Secondly, prices should, at least temporarily, respond more strongly to growth in output than in the last two decades because of the growing share of the developing countries in demand. They have not yet made the same shifts away from primary products in consumption or through savings in use in production which the industrial countries made in the 1970s. A revival of demand in the former centrally planned economies would give a further stimulus in the medium term.

Similar arguments (except for those from trade policy) apply to oil prices. There, however, there were no exceptional shocks in 1994, and the real price fell (Table 4). Most forecasters expected little, or a negative, change in 1995 and in the medium term. The EU was an exception, expecting a rise this year, which does appear (early May) to be happening. The possibility and timing of any return of Iraqi supplies to the market remains a major uncertainty here, as well as the long run position of some ex-USSR suppliers. The fall in price in 1994, as the WTO and others point out, meant that the price relative to manufactured exports was at its lowest since 1973.

One consequence of the fall in oil prices last year, and of the distribution of the volume changes in world trade, is that African terms of trade and the volume of its exports fell, the only area to see these falls. It is also the only area where the expected effects of the Uruguay Round may be negative, although, like the gains to food exporters, its losses from higher costs of imported food have probably already come through. For all the primary producing developing countries, the pattern of prices expected in the medium term suggests deteriorating trade performance, not offset, according to the trade volume forecasts, by any net gain in exports to the industrial countries. The improvement in 1994 from higher commodity prices was highly concentrated on a few countries, notably the producers of coffee and other beverages. The implication of the price forecasts here is a lasting need to finance present imbalances or any increase in imports. A more pessimistic forecast would give a continued strong deterioration in balances.

15

In the past, the changes in commodity prices of the magnitude observed in 1994 would have been expected to have important effects on inflation in the industrial countries. The OECD suggests that this is no longer important. In 1972, oil was 1.1% of total OECD demand, rising to 5.1% when the real oil price was at its peak, in 1982. By 1992, it had fallen back to 1.3%. Other primary products were comparable to oil in 1972, 1.2%, and they have fallen since then: to 0.7% in 1982 and 0.4% in 1992. Even after allowing for indirect effects through other prices and costs, the OECD estimates the effect of a rise in non-oil commodity prices of 15% (its estimate for 1994) on prices in OECD countries as 0.3%, coming through over three years. The corollary of this beneficial insulation from inflation is that the fall expected for these prices over the next 5-10 years is unlikely to have a positive effect on reducing OECD inflation or increasing its demand. Such analysis also suggests that any industrial country interest in policies to stabilise such prices would be even more limited than in the past. The potential inflationary effects on developing countries, however, remain at least as large as they would have been for industrial countries in the 1970s.

5. Forecasting capital flows

The implications of the trade volume and price forecasts of the last two sections are that as a group developing countries should have seen some improvement in their current balance in 1994, concentrated on countries with the appropriate primary products and especially on China; little change, however, can be expected in the future, with some deterioration for the more advanced, as their imports rise faster than their exports, and for Africa. This prospect is reflected in the current balance estimates and forecasts of the IMF. (Most forecasters do not quantify them.) They show a large increase in the deficit in 1993, from $74 billion to $98 billion; it then fell back to $91 billion in 1994. The IMF forecasts a small further reduction in 1995 (as Table 4 shows, the IMF expected some of the terms of trade effect to come through this year rather than in 1994) to $85 billion, but a return to $91 billion in 1996. This pattern seems to correspond to the other forecasters' expectations.

The recent history of private flows is discussed in more detail in Part II of this report. Table 5 summarises the estimates for all flows to developing countries. (The estimates are very uncertain, but the changes are clear.) In aggregate, the rapid increase of the early 1990s slowed sharply in 1994. Foreign investment continued to rise in 1994, but more slowly than before. The important change was the reduction in portfolio flows which had risen from $4 billion in 1990 to $46 billion in 1993. They fell to $37 billion. The disruption which marked some country markets in 1994 was a reminder that developing countries are risky markets. This was reinforced at the end of 1994 by the Mexican crisis. The size of the change in 1994 was greatest for Latin America, but Asia also saw a levelling of portfolio inflows.

Official grants have been stagnant since 1992, after falling sharply in that year. The increase in inflows to Africa came from net borrowing, not from grant finance which has remained flat since 1990. (The fall has been to the Middle East and North Africa.)

Table 5: Capital flows to developing countries16 US$ billion

1990 1991 1992 1993 1994 Net foreign direct investment

Sub-Saharan Africa 1.1 2.1 2.4 1.7 2.2Latin America 6.9 11.2 12.8 14.1 18.9Asia 9.8 16.3 21.8 40.7 45.6Total of above 17.8 29.6 37 56.5 66.7

Eastern Europe and central Asia 4.7 7 8.5 9.6 11.1 Total including eastern Europe and central Asia 22.5 36.6 45.5 66.1 77.8

Net portfolio equity flows

Sub-Saharan Africa 0 0 0.1 0.4 0.8Latin America 1.1 6.2 8.2 25.1 10.4Asia 2.4 1 5.5 20.1 25.7

East Asia and Pacific 2.3 1 5.1 18.1 17.6Middle East and North Africa 0 0 0 0 0.4South Asia 0.1 0 0.4 2 7.7

Total of above 3.5 7.2 13.8 45.6 36.9

Eastern Europe and central Asia 0.3 0 0.2 1.3 2.5 Total including eastern Europe and central Asia 3.8 7.2 14 46.9 39.4

Net flows on long term debt and bonds

Sub-Saharan Africa 3.7 2.9 3.3 1.3 6.3Latin America 8.9 7 7.4 19.3 11.5Asia 19.7 28.1 30.2 25.6 41.8

East Asia and Pacific 14.2 16.9 23.1 16.5 27.4Middle East and North Africa -1 3.4 2.4 3 6.9South Asia 6.5 7.8 4.7 6.1 7.5

Total of above 32.3 38 40.9 46.2 59.6

Eastern Europe and central Asia 11.9 9.8 21 23.2 20 Total including eastern Europe and central Asia 44.2 47.8 61.9 69.4 79.6

Grants

Sub-Saharan Africa 12 11.3 11.7 12.2 12.5Latin America 2.4 4.3 2.8 2.9 2.5Asia 12.8 12.4 9.3 8.1 8.5

East Asia and Pacific 2.3 2.2 2.5 3.1 2.8Middle East and North Africa 8.1 6.7 4.2 2.5 2.9South Asia 2.4 3.5 2.6 2.5 2.8

Total of above 27.2 28 23.8 23.2 23.5

Eastern Europe and central Asia 1.6 4.5 6.2 6.9 6.9 Total including eastern Europe and central Asia 28.8 32.5 30 30.1 30.4

Total flows

Sub-Saharan Africa 16.8 16.3 17.5 15.6 21.8Latin America 19.3 28.7 31.2 61.4 43.3Asia 44.7 57.8 66.8 94.5 121.6Total of above 80.8 102.8 115.5 171.5 186.7

Eastern Europe and central Asia 18.5 21.3 35.9 41 40.5 Total including eastern Europe and central Asia 99.3 124.1 151.4 212.5 227.2

Source: World Bank, World Debt TablesIMF, Balance of Payments Statistics Yearbook, 1994

17

There is surprisingly little discussion in this year's forecasts of whether capital flows to developing countries are adequate, or will be so. The assumptions in the forecasts seem to be that there will be a 'moderate' rise, with little indication of whether the fact that this matches the forecast of needs is because the inflows are regarded as a constraint on the balances, or because independently determined deficits are regarded as fmanceable. The discussion both in the forecasters' reports and in their institutions, however, strongly suggests that inflows might not be adequate, even to meet this moderate level of need. Moderate is not a very exact word, but it must mean a growth in inflows at least in line with the value of trade if it is to finance roughly the current level of deficit; this would suggest a figure around 10% a year.

