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Trade and investment policy training workshop Introduction to Domestic and Foreign Direct Investment Lesley Wentworth, economic diplomacy – SAIIA 21 July 2015. Definition of FDI.
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Trade and investment policy training workshop Introduction to Domestic and Foreign Direct Investment Lesley Wentworth, economic diplomacy – SAIIA 21 July 2015
Definition of FDI • Foreign direct investment is understood as the acquisition of a lasting interest, usually with at least 10% stake, in an enterprise operating outside of the country of domicile of the investor, with the purpose of gaining effective say in the management of the enterprise. • Source: Balance of Payments Manual: Fifth Edition (Washington, D.C., International Monetary Fund, 1993)
Importance of FDI • Economic growth is driven by capital accumulation, therefore increasing investment in developing countries in particular is viewed as a key policy objective. • In countries with persistently insufficient domestic capital formation, foreign direct investment (FDI) is often welcome as a means to financing development and FDI has become the leading source of external financing.
Importance of FDI • Inward FDI is an important foreign capital inflow because it consists of concrete and intangible assets deployed into the domestic economy by important corporate members of the global economy. FDI has been shown to contribute to growth and development, complementing domestic investment and by facilitating trade and technology transfer. • Yet, the overall effects of FDI on economic growth in developing economies are far from certain, and contrasting perspectives on the developmental impact of FDI.
Sustainable FDI • International organisations have been promoting a new generation policy framework for sustainable investment: • Create synergies with wider economic development goals or industrial policies, and achieve seamless integration in development strategies; • Foster responsible investor behaviour and incorporate principles of corporate social responsibility (CSR); • Ensure policy effectiveness in their design and implementation and in the institutional environment within which they operate. UNCTAD, 2012. Investment Policy Framework for Sustainable Development. Geneva.
Importance of FDI • FDI is found to be favourable to economic welfare of the host country only if appropriate conditions exist. This includes adequate absorptive capacity (new financial capital and new technologies in plants, as well as human capital). • Also it is important that domestic businesses are not "crowded out" and are able to face up to foreign competition.
…and domestic private investment? • Ideally, market gaps filled by foreign companies are over and above those that can and should be filled by home producers. This means that industrial policy - while staying within the precincts of the rules of the multilateral trading system - should also seek to prop up infant industries to the degree that they are competitive and do not distort competition
supply and value chains • With the rise of MNCs, complexity of supply and value chains has grown, spreading across continents. Today, global value chains have enhanced the significance of FDI as a critical engine of trade and development, creating jobs, and promoting knowledge and technology transfers. In 2012, global GDP was USD$ 70 trillion, global exports in goods and services were USD$ 22 trillion, the global stock of FDI was also about USD$ 22 trillion, and global sales from FDI affiliates were USD$ 28 trillion. MNCs account for 80% of world exports with half of this located in global value chains. WEF Global Agenda Council on Global Trade and FDI.
SA in Global value chains • South Africa is integrated into several global value chains (GVCs), particularly in the automobile, mining, finance and agriculture industries. It may be unique in Africa in possessing the efficiency and scale to drive a global value chain. • As the (2nd) largest African economy it is also an important regional hub, and South Africa capitalises on regional value chains, especially in retail, finance and telecomms.
SA in Global value chains • South Africa would benefit from the diversification promoted by linkages and spillovers between industries. In order to increase the depth of value chains, measures that target skills development, expansion of technological capabilities and access to capital are essential. • A country's ability to participate in GVCs is essential for economic integration; however, being able to benefit from GVCs depends on how much value that country creates within the GVC. • In 2009, 70% of final demand for manufactured goods and services in SA represented value created domestically. The foreign value share was 30%. • Foreign value is more important in final demand for manufactured goods than in market services (which had the largest domestic value addition).
Spillovers and linkages • The evidence of positive spillovers is strongest and most consistent in the case of backward linkages, with local suppliers in developing countries where MNCs can benefit the host economy through relations with local suppliers of intermediate inputs in their production process. Backward linkages from FDI are beneficial to local suppliers in forms of increased output and employment, improved production efficiency, technological, managerial capabilities and market diversification.
Spillovers and linkages • Spillover benefits may be realised through forward linkages when MNC operates at the upstream sector of the domestic firm where the MNC operates as the input supplier of the domestic firm. Forward linkages with customers include marketing outlets, which may be outsourced, for instance petrol stations and restaurant chains.
Spillovers and linkages • Horizontal linkages occur when domestic firms benefit from foreign affiliates which are operating within the domestic firm’s sector from technology leakage from MNCs to local firms in the same industry. There are three types of spillover effects, which can potentially work at the horizontal level: the human capital effect, the demonstration effect and the competition effect.
Spillovers and linkages • The human capital effect: refers to the need for developing countries to have reached a certain point of development in order to absorb new technologies. Enhancing human capital can lead to higher productivity and profitability. • The demonstration effect: occurs when local firms learn from foreign firm by simply observing and mimicking their product innovations, techniques, managerial performance or forms of organisation – with local adaptations. • The competition effect: occurs as a result of competition from foreign affiliates in the sector introducing competitive pursuits from domestic firms trying to catch up with MNCs through R&D activities and reallocation of resources.
BEE and local content • While considered rational by many, the government’s greater focus on maximizing the domestic benefits of FDI, including implementing local and black economic empowerment partnerships, as well as local content agreements, does complicate the structuring of FDI transactions. • M&As - the local firm is mostly equipped to comply with these requirements is most used FDI model. • Greenfield investment persistently weak into South Africa, would likely be more complicated – if much more desirable.
FDI: positive effect on domestic investment? • Foreign capital as a source of development financing in developing countries can exert spillovers to the host economies, provided that MNCs effectively engage contributing to productive capacity – not just participation in trade-related activities that tend towards enclaves with no real linkages to the domestic economy.
Types of fdi Source: SAIIA OP 105
FDI: positive effect on domestic investment? • The “right kind of FDI” – long term, high quality and sustainable – is probably more responsive to a positive business environment and investment climate, emphasising the protection of private property rights, that provides the investor with the perception of safety of invested capital. • he inflow of FDI can have unintended consequences on an economy, including the development of hostility between foreign and domestic firms. It is therefore necessary to accelerate and sustain market economic reforms alongside policies aimed at regulating FDI.
