_______ 2 1658_ _ _ I DEVELOPMENT BRIEF Number 14 The World Bank April 1993 Foreign direct investment- investment (see table). Top recipi- ents' ratios of FDI to GDP and to benefits beyond finance ~~~~~~~GDI (gross domestic investment) It stimulates production improvements, contributes to were often not very different from the averages for all developing technological advancement, boosts manufactu ring countries-1.1% and 4.5%, respec- employment, and generates exports tively. Exceptions were Argentina, Malaysia, and Venezuela, with high F oreign direct investment FDI flows to developing countries FDI-GDI ratios, and Malaysia, with flows to developing coun- have increased, reflecting improved a high FDI-GDP ratio. If the ratios tries have increased at a macroeconomic performance (par- of FDI to GDI for all developing rapid pace, reaching an estimated ticularly in some Latin American countries rose to the level of the US$38 billion in 1992, a fourfold in- countries, following debt reduction highest individual ratio, the in- crease since the mid-1980s and a agreements), more welcoming crease in aggregate net flows would 50% increase over the past two regulatory regimes (as in Thailand), be huge-about US$120 billion a years. FDI now is the dominant and active privatization and debt year, more than three times the cur- form of resource flows to develop- conversion programs. The share of rent level. ing economies and the primary FDI going to developing countries FDI in East Asia tends to contrib- source of private capital for low- increased from a low point of less ute to new fixed capital formation income countries, accounting for than 12% in 1987 to 22% in 1991. (especially power and infrastruc- more than a quarter of aggregate Two countries-the United States ture), while the bulk of flows in net flows and exceeding total long- and Japan-accounted for nearly Latin America has been directed to term debt flows.* 70% of the entire FDI flows to de- FDI is a large and growing source veloping countries in 1990. A conse- Major destinations of FDI to of equity investment that brings quence of source country concen- developing countries, 1991 with it considerable benefits: tech- tration is the so-called triad pattern Share of Share f nology transfer, management of FDI flows (with its regional asso- recipient recipient know-how, and export marketing ciations), which appears to be US$ GDP GDI access. Many developing countries growing more accentuated. U.S. Countries millionis (%) (%) will need to be more effective in at- multinationals favor Latin America, -_- tracting FDI flows if they are to whereas Japan and the Asian newly All develop- close the technology gap with high- industrialized economies (NIEs) are ing countries 35,895 1.1 4.5 income countries, upgrade manage- the main source of FDI in Asia. Mexico 4,762 1.7 7.4 rial skills, and develop their export There has also been some growth in China 4,366 1.2 3.3 markets. intradeveloping country flows, for Malaysia 3,455 7.4 20.5 example from Korea to China. For Argentina 2,439 1.9 15.1 FDI's growth in developing Eastern Europe, the European Thailand 2,014 2.2 5.6 countries Community is themVenezuela 1,914 3.6 19.2 countries Community is the major source of Brazil 1,600 0.4 2.0 After a spectacular growth in the FDI. Indonesia 1,482 1.3 3.6 second half of the 1980s, global FDI The concentration is less marked Korea, Rep. of 1,116 0.4 1.0 flows have declined over the past by receiving country. The share of Turkey 810 0.8 3.9 two years from their peak of nearly absolute flows in 1991 was 35% for US$200 billion in 1989. By contrast, the top three recipient countries Note. FDI based on net inflows, balance of payments basis. Data not yet and 71% for the top 10. This appar- available for Saudi Arabia. 'For rore details, see Global Econmic Prospects and the Devel- ent concentration largely disap- Source: IMF Balance of Paymenn s opmng Counf ...s, 1993, Washington, DC, World sank, April 1993. pears when FDI is scaled by Yearbook and World Bank estimates. FILE COPY the purchase of existing companies. One benefit is that foreign-owned quarter of employment in manufac- Often these companies are capital firms may stimulate local produc- turing in more than half of a sample hungry (Argentina's and tivity through backward linkages to of developing countries. Much of Venezuela's telecommunications service suppliers and the labor this employment was in production industries) and can be expected to force-and by serving as a model of with high technological and indus- attract future flows to support in- working practices and management trial know-how, such as electrical vestment in excess of initial outlays. techniques. It has been argued that and electronic equipment, In the 1980s and 1990s, FDI flows the best measure of FDI's impact is nonelectrical machinery, and have shifted from manufacturing not simply the initial balance of chemicals. and extraction to services, particu- payments transaction but also the The presence of foreign firms in larly the new capital-intensive ser- foreign firm's local purchases from manufacturing has also enabled vice industries, such as suppliers and sales to customers in them to generate a high share of telecommunications, transporta- the host market, because these are manufactured exports. For ex- tion, banking, and public utilities, analogous to exports and imports. ample, foreign firms account for which are being privatized and For the United States, total 1987 ex- more than half the manufactured opened to FDI in several develop- ports were less than half the sales exports in Malaysia, Mexico, and ing countries. During 1988-92, by U.S.-owned firms abroad. the Philippines, and a recent survey privatization transactions in devel- Foreign affiliates of transnational of firms in Thailand found the share oping countries amounted to US$56 corporations can contribute directly to be nearly three-quarters. billion. About US$14 billion, or to technological advancement in de- The macroeconomic impact of 25%, of the privatization proceeds veloping countries through a stimu- FDI varies considerably by region were financed by external capital lus to research and development and country. Outside the Pacific Ba- flows, with the balance financed by expenditures, changes in product sin developing countries, FDI has debt-equity conversions and local and export composition, and higher tended to substitute for other capi- financing. Infrastructure and finan- factor productivity. During the past tal flows, whereas in the Pacific Ba- cial services accounted for three- decade, the share of R&D expendi- sin countries, it has been additional quarters of these transactions. tures in sales for U.S. majority- to domestic investment and has not, owned affiliates in developing therefore, financed the balance of Impact on the host country countries, albeit small, has in- payments (that is, both domestic in- FDI contributes to the growth of creased. Technology can also be vestment and the current account host economies through various transferred through nonequity deficit have increased). Coupled channels in addition to physical channels, such as licensing and sub- with the observation that profits on capital formation, including tech- contracting. FDI often climb quite steeply after nology transfer, human capital Although direct employment by an initial period of unprofitability, (managerial skills) development, foreign-owned corporations in de- this suggests that FDI should not and promotion of foreign trade. But veloping countries is small (less generally be viewed as a means of its benefits will be lost if the host than 1% of the work force), foreign financing balance of payments economy is heavily distorted. affiliates accounted for more than a needs over the medium term. Developmnent Briefs are issued by the World Bank to inform the media, business, academic, and governmentpolicycommunities about developmentpolicyanalyses and results from the Bank's research activities. They are draswn from the work of individual Bank reseatchers and do not necessarily represent the views of the World Bank and its member countries-and should not therefore be attributed to the World Bank or its affiliates. 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