The IMF at its spring meetings was pressing, with support from some industrial country governments, for an expansion in its resources. There seemed to be a mixture of motives: to have more flexibility to meet crises like the Mexican without the last minute arrangements which that required; to have more resources to deal with existing debt; and to have more resources to increase lending to new borrowers. The proposals included increasing the special borrowing facilities introduced in the 1970s to meet the crises then, notably the General Arrangement to Borrow, an informal agreement with the major industrial countries and Saudi Arabia. Two formal measures were proposed. Issuing Special Drawing Rights increases the general liquidity of the IMF and the payments system; if the distribution is targeted, it could be used to increase resources for some countries more than others. Selling gold, also used in the past, shifts some reserves into interest-bearing assets; this makes it possible for the IMF to use the interest to finance lending. As the IMF is not itself a major supplier of capital, these increases would not have a major effect on total flows, although they could reduce the risks from sudden changes in balances by giving developing countries access to liquidity. One of the ways in which the IMF forecasts suggest that developing countries will deal with their increased deficits is through smaller additions to their own reserves.

Foreign investment, as discussed in Part II, was a strongly growing influence on developing countries in the late 1980s and until 1993. In 1994, the rise probably slowed; the IMF suggests a rise of under 10%; UNCTAD (1995, Recent Developments) one of 6%; the World Bank 17%. In 1993 the rise had been around 40%. As UNCTAD points out, both the large rise in 1993 and the smaller one in 1994 are distorted by the size of investment into China, much of which appears to be the result of Chinese investors seeking the incentives given for foreign investment. If this is excluded, the pattern is of a rise of 6% in 1993, in line with the increase observed for investment into developed countries and 13% in 1994. This would be in line with the increase in trade value. Any estimate for 1994, however, is still based on very limited data.

What seems common ground is that there are various reasons for believing that the increase will be moderated in 1995 and 1996, and perhaps into the medium term, and the IMF forecasts absolute falls of almost 20% and 10%. In addition to the long-term factors discussed in Part II (which also points out the growing outward investment from developing countries), there seems to be the possibility of falling (genuinely foreign) investment into China. Its improving balance of payments and the fact that it is no longer a new, untried, destination give it reasons to remove the special incentives which it has offered, and it has suggested that it will do so. While the effect of such incentives on foreign investment is usually found to be small, it is unlikely to be zero. Removing them will certainly reduce recorded investment if Chinese investors no longer have an incentive to appear foreign. The opening of China to

18

foreign investment brought it a rapid rise that could not be sustained, once the initial rush was completed, and some of the investors may withdraw or reduce expansion plans. If, as expected, the Chinese economy grows more slowly, this will also reduce the rise in inflows.

Other areas also offered new opportunities and growth in the early 1990s, and their effects will also be falling back. There was a general liberalisation of inflows, especially in Latin America and India, and de facto relaxations of controls in several southeast Asian countries. These changes cannot be repeated, so the rises in these areas should moderate. The World Bank found growth (p. 13) the 'single most important determinant' of foreign investment.

The arguments that trade liberalisation (GATT and NAFTA were both cited) would prompt higher foreign investment must now be treated with more caution if their direct effects on trade are expected to be small, although the new flows from the UK, Germany, and Japan into Mexico in 1994 could be attributed to NAFTA. The IMF and the World Bank both suggest that improving policy, in terms of fiscal balance and more directly in welcoming foreign investment had an effect in attracting it (World Bank, p. 1; IMF, p. 57). Even if this is true (and it contrasts with the World Bank's evidence on growth), the completion of the reforms should reduce future growth once foreign investors have responded to the past reforms.

For these reasons, a forecast of a 'moderate' rise in direct foreign investment may prove optimistic, as the recent rise even with all the temporary influences was only moderate. The temporary effect of the Mexican crisis, and of less dramatic falls in other 'emerging markets' is expected by the World Bank, and implicitly by other forecasters, to have at least a temporary negative effect on portfolio inflows. Other countries in Latin America remain uncertain prospects, as do areas with political risks like Hong Kong, while the continued delay in forecast growth in the eastern European countries also postpones any large inflows there. The rise expected in interest rates in the industrial countries (discussed in the next chapter) suggests that any 'push' factors from low returns in alternative markets will be weaker. A fall in portfolio investment is likely in 1995, and the forecasters are cautious about the future. The IMF says such funds are 'volatile and may well decline perhaps significantly' (p. 3). The sum of two declining or at best constant flows is unlikely to be a moderate rise. The other potential flows are trade credits, which, it is reasonable to suppose, will rise in line with trade, but not more rapidly by a margin sufficiently to replace rises in the others, and official funds, which are normally assumed to rise at best in line with nominal output in the industrial countries. Their prospects are not discussed in the reports this year, but they have not been meeting even a target of a constant share, and the 5% which this would imply for the future would not even preserve their present value relative to trade.

If prospects for the various sources of funds are poor, rather than moderate, this has different implications for different countries and sectors. In Africa, slow growth and low trade elasticities would mean that a slow growth in official flows could be consistent with the more pessimistic forecasts for trade and output (see Chapter 7). As indicated above, however, the reasoning behind the forecasts may have been from the funds to the output forecasts rather than the reverse. The impact of a reduction in direct investment flows from the industrial countries on Asian countries would be moderated for China and perhaps for other Asian countries if their need falls as deficits and growth rates become lower (if the forecasts discussed in Chapter 7 are reasonable). The net effect on the area will be reduced because an

19

increasing proportion of the flows are intra-Asian. The effect of a lower inflow from portfolio flows could be significant, but the rise in these was smaller, and the effect of the Mexican and other uncertainties in reducing flows will be smaller than in Latin America. It is there that the slower growth in foreign investment, the reduction in portfolio inflows, and the effect of higher US interest rates can be expected to be largest.

The IMF and the World Bank both discuss a potential risk even to the present level of support for the developing countries: an absolute shortage of world savings. The IMF points out that 'the high level of real interest rates that has persisted since the early 1980s is prima facie evidence of strong demand for investment funds relative to the supply of world saving' (p. 11). The question of capital shortage was raised in 1989 in the context of financing the reconstruction of the eastern European economies (as it had been in the 1940s when the World Bank was established as the International Bank for Reconstruction and Development). Other reasons which have been suggested during the 1980s, and which are suggested by the IMF and World Bank discussions in the current reports, include the need for high interest rates domestically because of reliance on monetary constraints and the short-term need in the European economies to reduce imbalances to qualify for the next stage of European union. Implicitly, as discussed in the next section, all the forecasters appear to accept some version of this hypothesis as they forecast very high interest rates.

The IMF's arguments for capital shortage as a problem are based on apparent trends in savings rates, private and public, in some industrial countries, which are themselves not adequately explained (here or in the understanding of those modelling those economies). It remains unclear how much the trends are themselves indirect or direct consequences of various macro or micro policies; the variations and timing responses are far from clear. The World Bank, although raising its interest rate forecast from last year, strongly rejects a capital shortage interpretation. It expects savings in developing countries to rise, because of falling dependency rates in the populations there; it is these countries which are increasingly important sources of investment for the developing countries, both in national saving and as sources of foreign investment. It also expects savings rates in the industrial countries to recover because of demographic changes: the growing share of the population in the high- saving 40s and 50s, and falling share among the young adults who borrow. 'It is estimated that this demographic shift would more than offset the negative effect on savings of a continuing rise in the share in population of those over 65' (p. 11) at least until after 2010, beyond any of the forecasts here.

The possibility that there is at least a current high demand for investment which is explaining high returns and high interest rates cannot be dismissed, even if crude descriptions like 'capital shortage' are misleading. For developing countries, the result remains that they cannot expect to attract as much capital on the same terms as they have done in recent years. To assume a 'moderate rise' in the face of the specific factors making flows to them less attractive and the general ones making capital more costly for all may therefore be optimistic.

