ECON3315 International Economic Issues Instructor: Patrick M. Crowley Issue 20: FDI

Overview What is FDI? What is FDI? Why is FDI important for developing countries? Why is FDI important for developing countries? Who does FDI? Who does FDI? Is FDI trade replacing? Is FDI trade replacing? What is the difference between FDI and other capital flows? What is the difference between FDI and other capital flows?

What is FDI? FDI = Foreign direct investment FDI = Foreign direct investment It appears in the financial account of the balance of payments It appears in the financial account of the balance of payments Increasingly important in terms of the size of flows from the 1980s onwards Increasingly important in terms of the size of flows from the 1980s onwards Most FDI is between developed countries Most FDI is between developed countries FDI can be: FDI can be: i) “greenfield” FDI – new plants ii) taking over control of existing plants

Why is FDI important for developing countries?  Main reason is that domestic savings do not support much investment in developing countries  Therefore FDI represents an important source of investment  But FDI also leads to: i) technology transfer – new technologies are introduced ii) higher pay – usually foreign firms hire best workers so payhigher wages than domestic firms – tends to put upward pressure on wages iii) more FDI if seen as a “signalling” that country is welcoming for foreign companies  FDI can also lead to higher exports if the foreign subsidiary services the region rather than the specific country

Who does FDI? Most FDI is done by MNEs (85%) Most FDI is done by MNEs (85%) MNE = Multinational enterprise MNE = Multinational enterprise Most MNEs expand their operations into other countries by acquiring existing companies or establishing a new subsidiary. Most MNEs expand their operations into other countries by acquiring existing companies or establishing a new subsidiary. This also leads to trade in intermediate goods (parts etc) from the home country to the subsidiary (e.g. Volkswagen producing vehicles in Mexico for NAFTA) This also leads to trade in intermediate goods (parts etc) from the home country to the subsidiary (e.g. Volkswagen producing vehicles in Mexico for NAFTA)

Is FDI trade replacing? Big debate in economics as to whether trade and FDI are compliments or substitutes i) i)If complimentary, FDI will increase the amount of trade in the host country (e.g. Mexico) ii) ii)If a substitute, FDI will reduce the amount of trade for the host country (e.g. Japanese car plants in the US) Clearly answer depends on type of FDI, and whether the FDI creates a plant which produces for domestic or regional market

What is the difference between FDI and other capital flows? FDI differs from other capital flows as it is not easily reversible. “Money” capital flows can easily be reversed so inflows can easily turn into outflows.  FDI inflows rarely turn into outflows within a 5 year period  Inward FDI is usually a commitment to the country for a specific period of time while production is ramped up and new clients/markets established  In some countries certain industries are protected from foreign ownership (e.g. Canadian media companies and Banks), so inward FDI in these sectors limited

The OECD and the MAI Forum for multilateral cooperation on trade is clearly WTO No obvious place for negotiating any multilateral agreement on FDI In 1996 OECD tried to take the initiative here by proposing a “Multilateral agreement on investment” (MAI) Main objective was to have reciprocal agreement on how to treat FDI and to limit government ability to “nationalize” foreign assets Agreement was put aside in 1998 after deluge of criticisms from anti-globalization protesters