The World Investment Report: The Shift towards services
By Christopher Ram
October 31, 2004
The World Investment Report 2004, a publication of the United Nations Conference on Trade and Development (UNCTAD) reports that global inflows of foreign direct investment (FDI) made up of reinvested earnings, equity and intra-company loans declined in 2003 for the third year in a row, to $560 billion. The report assumed unusual significance last year for the surprising finding that Guyana was among one of the highest-ranked countries for inward foreign investments. This week's Business Page looks at the report generally. Next week we will follow up with some observations on the report and the findings on Guyana which show some decline, but still credible performance which makes the non-reaction by Go-Invest this year quite surprising.
A major contributor for the decline was the fall in FDI flows to developed countries: at $367 billion, they were 25% lower than in 2002. World-wide, 111 countries saw a rise in flows, and 82 a decline. The fall in flows to the United States by 53% to $30 billion - the lowest level in the past 12 years - was particularly dramatic, although this does not feature in all the exchanges about Bush's management of the US economy. FDI flows to Central and Eastern Europe (CEE) also slumped, from $31 billion to $21 billion. It was only developing countries as a group that experienced a recovery, with FDI inflows rising by 9% to $172 billion overall. But in this group, the picture was mixed: Africa and Asia and the Pacific saw an increase, while Latin America and the Caribbean experienced a continuing decline. The group of 50 least developed countries (LDCs) continued to receive little FDI ($7 billion). Guyana is not among the fifty LDCs.
Prospects for 2004, however, are promising with higher profits allowing for in-creased reinvested earnings, and the continuing liberalisation of FDI regimes contributing to the recovery. In 2003, there were 244 changes in laws and regulations affecting FDI, predominantly in the direction of more liberalization. Eighty-six bilateral investment treaties (BITs) and 60 double taxation treaties (DTTs) were concluded.
Flows are expected to pick up, particularly in Asia and the Pacific and Central and Eastern Europe. China and India in Asia and Poland in CEE are considered to be especially well positioned for an upswing. Experts predict good times for some services, including a wide range of corporate functions and for electrical and electronic equipment, motor vehicles and machinery, according to these experts.
The report shows that international production re-mains fairly concentrated among the world's top companies. In 2002, the world's 100 largest TNCs, representing less than 0.2% of the global universe of TNCs, accounted for 14% of sales by foreign affiliates world-wide, 12% of their assets and 13% of their employment. Following a period of stagnation, these TNCs resumed growth in terms of their assets, sales and employment in 2002. A recovery does not mean that all countries will realize their FDI potential. Indeed, UNCTAD's Inward FDI Performance Index, a measure of the attractiveness of a country to FDI, shows that economies such as the Czech Republic, Hong Kong (China) and Ireland continued to attract significant investment even during the FDI recession. In contrast, countries such as Japan, South Africa and Thailand have yet to realize their full potential to attract FDI, according to their ranking on UNCTAD's Inward FDI Potential Index, as compared with that on the Inward FDI Performance Index.
Developing countries TNCs expand
As in the past, TNCs from developed countries will drive the renewed growth of world FDI flows. But, increasingly, TNCs from developing countries are contributing too. Their share in the global FDI flows rose from less than 6% in the mid-1980s to some 11% during the latter half of the 1990s, before falling to 7% during 2001-2003 (for an annual average of $46 billion). They now account for about one-tenth of global outward FDI stock, which stood at $859 billion after rising by 8% in 2003. Measured as a share of gross fixed capital formation, some developing countries invest more abroad than some developed ones: eg Singapore (36% during 2001-2003), Chile (7%) and Malaysia (5%), compared to the United States (7%), Germany (4%) and Japan (3%). As the economic recovery takes hold, FDI from these and other developing countries can be expected to resume growth. Latin America and the Caribbean accounts for another $10 billion, while outflows from Africa are much smaller and come mainly from South Africa. Significantly, a good part of investment flows from developing countries goes to other developing countries. In developing Asia, for example, they account for some two-fifths of total inflows. And flows between developing countries are growing faster than flows between developed and developing countries.
