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Asian Development Outlook 2004 : III. Foreign Direct Investments in Developing Asia
To draw some general principles, at least for developing Asia, this section assesses FDI inflows (and outflows), patterns, and policy regimes in six developing Asian countries, in the context of general economic trends, ownership structures, and policy reforms.20 One of the major arguments of this part of the Asian Development Outlook 2004 is that trade reform alters the incentive of production for the domestic market relative to exports, resulting in a fundamental shift in the behavior of MNEs and in the FDI cost-benefit calculation. Tables 3.4 and 3.5 present a set of comparative statistics for these six diverse Asian countries. These include some general economic indicators, as well as those relating to the trade regime and FDI. The tables also include some indicators of countries’ attractiveness to FDI. Table 3.6 offers some summary stylized facts of FDI regimes in the six.
The sample includes the world’s two most populous nations, together with a range of intermediate-sized countries with populations in the range of 20 million-100 million. In terms of GDP, the largest economy (PRC) is more than double that of the next largest (India) and about 35 times that of the smallest (Viet Nam). Korea is a rich OECD member. Malaysia is an upper middle-income developing country. The PRC and Thailand are in the lower middle-income group, while India and Viet Nam are low income. The range of per capita GDP from the richest (Korea) to poorest (Viet Nam) is about 30:1, or 7:1 in purchasing power parity terms.
All six have performed creditably for most of the past two decades. Their real per capita incomes in 2002 were at least double those of 1980, and more than five times higher in the case of the PRC. Since 1990, the PRC has consistently recorded impressive economic growth, to the point where it is now the East Asian growth locomotive, and a major global economy. If its current growth rates are maintained, it will become the world’s largest economy (in purchasing power parity terms) in a very few decades. Korea, Malaysia, and Thailand all grew at more than 6% until the Asian economic crisis; Thailand was the world’s fastest growing economy in the decade from the mid-1980s. All three experienced a sharp contraction in 1998, but recovery has been fairly rapid. Viet Nam grew strongly for most of the 1990s, with slower (but consistently positive) growth during the crisis. Until very recently, India never achieved the very high growth rates of the others. However, reforms from the late 1980s lifted its performance significantly, and it was largely unaffected by the crisis. All six have reasonably good macroeconomic management. Since 1990, all have averaged single-digit inflation. None is a heavily indebted economy. Malaysia and Thailand have the highest debt-to-GDP ratios. Both were running very large current account deficits before the crisis, albeit in the context of very high investment rates, low fiscal deficits, and (due to their outward orientation) moderate debt service ratios. The large variations in the foreign presence among the six countries are explained fundamentally by the countries’ attractiveness to FDI. This in turn reflects the rate of economic growth in each, and the policy environment, including ease of entry for foreign investors. In addition to macroeconomic management and openness, a number of factors codetermine both economic growth and attractiveness to FDI. Several proxies for these factors appear in Table 3.4. Informed analytically by the “three Is” (incentives, institutions, and infrastructure), these variables include proxies for human capital, quality of physical infrastructure, institutional quality and country risk, and financial conditions. The argument here is that, as economies open up, governments have to make the transition from protectionist/regulatory regimes to a new emphasis on investment promotion and efficiency. This may require emphasis on microeconomic, or second generation, reforms. Thus, there needs to be more effective R&D and other support schemes, better physical infrastructure, legal reform, improved education, and administrative reform. Broader still are issues of country risk and policy predictability. Hence, countries’ performance according to a range of “competitiveness” variables listed in Table 3.4 is central to economic progress. It needs to be emphasized that domestic investors are invariably the key players in any economy and that domestic investor sentiment weighs heavily in MNEs’ international location decisions. Therefore what matters is the host economy’s commercial environment in general, and not especially as it relates to foreign investors. Indeed, FDI regimes that are significantly “pro-foreign” in their incentives or other provisions are unlikely to be fiscally or politically durable, and are therefore heavily discounted by MNEs. It is important that any study of competitiveness and the business environment recognize this fact.21 The proxies and data in Table 3.4 are highly selective and subject to qualifications.22 But they are illustrative, and generally accord with a priori notions. Moreover, they effectively draw attention to the diversity of the six countries. The PRC’s human capital base is comparatively strong, with near universal literacy and segments of technical excellence. It is also increasingly able to tap into a very large international diaspora. It has R&D strengths, some military related, or resulting from the past emphasis on heavy industry. It is rapidly opening up to foreign trade and investment. Its commercial institutions have historically been weak, and the country continues to score poorly in international comparisons of corruption and protection of property rights. But institutional quality is improving quickly, especially in regions most connected to the international economy. Physical infrastructure