The South Centre recently published Research Paper No. 63: Foreign Direct Investment, Investment Agreements and Economic Development: Myths and Realities, authored by Yılmaz Akyüz.

ABSTRACT:

Foreign direct investment (FDI) is one of the most ambiguous and the least understood concepts in international economics.  Common debate on FDI is confounded by several myths regarding its nature and impact on capital accumulation, technological progress, industrialization and growth.  It is often portrayed as a long term, stable, cross-border flow of capital that adds to productive capacity, helps meet balance-of-payments shortfalls, transfers technology and management skills, and links domestic firms with wider global markets. However, none of these are intrinsic qualities of FDI.  First, FDI is more about transfer and exercise of control than movement of capital.   It does not always involve flows of financial capital (movements of funds through foreign exchange markets) or real capital (imports of machinery and equipment for the installation of productive capacity).  Second, only the so-called greenfield investment makes a direct contribution to productive capacity and involves cross-border movement of capital goods, but it is not easy to identify from reported statistics what proportion of FDI consists of such investment as opposed to transfer of ownership of existing assets.  Third, what is commonly reported as FDI contains speculative and volatile components.  Fourth, the longer-term impact of FDI on the balance of payments is often negative even in countries highly successful in attracting export-oriented FDI.  Finally, positive technological spillovers from FDI are not automatic but call for targeted policies of the kind that most investment agreements prohibit.

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CONCLUSIONS

Unlike maintained by the dominant corporate ideology, FDI is not a recipe for rapid and sustained growth and industrialization in EDEs. A hands - off approach to FDI, as to any other form of capital, can lead to more harm than good. FDI policy needs to be embedded in the overall industrial strategy in order to ensure that it contributes positively to economic dynamism of EDEs. The discussions above suggest several policy lessons:

· Encourage greenfield investment but be selective in terms of sectors and technology;

· Encourage joint ventures rather than wholly foreign - owned affiliates in order to accelerate learning and limit foreign control;

· Allow M&A only if there are significant benefits in terms of managerial skills and follow - up investment;

· Do not use FDI as a way of meeting balance - of - payments shortfalls. The long - term impact of FDI on external payments is often negative even in EDEs attracting export - oriented firms;

· Debt financing may be preferable to equity financing when there are no significant positive spillovers from FDI;

· FDI contains speculative components and generates destabilizing impulses which need to be controlled and managed as any other form of international capital flows;

· No incentives should be provided to FDI without securing reciprocity in benefits for industrialization and development;

· Performance requirements may be needed to secure positive spillovers including employment and training of local labour, local procurement, domestic content , export targets and links with local firms;

· Domestic firms should be nurtured to compete with TNCs;

· Linking to international production networks organized by TNCS is not a recipe for industrialization. It could trap the economy in the lower ends of the value - chain.

Policy space in all these areas might be somewhat constrained by the WTO agreement on TRIMs, but it is still possible for EDEs to encourage positive spillovers without violating the WTO commitments. However, many of the more serious constraints are in practice self - inflicted through investment and free trade agreements. There are strong reasons for EDEs to avoid negotiating the kind of BITs promoted by AEs. They need to turn attention to improving their underlying economic fundamentals rather than pinning their hopes to BITs in attracting FDI. Where commitments under taken in existing BITs seriously impair their ability to use FDI for industrialization and development, the y can be renegotiated or terminated, as is being done by some EDEs, even if doing so may entail some immediate costs.

South Centre Research Paper No. 63, October 2015, 45 pages, English, ISSN 1819-6926

To access the research paper, go to this webpage: http://www.southcentre.int/research-paper-63-october-2015/