20

6. Interest rates

Interest rates were about a point higher than expected in 1994 (Table 4), at about 5% for short-term dollar rates, giving real interest rates of slightly over 2.5%, instead of about 4% and 1.5%, as forecast. Beyond 1994, last year's forecasts expected a further increase to around 3-3.5%. This year all the forecasters, except the OECD, still expect a rise, but starting from the higher level to reach at least 4-4.5% in real rates, which, with slightly higher inflation forecast in the industrial countries, gives nominal rates between 7 and 8%. Although not giving explicit numbers, the level expected by the EU is similar, although with slight differences in timing among its members and in the US during 1995. The World Bank forecasts are held at that level through the medium term, i.e. to 2004. A decade at that level would be unprecedented. It is only in the 1980s that even a few years at such a level have been observed. Such a forecast is especially puzzling if the World Bank is correct in its assessment of a recovery in the world savings rate. If, as most of the forecasters explicitly or implicitly suggest, the present level of interest rates owes more to high fiscal deficits (in the view of most, too high) than to a permanent shift in savings or investment conditions, it is not clear why it should remain high. Most expect a reduction in deficits in Europe, as countries seek to meet the criteria for economic convergence set for the EU, and also in the US. In spite of these contractionary influences, the forecasters all expect higher inflation in the industrial countries, leading to tight monetary policy, but apparently do not expect the monetary policy to restrain the high inflation. In other words, countries will face high inflation, and use monetary policy against it; this will be unsuccessful so they will continue to do it indefinitely. In the World Bank's alternative forecast, for a temporary boom followed by 'bust' (given as the 'low' scenario in Tables 2, 3, 4, and 6), the 'bust' comes from monetary mismanagement of a 'boom' in 1995 (World Bank, pp. 24-7), and therefore brings higher inflation and higher interest rates than in the base forecast, again apparently continuing indefinitely.5 As well as potential political objections, it is difficult to see the economic logic in this argument.

The World Bank expects a rise in investment rates in the OECD (p. 10), and also expects these to obtain a higher real return than in the past. Other possible explanations for high interest rates have been used in the past in addition to the world savings supply question described in the previous chapter. Adjustment to the emergence of new borrowers (eastern Europe) or caution in the face of the trade and investment uncertainties of the early 1990s presumably will be becoming less important. As in the mid-1980s when there was a similar convergence of forecasts on high real interest rates, it is possible that the forecasters have been led astray by their reactions to last year's over-optimism.

A high rate, whether in the short term or indefinitely, has serious implications for the costs of existing debt, or of obtaining new capital inflows, whether in the form of further

5. The mechanism is explained entirely in terms of description of possible political scenarios, involving in the US disagreements between Congress and the administration and national elections; in Germany, worries about unemployment and then EU worries about the US; and in Japan fragile consumer confidence. It is not clear what qualifications the World Bank has for analysing all of these, and specifying robust 'reaction functions', or what its track record is in political forecasting.

21

borrowing or in terms of the return which direct investment or portfolio investment will seek. As discussed in the next chapter, however, the higher rates now forecast do not appear to have affected aggregate growth forecasts for the developing countries, although some of the forecasters note the risks for debt.

7. Output in the developing countries

In 1994, this section began 'Output in 1993 on the latest estimates grew about 5%, roughly as forecast, but as usual with Asia slightly better than expected and Africa worse'. The only amendment necessary is to substitute 1994, and to ask either why the forecasters persist in underestimating Asia's potential and overestimating Africa's, or why they cannot bring themselves to publish their real expectations. Latin America seems to have had higher growth than in the recent past, or than expected (Table 6).

Although the area development banks have given country forecasts in the past, and some of the international ones had started giving China, this is the first year with a range of individual country forecasts available. As some of the countries are major markets in their own right, and in most of the areas a few large countries have a strong influence on any aggregate forecast, this is an important contribution to using and to understanding the forecasts. Table 7 gives the forecasts available for the most important countries in terms of their effect on other developing countries (and for some others with large changes expected). (South Africa is included with Africa, although it is not yet included in all forecasters' definitions of the area.) The IMF now bases its discussion of the forecasts very much on the conditions and expectations for individual countries, rather than aggregate trends in world or area demand or commodity prices.

The largest changes expected in 1995 are in Latin America, in aggregate and in some countries. The crisis in Mexico (after the OECD had published its forecasts) means a recession there, while Peru is not expected to repeat its rapid growth. The IMF is also pessimistic about Argentina. The result is a slowing on average in 1995. The World Bank (Table 6) expects growth there to remain at about the recent level of 3.5% in the medium term; the IMF has a higher forecast. One of the reasons given for lower growth in 1995 is a reduction in capital inflows, particularly in portfolio investments. The UN (also pre-Mexican crisis) argued that Argentina, Bolivia, Brazil, Chile, and Colombia were 'converging at a "cruising speed" of 4-5%'. Although it attributes some of the good performance in 1994 to the rise in commodity prices, it does not apparently expect the ending of this to affect the countries adversely.

In Africa, the improvement on 1993 (when growth was under 1%) came from large changes in Morocco and Kenya, and also a general improvement from the boom in commodity prices. It is not clear what drives the further improvement in 1995 and the medium term. The World Bank suggests a delayed impact from commodity prices, and the UN notes the more stable conditions in southern Africa, although forecasts for South Africa

22 Table 6: Output in developing countries

1994

AllOil exportersNon-fuel exporters

AfricaSub-Saharan

AsiaSouthEastNICs

Western Hemisphere China

1995

AllOil exportersNon-fuel exporters

AfricaSub-Saharan

AsiaSouthEastNICs


Medium Term

All Africa

Sub-Saharan Asia

SouthEastNICs


IMF

1996

6.15.3

7.3

IMF(May)

6.32.97.22.7

8.6

4.612.0

5.62.56.43.7

7.6

2.38.9

1995-2000

6.24.5

7.4

UN WB EC(Dec) (Apr) (Dec)

4.8 4.6

2.62.2 2.26.4

4.79.3

7.33.3 3.9

11.5

5.5

3.253.0

6.75

7.13.7510.0

World Bank World Bank EC1995-1996 1995-2004 1996

Base Low Base Low

4.8 5.2

4.0 6.1 3.8 1.6

5.0 5.6 5.4 4.68.1 9.1 7.7 6.7

7.13.7 4.2 2.4 3.7 3.5 2.0

23

remain cautious for 1995. The IMF country forecasts (Table 7) show strong improvements for many countries, including Algeria, Cameroon, Cote d'lvoire, Nigeria, and significant improvements for some of the rest, with a fall in output in Morocco. The consensus forecast for the medium term (probably shared by the African Development Bank) is for growth slightly above the rate of population growth (this appears to have been the basis for the forecasts in the past). The terms of trade, as indicated above, do not, however, continue to improve and none of the forecasters appears to expect a large inflow of capital. The principal impulse to improved growth, therefore, appears to be an assumption that policies will improve, and that this will increase growth.

Growth in the Asian countries, including China, is expected to slow in 1995, although those defined in 'South Asia' (India, Bangladesh, Pakistan) have little change or an improvement (Tables 6 and 7). In the medium term, growth is expected to continue at about the 1995 rate. The pattern appears to remain slight slowing in the old NICs, still fast or faster in the new NICs, and steady growth in South Asia.

The World Bank forecasts are the most explicitly policy-based. The UN also stresses the importance of policy, but is less confident about what good policy will mean: 'bringing about a faster, yet sustainable, trend in the rate of growth of GDP in slowly growing economies is perhaps the major economic policy challenge that governments face, especially in the developing and transition economies' (p. 4). The World Bank gives a second forecast, based on 'boom' and 'bust' in the industrial countries (see Chapter 6). This gives rise to a very strong cycle in the developing countries. The result of what is described as 'lax macroeconomic policies' and 'overextended public sectors' and 'mismanaging' the economies is higher commodity prices, inflation (and consequent high nominal interest rates), and also more protection against imports into the industrial countries (presumably implemented either by direct breaking of WTO rules or through finding new ways of exploiting the loopholes). The effects on developing countries include 'reduced financing' and higher debt costs. They also take more protective action, presumably in turn affecting their neighbours. They also follow poor macroeconomic policies with 'deterioration in resource allocation efficiency, incentive structures, and productivity growth caused by the expansion of the state sector' (p. 27). Although the World Bank presents numerical estimates of the effects of all of these on growth (Table 6), the economic mechanism which goes from expansion of the public sector to the specified consequences is not described, and, in contrast to the graphic descriptions of the election-obsessed industrial countries, nor is the political mechanism which leads to the change in policy in the developing countries.

