We are serialising ITC’s publication National Trade Policy for Export Success. This is the second part of the series which will be carried every week.
Introduction
Much of the debate about export strategy is related to better trade policies and institutions, more efficient physical infrastructure and the availability of skilled manpower. However, the debate goes beyond domestic issues. The links between export and foreign investments are strong. Foreign investment has an important role to play in the development of a country’s exports. This chapter explains linkages between foreign investment and exports and makes recommendations as to how countries can promote export growth by adopting the ‘right’ policies towards foreign investment.
There are five areas in which exports and foreign investments are related. The first four relate to inward foreign investment. The last one relates to outward foreign investment.
- Exports and access to efficient service providers;
- The role of foreign investors in the access of exporters to credit and other forms of financing;
- Access to global supply chains;
- Export competitiveness and access to technology and know-how;
- Exports and outward FDI as alternative sources of supply. This is related to the choice of firms to export or to supply foreign markets by their subsidiaries established in those markets.
To better understand the links between exports and foreign investment, the following questions are explored:
- What are the linkages between exports and foreign investment?
- What are the channels through which foreign investment can improve export performance?
- Are all contributions of foreign investment to exports positive or are there also risks associated with foreign investment flows?
- Do different kinds of foreign investment have different impacts on a host country?
- What policies are needed to encourage foreign investment?
- In situations in which foreign investment involves heavy costs for host countries, should governments in those countries adopt more defensive positions? If so, what are the options open to them?
Foreign investment has for the most part played a positive role in development, economic growth and exports. Critics of foreign investment have identified situations in which foreign investment had negative effects on host countries, which incurred social costs from the foreign investors’ activities. Outflows of foreign investment have sometimes been seen as detrimental to home countries.
The majority of observers and policymakers now acknowledge that the benefits from foreign investment far exceed their costs, and that foreign investment plays a positive role in a country’s economic and social development.
FDI as a driver of the global economy
A positive correlation exists between exports and foreign investment – typically, export growth is accompanied by foreign investment growth in world markets.
Global merchandise trade grew faster than global output from 1950 to 2009, demonstrating that global trade in goods has become an important driver of global output growth).
Due to serious methodological problems of data collection, the official statistics on trade in services are underestimated. This suggests that globalization is no longer a matter of international trade in commodities and industrial goods, but reflects a deepening of global markets and a growing importance of trade in services, which also acts to facilitate greater goods trade.
FDI is growing faster than trade
The second important feature of global trends has been the rapid growth of global FDI. As global markets have deepened, there has been parallel growth in global FDI, particularly in recent years. The annual average percentage growth in the global stock of FDI exceeded the growth of global merchandise exports and services.
The impressive growth in global trade in goods and services can be largely explained by the heightened outsourcing and the emergence of supply chains as well as growth in trade in services. Research has commonly indicated that supply chain growth together with FDI growth into service sectors have led to rapid growth of global FDI. The list of service industries that are attracting foreign investors has dramatically increased over time.
The growth of FDI in services can be partly explained by the fact that many services are at best – or can only be – transferred through FDI. (In World Trade Organization’s (WTO) General Agreement on Trade in Services (GATS) terminology, that is Mode 3 – delivery of services through an established commercial presence abroad.) Globalization of production and enhanced technical know-how also has led to a considerable increase in intra-firm trade in services.
Growth in services entails significant flow-on effects: (i) services such as energy, communications and transport support exports of goods; (ii) the investment costs of service infrastructure projects are typically very high; as a result, FDI in those sectors is an attractive option for many developing countries with severe budgetary constraints; (iii) service sectors themselves have become dynamic exporters.
Global trade and global FDI are strongly correlated
The third global trend is the high correlation between the trade growth of trade in goods and services and FDI growth. Trade can be either a substitute for FDI or a complement to FDI, as noted above. Multinational enterprises (MNEs) may decide to service a foreign market either through exports or through a subsidiary by establishing a foreign presence. While establishing a subsidiary would lead to a substitution of exports by FDI, subsidiaries of MNEs often create new trade flows with their parent companies or foreign suppliers, and they can also export to third countries or back to the home country.
