INTERNATIONAL TRADE AND INVESTMENT TRENDS

by

Karl P. Sauvant

Chief, International Investment, Transnationals and Technology Branch

Division on Investment, Technology and Enterprise Development

UNCTAD - Room E.8006

Palais des Nations

CH-1211 Geneva 10

Switzerland

Tel.: 41-22 907-5707

Fax : 41-22 907-0194

Keynote address

First Annual Australian Conference on International Trade,

Education and Research

Australian APEC Study Centre

The University of Melbourne

Melbourne, 5-6 December 1996

***

ITE/PPR/1996/3

It is a privilege and pleasure for me to participate in this First Annual Australian Conference on International Trade, Education and Research. The topic given to me -- international trade and investment trends -- is particularly topical, given next week's WTO Ministerial Conference in Singapore. While the Singapore meeting focuses, of course, on trade, the question of whether or not investment ought to be put on the agenda is one of the issues on which the preparatory process could not reach consensus.

In the light of this, my presentation will not deal with trade per se and investment per se (although I will give some attention to investment trends), but rather on the interaction between investment and trade and the international policy framework in this area. In so doing, I can draw on the World Investment Report 1996, whose subtitle -- and, hence, focus -- is "Investment, Trade and International Policy Arrangements".

***

We all know about the importance of trade as an engine of growth and a mechanism to link markets internationally. I need not elaborate on this subject as Mr. Bora will speak, in the next presentation, about changing patterns of global trade. Suffice it to say that trade has grown rapidly, helped by the liberalizing framework of, first, GATT and, now, the WTO. The volume of world trade is now some $5 trillion.

***

Foreign direct investment (FDI), too, has grown rapidly, more rapidly indeed than trade and domestic production. In the early 1980s, world FDI flows amounted to some $40 billion; in 1995, FDI flows to developing countries alone amounted to $100 billion, with world flows reaching $315 billion.

These figures mask, of course, a number of important characteristics. Let me briefly look at them, first from a home country and then from a host country perspective.

1. There has been a considerable diversification of home countries. If, in the past, the U.S. and the U.K. had been the dominant home countries, today all developed countries have a significant number of firms that invest abroad. What is more, firms from developing countries are increasingly becoming outward investors, accounting for 15% of world outflows in 1995. Most of these outflows take place in a regional context, and there they can be quite important. In Asia, some 40% of the FDI inflows into the developing countries of the region originate in other developing countries in the region. As a result, enterprises from Asian developing countries have become the single most important investors in Asia, ahead of firms from Japan, the U.S. and Europe.

As far as European firms are concerned, one can even say that they neglected Asia. Today, only some 3% of the total FDI stock and flows of the EU are directed towards developing Asia. As it happens, this figure is quite similar when it comes to Asian developing countries' FDI in Europe, which accounts for about 4% of developing Asia's FDI. In other words, neither Europe nor developing Asia have directed their outward FDI significantly to each other. But while Europe's low share in Asia arguably reflects a neglect by European firms of a region that people agree is the most dynamic in the world today, Asia's low share in Europe, most people would also agree, simply reflects the fact that Asian firms are only just beginning to build up their outward investment stocks.

2. Looking at FDI flows from the host country side, one finds that the developed countries continue to dominate the picture. But, again, the more interesting aspect is that the share of the developing countries has increased, reaching some 30% of world inflows in 1995. Within the developing world, Asia has attracted the lion's share, some two-thirds of the $100 billion that went to developing countries in 1995, to be precise. Within Asia, China has been the star performer (although 1996 may well see a bit of a decline in FDI inflows), followed by the ASEAN countries.

The dominance of China also draws attention to another characteristic of FDI flows, namely that they are highly concentrated. To be more specific, the largest ten host countries receive about two-thirds of FDI inflows, while the smallest 100 recipients receive only 1%.

Australia, incidentally, had average annual FDI inflows of about $4 billion between 1991-1994, an amount that more than tripled to $13 billion in 1995. This compares to outflows of about $5 billion in the same year.

