Relationship between Trade, Investment and Development
WT/WGTI/W/72 13 April 1999
Working Group on the Relationship between Trade and Investment (99-1465)
The following communication, dated 22 March 1999, has been received from the Permanent Mission of India with the request that it be circulated to Members.
Relationship between Trade, Investment and Development
- Foreign direct investment (FDI) and trade have become more closely interconnected in the framework of efficiency oriented, integrated international production strategies pursued by transnational corporations (TNCs). No doubt, FDI and trade support one another in this context. Also, there is no denying the need for national policy coordination between FDI and trade policies. But to arrive at an understanding on the extent and the depth of mutual supportiveness of trade and investment, one crucial question still needs to be answered – where do firms locate their value added activities and why? Factors that make particular locations attractive for particular activities become important. UNCTAD studies have listed various determinants of FDI flows, both economic as well as policy factors. Primary amongst them are economic growth, market size, profitability, cheap labour and developed infrastructure amongst economic factors; and private sector development, macro economic reforms and liberalization amongst policy factors. These conclusions still beg the crucial question – is development a prerequisite to encourage investment or does development follow investment? Three introductory sets of questions here may help further the educative process underway in the Working Group.
- The first set involves the basic question of investment regulation for development. It is said that FDI follows a country’s success, it rarely leads it. India is encouraging investment inflows for its development, and development needs policy direction. Hence, should investment flows also be directed? Infrastructure spending priorities of the Government would be a factor for attracting investment. Having limited resources, should investment inflows, therefore, be directed more towards infrastructure sectors to reach a level of development necessary to make FDI, trade and development conducive to economic growth? These questions are generic in nature and may apply to most of the developing countries, although stages of development, market size, geographical and regional factors would be relevant for individual countries.
- Secondly, while trade concerns itself with delivery of economic goods, investment involves their production. Along with money, material and machinery, labour as a factor of production would need to be equally considered. If other factors of global production are liberalized, can restrictions on mobility of labour be conducive to mutual supportiveness of trade and investment, or to economic growth and development? The extensive debate on free mobility of capital may have to be supplemented by an equally extensive study on free mobility of labour. If cheap labour is an important determinant of investment decisions, and results in higher profitability for investors which can be ploughed back into the home country economy, it may be, at the least, equitable to augment host country economies by returns from a mobile labour working in the investors’ home country.
- Thirdly, ‘more’ is not necessarily ‘better’ in the case of multinational corporate activities in developing countries. Studies have shown that between 25 and 45 per cent of FDI has a demonstrably negative impact on host societies. That is, the costs in terms of using scarce domestic resources inefficiently substantially outweigh the benefits of national income. Obviously, it introduces the need for competition and, thereby, efficiency. To ensure the greatest contribution to their own development, host governments may in fact have to refuse to grant the kind of treatment that many international companies want most. In fact, screening mechanisms can help developing countries sort out beneficial from detrimental foreign investment projects. This gives rise to the related question of investor’s obligations. Such obligations may be important for various economic, social and cultural necessities. Any study of trade and investment interface thus inevitably introduces concepts of TNC obligations, which are not new to the discussants here. We need to avoid tragedies of the type we had in Bhopal, India, a decade ago. We may also need to study obligations for protection of environment and sustainable development. Should TNCs, for example, not be asked to maintain the same environmental standards in host countries as they have in home countries, even though host country domestic investors have certain lower standards on account of lack of capital, technology or skills required, or on account of better assimilative capacities in their regions? These are issues that need further study.
- With this background, and with a view to coming back to these and other issues involving the development and economic growth dimension of the trade-investment relationship, let us further the educative process in certain critical areas, inter alia:
The relationship between investment and trade liberalization and stages of development, in particular, the experiences of countries, including the present industrial countries, in this connection
- Broadly speaking, stages of development as well as timing of investment in terms of stage of industrialization and globalization, affect the development and economic growth dimension in the trade-investment interface. As per Kiyoshi Kojima (1991), the micro-economic interests of MNCs dominate America’s FDI and as a result macro-economic impacts, such as the impact of FDI on patterns of comparative advantage, are largely ignored. On the other hand, the pattern of Japanese FDI has been characterized as the ‘trade-oriented type’ in which macro-economic impacts have been considered either explicitly or implicitly. He adds that Japanese FDI has contributed to the development of host countries with more efficiency than American FDI has in most cases. An industrial country example of managed economic growth through FDI in vertically integrated industries is cited in WIR 96 (page-119) viz. Japan’s early industrial strategy selectively promoted FDI in resource extraction, matching it with liberal import regulations for raw materials, protective policies against competitive FDI or manufactured good imports and export-promotion programmes to assist final product sales.