Despite the increased activity of TNCs by developing countries, developed countries continue to account for over 90% of total outward FDI, concentrating the ownership advantages of TNCs based in countries with significant outward FDI. Significant among these are the Netherlands, Sweden, Switzerland and the United Kingdom, all of which appear to be getting stronger. The introduction of a new measure (UNCTAD's Outward FDI Performance Index) of the ratio of a country's share in world outward FDI flows to its share in world GDP, places at the top of the leader board Belgium and Luxembourg (because of transshipped FDI), Panama and Singapore, but also includes the four countries mentioned earlier in this paragraph as well as other developed countries.
An international perspective
FDI inflows to Africa rose by 28 per cent, to $15 billion, in 2003, but fell short of their 2001 peak of $20 billion. Thirty-six countries saw a rise in inflows, and 17 a decline. The recovery was led by investment in natural resources and a revival of cross-border M&As, including through privatizations. Morocco was the largest recipient of inflows. Overall, natural-resource rich countries (Angola, Chad, Equat-orial Guinea, Nigeria, South Africa) continued to be the principal destinations, but a large number of smaller countries shared in the recovery.
FDI in services is increasing, particularly in telecommunications, electricity and retail trade. In South Africa, for instance, FDI in telecommunications and information technology has overtaken that in mining and extraction. Africa's outlook for FDI in 2004 and beyond is promising, given the region's natural resource potential, buoyant global commodity markets and improving investor perceptions of the region. However in comparison with the other regions of the world, leading TNCs surveyed by UNCTAD in 2004 view the region's prospects less favourably than those for other regions.
The rebound of inflows to the Asia-Pacific region, up by 14% to $107 billion in 2003, was driven by strong domestic economic growth in key economies, improvements in the investment environment, and regional integration that encourages intra-regional investment and facilitates the expansion of production networks by TNCs.
For all the hype about the outbreak of the Severe Acute Respiratory Syndrome (SARS), that epidemic appears to have had only a marginal effect on FDI flows to the region.
Overall, 34 economies received higher inflows, and 21 lower ones. Within the region, there was considerable unevenness of FDI flows to different sub-regions and countries, as well as industries. Overall, inflows were concentrated in north-east Asia ($72 billion in 2003) and in services. Setting aside the special case of Luxembourg (owing to transshipping), China became the world's largest FDI recipient in 2003, overtaking the United States, traditionally the largest recipient. Flows to south-east Asia rose by 27% to $19 billion. South Asia received only $6 billion, in spite of a 34% increase.
Flows to resource-rich central Asia rose from $4.5 billion in 2002 to $6.1 billion, and to West Asia from $3.6 billion to $4.1 billion. Flows to the Pacific islands remained low (at $0.2 billion), despite a noticeable increase in FDI to Papua New Guinea, another resource-rich country. The FDI stock in services climbed from 43% of the region's total inward stock in 1995 to 50% in 2002, while that of manufacturing fell to 44 per cent. In the primary sector, oil and gas, in particular, were magnets. While manufacturing attracted the most FDI in China, the share of services in FDI inflows to other economies rose in absolute and relative terms.
Latin America and the Caribbean
The report shows that for the fourth year in a row, FDI flows into Latin America and the Caribbean (LAC) fell, by 3% in 2003, to $50 billion - the lowest annual level of inward FDI since 1995. Of 40 economies, 19 saw declining inflows. In particular, declines were registered in Brazil and Mexico, the region's largest recipients. With fewer state-owned entities to privatise, weak economic recovery in the European Union (EU) (the region's principal source of FDI, apart from the United States) and recession or slow growth in several countries in the region in the aftermath of the Argentine crisis, LAC has been hit hard by the FDI downturn, although several smaller economies, such as Chile and Venezuela, registered increases in 2003, the former recouping its losses of the previous year.
Central and Eastern Europe
Central and Eastern Europe had the most dramatic declines - from $31 to $21 billion, possibly as the initial wave of bargain-hunting receded. The decline was most marked in the Czech Republic and Slovakia, two of the largest recipients in the region.