is being upgraded rapidly, although its quality is spatially very uneven. India’s human capital and R&D base has pockets of international excellence, most notably in information technology and in some defense-related heavy industry. Until recently, and in contrast to much of East Asia, its educational priorities resulted in centers of international quality alongside quite high levels of illiteracy. It also differed in that its inward-looking strategy meant that it was unable to exploit its human capital strengths in the global economy. Thus, in contrast to the PRC, its major intrusion into the international information technology industry has been via services rather than manufacturing. Its commercial environment is broadly predictable, and the legal system cumbersome but independent. It also has the highest level of decentralized economic policy making among the six countries. A large diaspora facilitates its connections to the international economy. The 1991 reforms and their aftermath have begun to transform the commercial environment, but the unfinished agenda is large and complex, and the forward momentum appears to have slowed significantly in recent years.23 Korea’s development strategy has been underpinned by exceptional strength in certain areas. It reached OECD levels of educational achievement and R&D expenditure at comparatively low levels of per capita income.24 Its Internet access and usage are among the highest in the world. Its infrastructure and institutional quality are good, if not outstanding. External factors-aspiring to membership of international organizations and the Asian economic crisis-have been important factors in Korea’s policy reforms. As with its trade and FDI regimes, the internationalization of its human capital strengths has proceeded more slowly (Dahlman and Andersson 2000). Malaysia emerges as a country with comparatively high institutional quality, excellent physical infrastructure, and large public investments in education, much of it designed to redress past ethnic imbalances. It has had the most consistent commercial policy environment of the six. Nevertheless, there are concerns that the independence of its legal system may have been weakened over the past two decades, and there has been a persistent loss of high-level non-bumiputra human capital. Its very open international labor market has delayed the process of upgrading its technological capabilities, and in particular it faces competitiveness challenges from below (especially the PRC) and from above (the Asian newly industrializing economies). Thailand scores well on most indicators, with the principal exception of human capital. Until recently, while achieving almost universal primary enrollment, its retention of students through secondary school was low. In consequence, during the 1990s, as real wages began to rise quickly in the wake of rapid economic growth, it experienced difficulty managing the transition out of labor-intensive activities. It has become progressively more open in its trade and FDI policies. Historically, its legal and commercial institutions were not strong, though its informal commercial “rules of the game” were widely understood and observed (by foreigners as well). Physical infrastructure is generally good. Having successfully completed the first round of macroeconomic and commercial policy reforms, the principal challenges in Viet Nam relate to establishing the infrastructure that underpins a market-based economy, since property rights, the legal system, financial intermediation, and physical infrastructure all remain poorly developed. Illiteracy levels are low, but so too is the stock of internationally experienced entrepreneurs. Many small and household enterprises operate in an insecure commercial environment. SOE reform lags. The quality of the physical and commercial infrastructure shows pronounced regional differences. Foreign Direct Investment Regimes An Overview In their FDI regimes, it is useful to divide the six countries into three groups. The first comprises those with historically very restrictive regimes, including outright prohibition, which have opened up during the past quarter century, namely PRC, India, and Viet Nam. The second covers those which have traditionally been reasonably open, and become progressively more so. Malaysia and Thailand belong to this group. Finally is the special case of Korea, which was initially highly selective in its opening up to FDI, and which has become progressively more open over time. None of the sample countries has become less open toward FDI. The comparative FDI data reported in Table 3.4 illustrate these general characterizations. In 1990, Malaysia, the least populous of the six, had the largest stock of FDI after the PRC. Thailand was well ahead of the other three. The amount in Viet Nam was negligible. By 2001, the PRC had emerged as the dominant recipient, with more than seven times the stock of the next two, Malaysia and Korea. In 2002, it was the world’s largest FDI recipient, overtaking the US. India and Viet Nam still had the smallest stocks, though they had both increased quickly, especially Viet Nam. Relative to GDP, Malaysia was the largest recipient of FDI in both years, and India the smallest. The greatest absolute increase in these ratios occurred in Viet Nam, followed by Malaysia. In some cases, it is possible to date the opening up to FDI as part of a package of major general reforms. In Korea, there was gradual liberalization from the late 1980s, with major reforms in 1997-98 in the wake of the economic crisis. In the PRC, the reform process began in 1978. It was further consolidated in the late 1980s, and again in 2002 upon accession to WTO. In India, 1991 is regarded as the key reform year. In Viet Nam, it was the late 1980s Doi Moi reforms, with further liberalizations around the turn of the century. By contrast, Thailand, and particularly Malaysia, have always been quite open to FDI, and over time have