The economic connection between the crash in the industrial countries and that in the developing is clearer, through reduced exports, in volume and price, presumably even more reduced imports (not given in the tables) because of lack of access to funding, both credit and foreign investment, and also (presumably) lower official assistance if this is treated as a constant or falling share of income in the industrial countries. The effect of the alternative forecast is felt most strongly in sub-Saharan Africa which would grow 2 points faster, at a surprising 6%, during the period of boom, followed by a fall back to only 1.5% in the subsequent recession. The linkage is through commodity prices, the cost of servicing debt, and reduced financing. The reduction in output is thus greater than that in the industrial countries. It is in these countries that the deterioration in their own policies is apparently expected to be greatest (p. 27). The smallest effect is felt in Asia. This is explained in East Asia by 'low

24Table 7: Selected developing countries: real GDP

percentages

1994

IMF UN OECD IMF (May) (Dec) (Dec) (May)

1995 1996

UN OECD Asian OECD(Dec) (Dec) DB (Dec)

Developing countries 6.3 4.8 5.6 5.5

Africa

CameroonC6te d'lvoireGhanaKenyaMoroccoNigeriaSouth AfricaSudanTanzaniaTunisiaUganda

Asia

BangladeshChinaHong KongIndiaIndonesiaKoreaMalaysiaPakistanSingaporeTaiwan Province of ChinaThailandIranSaudi Arabia

Western Hemisphere

ArgentinaBrazilChileColombiaMexicoPeruVenezuela

2.7 2.6 3.7 3.25

-3.81.73.83.0

11.80.62.35.55.04.47.0

8.6

5.012.05.74.97.08.38.54.1

6.28.51.90.3

4.6

7.15.74.25.33.5

12.9-3.3

2.0

6.4

11.5

56.8

8

6.18.3-4

-3.0

3.3

5.04

3

11.55.6

8.38.7

9.56.28.4

4.4

6.24.55.04.5

8.0-3

4.06.45.04.9

4.03.07.25.06.35.5

7.6

5.08.95.75.87.37.48.75.7

6.58.45.01.4

2.3

2.54.55.55.5

-2.04.5

-2.0

3

6.75

10

5.757.07.5

6.58.5

11

3.75

54

3.5

105.4

7.58.5

7.66.38.6

3.7

6.03.06.04.7

6.00.0

5.5 9.0 5.9 4.8 7.0 6.9 8.4

76.0 6.6 8.5

9.5 5.3

7.0 8.3

6.2 8.4

4.2

5.5 3.8 6.2 5.1

5.0 2.0

25

reliance on primary commodities, competitive positioning of manufactured exports, the growing importance of intraregional trade, policies choices in the boom to save more of the windfall gains, lower debt, and continued access to external financing'. In South Asia the smaller impact is again partly because of policy, but also because of lower export dependence. Latin America suffers an intermediate loss because of its strong dependence on the highly cyclical US import demand.

This ranking of the developing areas for dependence on performance in the industrial countries is different from the traditional. Only in South Asia is the old rule, that low exposure to trade and low dependence on income-elastic manufactures reduces dependence, still working. In East Asia, the region has on this analysis become semi-autonomous though its own strength as a region. This suggests as a corollary that it is less likely than in the past to be an important source of growth or stability in recession for the rest of the world. The very high dependence of Africa, however, is harder to understand. The implied elasticity of its exports to growth in the industrial countries (a rise in its exports of 2.7 points when industrial countries' output rises 1.3 points and a reduction of 2.8 percentage points when their output falls 1.6 points) is very high. Perhaps official assistance falls more than proportionately to industrial country output. In contrast, in spite of its high share of manufactured goods, East Asia responds with the same rise in exports, in the boom as in Africa, but a much smaller fall, of 1.9 points in the recession (Table 3). The import volume forecasts for the industrial countries (Table 2) show a slightly smaller rise during the boom than the fall in the recession (2.9 points and 3.5 points respectively), but traditionally the demand for primary products would be more closely related to the output changes, while that for manufactures would depend on the (higher than one) elasticities for these. In Latin America, the reduction in exports during the recession is slightly less than the rise during the boom, although their close dependence on the US would suggest that it should be greater, because the fall in developed countries' imports is greater than the preceding rise. These forecasts give a mixed picture for how the greater global interdependence is affecting different types of developing countries.

The UN sees improved policies in Latin America and Africa, combined with hopes for the ending of the various military conflicts in Africa, as helping to justify better performance than past trends in both areas, although it stresses the need for finding more fundamental structural reforms. As it expected both real demand and commodity prices to remain strong, this meant at least as good and possibly better conditions for growth in all the areas, with inflationary risks in Asia explaining the possibility of more cautious policies and lower growth there.

8. Special topics

The reports have a variety of notes and sections to give additional background and analysis to their forecasts. The IMF includes a comparison of Brazil and Korea as a 'powerful illustration of the contribution that stable macroeconomic policies, structural reforms, and

26

outward orientation can make toward sustaining high growth'. This is a comparison which has been made frequently in recent years, although in terms of the two countries' developments the first stage of Brazil's industrialisation in the 1950s or 1960s might seem a more appropriate experience to compare than its adjustment periods in the 1980s and 1990s. It also discusses the Mexican crisis, asserting that it was an unexpected event which needs to be understood. The explanations which it finds, however, are fairly traditional ones: adverse shocks, the current balance deficit, and mistakes by the government (the latter include some characteristics that often mark the final year of Mexican presidential terms). It also compares the performance of the 'strong' and 'late' adjusters in Africa.

The World Bank, as has been indicated, includes sections on the results of the Uruguay Round, services, and internationalisation. The EBRD as well as its discussion of alternative measures of output, has an important section on macroeconomic forecasting for the economies in transition. This not only compares a range of the forecasts, to each other and to (apparent) outcomes, but discusses the difficulties which forecasters have found in making projections for these economies.

9. Conclusions and questions

The overall picture which emerges again from the forecasters is that the various areas are expected to continue to face approximately the same external conditions, in terms of growth, interest rates, and inflation in the industrial countries which they have seen in 1994, but without the special crises, and to respond with approximately the same absolute and relative growth rates. Although there is the usual limited convergence, by means of slight slowing in Asia and slight acceleration in Africa, these are not large (except in the World Bank variants) and not strongly stressed or explained. The areas are apparently simply assumed to be different, and to remain so, with minimal analytical content (except in the discussion of the economies in transition in the EBRD report). Only the IMF, with its more country-based forecasts, has a different approach, which produces a few changes in the implied forecasts for areas. The resulting consensus forecast is a better performance than was expected a year ago, but with higher interest rates, and apparently more constraints on the availability of capital. Although there is some discussion of whether there are fundamental or cyclical explanations for the change in capital flows, any effect from this must therefore be small (except, again, in the World Bank variant for Africa), although the forecast for 4-4.5% real interest rates implies be a fundamental difference from previous periods of sustained good performance by the developing countries.

The policy implications which the forecasters draw are mixed and contradictory. There is a strong emphasis on the importance of macroeconomic policies, in both industrial and developing countries, and in some of the forecasters, also on structural reforms which may be needed in labour or capital markets. It is clear that neither the UN (for labour markets) nor

27

the BIS (for capital markets)6 thinks that these markets can be left to correct and manage themselves. The need for appropriate macroeconomic policies has been increased by globalisation of capital markets.