Overall, inflows rose in ten countries and fell in nine. Inflows to the Russian Federation also declined, from $3.5 billion to $1 billion. By contrast, outflows from CEE rose from $5 billion to $7 billion, with the Russian Federation accounting for three-fifths of that figure. Four out of the five top TNCs in 2002 among the region's 25 largest TNCs were Russian. FDI by Russian firms is motivated by a desire to gain a foothold in the enlarged EU, and a desire to control their value chains globally.
As part of their efforts to enhance their attractiveness to investors (domestic and foreign), several new EU members have lowered their corporate taxes to levels comparable to those in locations such as Ireland. The combination of relatively low wages, low corporate tax rates and access to EU subsidies - enhanced by a favourable investment climate, a highly skilled workforce and free access to the rest of the EU market - makes the accession countries attractive locations for FDI, both from other EU countries and from third countries.
The year 2003 saw a mixed FDI picture for the developed countries: ten posted higher inflows and 16 lower ones with an overall decline of 25% to $367 billion, contributed largely by the slow pace of economic recovery in those countries. United States FDI inflows halved, from $63 to $30 billion, which placed that country behind Luxembourg (because of transshipped FDI), China and France. Flows into the EU as a whole, declined by 21% to $295 billion. At the same time, FDI outflows from developed countries increased by 4% (to $57 billion), largely owing to higher outflows from the United States - they rose by close to a third, to $152 billion. The United States was again the largest source of FDI, followed by Luxembourg (because of transshipped FDI), France and the United Kingdom, in that order. Higher FDI outflows and lower inflows combined for a negative net balance of $122 billion for the United States on these two items, the largest such deficit ever.
The shift to services
The report notes that the structure of FDI has shifted towards services. In the early 1970s, this sector accounted for only one-quarter of the world FDI stock; in 1990 this share was less than one-half; and by 2002, it had risen to about 60% or an estimated $4 trillion. Over the same period, the share of the primary sector in world FDI stock declined, from 9% to 6 per cent, and that of manufacturing fell even more, from 42% to 34 per cent. On average, services accounted for two thirds of total FDI inflows during 2001-2002, valued at some $500 billion. Moreover, as the trans-nationalisation of the services sector in home and host countries lags behind that of manufacturing, there is scope for a further shift towards services.
Outward FDI in services continues to be dominated by developed countries, but has become more evenly distributed among them. A few decades ago, almost the entire outward stock of services FDI was held by firms from the United States. By 2002, Japan and the EU had emerged as significant sources. The composition of services FDI is also changing. Until recently, it was concentrated in trade and finance, which together still accounted for 47% of the inward stock of services FDI, and 35% of flows in 2002 (compared to 65% and 59 per cent, respectively, in 1990). However, such industries as electricity, water, telecommunications and business services (including IT-enabled corporate services) are becoming more prominent. Between 1990 and 2002, for example, the value of the FDI stock in electric power generation and distribution rose 14-fold; in telecoms, storage and transport 16-fold; and in business services 9-fold.
The Caribbean region, including Guyana, is becoming increasingly marginalised in the global scheme of economic development. Foreign direct investment reflects globalisation, a phenomenon about which there is still some ambivalence. For us, more than for others, it requires striking a balance between economic efficiency and broader developmental objectives. As the report notes in its conclusion, it matters to have the right mix of policies. In light of the shift towards FDI in services, developing countries face a double challenge: to create the necessary conditions - domestic and international - to attract services FDI and, at the same time, to minimise its potential negative effects. In each case, the key is to pursue the right policies within a broader development strategy. Basic to them is the upgrading of the human resources and physical infrastructure (especially in information and communication technology) required by most modern services. An internationally competitive services sector is, in today's world economy, essential for development.
Today we present the second and concluding part of the article prompted by the publication of United Nations Conference on Trade and Development's (UNCTAD) 2004 World Investment Report dealing with investments by multi-national companies across borders. We noted in part one which appeared in Sunday, October 3, 2004 that the report assumed particular prominence in 2003, mainly in the state-owned media, for its disclosure that Guyana was among one of the highest-ranked countries for inward foreign investments in 2002. Despite the time that has elapsed since the 2004 report this year, Go-Invest which was the cheerleader in 2003 has been noticeably silent this time round.