become progressively more so. In neither case have there been major swings in the policy pendulum. In the decade up to the Asian economic crisis, Thailand was a huge capital importer, in some years running a current account deficit of more than 8% of GDP. While FDI increased to record levels, an increasing proportion of the total capital flow was portfolio and other short-term capital. The Government’s objective to promote Bangkok as a regional capital market center in competition with Hong Kong, China and Singapore was a factor here, as virtually all restrictions on capital flows were removed. Following the 1997-98 capital flight and consequent collapse of the Thai baht, the Government maintained its open posture toward FDI, despite a growing nationalist backlash, and FDI flows actually increased for a period. In Malaysia, the principal ownership issue has arguably been the political imperative to redistribute toward the bumiputra community (Gomez and Jomo 1997), rather than the foreign presence per se. Under the New Economic Policy, announced in 1970, the bumiputra share of the corporate sector was to rise from 2% to 30%. With the share reaching about 20% in 1990, the scheme has been somewhat de-emphasized. In fact, the very high foreign presence at the outset of the New Economic Policy facilitated this transformation, as the major redistribution occurred not from non-bumiputra to bumiputra but rather from foreign to domestic groups. The non-bumiputra share actually rose throughout the period, while the foreign share fell continuously until recently (see Speed of Technology Transfer, above). It is worth pointing out that a range of internal and external factors was operational, in most if not all the six countries. At an intellectual level, these factors include a recognition that outward-oriented economies grow more quickly, and that it is possible to achieve national objectives in an open economy context. Competitive liberalizations-keeping up with one’s neighbors-have been a factor. Foreign pressures, including a desire to join international agencies (GATT/WTO and, for Korea, OECD) have often coaxed countries along. Conversely, the demise of an international benefactor (the former Soviet Union) was a major trigger in Viet Nam’s reforms. Coalitions of key bureaucrats and political figures have often accelerated progress once they judged the environment for reform to be favorable. Obviously, policy reform has very different connotations across the six countries. In traditionally open Malaysia and Thailand, it has implied a gradual shift of focus. In other cases, reform has constituted a major change in policy emphasis, even a U-turn, in which FDI liberalization has been important. The PRC and Viet Nam are both significant cases of a transition from a prohibitive to a quite open FDI regime. At the most, only a handful of countries globally have completely open FDI regimes. Thus, while FDI regimes have become more open among the six, considerable selectivity remains across sectors and firms. Governments have typically been slower to open up the services sectors to FDI. All countries have national projects where a range of noneconomic considerations intrude. Among the sample, for instance, even the most open economy, Malaysia, has consistently protected its uneconomic automotive industry, and restricted foreign equity participation in it. More generally, countries usually have a mix of both rent-seeking and efficiency-seeking FDI, reflecting both partial reform of their trade regimes, and the political economy of dispensing patronage. Consequently, all the countries studied draw attention to what may be termed “dual policy” regimes. For example: • FDI policy may differ between regions. Three of the six countries (PRC, India, Malaysia) feature quite high levels of decentralized economic policy making. Thailand has been pursuing a policy of industrial decentralization for some time. In all but Malaysia, economic authority is being progressively devolved away from the center at varying degrees and speeds. • There are large interindustry differences in protection, and thus incentives, in all six. • SOEs frequently receive preferential treatment, especially in PRC, India, and Viet Nam, and so therefore do their MNE joint venture partners. • Most countries offer some sort of fiscal or financial incentives to foreign investors. These vary by sales orientation, technology introduced by the foreign investor, location of investment, and other factors. • The regulatory regime frequently offers more than one entry option for potential foreign investors, especially in the late reformers, i.e., the PRC and Viet Nam. Not surprisingly, this phenomenon of dual policy regimes is particularly pronounced in the late reformers. Governments there reveal the greatest ambivalence toward foreign investors. There is often an awareness, at least among the reform lobby, that after a period of commercial isolation, special promotional measures may be required as the country attempts to enter the international commercial mainstream. Sometimes this results in more generous treatment of foreign firms at the expense of domestic firms. Such preferential treatment can often be easily circumvented (e.g., the PRC “round-tripping” discussed in the section Foreign Direct Investment Inflows and Patterns, below), and runs the risk of a domestic backlash. In such cases, there is at one extreme FDI flowing into joint ventures with SOEs, often in protected, uneconomic sectors, producing negative value added at international prices. FDI also frequently flows into nontradables such as real estate and hotels where, in thin markets for international-quality assets, asset-price bubbles may occur. Meanwhile, another group of foreign investors enters sectors with comparative advantage-SMEs and labor-intensive, export-oriented activities. Often the latter locate in special zones that are free of the regulatory and bureaucratic complexities found elsewhere in