Both the BIS and the World Bank suggest that vulnerability to withdrawal of international funds makes confidence-insiring macro policies more important and also increases the incentives for developing countries to 'maintain reform-minded policies' (BIS, p. 211, but also World Bank, p. 1). Thus, just as foreign investment is now seen as having an important role in improving efficiency and technology, as well as in providing capital, portfolio funds have a role in promoting good (or punishing bad) policies as well as providing finance. Governments (and, by implication, also international public institutions like the IMF and World Bank) have a vital role in the monetary and fiscal management of these economies (the stress of IMF and OECD recommendations). In contrast, they should not 'overextend' and should in most cases retreat from their direct intervention in all other areas of the economy, including domestic production and restraints on international trade because these can be better managed by the private sectors.

The BIS implicitly recognises the possible inconsistencies in the assumptions behind these analyses. It notes that 'If anything, more depth and liquidity in markets, and a greater ability to disaggregate exposures and hedge unwelcome risks, should reinforce the stabilising of markets. Still, innovations mean that changes in the markets' perceptions of underlying policies can be more quickly translated into price movements than before. This reinforces the need for monetary policy to be seen to be holding to a stable course' (p. 212). This seems to mean that markets should behave rationally, but they don't, and governments need to allow for this. This is probably a reasonable interpretation of other forecasters' expectations about capital markets. The risks of waiting for rationality to reassert itself are potentially too great for governments to accept them, without stabilising demand or sterilising capital markets, as appropriate. It is not clear why the forecasters apparently believe that these errors and the consequent need for government intervention occur frequently in capital markets, but never in decisions about investment, choice of sectors, or trade. Exchange rates, where the arguments for and against intervention have been important in previous years' reports, receive surprisingly little attention, given the size of recent fluctuations.

The quantitative effects of following or ignoring the policy recommendations of the forecasters cannot be derived from the forecasts as they are presented here. The World Bank's alternatives are the nearest approach, but they also include major effects from changes in the industrial countries and are too aggregated across continents to identify the amount of the variations due explicitly to choice of policies. On the other hand, the IMF discussion of individual countries uses policies to explain some of the forecasts, but without quantifying the alternative.

6. 'What has become abundantly clear from recent experience is the need for stable and consistent underlying policies if capita flows are not to lead to exchange rate instability and/or threaten domestic liquidity management (p. 211).

28

The three question marks which seem to hang over this year's forecasts are therefore:

the basis of the forecasts for interest rates, and the potential long-term effects;

the extent and the explanations of developing countries' dependence on performance in the industrial countries (and of industrial on developing), in particular the role of the Asian region;

the scope of policies which developing countries should, and should not follow, what they and the markets respectively actually have the ability to do, and the potential effect which their policies can have on their own economies and on their dependence on the rest of the world.

The difficulties which the forecasters continue to have in identifying and explaining turning points in economic performance illustrate how inadequate are the answers which they have found.

Part H

Recent Trends in Foreign Direct Investment in Developing Countries

New sources and directions

According to UNCTAD (1995, Country and Regional) foreign direct investment (FDI) inflows to developing countries were $80bn in 1994, up 13% from the previous year (see Table 5). This indicates a levelling off of inflows after the huge increases in 1992 and 1993. With inflows to industrial countries decreasing from their peak in 1990, developing countries' share of world FDI flows in 1994 was 40%. Net inflows (inflows-outflows) to developing countries were $67bn. FDI has traditionally been concentrated in a handful of countries. In 1970 four countries - Brazil, Mexico, Singapore and Malaysia - accounted for about three-quarters of all FDI flows to developing countries. Ten years later eight countries - the above four plus Argentina, Hong Kong, Thailand and Egypt - received the same proportion. In 1993 the number increased to ten - China, Singapore, Argentina, Mexico, Malaysia, Indonesia, Thailand, Hong Kong, Taiwan and Nigeria (Table 8).

With respect to regional flows, Asia has witnessed the most rapid rise since the late 1980s, with FDI inflows of $53bn in 1994. $34bn of this went to China, where inflows jumped by 23% from the previous year. Flows to Asia excluding China increased by 10% in 1994. One of the Asian developing countries' most important investors has been Japan. Japanese investment in China has increased dramatically from 1991 ($0.6bn) to 1993 ($1.7bn). This increase to China has been accompanied by an increase in Asia's share of overall Japanese FDI (from 14% to 18%) indicating that the effect of China is 'FDI creating', rather than simply 'FDI diverting' within the region.

Until 1988 Japanese FDI in Asia was roughly equal to that in Latin America, but since then Japanese investments in the two regions have diverged. In the 1990s Japanese FDI flowing to Latin America was half that going to Asia. In 1992 and 1993 approved Japanese FDI in Asia equalled that to Europe.

The major beneficiaries of FDI in Asia over the last few years have been the countries in the East Asia and Pacific region. South Asian and Middle Eastern countries have not seen their levels of FDI rise as markedly. However, the change in attitude towards FDI in India has resulted in doubling of FDI in 1992 and again in 1993.

FDI in Latin America doubled over the period 1987-90 and again over 1990-93 (reaching $16bn at the end of that period). UNCTAD (1995, Recent Developments) reports a 16% increase in 1994. In 1993 Argentina and Mexico took 70% of these inflows (receiving $6bn and $5bn respectively). Initial estimates suggest that FDI to Mexico exceeded $8bn in 1994 with the UK, Germany and Japan accounting for the increase, although the US remains the

30

Boxl Problems with data on foreign direct investment

Before the problem of data collection errors even starts, there are problems at the theoretical level in defining foreign direct investment. The definition varies from country to country and from institution to institution.

What constitutes foreign investment (FDI)? Is it a 10%, 15% or 20% (or higher) foreign stake in a domestic company? Does FDI include investments such as real estate investment or not? (The IMF includes it and the OECD treats it as portfolio investment.) And reinvested earnings should surely be reported as FDI flows. The IMF recommends this. Japan, amongst many others, does not record them. How should capital gains be treated, and what is the best measure of FDI stock? For the purposes of analysis one has little choice but to side step these vagaries of the data and hope that the picture that emerges corresponds at least roughly to reality.

Of countries reporting to the IMF in the Balance of Payments Statistics Yearbook, virtually all the countries report inflows of FDI. However, on the outflow side of the equation there are notable omissions: data for Argentina, Mexico, India, Indonesia, Malaysia, Nigeria and South Africa are not recorded. Of the countries not reporting to the IMF, Taiwan and Hong Kong are the big importers and exporters of FDI excluded. Taiwan publishes official records of FDI data but Hong Kong does not.

Detailed breakdown of FDI (in terms of the sectoral destination, country of origin, etc.) is usually only available for data collected on an approval (as opposed to balance of payments) basis. However, balance of payments data usually provide a more accurate measure of actual flows since inflows (and outflows) by approval overstate the realised flows. Approvals data incorporate investments pledged to be carried out over a number of years, some of which may not actually materialise. Japanese FDI outflow statistics provide a good example of this phenomenon - in the past FDI abroad recorded on an approvals basis has consistently been 1.5 to 2 times bigger than the actual FDI outflows. Another example is Indonesian FDI inflow data provided by the Capital Investment Coordinating Board (who exclude approvals in the banking and oil sectors) which was six and eight times the balance of payments measure in 1992 and 1993 respectively. This was not only due to the fact that the former measure is on an approval basis, but also because it incorporates investments by domestic firms in joint ventures.

Taiwan, on the other hand, provides a dramatic example of a country where approved FDI outflows can severely understate the actual flows. In 1989 when Taiwanese investment abroad peaked at a massive $7bn (according to the balance of payments data) FDI registered only $0.9bn in the approvals data. This can be explained by under-reporting of outward investment by Taiwanese firms to avoid taxation, as well as unreported investment in mainland China (which is still banned by the Taiwanese authorities).