Trade can also complement FDI. Establishing foreign affiliates leads to new trade from the parent company to its subsidiary, or from other home or third country suppliers to the subsidiary. Under both situations – substitute and complementary trade to FDI – greater trade correlates with greater investment flows.
Why multinationals invest abroad
In addition to factors such as the overall policy framework and business facilitation environment, the three main motivating economic reasons for firms to invest in foreign markets are to seek markets, seek resources and seek efficiency.
Market-seeking FDI
FDI that is carried out to augment sales in the existing market or to seek out opportunities for new markets is called ‘market-seeking FDI’. Investing locally can be motivated by favourable regulations or to save on operational costs such as transportation. For example, General Motors’s investment in China may best be seen as market seeking because the cars assembled in China are sold in China.
A market-seeking MNE invests to serve the host country’s demand for goods, resulting in horizontal FDI. This occurs when a multinational company carries out a similar business operation in different countries; that is, when the same production activities are replicated in several locations to satisfy local market demand. Inevitably, the market demand on FDI inflows is influenced by the market size or absolute value of gross domestic product (GDP), and market quality, or GDP per capita.
Resource-seeking FDI
Resource-seeking FDI is investment undertaken to gain access to natural resources, such as minerals, oil, natural gas and agricultural products, in particular countries. This type of investment seeks to acquire factors of production that are more obtainable in the host country. The investment seeks access to existing resources, such as Exxon Mobil investing in oil production in the North Sea.
Efficiency-seeking FDI
FDI activities may also be undertaken to guarantee optimization of accessible opportunities and economies of scale. Typically, firms partake in this type of investment in the hope that they will increase their efficiency by exploiting the benefits of economies of scale and scope. In addition, efficiency-seeking FDI typically involves investing in foreign markets to take advantage of a lower cost structure.
While market-seeking FDI results in horizontal investment, efficiency-seeking FDI implies vertical investment. The vertical investment strategy of MNEs connotes that it divides different stages of the production process among geographical locations to minimize production costs. For example, a production stage that is labour intensive is located where appropriately skilled labour is available at low cost. An example of efficiency-seeking FDI is that of a credit card company opening a call centre in India to serve United States customers.
FDI flows
Most FDI originates in developed countries. Historically around two-thirds of this FDI has gone to developed countries, meaning FDI flows are heavily tilted towards developed country markets. For the first time developing countries levels surpassed the 50% mark of global FDI flows in 2010, as figure 3 indicates.
According to the United Nations Conference on Trade and Development’s (UNCTAD) 2010 World Investment Report, the 10 leading developing countries for FDI inflows, account for approximately three-quarters of total developing country FDI inflows. However, the share of developing economy FDI has been tilted towards certain favoured investment destinations such as China, India, Mexico, Brazil and Turkey, rather than being more evenly spread across all countries.
Of further interest is the huge rise of FDI inflows in these and other most favoured economies. For example, China recorded FDI inflows of US$ 578,818 million in 2010 compared to US$ 20,691 million in 1990; India recorded US$ 197,939 million in 2010 compared with US$ 1,657 million in 1990; Mexico recorded US$ 327,249 million in 2010 compared with US$ 22,424 million in 1990; Brazil recorded US$ 472,579 in 2010 compared with US$ 37,143 million in 1990; Turkey recorded US$ 181,901 in 2010 compared with US$ 11,150 million in 1990.
Clearly, because of the link between FDI and increased exports, developing countries endeavouring to participate more in international trade must pay more attention to creating an enabling environment for investors. Developing countries must also learn from the experiences of those similarly placed countries that have undergone reform to attract investment.
Next issue: Part 2.2 FDI and access to efficient infrastructure services.
Previous issues:
National Trade Policy for Export Success - Part 1: The trade policy and export competitiveness framework