EU and Global FDI Overview

EU and Global FDI

The EU's share of global outward FDI grew from 38% in 1980 to 52% in 2006.
France, the Netherlands, and the UK were the main contributors to this growth.
New EU members like Spain, Italy, and Sweden significantly increased their FDI shares between 1980 and 2001.

Host Countries

Inward FDI has always been more diverse than outward FDI due to attractive location advantages offered by different countries.
The US became the largest host country for FDI in the 1980s and maintained its lead, holding 15% of the global stock in 2006.
China rose from 17th to 4th in global inward FDI by the 2000s, fueled by investments from developing Asian countries.
Central and Eastern Europe emerged as a significant FDI destination in the 1990s, increasing its share from nearly zero to 2.6% by 2002.
The EU's global inward FDI share increased from 31% in 1980 to 37% by 2001, becoming the largest host region with three times the US stock by 2006.

Investment Shift

FDI has shifted from resource-rich countries like Canada and Australia towards industrialized nations, especially the US and Europe.
Asia, particularly South, East, and Southeast Asia, has become a primary destination for FDI, replacing Africa and Latin America.

Developing Countries and FDI

FDI inflows to developing countries have steadily increased from 1970 to 2005, with an annual average of $210 billion during 2001-2005.
Developing countries consistently received around 30% of global inflows during this period despite fluctuations.
Latin America, particularly Brazil, was the largest host region for FDI in developing countries in the 1970s.
Asia surpassed Latin America in subsequent decades, with China emerging as the top host country in the 1990s.
The 1980s posed challenges for Latin America due to economic crises, while many Asian countries experiencing rapid economic growth attracted more FDI.
Latin America rebounded in the 1990s, opening its service industries to FDI, but Asia, especially China, continued to dominate FDI inflows.
Africa, although seeing growth in absolute FDI inflows, did not match the growth rates of Asia and Latin America.
By 2006, Asia held 60% of the FDI stock in developing countries, Latin America held 25%, and Africa held just 12%.

Transnationality Index

Although inward FDI is becoming more geographically distributed, it remains concentrated in specific countries.
The top five host developed countries hold 70% of inward FDI stock, while the top five developing countries hold 60%, and the top ten account for over 70%.
Between 1990 and 2001, the top ten host developing countries consistently accounted for 70-80% of FDI inflows.
FDI concentration ratios can create the impression that many countries, especially developing ones, are marginalized in international production.
UNCTAD's transnationality index provides a more accurate picture by considering:
- FDI inflows relative to gross fixed capital formation
- FDI stock as a share of GDP
- Value added by foreign affiliates relative to GDP
- Employment in foreign affiliates relative to total employment
Smaller countries often rank higher on the transnationality index compared to their FDI stock rankings, indicating their deeper involvement in international production.
Of the top ten developing FDI host countries, only Hong Kong, Singapore, and Chile are also in the top ten of the transnationality index.
Smaller developing countries like Trinidad and Tobago, Panama, and Costa Rica are more engaged in international production relative to their size than large countries like China.
In developed countries, smaller EU nations like Belgium, Luxembourg, and Ireland dominate the transnationality index, while the U.S. ranks much lower at 19th.
Overall, the transnationality index provides a more nuanced view of countries' involvement in global production than FDI concentration ratios alone.

Key Factors Determining FDI

The OLI framework explains FDI through three factors: ownership advantages, location advantages, and internalization.
Firms prefer FDI when they can leverage these advantages, and governments can attract FDI by enhancing location benefits.

Firm-Specific Determinants of FDI

Firms need ownership-specific advantages, like technology or expertise, to compete with local firms and engage in FDI.
They choose FDI over external transactions when internalizing production offers greater benefits, especially in imperfect markets.

National FDI Policies

Key Issues:
- How to define investment
- How to treat the entry of FDI and subsequent operations of foreign affiliates, including national treatment before and after entry
- What protection standards to use for takings of property, including nationalization or expropriation of foreign investors' property as well as indirect takings, and where to draw the line between regulatory takings and legitimate policy action
- What mechanisms to use for dispute settlement
- How to use performance requirements and incentives
- How to encourage the transfer of technology
- How to ensure competition, including the control of restrictive business practices by foreign affiliates
The main question regarding the definition of investment in national laws and IIAs is not whether FDI should be defined as investment, but what other investment should be granted the same status: portfolio investment, other capital flows, and various investment assets including intellectual property rights.