There is one more thing that I would like to mention, namely that a good part of FDI consists of "sequential" and "associated" FDI. "Sequential" FDI is undertaken by foreign affiliates that are already established, and consists mostly of reinvested earnings. "Associated" FDI is FDI that is triggered by the establishment or expansion of existing foreign affiliates; it is typically undertaken by suppliers or by rival firms that follow a leader into foreign markets. A good part of FDI in the services sector also falls into this category. Services FDI, incidentally, now accounts for about 50-60% of FDI flows.

As a result of the rapid growth of FDI flows, the world stock of FDI is now nearly $3 trillion, owned by some 40,000 transnational corporations (TNCs) through more than 270,000 foreign affiliates (not counting numerous non-equity forms of controlling assets abroad, including through strategic alliances). This stock of $ 3 trillion gives rise to some $6 trillion of sales by foreign affiliates.

***

What does this all add up to?

I had made reference earlier to trade as an engine of growth and a mechanism to link markets internationally. I mentioned also that world exports are now worth about $ 5 trillion.

If this $5 trillion of exports is compared with the $6 trillion of sales by foreign affiliates, it becomes obvious that FDI has become more important than trade in terms of delivering goods and services to foreign markets and, thereby, linking markets internationally. In the case of the U.S., in fact, three-quarters of all goods and services delivered to foreign markets are actually delivered by foreign affiliates. This is a situation that is strikingly different from that which prevailed immediately after World War II, when trade alone reigned supreme when it came to international economic transactions.

But FDI is not only a mechanism to link markets, it is also a mechanism to link the production systems of countries internationally. In the past, this linking of production systems was not very pronounced, as most TNCs pursued stand-alone strategies, in the framework of which foreign affiliates were largely autonomous units, only loosely integrated into their overall corporate networks. Today, however, an increasing number of TNCs is pursuing complex integration strategies that are characterized by a vertical and increasingly horizontal international intra-firm division of labour in which any part of the value-added chain can be located abroad while remaining fully integrated in the corporate network as a whole. Complex corporate integration strategies seek to exploit regional or global economies of scale and a higher degree of functional specialization. The results are integrated international production networks at the firm level. The aggregation of these production networks, in turn, leads to the emergence of an integrated international production system -- the productive core of the globalizing world economy.

This linking of the productive systems of countries represents deeper integration than that achieved by trade. Unlike trade -- which normally involves one-off transactions of goods and services -- FDI, by its very definition, involves the establishment of lasting relationships that engage the factors of production of the countries involved. At the same time, the corporate networks that are being established in the process can serve as conduits between countries -- not only for capital, but also for technology, know-how and skills, as well as for imports and exports. This underlines that FDI is actually a package of tangible and intangible resources, all of which can make FDI an engine of growth.

***

The reference I just made to TNC networks being conduits for imports and exports brings me to the interrelationships between FDI and trade. At the aggregate level, we estimate that about one-third of world trade is intra-firm trade (i.e., takes place internationally within the same corporate networks), and that another one-third of world trade is undertaken by TNCs. These figures show how closely FDI and trade are, indeed, interrelated -- an interrelatedness that we can expect to increase further with the growing international integration of corporate production networks.

This raises an important question, namely: how are FDI and trade interrelated? Or, to put it differently, does trade lead to FDI? Or does FDI lead to trade?

In trying to understand the interlinkages between FDI and trade, it is useful to begin by noting that, historically, the internationalization process for a product (and, often, for a firm) has been characterized by a sequential movement running from trade to FDI or from FDI to trade. In the case of market-seeking manufacturing firms, the sequence typically runs from domestic production in the country of origin, to exports, often followed by licensing or other contractual arrangements, and finally, FDI. On the other hand, in the case of manufacturing firms seeking low cost inputs, the process could begin with FDI, followed by exports from the host country. This latter sequence is also, obviously, the one that characterizes the process in many natural resources. In services, of course, trade (as traditionally understood) is not an option -- or at least it was not, until recently -- and firms must engage in foreign production if they want to expand into international markets: the linear sequence of moving comfortably from exporting to FDI gets truncated; services firms that have built up competitive advantages generally have to invest abroad in order to exploit these in foreign markets. As services, especially in information-intensive industries, become transportable due to advances in telecommunications and information technologies, this situation may change.