Readers will recall that there was a financial decline in 2003 in the Caribbean and Latin America, where for the fourth year in a row, FDI (FDI) flows into Latin America and the Caribbean (LAC) fell by 3% in 2003, to $50 billion - the lowest annual level of FDI since 1995. Guyana, which is classified as an LAC was one of the countries contributing to the decline. The report shows that in 2003 FDI was $26M compared with $67M in 2000, $56M in 2001 and $44M in 2002. In relative terms Guyana's ranking has declined from the 2000-2002 average of 18, to 26 for the three years 2001-2003.
It is, however, erroneous to place too much significance on performance in any one year, although a declining trend is clearly a major concern. If foreign investment is indeed considered the driver of economic progress and government the facilitator, then we have a real problem. Most of the investment taking place in Guyana is done at the government level. Does the IDB, for example, believe that the private sector is the engine of growth, and if so, how does it justify the billions it lends to the government? The same may be said of the other donor agencies and countries, though on a smaller scale.
The decline in the region has been partly attributable to the effect of privatization in the region. For example, much of the region's increase in the latter part of the last decade was due to the privatization process, which in many countries has now run its course. There simply are no more entities to privatize or the process has simply run into political opposition at home, particularly since almost without exception the process delivered much less than it promised.
The report also reflects data limitations, such as those tables listing the economies for which national official source data were available. There is some ambiguity about the source of the data used in the report for Guyana, although the report indicates that Guyana is among these countries which confirmed the data used.
Guyana is shown as having fifty-six (56) parent corporations and foreign affiliates operating in Guyana, and it would be interesting to determine who these are and the extent of their investments by year. For the purpose, however, there is a fairly narrow definition of foreign affiliate. If the numbers shown are accurate then Guyana is within a reasonable range, but they also suggest that the average investment by these companies is fairly low, despite what one would consider the nature of the investment opportunities in Guyana. We have been trying to attract investments in extractive and manufacturing industries which are largely capital intensive, but the reported investments indicate an average of less than US$1/2M per entity. Clearly there is research work to be done and we need to enquire whether those companies which have received huge concessions are in fact making their promised investments.
Facilitating the shift
One area that the report stresses is the number of agreements signed among states to facilitate foreign investments, and here both Guyana and Caricom fare very badly. In fact only a bilateral agreement between Caricom and Costa Rica was concluded while the report indicates that negotiations are taking place on a Caricom-European Union agreement. The absence of agreements facilitating this type of investment might help to explain the low level of investments in the region.
The other is whether the region possesses the capacity to benefit from the shift to services - an area in which Bangalore in India is fast approaching first-world status. The report's conclusion is that to benefit from the increasingly globalised world economy, countries need to strengthen their services, and notes that with the right conditions, FDI can help to achieve this. Countries need to bring together the capital, skills and technology which are the essential ingredients for set up competitive service industries whether they be the highly prominent IT-enabled services, or traditional services such as infrastructure and tourism.
While many services are local, many are also growing in their international relevance and coverage, and are therefore becoming more tradable. The report is convinced that FDI can help link developing countries to global value chains in services, since they include networks that are increasingly important to access international markets. It cautions, however, that care must be exercised in countries' efforts to attract FDI in services. Some services (especially basic utilities and infrastructure) may be natural monopolies and hence susceptible to abuses of market power (whether firms are domestic or foreign). Others are of considerable social and cultural significance, which can alter in undesirable ways the whole fabric of a society.
Not surprisingly, therefore, the report does not seek to be prescriptive, and recommends that countries need to strike a balance between economic efficiency and broader developmental objectives. Perhaps the best way to conclude this piece is to quote from the conclusion in the Overview of the Report which states: "This is why it matters to have the right mix of policies. In light of the shift towards FDI in services, developing countries face a double challenge: to create the necessary conditions - domestic and international - to attract services FDI and, at the same time, to minimize its potential negative effects. In each case, the key is to pursue the right policies, within a broader development strategy. Basic to them is the upgrading of the human resources and physical infrastructure (especially in information and communication technology) required by most modern services. An internationally competitive services sector is, in today's world economy, essential for development."