the economy. Such a pattern has been clearly evident in the case of the PRC. The country’s initial export orientation was confined to four southern coastal zones. Most of the labor-intensive FDI originated in Hong Kong, China, and later in Taipei,China. This FDI coexisted with FDI going into joint ventures with SOEs, much of it in uneconomic and protected heavy industry. Firms from OECD countries were the dominant investors in these activities. The domestic welfare implications of different types of FDI are of fundamental importance. There is no such thing as a single FDI model in these economies. A major feature of the reform process is, therefore, the diminished importance of rent-seeking FDI, and its progressive replacement with efficiency-seeking FDI. Even among the relatively successful late reformers, policy progress is invariably uneven and unpredictable, as is the response of investors. Viet Nam in the 1990s illustrates both these propositions. Following Doi Moi, growth accelerated and there was an initial period of euphoria among foreign investors. By the mid-1990s, however, they became more wary as the reality of doing business in a transitional, partially reformed, centrally planned economy sank in (Freeman 2003). The prolonged commercial isolation and prevailing ideology permeating much of the bureaucracy and the Communist Party meant that policy makers frequently had little understanding of how to manage a foreign commercial presence. For example, they often had unrealistic expectations of FDI.25 Moreover, many of the broader problems associated with the business environment were not addressed in the first round of reforms: red tape, corruption, insecure property rights, an ill-defined legal environment, poor physical infrastructure, limited financial development, and the huge, inefficient, and privileged SOE sector. Finding private sector business partners was difficult, especially as much of the non-SOE business sector was either neglected or had its operations hindered. The transition from rent-seeking to efficiency-seeking FDI has thus been gradual, though, as part of the Association of Southeast Asian Nations (ASEAN), which it joined in 1995, Viet Nam is learning from the experiences of its neighbors in attracting and managing FDI (Box 3.7). The PRC is an excellent illustration of the political economy proposition that, in some circumstances, partial reform is desirable if it can be a precursor to successful economy-wide liberalization. Evidently, the latter was not politically feasible during the early years of reform in the PRC. As the coastal zones began to grow at a spectacular rate, they became the model for the rest of the economy to emulate, and reform progressively extended to other regions and sectors.26 Reform: Rhetoric versus Reality Frequently, the investment boards charged with regulating FDI have little general authority. “One-stop shops” may simply refer to their own operations and not the regulatory complexities of many other, more powerful agencies. Moreover, the rationale for the existence of these boards continues to be obscure. Over a decade ago, there was concern in the literature over how Asian investment boards married their (potentially conflicting) promotion and regulatory functions.27 Such a concern appears to be even more valid today, in the wake of the transition to outward orientation and of the region’s 1997-98 economic crisis (Buckley 2003). In any evaluation of policy regimes, it is crucial to distinguish between formal FDI and trade regimes, and their operation in practice. Nominally open regimes may in fact be highly complex and corrupt. Widespread physical and technical smuggling, and unrecorded capital flows, are present in all six countries, especially the less reformed ones. For example, smuggling renders irrelevant much of Viet Nam’s formal trade regime. The value of investment incentives is significantly eroded by administrative complexities and corruption. Moreover, reform at the center does not necessarily ensure that liberalization proceeds smoothly everywhere. This is illustrated in the case of India, where power is diffused and the vested interests and philosophical predisposition toward planning and intervention built up during decades of dirigisme cannot be quickly overturned. The reforms have been a “positive-sum game,” since growth has accelerated. But there have been losers too, notably among the bureaucrats who dispensed power and patronage, the SOEs sheltered from competition, and the unions in cosseted (especially state-owned) industries. In addition, under India’s federal structure, the states wield considerable power.28 In Korea, too, there seems to have been ambivalence about recent reforms in sections of the bureaucracy that are reluctant to relinquish control. Considerable sector restrictions on FDI remain, while business surveys (e.g., that conducted by AMCHAM Korea in December 2001) report that foreign investors find the business environment fairly unaccommodating. To overcome these difficulties, reformers have proposed the establishment of “free economic zones,” where liberalization (particularly of labor markets) can proceed more quickly than elsewhere. It is unlikely that Korea could achieve its current objective of becoming an economic hub for Northeast Asia unless these reforms are introduced and implemented successfully. One general lesson from the reform experience is that one-party states like the PRC and Viet Nam can reform very quickly, once key leadership figures are convinced of the case for change. Democratic states such as India invariably move more slowly. Conversely, it may be that the reforms are likely to be more durable in democratic states, since greater persuasion is required to get the reforms through and potential losers are more likely to be compensated-with the result that opposition is more likely to be lessened. Korea undertook its major liberalizations after it had become democratic, but in any case it