The relevance of the traditional sequence of internationalization that I have just mentioned for the interrelationship between FDI and trade is that, to some extent, the sequence as it occurred in many manufacturing products is partly responsible for the notion that FDI and trade are substitutes. Yet, if one looks at the process all the way, it becomes clear that, by and large, FDI and trade are complementary or mutually supportive: if one considers the relationship at the level of a single product or a single-product firm, the only situation in which FDI substitutes for trade is that of a market-seeking manufacturing investment that might replace exports of a given product or firm. In all other cases, FDI is either trade-creating or, as in the case of services, neutral. Once we move to consider the effects at an industry or country level, of course, the relationship becomes much more complicated, because of associated or secondary effects operating through exports of intermediate products, machinery or services by parent firms or other firms in a home country to foreign affiliates, regardless of sector, or through associated FDI that often follows when investment in a particular product -- whether a good or service -- has been made. From what we know on the basis of empirical studies, it seems that the overall impact of the various direct and indirect effects that occur, regardless of the initial sequence, is that FDI is unlikely to be trade-replacing, either for the home or the host country, except of course, where policies are implemented with the specific idea of replacing trade by FDI or FDI by trade.

The expansion of FDI and trade therefore creates, at least globally, a win-win situation. In the best case, this expansion links the trade engine of growth with the investment engine of growth.

The complexity of the interrelationship between FDI and trade is increasing significantly as a result of changes in the economic environment for international transactions that have taken place in recent decades -- in particular, the reduction of technological and policy-related barriers to the movement of goods, services, capital, professional and skilled workers and firms. One result has been that international production has grown significantly and the number of TNC parent-firms and foreign affiliates has increased substantially. This, coupled with a much more enabling environment both technologically and policy-wise, has meant that firms are much freer to choose how to serve markets or how to obtain foreign resources. They can, moreover, start the internationalization sequence for a new product anywhere within their TNC systems, and skip over steps in the process. All of this gives firms much greater leeway to take a regional or global view of markets and to serve them in the most efficient way possible, combining FDI and trade.

The decision to locate any part of the value-added chain wherever it is best for a firm -- be it transnational or national -- to convert global inputs into outputs for global markets means that FDI and trade flows are determined simultaneously. They are both immediate consequences of the same locational decision. The question therefore becomes more and more, no longer whether trade leads to FDI or FDI leads to trade; whether FDI substitutes for trade or trade substitutes for FDI; or whether they complement each other. Rather, it becomes: how do firms access resources -- wherever they are located -- in the interest of organizing production as profitably as possible for the national, regional or global markets they wish to serve? In these circumstances, the decision where to locate is a decision where to invest and from where to trade. And it becomes a FDI decision, if a foreign location is chosen. It follows that, increasingly, what matters are the factors that make particular locations advantageous for particular activities, for both, domestic and foreign investors.

***

This increasingly simultaneous determination of FDI and trade flows and the role of trade and FDI in development have profound policy implications. To begin with, for governments this means that, increasingly, they have to make sure that their policies towards FDI and trade are in harmony with each other if they wish to take advantage of the interrelationships between FDI and trade. Broader, the distinction between domestic investment and foreign investment becomes more and more blurred. More specifically, governments need to make it not only attractive for foreign investors to come to their shores; they increasingly need to make it also attractive for domestic investors to stay on-shore, if they wish to fuel economic growth.

In brief, governments have to create an environment in which investment -- be it domestic or foreign -- can prosper. What is more, they have to do this under conditions in which all governments are competing -- and are competing fiercely -- to do the same, namely to entice their own firms as well as foreign firms to locate production facilities on their territories.