- Going to the next rung of development, two newly industrialized countries have been studied quite extensively. While FDI contributed significantly to the net private capital inflows in one of them, it was only marginal in the former. But both countries have shown equally gallant strides in economic growth as well as development.
- At the third rung, governments of low-income (as well as other) developing countries are increasingly aware of the potential value of foreign investment. There is, however, a danger of exaggerated expectations of what foreign investment can achieve, particularly of its rôle in resolving a severe foreign-exchange position through net inflows. The limited natural resource endowments and home markets of many low-income countries tend to make these countries particularly unattractive to foreign investors. Thus, without strong ‘fundamentals’ for economic growth and development, investment liberalization may mean little to them.
- Given this wide array of experiences, there is surely a need for a more coherent analysis of implications of investment and trade liberalization on economic growth of countries at various stages of development. The recent South-East Asian crisis adds to the need for further analysis before drawing any firm conclusions on the issue.
The rôle of FDI in transferring intangible assets, notably in the fields of technology and human resource development, the implications of this for development and the relation to the protection of intellectual property rights
- The implications in this case are even more nebulous. While traditional theory advocates the assumption that FDI promotes technology transfer, various studies, beginning with WIR 1991, pointed out that countries at low levels of development are likely to be able to induce FDI only into low-technology activities. The chicken-and-egg dilemma confronts us again here – should development and economic growth precede FDI to engender technology transfers? Certainly, as indicated by Lan and Young (Transnational Corporations, Vol.5 No.1, April 1996) a study of the problems of technology transfer into low-income countries is necessary. No doubt, national policy on the issue is of increasing concern for TNCs. To meet this demand, the international community has successfully concluded many conventions on the issue of property rights, most important being the TRIPs Agreement. But the connected issues of the international market for technology and, more generally, the advantages to host countries from the transfer of technology have not met with similar success. This crying need to study this issue in the context of development and economic growth needs to be addressed before FDI’s conclusive positive rôle is presumed.
- Another aspect of this issue is the positive national policy intervention required in order to facilitate transfer of technology through FDI. Joseph M. Grieco (1984) had taken the example of the computer industry and India and suggested that despite initial ‘turbulence’, ‘assertive’ countries can develop closer ties with international firms in high-technology to the domestic industry – a circumstance more conducive to a new and perhaps higher level of international order. It can be said, then, that national policy intervention may be a necessary prerequisite for developing a positive rôle of FDI in transferring intangible assets while ensuring protection of intellectual property rights at the same time.
The relationship between different types of FDI and the development process; experience with sectoral targeting and the rôle of industrial policy
- The FDI-trade linkage needs to be studied from the point of view of relationship of development and economic growth with sectoral thrusts in national policies. Grieco’s study (above) shows a symbiotic relationship between sector specific national policy intervention and development. There are numerous such examples that may be collected, collated and studied for their implications. Of particular interest would be to study sectors where comparative advantage lies with the developing countries – such an analysis would help the process of development and economic growth that we wish to achieve through this educative process.
- Two sectors of importance to developing countries are agriculture and textiles. In view of the continuing impediments to developing country access to industrialized countries’ market in agriculture and textiles, despite (or because of) the Uruguay Round agreements on those aspects, investment policy aspects may be studied in these two sectors specifically. For example, it is reported that some obsolete textile machinery is finding its way from industrialized to developing countries through various forms of investments or outright sales, thus blocking precious funds in technologies that may deny comparative advantage to host countries even after the Multi-Fibre Arrangement ends. Secondly, in agriculture, new forms of investments and innovations too often have been seen as a panacea by developing countries whereas there is ample evidence that in some cases the new forms shift risk to host-country producers.