Estimates of FDI flows to and from Hong Kong can be made by turning to data from other countries exporting or importing FDI to and from the colony. However, there are two reasons why such a measure would lead to overestimates of actual FDI outflows from Hong Kong to its most important destination - China. First, there is the effect of Chinese round-tripping whereby Chinese investments flow back into China via Hong Kong in order to take advantage of tax incentives on inward FDI offered by the Chinese authorities.* The role of Hong Kong as a stepping stone for genuine foreign investments in China will also lead to an overestimate of Hong Kong FDI if it is recorded by the Chinese as originating from Hong Kong.

With its well-developed financial sector, Singapore may similarly be acting as an entrepot for investing in the southeast Asian region since its FDI inflows cannot be reconciled with data on outflows to the island from its main investors. (Over the period 1987-93 the Balance of Payments Statistics Yearbook records average inflows at $4.4bn, whereas data gathered from countries investing in Singapore reveals that the actual inflows were about half this number.)

* Some estimates, based on previous years' trends, put the level of round-tripping in 1993 as high as $20 billion out of recorded inflows of $27.5 billion.

Table 8: Foreign direct investment inflows by countryUS$ million

31

1987 1988 1989 1990 1991 1992 1993

Africa 1519 1361 2824 1154 2257 2574 1834

AlgeriaAngolaCameroonCote d'lvoireEgyptGabonGhanaKenyaMauritiusMoroccoNigeriaSouth AfricaZambiaZimbabwe

41191288

948905

431760

603-7575

-31

131316752

119013350

2485

37711693

-18

12200-8718

1250-31156236167

18828

164-10

n/a335-5732

73473155741165588-5203-12

12665-1781

253-55201919

320712-8343

288-1777

459127236

15424897-5

15

-8130

49397

28

522

-8

28

Asia

ChinaHong Kong*IndiacIndonesiaKoreaMalaysiaPakistanPhilippinesSingaporeThailandTaiwan2

8258

2314

385601423129307

2836352

12450

31942627

57687171918693636551105959

13908

33931077

6827581668210563

288717751604

18380

34871728

1093715

2332244530

557524441330

20938

4366538150

148211163998257544

488820141271

29395

1115619183411777550

4469335228

67302116879

44935

275151667620

2004516

4351346763

68291715917

Latin America 3744 7415 7937 7987 12474 13628 16091

ArgentinaBrazilChileColombiaMexicoVenezuela

-191225230319118421

11472969141203

201189

102812671289576

2785213

1836901590500

2549451

2439972523457

47421916

41791454699790

4393629

6305802841

4901372

Source: IMF, Balance of Payments Statistics Yearbook 1994, except

a UNCTAD, World Investment Report 1994h 1993 data from UNCTAD (1995) Recent DevelopmentsQ Reserve Bank of India Bulletin, August 1994

32

major source. After reaching $3bn in 1988, inflows to Brazil have remained around the $lbn mark. Although intra-region investment is present, unlike the Asian experience it is not a major source.

Privatisation has played a bigger role in wooing FDI to Latin American countries than in other developing country regions. This followed in the footsteps of debt-equity swaps in the late-1980s which were also important in encouraging FDI. Privatisation programmes have raised $55bn (World Bank, 1995) over 1988-93, 60% of the developing country total. Of this sum $17bn came from abroad. An estimated $10bn of this is FDI, accounting for 15% of total FDI flows (1988-93) to Latin America.

In Africa, given the relatively small size of the economies, FDI cannot be expected to reach the levels it has done in Asia or Latin America. FDI has not taken off in Africa as it has done elsewhere: inflows to the region have remained around $2bn since 1987. As a consequence Africa's share in FDI flows to developing countries has been declining (hovering between 5 and 10% until the late 1980s, subsequently dropping to about 3%). Investment in Africa has tended to concentrate in the oil-producing countries with Nigeria accounting for at least a third of all FDI inflows in recent years. Over half of FDI in Africa is established in the primary sector - a much higher proportion than in other developing regions (UNCTAD, 1995, Country and Regional).

Following heavy foreign involvement in the previous two decades, South Africa witnessed no foreign investment over the 1980s. There were high hopes of a reversal of this trend following the collapse of the apartheid regime, but FDI does not seem to have revived to a significant degree. The latest estimate for all long-term inflows in 1994 is under $0.4 billion. It would seem that investors have adopted a wait and see attitude. Data from the South African Reserve bank shows that 40% of FDI committed in South Africa up till end-1992 had been in the manufacturing sector, with another 30% in the finance and real estate sector. If South Africa manages to increase the inflows of its FDI then these sectors are set to benefit in the future.

Keeping in mind the problems with the data, Table 9 is an attempt to provide a snapshot of FDI flows in 1992. It provides a number of interesting points on the geographical distribution of flows:

In Asia the NICs (Hong Kong, Singapore, South Korea and Taiwan) can be distinguished from the other 'dynamic Asian economies' since they are both important recipients and suppliers of FDI. In particular, the ASEAN-4 (Indonesia, Malaysia, Philippines and Thailand) received about a quarter ($2bn) of their FDI from the NICs. The other $6bn to the ASEAN-4 came from Japan, the US and Europe. China received $1 Ibn worth of FDI, 70% of which was from Hong Kong, and another 10% from Taiwan. The remainder came from Japan, the US, Europe and Macau. Foreign investment in China has been heavily concentrated in the coastal regions, with just four of these provinces taking 70% of the total FDI inflow. FDI as a share of gross national investment is currently around 10% whilst foreign affiliates accounted for 28% of Chinese exports in 1993 (UNCTAD, p. 68).

In 1992 the NICs received $8bn (excluding any FDI going to Hong Kong from China). Apart from some interaction between Hong Kong and Taiwan, there is little indication of

Tab

le 9

: G

eogr

aphi

cal

brea

kdow

n of

for

eign

dir

ect

inve

stm

ent,

199

2U

S$ m

illio

n

Out

flow

s fr

om:

Inflo

ws

to:

Asi

a C

hina

N

ICs

Hon

g K

ong

Kor

ea

Sing

apor

e Ta

iwan

A

SEA

N-4

In

done

sia

Mal

aysi

a Ph

ilipp

ines

Th

aila

nd

Flow

s to

Asi

an-9

La

tin A

mer

ica

Arg

entin

a B

razi

l C

hile

M

exic

o Fl

ows

toLa

tin A

mer

ican

-4

Afr

ica

East

ern

Euro

pe

Japa

n U

SEu

rope

B

elgi

um

Fran

ce

Ger

man

y U

KA

ustra

lia

Flow

s to

Dev

elop

ed

Tot

al O

utflo

ws

Chi

naH

ong

Kon

g

7706 X 10 16

2

176 33 573

8660

Kor

ea

Sing

apor

e Ta

iwan

In

done

sia

Thai

land

A

rgen

tina

Bra

zil

37 5 57

53

-15

499

290

926

9586

120 13

X

6 4

168 39 48 10

408 18 29 12 379 -5 -21

204 1

570

1026

126 X 43 80 188

265

702 18

-22

112 1 I 16 126

828

1053 54 9 X 39 591 1 87

1834 17 25 19

3 2 4 1224

0

2092

X18

8

188 36 8 46 234

19

II

20 0 3 X 53 11 27 40 93

Chi

le

Mex

ico

Japa

n U

S

748

519

Euro

pe

Oth

ers

134 X 1

135 21

909 X 1

910

476

21 156

476

910

' Inf

low

s fr

om B

enel

ux,

Fran

ce,

Ger

man

y, I

taly

, Sw

itzer

land

, U

K;

b E

xclu

des

intr

a-E

urop

ean

fore

ign

dire

ct i

nves

tmen

t.