***

Part of this competition takes the form of policy competition and is aimed at establishing the best enabling framework for investment. Policy competition takes place at several levels:

- First and foremost at the national level. To illustrate, in 1995 alone, 106 out of 112 regulatory changes in the FDI regimes of 64 countries went in the direction of greater liberalization or promotion. If one takes the period 1991-1995 as a whole, only 11 out of 485 policy changes that could be identified went into the direction of greater control. This signals a powerful liberalization trend indeed. In fact, in the highly competitive world market for FDI, "best practices" by one government in respect to the regulatory framework for FDI rapidly become "benchmarks" for other governments. And such benchmarking is particularly relevant in a regional context.

- Something comparable is happening at the bilateral level as well, where the principal instruments are double-taxation treaties and bilateral investment treaties. As of June 1996, there were 1,160 BITs in existence, two-thirds of them concluded during the 1990s. Some 158 countries participate in them, including, increasingly, developing countries concluding such treaties with other developing countries.

- At the regional level, too, governments seek to improve the framework for investment flows, especially in the context of the EU, NAFTA, the Lomé Convention, APEC and Mercosur. In fact, these agreements are no longer only free trade agreements but more and more free investment agreements as well.

- At the multilateral level, finally, the OECD has embarked on negotiations on a Multilateral Agreement on Investment. In addition, a number of issue-specific arrangements exist, including as regards services, performance requirements, intellectual property rights, insurance, settlement of disputes and employment and labour relations. Attention is also being paid to restrictive business practices, incentives and consumer protection.

Experience with past efforts suggests that the evolution of international arrangements for FDI has followed and interacted with developments at the national level and reflects the priorities and concerns of a particular period. Progress in the development of international investment rules is linked to the convergence of rules adopted by individual countries. Furthermore, an approach to FDI issues that takes into account the interests of all parties is more likely to gain widespread acceptance and, ultimately, to be more effective. This raises the question of how an appropriate balance of rights and obligations among the actors affected can be found.

Widespread recognition is emerging at the present time on the principal issues that need to be addressed by international discussions on FDI, including general standards of treatment of foreign investors in relation to entry and establishment and operational conditions; protection standards, including dispute settlement; issues relating to corporate behaviour; and other issues, such as the promotion of FDI. Thus, there seems to be some consensus that greater international cooperation on FDI issues is desirable.

But there are quite keenly-felt differences between governments about how to proceed in the immediate future. Some favour allowing current arrangements -- which, after all, are working quite well in providing an enabling framework for FDI to expand and contribute to growth and development -- to evolve organically, while improving them by deepening and expanding them. Others favour an approach that involves the construction, through negotiation, of a comprehensive multilateral framework for FDI, the rationale being that the globalization of business, increased volumes and the growing importance of FDI, and the intertwined nature of FDI and trade require a global policy framework.

These differences in approach partly hinge on the question of what consequences a multilateral framework would have, especially as regards investment flows and their impact on development. Many developing countries, in particular, look at this issue from the perspective of the implications of a multilateral framework for national development.

Having said this, it is clear that most efforts at the national and international levels in the area of investment have one thing in common: they seek to facilitate cross-border investment, with a view towards attracting FDI, and in recognition that such investment has an important role to play in the development of countries. This is not to say that development is not possible without FDI, or that FDI cannot have a negative impact in individual countries, e.g., where competition is stifled, certain restrictive business practices are employed or transfer prices are manipulated. As always, governments need to play a pro-active role in order to increase the contribution that FDI can make to development. This role, however, needs to be carefully calibrated, and formulated in full awareness of the constraints -- and opportunities -- created by a liberalizing and globalizing world economy. As the specific configuration of these constraints and opportunities varies from country to country, it is a true challenge for policy makers to find the proper policy mix that makes their countries attractive for domestic and foreign investors and that lets their countries benefit as much as possible from the investments of these investors.

* * *

Australian APEC Study Centre Publications

The Australian APEC Study Centre Homepage

Http://www.monash.edu.au/ausapec/citer1 Last update: 17 March 1997