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Asian Development Outlook 2004
Foreign Direct Investment in Developing Asia The rapid growth of developing Asia has attracted, and been facilitated by, foreign direct investment (FDI), flows of which have increased substantially in recent decades. Part of the reason for this is that developing countries, particularly in Asia, have removed restrictions and implemented policies to attract FDI inflows to benefit from the investments and potential spillover effects. The potential benefits of FDI inflows extend far beyond financial resources-but costs may be entailed as well. Governments throughout the region have been striving to find an appropriate policy mix for FDI that will maximize the net benefits for their economies. Consequently, there is considerable variation in policies and experiences with FDI across countries, reflecting differing economic, social, and political conditions. Until the mid-1980s, most developing countries worldwide viewed FDI with great wariness. The sheer magnitude of FDI from multinational enterprises (MNEs) was regarded as a threat to host countries, raising concerns about MNEs' capacity to influence economic and political affairs. These fears were driven by the colonial experience of many developing countries and by the view that FDI was a modern form of economic colonialism and exploitation. In addition, the local affiliates of MNEs were frequently suspected of engaging in unfair business practices, such as rigged transfer pricing and price fixing through their links with their parent companies. Consequently, most countries regulate and restrict the economic activities of foreign firms operating within their borders. Such regulations often include limitations on foreign equity ownership, local content requirements, local employment requirements, and minimum export requirements. These measures are designed to transfer benefits arising from the presence of foreign firms to the local economy. At the same time, most countries also offer incentives to attract FDI. These often include tax concessions, tax holidays, tax credits, accelerated depreciation on plant and machinery, and export subsidies and import entitlements. Such incentives aim to attract FDI and channel foreign firms to desired locations, sectors, and activities. This carrot and stick approach has long been a feature of the regulatory framework governing FDI in host countries (McCulloch 1991). In recent years, however, FDI restrictions have been substantially reduced as a result of a host of factors-accelerating technological change, emergence of globally integrated production and marketing networks, existence of bilateral investment treaties (BITs), prescriptions from multilateral development banks, and positive evidence from developing countries that have opened their doors to FDI. In addition, the drying-up of commercial bank lending in the 1980s due to debt crises brought many developing countries to reform their investment policies to attract more stable forms of foreign capital, and FDI appeared to be an attractive alternative to bank loans as a source of capital inflows. In the process, incentives and subsidies were aggressively offered, particularly to MNEs that supported developing countries' industrial policies. This part of the Asian Development Outlook 2004 reviews recent developments in FDI flows and their impacts in developing Asia, and the importance of the policy context in which those flows occur. It summarizes findings of an Asian Development Bank-supported study of FDI in general and particularly in six diverse, developing Asian countries.1 Flows of FDI have seen a dramatic rise in the last 20 years due to increasing openness of host economies. The growing internationalization of trade and investment has prompted a proliferation of BITs. From diverging perspectives, host and source countries have a common interest in establishing some-perhaps minimal-accepted international architecture, the rules of the game, regarding MNE obligations and host country responsibilities. This has led some countries to call for increased cooperation through the establishment of international investment rules and commitments. The failed multilateral agreement on investment (MAI) initiative led by the Organisation for Economic Co-operation and Development was one attempt in this direction. FDI is now on the World Trade Organization (WTO) Doha agenda, which has explicitly included development issues. Whether this will progress any further than the MAI appears doubtful at present. Collective action toward a common business regulatory framework is even more complex than coordinated trade liberalization.
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