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Trends in FDI in Developing Countries: Background

Written by: OECD Development Centre

Article Overview: During the past two decades, a number of developing countries witnessed a growing importance of FDI as the primary source of financial capital flows into their economy. FDI brings not only increased access to foreign exchange, trade and employment, but also new products, information and technology. It is no coincidence that this rapid growth of FDI was accompanied by an increase in the level of human capital. The latter was achieved by strong government commitments to expand formal education and vocational training along with improved enterprise efforts to improve training opportunities for workers. This section looks at recent trends in both FDI and HRD in order to highlight the magnitude of this issue as well as to explain some of the key issues raised in this paper.

Trends in FDI in Developing Countries: Background

During the past two decades, a number of developing countries witnessed a
growing importance of FDI as the primary source of financial capital flows into their
economy. FDI brings not only increased access to foreign exchange, trade and
employment, but also new products, information and technology. It is no coincidence that
this rapid growth of FDI was accompanied by an increase in the level of human capital.
The latter was achieved by strong government commitments to expand formal education
and vocational training along with improved enterprise efforts to improve training
opportunities for workers. This section looks at recent trends in both FDI and HRD in
order to highlight the magnitude of this issue as well as to explain some of the key issues
raised in this paper.
II.1. Trends in FDI in Developing Countries
Developing countries receive financial flows from numerous private and public
sources. Private flows come from FDI and capital markets, the latter being bank lending,
bond financing and equity flows. Most official flows come from official development
assistance (ODA). Figure II.1 presents trends of different sources of financial flows to
developing countries during the past decade. It indicates that FDI used to be relatively
less important as compared to official flows, before the early nineties. After 1993,
however, both the share and the level of FDI grew substantially and it is now the
dominant source of financial flows into developing countries.

This large expansion in FDI took place in two different forms: mergers and
acquisition (M&A) and Greenfield investment. The former include equity acquisition of
private companies and privatisation of public enterprises, the latter being quite popular in
developing countries. Greenfield investments involve new capital investments by MNEs
via establishing overseas subsidiaries (or affiliates) that serve as part of the global
production/distribution network. Due to the difference in the mode of investment, M&A
and Greenfield investment are expected to exhibit different impacts on host developing
countries. Greenfield investment is more likely to have strong impact, at least in terms of
HRD, since the former is a change in ownership structure while the latter is in essence a
new investment which requires large MNE involvement to the local environment.
Table II.1 presents FDI by forms of investment. It shows that industrial countries
have invested two to five times more in M&A than Greenfield investments during the past
15 years. In developing countries, however, Greenfield investment has been the major
mode of FDI. This trend implies, to some extent, that developing countries do not as yet
have abundance of firms attractive enough for foreign investors to acquire. However, for
host developing countries seeking large capital investment in infrastructure and human
resources, Greenfield investment provides large prospects for streamlining government
and private sector investments that can be complementary. For developing countries
with severe budgetary constraints, increased Greenfield investment may also
compensate for underinvestment by the governments.

The gradual increase in M&A and Greenfield investment as well as its relative
importance in developed and developing countries should be reflected in the trends of
FDI across time. Table II.2 presents inward flows and stocks of FDI during the past two
decades. It shows a gradual increase in FDI flows until the year 2000 for developed and
developing countries. The sudden drop in FDI flows in the year 2001 is related to
depressed stock market sentiments and business cycles, both of which led to a massive
drop in M&A investments especially in the developed countries (UNCTAD, 2002a).
Table II.2 also indicates that FDI in developing countries is not necessarily a small
fraction of the global FDI. While the drop in FDI in the year 2001 is acute in developed
countries, developing countries show a relatively mild drop4. This is presumably due to
the fact that a large fraction of FDI in developing countries is in Greenfield investment
(UNCTAD, 2001).

In spite of the rapid growth in the level of FDI during the past two decades, these
investments have not been equally distributed within the developing regions. To see this,
Table III.3 breaks down the flows and stocks of FDI by regions within developing country.
The African region has not been successful in attracting a large amount of FDI due to the
fact that it has only been able to attract FDI in primary and resource-based
manufacturing sectors, both of which have limited scope for future expansion. The Latin
American and the Caribbean (LAC) and Asian & Pacific (AP) regions, however, have
both succeeded in increasing the level of FDI during the past two decades. This is partly
due to these regions successfully attracting relatively higher value-added FDI over time.
Table II.3 thus indicates large cross-regional inequality in the level and growth of FDI
over the past two decades.

One reason behind cross-regional disparities of FDI in developing countries may
be due to concentration of FDI in selected countries. Indeed, the five largest host
countries in the developing world received 62 per cent of total FDI inflows while the ten
largest host countries received three-quarters of total FDI in 2001 (UNCTAD, 2002a).
This, however, does not necessarily diminish the role of the small country’s role in FDI. If
FDI is measured as a fraction of GDP, many small countries actually fair better than most
of the above-mentioned five largest host developing countries (World Bank, 2003).
To summarise, FDI has been the most important form of financial flow in the
developing countries with Greenfield investment being the most dominant form. Although
these countries have enjoyed a gradual increase in both the stocks and flows of FDI over
the past decade, the growth of FDI was unevenly dispersed across the developing
region.

OECD DEVELOPMENT CENTRE
Working Paper No. 211
HUMAN CAPITAL FORMATION
AND FOREIGN DIRECT INVESTMENT
IN DEVELOPING COUNTRIES
by
Koji Miyamoto

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Article Tags: capital investments, development assistance, dominant source, exchange trade, fdi in developing countries, financial flows, formal education, global production, government commitments, greenfield investment, greenfield investments, hrd, importance of fdi, information and technology, mergers and acquisition, mnes, overseas subsidiaries, private flows, production distribution, public sources



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