- While such sectoral studies in areas relevant for comparative advantage would be helpful, it is equally essential to study the need for investments in certain sectors for development and economic growth. Core sectors, infrastructure, value added food products, textiles and other sectors have been requiring positive policy intervention. The rôle of industrial policy to encourage investment in such sectors is not denied. How this interfaces with the different types of FDI, and what is the right mix, is not clear though. A study of these issues is more likely to result in a recommendation for sector specific national efforts to facilitate development.
The determinants of the locational decisions of multinational enterprises
- These determinants, as identified by UNCTAD and elsewhere, have already been referred to in the introduction. The most important factors influencing the location decisions are concerned with the structural features of the host economy. Important positive determinants could be the level of prosperity, market size, growth rates, extent of industrialization and quality of infrastructure, and negative determinants could be high rates of inflation, current account deficits and political instability. Degree of openness of the economy, investment incentives and liberalization are not significant determinants. In fact, many investors prefer a protective régime so that they can bar the entry of potential competitors once they have jumped the tariff wall. Requirements of investment protection and dispute settlement are already being taken care of through bilateral agreements. Rather, as was evident in the recent UNCTAD expert meeting, even bilateral investment agreements have little effect on FDI flows. Given such conclusive evidence, determinants of locational decisions of TNCs have little implication for the trade-investment interface, and for this reason, there appears no reason to study their impact on development and economic growth. What is perhaps required is policy stability, which depends on domestic factors like political stability and economic fundamentals.
- The term FDI is being currently used, in a generic sense, to refer to the increase in the book value of the net worth of investments in one country, held by investors in another country, where the investments are under the management control of investors. It should be recognised at the outset that the term investment here is a misnomer because all the reported values of FDI flows do not imply addition to the stock of capital i.e., capital formation in the host economy. For example, take-overs do not add to capital. Hence, empirical data needs to be collected at the outset on the volume of take-over form of FDI flows and other forms to analyse the relative importance of those FDI flows, which lead to development and economic growth.
- The recent South-East Asian case demonstrates the unsustainability of large trade and current account deficits and profligacy induced by distorted trade and investment patterns. It shows how it has affected the value and level of domestic savings, fiscal position and balance of payments of these countries. Although more study and analysis may be required by taking stock of recent developments in that region, it can prima facie be concluded that FDI when channelled in the right way and in desirable sectors can positively contribute to economic growth and development. This may call for progressive and prudent liberalization and management of their trade regimes by developing countries so as to calibrate their impact on macro-economic stability.
- The Trade and Development Report (1997) indicates that trade, investment- and technology-led globalization has posed a major challenge to employment generation, income and wealth distribution within and among countries. That shows the importance of making international trade and investment policies more conducive to employment, income and wealth generation in developing countries commensurate with their natural, human, entrepreneurial and other resources. There should be both value creation and value realisation of their resources by developing countries in the context of international trade and investment flows.
- Competitiveness, transfer of technology and managerial skills are important benefits of trade and investment for development and economic growth. However, much would depend on how the investing firm actually transfers relevant and state of the art technology, shares managerial skills and competitive advantages such as global marketing and distribution networks and brand image. It is not sufficient for liberal trade and investment policies to be in place to ensure maximum positive impact on development and economic growth of developing countries in all their dimensions. Unless some responsibilities are also taken by investing firms, the positive nexus between trade and investment on the one hand, and development and economic growth on the other, may not materialize. Hence, the need for any international debate on the FDI issue to insist that these parameters be consciously provided for in terms of governmental policy as well as the investors responsibility and behaviour.
- Domestic markets of developing countries are generally moving towards larger indigenous enterprises, alone or in collaboration with foreign enterprises capturing market shares in a large spectrum of goods and services. SMEs are facing a crisis of competition and survival. This issue of a level playing field for domestic enterprises of developing countries in the context of their globalization is an issue that must be addressed in this Working Group, as well as that on trade and competition policy.
- Finally, mobility of all factors of production needs to be studied for a comprehensive educative process on this issue. Thus, mobility of labour should be inextricably linked with the discussions on trade-investment linkage if the WTO is to go beyond looking at delivery systems to look at production systems.