546

1676

476

1758

8 26

004

314

687

735

225

670

292

1676 704

160

337

5547 18

464 32 87 601

238 52 X

3960

6644

1856 380

1097 184

159

1295 -17

464

5937 586

2484 1%

1652

4918

-1045

378

867 X

13273

144

225

1331 165

235

495

271

3180

1124

-480 156

1024

1824

1855

2391

1449

11166 X

247

835

1147

2310

2

Tot

al

Inflo

ws

1129

2

2813 840

3133 850

2533

3536 192

2254

2789

2468 384

3604

1094

2821

2419

1624

119

917

3680

Sour

ces:

O

EC

D I

nter

nati

onal

Dir

ect

Inve

stm

ent

Year

book

, 19

94;

OE

CD

(19

94)

Stat

isti

cs o

n D

irec

t In

vest

men

t of A

sia

and

Latin

Am

eric

a; C

hina

Sta

tist

ical

Yea

rboo

k, 1

993;

K

orea

, E

cono

mic

Sta

tist

ics

Year

book

, 19

94;

Tai

wan

, St

atis

tica

l D

ata

Boo

k,

1994

; In

done

sian

Fin

anci

al S

tatis

tics,

199

4; T

hail

and,

Qua

rter

ly B

ulle

tin;

Mex

ico

(199

3).

U>

34

intra-NIC investment - nearly all of the FDI still comes from the US, Japan and Europe.

The dearth of intra-NIC investment is in contrast to investment patterns observed between more developed economies. The US and Europe compete with each other as fiercely as the NICs do, but European and US firms exploit their firm-specific advantages by investing abroad to gain market share. This has not happened with the NICs. One obvious explanation is that they do little trade with each other (one NICs trade with the other three is typically no more than 10% of its total trade). Another reason might be that with so many other investment opportunities in the region intra-NIC investments are not lucrative enough.

The emergence of NICs as outward investors in the mid- to late-1980s (Table 10) can be explained by the rise in real wages, appreciating exchange rates and a need to move into higher value added activities. Whether outward FDI can also be attributed to current account surpluses is doubtful (South Korea, for example, was recording surpluses in the late 1980s, but was in deficit again from 1990 - exactly the point when its FDI abroad jumped to a relatively high plateau). Outward FDI enabled the lengthening of the life of old (export) industries such as footwear, textiles and consumer electronics which could no longer be competitively produced at home.

The role of inward investment has varied from country to country in east and south-east Asia. Korea and Taiwan, two countries with the most complex, 'deep' and dynamic manufacturing base have relied relatively little on FDI as a source of growth and structural change. In Korea, for example, FDI as a proportion of gross fixed capital formation averaged just 1.1% over 1986-92 (UNCTAD, 1994, World Investment Report). In addition, with respect to (inward) technology transfer, licensing agreements, sending engineers abroad and imports of capital goods have all been much more important than FDI (see, for example, Yoo-Soo, 1995). Strategic alliances and acquisition of companies in developed countries have also emerged as important vehicles for technology transfer. However, recently the Korean authorities have been pushing measures to encourage greater amounts of 'high quality' inward FDI (see below). In contrast to Korea, Singapore and Malaysia have relied much more heavily on FDI (FDI as a proportion of gross fixed capital formation averaging 32% and 12.8% respectively over 1986-92 (UNCTAD, 1994, World Investment Report).

In the most recent years, as some of their industries start to mature, the ASEAN-4 themselves have become significant sources of FDI. Malaysia, for example, reported outflows of $1.7bn in 1994. It has been an important source of FDI for Cambodia and Vietnam; Thai companies have been investing in Laos. This indicates that following Japan and the NICs, the ASEAN-4 are now emerging as the third generation of outward investors in east and south east Asia.

The NICs invested $2bn in developed countries in 1992. Since 1987 they have been most active in the US, but they have never accounted for more than about 2% of total US FDI inflows. More recently, the NICs have begun to focus more closely on Europe. In 1994 Korean chaebols such as Samsung and Daewoo implemented large investments in France, Germany and the UK. Whereas NIC investments in Asia are usually made to gain cost advantages in export sectors, investments in the US and Europe tend to be in response to high tariffs, anti-dumping actions, etc. The prime motive is to gain domestic market share, although the NICs have also been buying up domestic companies in order to acquire new technologies

Table 10: Foreign direct investment outflows by countryUS$ million

35

1987 1988 1989 1990 1991 1992 1993

Africa 142 89 85 69 137 133 91

AlgeriaAngolaCameroonC6te d'lvoireEgyptGabonGhanaKenyaMauritiusMoroccoNigeriaSouth AfricaZambiaZimbabwe

15012019g0

_20

n/a8800

502901210020

180

22

80

260

238011

-200

5-11501229001

n/a00

500220621500

11

00

033042600

43

0

220

03330

Asia

ChinaHong KongIndiaIndonesiaKoreaMalaysia 'PakistanPhilippinesSingaporeTaiwan bThailand

1932

645 n/a n/a n/a 183

19n/a

206

170

5313

850

9022

780

8611

830

4732

913

7625

4000

4246

151

13

1174120

24

305

43

8826951

50

820

2

15705243140

1357

-A

4441854167

1047500-12

7481701136

10561400-2

767

Latin America

ArgentinaBrazilChileColombiaMexicoVenezuela

200 296 713 1051 1320 783 2018

n/a138026n/a37

1750

44

68

5231029

136

665816

355

101412324

147

14637850

200

1094431

427

Source: IMF, Balance of Payments Statistics Yearbook 1994, except

a Bank Negara, as reported in Far Eastern Economic Review (27 April 1995) b UNCTAD, World Investment Report 1994

36

and production techniques.

Future prospects

In the near term FDI to developing countries will not be following the steep upward trend of recent years. In all likelihood these flows peaked (in aggregate) in 1994. There are two major reasons for this conclusion: the first is due to the dip in FDI to China, the second arises from the knock-on effect of the December 1994 Mexican crisis.

China accounted for 40% of FDI to developing countries, and its rate of growth of FDI inflows has been higher than for developing countries as a whole. In 1995, though, FDI is expected to decline from its 1994 peak (contracted investment was down 25% in 1994). There are various reasons why this is happening. The first could be that investments naturally ran their course after the foreign investment boom in the early 1990s. Another could be a deterioration in the investment climate and genuine investor disillusionment following bureaucratic and labour confrontations. Finally, it should be noted that the Chinese government is beginning to adopt a more discerning attitude towards FDI and is no longer prepared to offer tax incentives across the board for foreign investors. This may in fact result in less round-tripping of Chinese investment. Thus even though the recorded inflows may decline in 1995, actual FDI to China may not decrease by as much - indeed the true trend may still be upwards.

The problems in Mexico highlighted the dilemma of using foreign capital, which can move in and out of an economy with alacrity. This episode has triggered a change in 'market sentiment' towards emerging markets and flows to some countries are expected to dry up. Given that FDI and portfolio flows have moved up together, will they now fall together, following similar trends? Or could FDI remain relatively stable? One could argue that FDI is inherently more stable than portfolio flows since the current levels of FDI reflect fundamentals such as the growing importance of developing countries in trade and wealth creation. Since company decisions about investing abroad are based on long-term criteria, one could expect less of a downturn in FDI than in portfolio flows.

However, as the IMF has pointed out (IMF, 1995, Private Market Finance), in times of crises FDI can also be volatile (and will therefore further exacerbate a country's external finance position). For example, during the 1980s debt crisis, in six highly indebted countries as earnings declined, foreign firms decreased the reinvested component of their income (often a substantial proportion of foreign investment) by more than their earnings loss. Repatriated earnings were kept roughly constant, but investment declined.

The recent upheavals in Mexico are not a repeat of the debt crisis, but at the very least they helped to introduce a note of caution in the minds of investors and host governments alike. This will undoubtedly have a damping effect on FDI flows to developing countries. In addition, investors may also be more choosy about the countries they pick to invest in. As

37

investors whittle down the group of 'safe' developing countries to just a handful, the club of countries receiving the bulk of FDI may become even more exclusive.