appears that external factors were a major trigger for reform. Two factors in particular stand out. One was the Government’s desire to join international organizations (GATT then OECD), membership of which required reform. The second was the Asian economic crisis when, in spite of intense nationalist sentiment, the Government felt it had no choice but to open up the economy. Across developing Asia, especially in larger states, subnational policy regimes matter increasingly. In well-established federal structures like those of India and Malaysia, states compete for investment and the rules of the game are quite well established, but can be quite unequal. Decentralization is, though, taking place rapidly in most of East Asia’s nominally unitary states (Hill 2002). Regional authorities are now offering a range of incentives, some only quasi-legal. The general presumption is that this intranational competition for FDI (and investment in general) is desirable, since it will be a spur to improve the quality of governance at the local level. However, there are dangers, especially moral hazard concerns of local governments offering excessively generous incentives, secure in the knowledge of central government bailouts. Moreover, as international barriers to commerce are declining, paradoxically, subnational barriers are occasionally rising. Ownership Structures and the Foreign Presence Rising FDI flows into the six economies have generally been associated with an increased foreign presence, as measured by MNE shares of output, employment, and exports. However, it needs to be emphasized that rising FDI inflows do not necessarily result in increasing foreign ownership for a number of reasons.29 First, especially in high-growth economies, increased FDI flows have been accompanied by rising domestic investment rates, and thus the share of foreign-owned firms has not necessarily risen. Second, much FDI takes the form of reinvested earnings rather than capital inflow. This is especially the case in countries with long-established foreign investors, such as Malaysia. In recent years, retained earnings have accounted for as much as half of all new FDI in that country. Even in the rare instances where ownership statistics are comprehensive, the foreign presence is always recorded imperfectly. There are substantial non-equity forms of foreign commercial involvement, such as licensing and franchising. In some cases, foreign firms have no choice but to enter through non-equity forms, principally licensing arrangements. It is generally-though not necessarily-the case that these commercial arrangements are less important in countries with more open FDI regimes. Thus, for example, the foreign presence is probably more accurately captured in the ownership statistics in Malaysia than in India or Korea. Also, international labor flows are increasing, thus bringing in an additional element to the foreign presence. Moreover, ownership is often an empirically slippery concept, and the distinction between foreign and domestic is likely to become blurred in the future. The existence of large diasporas will hasten this trend. These originated in all six countries, particularly PRC, India, and Viet Nam. But, perhaps inevitably, their commercial activities are not consistently recorded. Official attitudes to this community also vary, from embrace to suspicion. To place these rising FDI flows in context, and bearing in mind the serious data deficiencies, it is useful to briefly examine patterns of ownership in the six countries. Accurate economy-wide ownership data are unavailable for the PRC. The best documented sector is manufacturing, where the major ownership feature has been the rapidly diminishing importance of the once dominant SOE sector. Its share of industrial output declined from 49% in 1994 to just 18% in 2001. Over this period, shares of the non-SOE domestic sector and foreign firms rose by approximately similar amounts: 38% to 53% for the former, and 13% to 28% for the latter. Among the latter, firms from Hong Kong, China; Macau, China; and Taipei,China account for 40-45% of the total. There has been some, but limited, privatization of SOEs. The major change has been the unshackling of the nonstate sector, which has been the source of the country’s economic dynamism since the late 1980s. In India, too, economy-wide ownership data are patchy, but all estimates point to minor ownership changes over time and a modest foreign presence. As would be expected, foreign shares declined prior to liberalization, from around 30% of industrial output in the early 1970s to about 25% in 1990, according to unpublished Reserve Bank of India data cited by Athreye and Kapur (2001). These figures likely overstate the foreign presence since they refer only to medium and large public companies surveyed by the Reserve Bank of India. As the authors note (p. 409), the decline is explained by “… the restrictions placed on foreign firms by the overall regulatory framework. Greater selectivity in industrial licensing restrained the growth of many multinationals [which] were unable to compete against well-organized domestic industrial lobbies.” Post liberalization, this trend appears to be slowly reversing. For listed companies on the Indian stock exchange-a data series that cannot be directly compared with the source above-the share of foreign firms in manufacturing output gradually rose toward the end of the century: from 9.5% in 1990 to 12.8% in 2000. It could be that the foreign presence has risen more sharply in other sectors, especially the newly opened service industries. The foreign presence in India’s manufactured exports is minuscule as noted, especially compared with East Asian norms. The foreign presence has always been modest in Korea, given its historically restrictive ownership regime. Within manufacturing, at the onset of the Asian economic crisis, foreign firms produced about 10% of manufacturing output and employed 5.5% of the industrial