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FDI Trends Essay

In the 1970s, there existed large constraints on the movement of capital across countries. Despite savings falling short of investment demand in most countries, policy makers had their reservations against FDI. In the current era of deregulated capital markets, countries perceive FDI as engines of growth and actively solicit FDI flows. There has been a qualitative shift in the pattern of FDI flows. It is no more common for FDI to occur through Greenfield investments1. Now, almost all of the world’s FDI is done in the form of cross-border Mergers and Acquisitions (M&A). In 2000, 100 per cent of inward FDI for developed countries was a result of M&A activity, up from 80 per cent in the mid 1990s. In developing countries this figure was closer to 40 per cent. The exponential growth in the magnitude of cross border M&A is shown in Appendix 2. In this connection, analysts have remarked that it would not be inappropriate to refer to FDI as an M&A activity.

The sectoral distribution of FDI depends upon the privatisation process or on countries endowments of natural and other production resources. Manufacturing companies are usually the first targets of privatisation. Consequently, the manufacturing sector would account for

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the highest share in FDI during the early stages of a country’s development. The privatisation of services usually comes at a later stage, with the sale of state owned companies in telecommunication, financial services and retail trade. In the 1970s, most FDI was concentrated in natural resources and manufacturing.

However, since then, predictably, the services share of total FDI inflow has increased for most OECD2 countries. This shift has been particularly pronounced from the mid 1980s onwards. The service sector now accounts for about half and perhaps close to two-thirds of FDI flows. Most services have to be consumed at the place of production. This make exports an unlikely channel to access foreign markets. This means that firms need to establish themselves in the foreign markets by creating subsidiaries. Given the fact that the service sector is still not as transnationalised as the manufacturing sector, analysts point out that the share of services in total FDI is expected to increase further. Appendix 4 gives details of sector wise FDI flows.

M&A is also driven by industry specific factors. It is observed that cross border M&A activities are more likely to occur in specific industries. For instance, significant mergers have happened in the retail industry. The reason is not difficult to decipher. Retail firms, particularly in Europe, are involved in major M&A activities to grow bigger and thus ward off foreign competition. Increasing returns to scale in R&D has also prompted M&A in R&D intensive industries like chemicals and pharmaceuticals. But the largest M&A have occurred in the telecommunication industry, which in 1999, accounted for 20 per cent of the total worldwide M&A activity. Financial and Energy industries have also been witnesses to global mergers. Chapter V of the report links the industry specific M&A or FDI activity to exchange rates.

FDI has always been a phenomenon largely among developed countries. FDI to developed countries shot up 21 per cent in 2000 to just over US$ 1 trillion. United States (US$ 281 billion) and Germany (US$ 176 billion) were the largest recipients of FDI flows. Canada and the United Kingdom attracted US$ 63 billion and 130 billion respectively. The developed countries continue to be the top destination for FDI overall, garnering more than three-quarters of global inflows.

The European Union (EU), United States and Japan accounted for 71 per cent of world inflows and 82 per cent of outflows in 2000. In the last few years, Japan has become somewhat more important as a destination for FDI and less important as a source, although its significance as an outward investor is still much greater than that as an FDI recipient. The EU has replaced US as the largest outward investor. For that matter, the EU, as a group is dominant as both investor and recipient. The FDI flows of the ten largest recipients and source nations are given in Appendix 5.

The developing nations share of world FDI has been falling since 1994. Refer Appendix 6 for data on FDI inflows by region for the years 1990 to 2000. This decline in 2000 relative to levels in 1997-98 reflects a continuation of the investor risk aversion that began during the Asian crisis. It could also be a result of better growth opportunities and higher returns that were available in the industrial countries (particularly US) during this period. This suggests that sudden movements in exchange rates are likely to influence FDI flows. This topic is now attracting considerable research attention. We shall revert to it in Chapter VIII of the report.

Further, a careful look at the country wise decomposition of FDI flows to developing countries reveals that the distribution is highly skewed. Ten middle-income countries accounted for about 70 per cent of FDI flows to developing countries in the 1992-1998 period. The middle-income countries as a group accounted for over 90 per cent of FDI inflows to developing countries, while the share of low-income countries was only 6-7 per cent. In particular, China received over 25 per cent of all FDI to developing countries, with Brazil, Mexico, Argentina and Malaysia accounting for another 22 per cent.

UNCTAD3 reports that World FDI flows are likely to decline by 40 per cent in 2001. This would be the first drop in FDI flows since 1991 and also the largest over the past three decades. This projected fall is the result of a recent decline in cross-border M&A’s. The decline in M&A’s is related to the slowdown in the world economy. A lull in the consolidation process (through M&A’s) in certain industries like telecommunications and automobiles also contributed to this fall. In case of developed countries, FDI flows are expected to decrease significantly from US$ 1.005 trillion in 2000 to an estimated US$ 510 billion in 2001. For developing countries, the extent of decline is estimated to be lower. The FDI flow is expected to reduce from US$ 240 billion in 2000 to US$ 225 billion in 2001.

The analysis of the role of MNEs can give substantial additional insights to the phenomenon of FDI. After all, it is the MNE that carries out FDI activities. Rugman (2000) observed that the worlds’ 500 largest MNEs are based mostly in the US, EU, and Japan (Refer Appendix 7). These countries account for more than 80 per cent of the worlds’ stock of FDI and over half of world trade. Rugman further indicated that in reality, a vast majority of MNE manufacturing and service activity is (and has always been) organized regionally, not globally. MNEs tend to operate in each other’s home markets thus resulting in the regional concentration of FDI flows.

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