National Treatment

Treatment of FDI with respect to its entry and subsequent operations of foreign affiliates is probably the most important issue related to national FDI policy.
Arguments for:
- Pre-establishment national treatment for host countries: This is related to the promotion of national enterprises, building and enhancing domestic capabilities. This relates to:
  - Protecting infant entrepreneurship
  - Local technological strengthening
  - Exploitation of new technology
  - Greater spillovers
  - Footloose activity
  - Loss of economic control
- Post-establishment national treatment: This is on grounds of market and institutional failures. This includes:
  - Incentives give rise to administrative costs, which tend to increase as the discretion and complexity of schemes increase.
  - Potential efficiency losses if firms are encouraged to locate where incentive-based subsidies are most generous rather than where location factors are most favorable for efficient resource allocation.
  - Incentives may sometimes give rise to unintended distortions by discriminating between firms that are relatively capital-intensive and those that are relatively labor-intensive, between projects of different cash-flow profiles, or between large and small firms.
  - Tax incentives may induce TNCs to use transfer pricing to shift profits to locations with the most generous tax conditions, eroding the tax base in several host countries.

Transfer of Technology

Technology diffusion = technology spread
The transfer and use of new technology to TNCs foreign affiliates is only one facet of the contribution that FDI can make towards strengthening the technological capabilities of host countries.
Another benefit, often larger, is the diffusion of technology and skills to people and domestic firms within the host economy.
Much of this diffusion takes place in the form of spillovers or externalities that arise involuntarily or result from actions deliberately undertaken to overcome information problems.
Positive spillover effects leading to the diffusion of technology and skills from foreign affiliates to a host economy may occur through four channels:
- Competition with local firms, stimulating foreign affiliates to improve efficiency and technological capabilities, and raise productivity.
- Cooperation between foreign affiliates and local suppliers, customers, and institutions with which they have linkages, leading to information exchange and technical collaboration that enhances the technological capabilities of the linked local agents.
- Labour mobility, particularly of highly trained personnel, from foreign affiliates to domestic firms including supplier firms set up by former TNC employees, often with the support of their former employers.

Definition of Investments and Investors

To define investments and investors, you need to consider your country's specific policies regarding investment.

Admission and Establishment

Right of Admission: This deals with the entry and presence of foreigners in the territory of a host country. It grants a permanent or temporary right to carry out business transactions in a host country, but does not necessarily include the right of establishing a permanent business presence.
Right of Establishment: This deals with the rights of a foreign investor to establish a permanent business within the territory of a host country. This right is therefore narrower than the right of admission.
National Treatment (NT): This principle means that a host country extends to foreign investors treatment that is at least as favorable as the treatment that it accords to national investors in like circumstances.
Most-Favored-Nation Treatment: This principle means that a host country extends to foreign investors treatment that is at least as favorable as the treatment that it accords to other foreign investors in like circumstances.

The Post-Establishment Approach

This approach is an application of the customary law principle that grants limit admission and establishment of foreign investments within their territories.
Under this approach, national treatment is granted only after the establishment of a foreign investment within the territory of a host country.
Consequently, IIAs do not accord positive rights of entry and establishment to foreign investors of the other contracting party.

The Pre-Establishment Approach

Pre-establishment rules provide clear and transparent provisions that increase predictability and reduce the degree of risk when entering a new market. They aim to avoid discrimination between foreign and domestic investors and/or investors from different foreign countries.
Under this approach, the host State limits its sovereign power regulating the entry of foreign investors and grants them full rights of admission and establishment based on whichever is better, national treatment or most-favored-nation treatment.
This is subject only to a reserved list of sectors or activities to which such rights do not apply.

Exercises

Question 1: The difference between admission and establishment of a foreign investor is that the right of admission grants the right to carry out business transactions in a host country, but not necessarily establish a permanent presence. The right of establishment, on the other hand, allows for the establishment of a permanent business within the host country.