work force. Liberalization and M&A activity raised these shares to 13.3% and 8% respectively by 1999. Over the period 1997-1999, foreign firms accounted for about 15% of the country’s manufactured exports. The Malaysian data confirm the historically large foreign presence in the economy. Foreign firms owned approximately one third of the nation’s share capital in 1999, although down from over one half in 1970. Within manufacturing, foreign firms generated about 44% of value added and 38% of employment in 2000. They also accounted for 73% of manufactured exports and 65% of total exports in 1995. Ownership statistics for Thailand are the weakest of the six countries. No economy-wide estimates are available, while even for manufacturing the first reasonably comprehensive data were prepared only in 1996. They report that firms with a foreign presence (i.e., a foreign share greater than zero) produced about 50% of the country’s industrial output and employed 41% of its work force. Estimates for 1999 suggest little change in the immediate aftermath of the economic crisis. Ownership structures in Viet Nam are unusual. As FDI flowed in from the late 1980s, the share of the SOE sector actually increased. The explanation is that the SOEs retained their privileged access to secure land titles and the domestic banking sector for much of the reform period, and thus foreign investors interested in entering the economy were forced into joint ventures with them. Meanwhile, the policy regime suppressed the emergence of a domestic SME sector. This trend began to reverse, but very slowly, as the monopoly privileges of SOEs were eroded. One important milestone in this respect was the granting of 100% foreign ownership in certain circumstances (principally for firms in export zones), and the formal recognition that foreign firms are no longer part of the “state capitalist sector.” Another was the passing of the Law on Enterprises in 2000, which provided a more secure environment for the domestic private sector. Over the period 1995-2001, there were no major changes in economy-wide output shares by ownership, apart from a doubling of the foreign firms’ share (6% to 13%). The state sector remained virtually constant (39-40%), while collectives and the private/household sector declined slightly (10% to 8%) and (39% to 36%), respectively. The small mixed sector remained unchanged (4%). In these respects, Viet Nam is yet to experience the far-reaching ownership changes evident in the PRC. The foreign share of Viet Nam’s manufactured exports has been rising sharply, from 17-19% in 1993-1995 to 57% in 2000. This share is likely to rise still further in the medium term as the country entrenches itself as an attractive destination for labor-intensive manufactured exports.
Foreign Direct Investment Inflows and Patterns At least five features of the FDI flows and patterns discussed above are worthy of comment. The first concerns inflows to the PRC and PRC-India comparisons. Although the PRC is now considered the world’s largest FDI recipient, the size of its inflows is a subject of debate. The principal uncertainty relates to round-tripping, that is, PRC investments being channeled through Hong Kong, China and returning as “foreign” investment to secure the greater privileges and security that foreign investors typically receive. As the PRC reforms progress, however, and the gap between the commercial environment in Hong Kong, China and adjoining southern regions narrows, this round-tripping FDI appears to be a diminishing proportion of total inflows. These magnitudes have also triggered a recent debate about the comparative attractiveness of the PRC and India to foreign investors. Superficially, the PRC appears to be a far more attractive destination, owing to its earlier reforms, faster economic growth, and recorded FDI inflows some 20 times greater in recent years. However, recent literature has argued that the reported differences are greatly exaggerated. At least 20% of the PRC’s FDI is still thought to be round-tripping, while Indian statistics until recently have significantly understated its FDI receipts, partly due to the way it measures outflows. In addition, the PRC’s economy is more than double that of India. Making these adjustments, the reported 20:1 differential in flows becomes perhaps 3:1 in terms of FDI-to-GDP ratios. Since the PRC’s investment rate (relative to GDP) is at least one third higher than India’s, the FDI to gross domestic investment ratio is about 2:1. Thus, in the PRC-India comparison, the PRC is less exceptional (and more generally, is less of an outlier). Its magnitudes are extremely large, owing as much to its size as to its openness to FDI. A second feature of FDI flows is their changing sector composition. Prior to the 1980s, most FDI in developing countries was in extractive industries and import-substituting manufacturing. The first major compositional shift was within manufacturing, from import-substituting to export-oriented manufacturing. This transition began in the late 1960s, but really accelerated from the 1980s. A more recent shift has been toward services. By 2000, about half the total stock of FDI in developing countries was in services, more than double the figure in 1990 (UNCTAD 2002). Three factors principally account for this trend: the rising share of services in practically all countries, the increasingly tradable nature of many service outputs, and liberalized entry into many service industries previously closed to foreign businesses. However, substantial barriers to FDI in services are still in place. These global changes are evident in all six economies, and have been driven in particular by the opening up of service industries to FDI. The changes are particularly pronounced in the more recent reforming economies. In the PRC, FDI began entering the banking and the foreign and domestic trade sectors in the 1990s. With the PRC’s WTO accession, insurance, telecommunications, and other