In spite of the above, there are some powerful forces acting to contain the downturn in FDI flows: these arise from the more accommodating policies in host countries towards FDI, the emergence of a new group of investors, closer links at the regional level and continued strong growth prospects in developing countries.

A major reason behind increased foreign investment in developing countries has been the improvement in the environment for FDI. Liberalisation has gone some way in helping clear the way for FDI. This normally involves opening up of previously restricted sectors, streamlining investment procedures, allowing free repatriation of earnings, and imposing less severe conditions on domestic participation. For foreign investors in high technology sectors protection of intellectual property rights has also become an important factor.

Competition for FDI amongst host countries has intensified and the liberalisation trend has been gathering momentum. This process should help keep inflows to developing countries buoyant. One of the most recent liberalisers is India - the change in attitude towards FDI is likely to make India an important host (FDI by approval was up from $200m in 1991 - the year of the first FDI reforms - to nearly $3bn in 1993 (UNCTAD, 1994, World Investment Report, p. 81)). Similarly, changes have taken place in recent years in Vietnam, Cambodia and Laos. More successful countries have also been shifting policy on FDI. South Korea, which has traditionally been relatively closed to foreign investors, embarked on a 'Five Year Liberalisation Plan for PDF in 1993 and set up a Task Force' for the promotion of (inward) FDI the following year.

In the past one strategy to attract foreign investors has been for governments to set up free investment and export processing zones (which usually offer a mix of tax holidays, exemption from import tariffs on capital goods, raw materials, and intermediate goods). In an attempt to attract higher value-added high-technology investments a more recent development has been the establishment of facilities such as science parks where foreign investors have access to highly skilled labour and can carry out research and development work.

In addition to new and increasingly favourable destinations for FDI, there are also new suppliers of FDI. As explained above, Asia has witnessed three generations of investors - Japan, the NICs and (most recently) the ASEAN-4. In Latin America Brazil is the big investor abroad, having been a net exporter of capital in 1991 and 1993. Table 9 shows that Chile has been investing heavily in Argentina as well as in Peru. Mexico has been active in Chile, Venezuela and several central American countries.

Closer trade links (via groupings such as the ASEAN Free Trade Area in Asia, MERCOSUR in Latin America) could boost intra-regional investment as companies invest abroad to exploit not only cost advantages in export industries, but also to exploit domestic markets.

Continued strong growth is expected in Asia, so one would expect inward foreign investment directed at the domestic market to remain strong. The fiscal and monetary

38

contraction under way in many Latin American countries will reduce growth and hence domestic demand-driven inward FDI is likely to slow down. Mexico could improve its prospects for FDI in the export sector if the peso stabilises since foreign investors can set up plants more cheaply than before, whilst the real devaluation of the peso makes exports more competitive.

Currencies are currently also an important consideration in Asian countries receiving Japanese investment. The recent dramatic appreciation of the yen should further accelerate the shift of Japanese production to its neighbouring countries. However, the strong yen is a mixed blessing since it poses problems for those firms in Asia which source a significant proportion of intermediate components from Japan.

Africa has not witnessed a surge in FDI inflows, but UNCTAD (1995, Country and Regional) identifies a number of countries with potential for inward investment. Based on indicators such as the level of development, market size, market growth, Ghana, Mauritius, Senegal, Tunisia, Uganda (amongst others) are highlighted as African countries where FDI potential has gone unexploited. Though it probably would not generate large increases in FDI by itself, privatisation could act as a catalyst for increased foreign investment by providing an opening for overseas investors. Foreign participation in infrastructure projects (power, water, etc.) could also help improve the conditions for investment and lead to a 'virtuous FDI cycle'.

39

Appendix

Reports discussed

Forecasts by international institutions

Asian Development Bank, Asian Development Outlook 1994Bank for International Settlements, 64th Annual Report (June 1994)European Bank for Reconstruction and Development, Transition Report (October 1994)European Communities Commission, European Economy (November/December 1994)Hamburg Institute for Economic Research (HWWA), Gro6er and Weinert (1995) 'Upswing in the

World Economy', Intereconomics (January/February 1995) International Monetary Fund, World Economic Outlook (May 1995) Japan Center for Economic Research, JCER Report 7:4 (May-June 1995) NIESR, National Institute Economic Review (February 1995) Organisation for Economic Co-operation and Development, OECD Economic Outlook (December

1994)UN, The World Economy at the Start of 1995 (December 1994) UNCTAD, Trade and Development Report 1994 United States Information Service, US Export Growth Projected to Climb Strongly (20 April

1995) The Vienna Institute for Comparative Economic Studies (WIIW), Havlik et al (1995), 'Growth

in Central and Eastern Europe Contrasts with Recession in the CIS', Transition Countries:Economic Situation in 1994 and Outlook (February 1995)

World Bank, Global Economic Prospects and the Developing Countries 1995 World Bank, Dubozi and Pohl (1995), 'Real Output Decline in Transition Economies - Forget

GDP, Try Power Consumption Data!' Transitions (January/February 1995) World Bank, Commodity Markets and the Developing Countries (February 1995) World Bank Quarterly, Commodity Markets and the Developing Countries (February 1995) World Trade Organization, Press Release, World Trade Growth (28 March 1995)

Other reports used

China, Statistical Yearbook, 1993, State Statistical Bureau of the People's Republic of China India (1994) Reserve Bank of India Bulletin (August) Indonesia (1994) Indonesian Financial Statistics, Bank Indonesia IMF (1994) Balance of Payments Statistics Yearbook IMF, International Financial Statistics (monthly) IMF (1995) Private Market Finance for Developing Countries Korea (1994) Economic Statistics Yearbook, The Bank of Korea GATT (1994) The Final Act of the Uruguay RoundMexico (1993) 'Evoluci6n de la Inversi6n Extranjera en Mexico Durante 1992', El Mercado De

Valores (1 May)

40

Mexico (1995) 'Evolution de la Inversi6n Extranjera en Mexico Durante 1994', El Mercado DeValores (4 April)

OECD (1994) International Direct Investment Statistics Yearbook OECD (1994) Statistics on International Direct Investment of Dynamic Non-member Economies

in Asia and Latin America, OECD Working Paper 68Page, Sheila (1994) Prospects for Developing Countries: Trade and Capital (15 February) Page, Sheila and Davenport, Michael (1994) World Trade Reform - Do Developing Countries

Gain or Lose? ODI Special Report Sapsford, David and Balasubramanyam, V.N. (1994) 'The Long-Run Behavior of the Relative

Price of Primary Commodities: Statistical Evidence and Policy Implications', WorldDevelopment 22(11)

Thailand (1994) Quarterly Bulletin, Bank of Thailand (December)Taiwan (1994) Taiwan Statistical Data Book, Council for Economic Planning and Development UNCTAD (1994) World Investment Report 1994: Transnational Corporations, Employment and

the Work-place UNCTAD (1995) Recent Developments in International Investment and Transnational

Corporations (TD/B/TTNC/2) UNCTAD (1994) Country and Regional Experience in Attracting Foreign Direct Investment for

Developing Countries (TD/B/ITNC/3) Yoo-Soo, H. (1995) Technology Transfer: The Korean Experience', Republic of Korea Economic

Bulletin (January) World Bank, World Debt Tables 1994-95

Definitions and country groups

For full definitions see individual reports; the forecast tables have used the nearest available category.

LIBOR - London Inter-Bank Interest Rate for dollars for six months. LIBOR is deflated by the consumer price.

Oil (real) - Oil price deflated by the manufactured exports price.

The World Bank now includes Eastern Europe and the former USSR states as developing countries in all the tables; as far as possible the 'developing countries' totals in the tables given here exclude them; the UN and OECD do not include them. The IHF now separates them. For the problems of foreign investment definition, see the Box in Part n.

prospects for trade and capital flows in the developing ......prospects for trade and capital flows...

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