SOUTH BULLETIN Published by the South Centre ● www.southcentre.int ● 16 May 2016, Issue 90 Foreign Investment, Investment Treaties and Development: Myths & Realities The growing debate on in- vestment agreements has underscored the im- portance of understanding the nature and effects of foreign investment. The issues of FDI, investment treaties and development are examined in this South Bulletin. Pages 2-5 A night scene of multinational firms: what are their effects on development? South Analysis of the Centre Paris Board Agreement Meeting IISD on climate Pages 6-7 change Pages 14-20 China boost to South-South Implications of Argentina’s deal cooperation Pages 8-9 with the “holdouts” Pages 10-13 Boutros Boutros- Patents and the high cost of medicines Pages 21-22 Ghali—The Nobility of Ideas and Ideals South Centre Statement to UPOV on FAO-ITPGRFA Pages 23-24 Page 22 FDI, Investment Agreements & Development: Myths & Realities This article by the South Centre’s Chief Economist briefly ex- the notion that FDI is functionally in- plains the myths and realities of foreign direct investment (FDI). distinguishable from fresh capital in- It then analyses how a country’s investment policy is being con- flows and represents a flow of foreign strained by rules in the WTO and in the bilateral investment trea- resources crossing the borders of two ties (BITs). countries has no validity. Second, an important part of FDI involves transfer of ownership of ex- isting firms. Only the so-called green- field investment makes a direct contri- bution to productive capacity and in- volves cross-border movement of capi- tal goods. But it is not easy to identify from reported statistics what propor- tion of FDI consists of such invest- ment. In particular, statistics provide almost no information on how re- tained earnings and loans from parent companies, two of the three sources of finance for FDI, are used. Further- more, even when FDI is in bricks and mortar, it may not add to aggregate investment because it may crowd out domestic investors, as shown by most studies on the effects of FDI on domes- The Daily The Bell tic investment. Evidence also shows widespread association between rising FDI and falling gross fixed capital for- mation (GFCF) in the developing world. All these suggest that the eco- nomic conditions that attract foreign ways involve flows of financial capital By Yılmaz Akyüz enterprises may not always be condu- (movements of funds through foreign cive to faster capital formation and Foreign Direct Investment exchange markets) or real capital that the two sets of investment deci- (imports of machinery and equipment and Development sions may be driven by different con- for the installation of productive capac- Foreign direct investment (FDI) is per- siderations. ity). A large proportion of FDI does not haps one of the most ambiguous and entail cross-border capital flows but is Third, what is commonly known least understood concepts in interna- financed from incomes generated on and reported as FDI contains specula- tional economics. Common debate on the existing stock of investment in host tive components and creates destabi- FDI is confounded by several myths countries. Equity and loans from par- lizing impulses which need to be con- regarding its nature and impact on cap- ent companies account for a relatively trolled and managed as any other ital accumulation, technological pro- small part of recorded FDI and an even form of international capital flows. gress, industrialization and growth in smaller part of total foreign assets con- Many of the changes in financial mar- emerging and developing economies trolled by transnational corporations kets that have facilitated international (EDEs). It is often portrayed as a long- (TNCs). In 2008, retained earnings con- capital movements have not only in- term, stable, cross-border flow of capi- stituted 60% of outward FDI stock for creased the mobility of FDI, but also tal that adds to productive capacity, non-bank affiliates of US non-bank made it difficult to assess its stability. helps meet balance-of-payments short- corporations. In the same year, total FDI inflows to EDEs are subject to falls, transfers technology and manage- assets controlled by US affiliates were boom-bust cycles and closely correlat- ment skills, and links domestic firms 8.6 times the net external finance from ed with non-FDI (portfolio) flows as with wider global markets. US sources. Globally, in 2011, retained they are also influenced by global li- However, none of these are intrinsic earnings accounted for 30% of total FDI quidity conditions and risk appetite. qualities of FDI. First, FDI is more flows. In the same year, half of the Surges in FDI inflows could generate about transfer and exercise of control earnings on FDI stock in EDEs were unsustainable currency appreciations than movement of capital. Contrary to retained, financing about 40% of total in much the same way as surges in widespread perception, it does not al- inward FDI in these economies. Thus, other forms