sectors are being progressively opened. In India, liberalization has resulted in a sharp decline in the earlier dominance of manufacturing, from 85% to 48% of the total. Most of the increase has gone into services. There is also a more even distribution of FDI across subsectors. In Korea, most service industries were closed to MNEs prior to the 1990s. Here too reform has led to a major reallocation of FDI flows. Third, there are the changing modalities of capital flows. For a period in the 1990s, portfolio investment flows to Southeast Asia exceeded FDI. During and after the 1997-98 crisis, this trend was dramatically reversed. Moreover, the nature of FDI is also changing. The old pattern of greenfield FDI, and durable, long-term joint ventures is increasingly being replaced by M&As. The extent of M&A FDI is poorly documented, but appears to be increasing in most countries. These activities certainly increased in the late 1990s in the five crisis-affected countries (i.e., Indonesia, Korea, Malaysia, Philippines, and Thailand), as exchange rates and stock markets collapsed, inducing so-called “fire-sale FDI,” that is, foreigners purchasing distressed and much cheapened assets. In India, too, there was a sharp rise in M&A FDI. During the restrictive era, virtually all FDI was greenfield by government diktat; now about 40% is M&A. However, there continues to be much official ambivalence about the domestic welfare effects of this form of MNE entry. The modalities of foreign capital entry have varied significantly among the six economies (Table 3.5). FDI has been the major source of capital flowing into the PRC, dwarfing portfolio investment owing to the semiclosed capital account, including restrictions on foreigners trading shares on the domestic stock market. Total capital flows to India have risen significantly since the 1991 reforms, with a sharp increase from 1996. FDI still remains a relatively unimportant part of these flows, though it is rising over time as MNEs adjust to the country’s more open policies. Capital flows to Korea also increased sharply in the first half of the 1990s, until the Asian economic crisis precipitated major capital flight. The major declines occurred in portfolio and other capital flows; as noted earlier, FDI inflows increased strongly in 1997-1999. In contrast to the other countries, and reflecting its consistently open regime, Malaysia has traditionally received most of its capital in the form of FDI. FDI declined during the onset of the crisis, though it was still large. In the wake of the September 1998 imposition of capital controls, portfolio flows turned negative, but FDI strengthened. Thailand experienced the greatest volatility in capital flows, reflecting the large swing in its capital account balance during the crisis, equivalent to about 15% of GDP. Capital flows were negative in 1997-2002, but FDI remained positive, increasing strongly in the immediate aftermath of the crisis. Comprehensive capital flow data to Viet Nam are poorly recorded. It has the least internationally integrated capital market of the six. Most of the capital inflows have taken the form of FDI, remittances, and transfers. Inflows declined in the wake of the economic crisis, but remained positive. Fourth, the major sources of FDI vary across countries, although some common patterns may be discerned. The EU, Japan, and US are typically the major investors. In addition, in some cases much smaller, but very open, proximate, and historically connected economies are major players in much larger economies. Thus, Hong Kong, China is the largest investor in the PRC, given its traditionally important (though declining) role in connecting that country to the global economy. Round-tripping is also a factor. Singapore remains a significant actor in Malaysia, reflecting their historically close commercial ties. A major foreign investor in India is Mauritius where, in addition to historical connections, special taxation privileges have played a key role. The 1970s FDI debates about whether particular source countries matter, and whether some are more desirable than others, no longer resonate.30 This is so for several reasons: the evidence demonstrates that FDI, when well managed, contributes to growth; there is a greater diversity of sources compared with earlier periods of US and European domination; and even middle-income countries are now investing abroad. Much of the literature on “FDI differences” simply reflected the particular stages of development of the source countries. These alleged “unique” MNE characteristics generally faded as the source countries’ industries were transformed. Finally, there is the issue of FDI behavior during crises, including the magnitude and composition of flows. Three of the six economies in the sample (Korea, Malaysia, and Thailand) were severely affected by the Asian economic crisis, and another (Viet Nam) saw markedly slower growth. It is therefore useful to examine briefly the behavior of FDI, and related policy responses, during this episode. Sudden capital flight is indeed a central feature of modern economic crises. Crisis economies typically switch quickly from current account deficits to surpluses. On the current account, expenditure switching and absorption effects reduce imports and promote exports. In addition, slower economic growth and increased economic and political uncertainty result in the rest of the world being unwilling to finance a current account deficit. Moreover, the behavior of different forms of capital diverge during crises. Portfolio and other forms of highly mobile capital are more likely to exit a country. By contrast, FDI flows are usually much less volatile. In fact, postcrisis FDI may well increase, along the lines postulated in Krugman’s fire-sale FDI thesis (Lipsey 2001). Asset prices become cheaper owing to depreciated exchange rates, demand contractions, and financial collapse. Policy regimes are typically liberalized as part of the government’s recovery package. Athukorala (2003) demonstrates that this is precisely what happened in most of the five crisis-affected countries in 1997-98. In aggregate, there were immense net capital outflows, principally portfolio investment and nonrenewal of short-term debt. Yet FDI actually rose modestly.31 FDI may also play an important role during the recovery of crisis-hit economies. The analytical connection between the two starts with the collapse in aggregate demand during a crisis: consumer confidence and therefore expenditure wanes; the capacity for governments to run fiscal deficits is often constrained; and domestic investment falls owing to financial fragility, weak domestic demand, and uncertainty. Exports are therefore the critical component in the immediate recovery period. Crucial to the latter are MNEs. Given their global market networks and know-how, deeper pockets, and stronger connections to global capital markets, they have the capacity to translate large increases in potential competitiveness (arising from the depreciated currency) into export growth, in turn facilitating economic recovery. The 1997-98 crisis also served as a reminder that restrictions on short-term capital flows may be compatible with an open FDI regime, at least in the short to medium term. This is the major conclusion of the controversial Malaysian policy experiment introduced in September 1998.32 Nevertheless, it is important to note Malaysia’s special circumstances: its very open economy, its high-quality bureaucracy, and the fact that it has never had a balance-of-payments crisis. Foreign Direct Investment Outflows Capital outflows are central to the process of globalization. Although occasionally the subject of mercantilist objections, to the effect that national savings are being employed for the benefit of others, theory and the vast majority of empirical evidence point clearly in the opposite direction. Outward FDI benefits the source economy, since domestic factors of production are able to maximize their returns. It is also presumed to constitute a spur to better economic policy, to the extent that the option of “exit” for investors exerts a policy discipline on governments. Outward FDI has become significant for a number of developing Asian economies (Figure 3.11). The Korean case, at a relatively low per capita income becoming a large investor abroad with outflows often exceeding inflows, is very unusual. This appears to reflect a number of factors. One was its traditionally restrictive approach to inflows. The second was the country’s rapid loss of comparative advantage in labor-intensive activities during the 1980s and the consequent relocation on a huge scale of much of this industry to high-growth, receptive, nearby economies. A third was the aggressive internationalization of the major chaebol from the late 1980s, with support from the Government. A considerable proportion of its FDI was high-end investment in sectors where protection in the targeted markets necessitated investment rather than export from the home base (e.g., the automotive and consumer electronics industries). Reverse engineering-type FDI, to obtain access to host country technology, has sometimes been a factor. (In India too, this motive is increasingly important.) The PRC is also emerging as a major investor abroad. This phenomenon may appear surprising in view of its rapid growth, on the presumption that returns on capital would be higher at home than abroad. Three factors appear to be relevant in this story (Garnaut and Song, eds., 2003). One relates to macroeconomic policy. The PRC is running large current account surpluses and is accumulating substantial international reserves, currently estimated to exceed $400 billion. Most of these reserves are held abroad, albeit largely in the form of government securities rather than FDI. The second factor is the outward leg of the round-tripping phenomenon. This is not of course genuine FDI, and should be discounted from the outflows figure. The third relates to investments abroad by state-related entities in sectors deemed to be of commercial and strategic importance, such as natural resource projects or M&A activity to acquire technology. For some countries, it is useful to distinguish between what may be termed state-sponsored and market-driven investments. This is evident in Malaysia, for example. The Government has sponsored several major investment projects abroad, including directly through its state-related entities. Some of these have been high profile, quasi-political investments in other developing countries, with mixed commercial results. Alongside these have been straightforward efficiency-motivated investments, principally in neighboring countries and reflecting firms’ competitive advantages. Three additional features of these outflows are worthy of mention. First, as noted above, many of the outward investment projects draw on the country’s overseas communities, which is to be expected given that this diaspora lowers the transaction costs of going abroad. Second, in countries with complex regulatory systems, outward FDI may be a means of exploiting firm-specific advantages in a less restrictive environment. This has been hypothesized in some of the Indian literature, though presumably it is now a less important motive. Third, it appears to be the case that increasing outward FDI has contributed to the liberalization of policies toward FDI inflows. The argument is that investing abroad increases appreciation, i | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Outflows present a mixed and imperfectly recorded picture, but it is clear that patterns vary across the six economies focused on here. In all but Viet Nam, these investments abroad are sizable. In all cases, there has been a general relaxation of controls on outflows, although in some cases quite onerous restrictions remain in place. However, with the exception of Korea, all six are generally net FDI recipients.