of capital inflows. FDI in Page 2 ● South Bulletin ● Issue 90, 16 May 2016 property is often motivated by specula- networks, but participation in such mestic content, export targets and tive capital gains and subject to severe networks also carries the risk of getting links with local firms; bubble-and-bust cycles. More im- locked into low-value-added activities. portantly, financial transactions can Domestic firms should be nur- To sum up, contrary to what is accomplish a reversal of FDI. What tured to compete with TNCs; maintained by the dominant corporate may get recorded as portfolio outflows ideology, FDI is not a recipe for rapid Linking to international produc- may well be outflows of FDI in dis- and sustained growth and industriali- tion networks organized by TNCs is guise: a foreign affiliate can borrow in zation in EDEs. However, this does not not a recipe for industrialization. It the host country in order to export cap- mean that FDI does not offer any bene- could trap the economy in the lower ital. Furthermore, foreign banks estab- fits to EDEs. Rather, policy in host ends of the value-chain. lished in EDEs can be a major source of countries plays a key role in determin- financial instability. They tend to con- Multilateral and Bilateral Con- ing the impact of FDI on industrializa- tribute to build-up of fragility in host straints on Investment Policy tion and development. A laissez-faire countries and transmit shocks from approach could not yield much benefit. The experience strongly suggests that home countries, as seen during the eu- It may in fact do more harm than good. policy interventions would be neces- rozone crisis. Successful examples are found not nec- sary to contain adverse effects of FDI Fourth, the immediate contribution essarily among EDEs that attracted on stability, balance of payments, capi- of FDI to the balance of payments may more FDI, but among those which used tal accumulation and industrial devel- be positive, since it is only partly ab- it in the context of national industrial opment and to activate its potential sorbed by imports of capital goods re- policy designed to shape the evolution benefits. Still, the past two decades quired to install production capacity. of specific industries through interven- have seen a rapid liberalization of FDI But its longer-term impact is often neg- tions. In this respect the experience of regimes and erosion of policy space in ative because of profit remittances and successful late industrializers, notably EDEs vis-à-vis TNCs. This is partly the high import content of production in East Asia, yields a number of policy due to the commitments undertaken and exports by foreign firms. Many lessons: in the World Trade Organization countries with a long history of in- (WTO) as part of the Agreement on volvement with TNCs face negative net Encourage greenfield investment Trade-Related Investment Measures transfers on FDI; that is, their new FDI but be selective in terms of sectors and (TRIMs). However, many of the more inflows fall short of profit remittances technology; serious constraints are in practice self- on the stock of inward FDI. Again, in a Encourage joint ventures rather inflicted through unilateral liberaliza- large majority of EDEs, export earnings than wholly foreign-owned affiliates in tion or bilateral investment treaties by foreign companies do not cover order to accelerate learning and limit (BITs) signed with more advanced their import bills and profit remittanc- foreign control; economies (AEs) – a process that ap- es. This is true even in countries highly pears to be going ahead with full successful in attracting export-oriented Allow mergers and acquisitions force, with the universe of investment FDI such as China. (M&A) only if there are significant ben- agreements reaching 3,262 at the end efits in terms of managerial skills and of 2014 (UNCTAD IPM, 2015). Alt- Finally, superior technology and follow-up investment; hough there is considerable diversity management skills of TNCs create an in the obligations contained in various Do not use FDI as a way of meet- opportunity for the diffusion of tech- BITs, the constraints they entail are ing balance-of-payments shortfalls. nology and ideas. However, spillovers becoming increasingly tighter than The long-term impact of FDI on exter- are not automatic but need to be ex- those imposed by the WTO regime. tracted through policy guidance and nal payments is often negative even in interventions. Foreign firms invest in EDEs attracting export-oriented firms; There are two main sources of EDEs in order to exploit their existing WTO disciplines on investment- Debt financing may be preferable competitive advantages such as rich related policies: the Agreement on to equity financing when there are no natural resources and cheap labour and TRIMs and specific commitments significant positive spillovers from infrastructure services rather than to made in the context of the General FDI; move them up on the technological Agreement on Trade in Services ladder.