The economic crisis slashed global FDI flows by around 40 percent in 2009, affecting, albeit to a varying extent, all countries, all sectors, and all forms of investment. Mergers and acquisitions in high-income countries were the quickest to contract soon after the sub-prime mortgage crisis in 2007. Gradually the contagion spread and affected new, greenfield investment, and expanded geographically from the Western industrial countries to the emerging markets and developing economies. Still, developing countries faired marginally better during the crisis. According to UNCTAD, a UN agency, FDI flows to developing countries in 2009 declined by 35 percent, slightly less than the 41 percent fall in high-income countries. As the graph below indicates, they still show a robust increase over the levels of five or more years ago.
Strong growth in FDI to developing countries
The contribution of developing countries to the global economy is rapidly increasing. In 2004, less than a fifth of the value of the world’s economic output was produced in developing countries. By 2008, this figure reached almost 30 percent. In other words, over the last 20 years developing countries have grown faster than developed economies. The global economy grew at 3.5 percent per year during the five-year period prior to the financial crisis. During this same period, the GDP of high-income countries rose only by 2.4 percent each year, while developing economies expanded three times as fast, at 7.3 percent. The gap between growth rates of developing and high-income countries has widened steadily since 1999 (see graph overleaf).
Developing countries increase FDI
Rapid growth and industrialization in the developing world has also given birth to new multinational companies (MNC) from these countries. Brands such as Samsung, Hyundai, Cemex, Embraer, Infosys, Tata, Lenovo, PETRONAS or Standard Bank have now become ubiquitous. According to UNCTAD’s 2009 World Investment Report, seven of the world’s 100 largest MNCs now come from developing countries. Their relative size has also grown rapidly. In 2007, assets of the 100 largest MNCs from developing countries rose by 29 percent from their level in 2006. In comparison, this figure reached only 16 percent for the 100 largest MNCs worldwide. Developing country MNCs are increasingly becoming significant market players in their domestic, regional as well as global markets, leading to rapid growth in South-South FDI.
MNCs from all parts of the world are usually attracted to developing countries by lower costs, strong growth prospects, and in many cases untapped natural resources. In other areas which are typically key drivers of foreign investment – political and macroeconomic stability, quality of infrastructure, and rule of law, among others – most developing countries still have a lot of catching up to do. By some measures, however, developing countries are making quite a bit of progress. According to the Doing Business project of the World Bank Group, between June 2008 and May 2009 low- and lower-middle-income countries introduced twice as many reforms in their business environments as high- and upper-middle-income countries. By this measure, the top 10 reforming countries over the last few years have mostly been developing countries, such as Egypt, Rwanda, Colombia or the Kyrgyz Republic.
Developing countries are not a homogenous group, however. The larger the country, the more opportunity for business, and hence more opportunity for investment: top performers are the BRIC countries as well
as other large economies such as Mexico or Turkey.
While China does very well on an absolute basis (first data column), its FDI per capita and FDI as a share of GDP are relatively low compared to the other leading recipients of FDI in the developing world. Bulgaria, Chile, and Romania stand out on a per capita basis (second data column). In addition to these three countries, in Russia, Thailand, Egypt, and Malaysia, FDI constitutes a relatively large share of the domestic economies.
Sub-Saharan Africa’s vibrant development
FDI to low-income countries has also grown significantly faster than in high-income countries. Average inflow to low-income economies during the five-year period before the crisis (2003-2007) was more than 100 percent higher than during the five year period at the turn of the decade (1998-2002). The comparable figure for the high-income economies is only 14 percent. Two key factors are simultaneously at play here. Firstly, many developing economies are starting from a low base, so even a couple of large investments can easily double or treble a country’s performance over the year before. Secondly, and more encouragingly, multinational companies are increasingly confident about returns on investment in developing countries, including Sub-Saharan Africa.
According to the Africa Competitiveness Report 2009 published by the World Economic Forum, Africa’s FDI stock nearly doubled between 2003 and 2007, and annual GDP growth averaged 5.9 percent during 2001-2008. Furthermore, most African economies have steadily improved their competitiveness during this period. The report notes that the most significant improvements have been in goods market efficiency, greater market openness, quality and quantity of higher education and training, and greater sophistication of business practices. On the other hand, infrastructure, macroeconomic stability, and health conditions have either not improved, or have regressed in some African countries.
This positive trend for Africa is echoed by the Doing Business report. Last year the report found that Sub-Saharan Africa was the second fastest reforming region in the world, after Eastern Europe and Central Asia. Two out of every three countries in Africa made at least one reform, many of which were supported by World Bank Group advice.
The recent financial and economic crises have changed, at least temporarily, investors’ outlook and perception of risk. Results of a recently conducted investor survey of political risk, reported in the 2009 World Investment and Political Risk report by the Multilateral Investment Guarantee Agency, paints a mixed picture. On the one hand, the report states that “the global economic downturn … has exacerbated specific political risks in the most vulnerable investment destinations.” On the other hand, the study concludes that “… [the economic crisis] does not appear to have led to a reassessment of emerging market risk across the board… As the global economy recovers, concerns over longer-term political risks will remain prominent, even though some of the perils directly related to the fallout of the crisis recede.” Political risk is of course only one determinant of FDI decisions.
Investment flows to rebound
Most recent indicators signal that 2010 will be a slightly better year for FDI than 2009. UNCTAD’s Global Investment Trends Monitor report from early 2010 predicts that gradually rising profits of multinational corporations and an uptake in the global demand for goods and services “will ultimately encourage companies to revise upward their international investment plans for 2010 onward, which in turn should give rise to growing FDI flows.” A slightly more nuanced picture of the future FDI flows is provided by the sentiment of senior executives polled by the consultancy A.T. Kearney for its regular FDI Confidence Index. Business leaders give high marks to the largest BRIC economies, but are less sanguine about investment prospects in other emerging markets. Several advanced high-income economies last year rose in the index, pushing down the ranks many middle-income developing countries which had done well during the bullish years before the crisis.
One of the principal implications of these trends for the 100+ developing countries which do not yet feature prominently on most multinational companies’ investment maps is that they will have to try even harder to get on investors’ radar screens. Competition for foreign companies’ attention has heightened, and investors’ business decisions are more carefully calculated than before. What are then some of the key actions that developing countries can take to become more attractive destinations for FDI?
Improving FDI competitiveness
In the short-run, developing countries can send convincing signals to the business community that they are open and ready for investment through actions which do not require significant amounts of time or resources:
» First, countries can improve their business environments by removing regulatory and administrative red tape, which is often an impediment to entry and operation of companies. Onerous start-up procedures, excessive licensing and permit requirements, and time-consuming export and import processes can make a country less attractive to FDI. The World Bank Group’s forthcoming Investing Across Borders report compares many of these barriers across countries.
» Second, while focusing on new investments, countries should not forget about the companies which have already invested in their economies. Reinvested earnings account for over 30 percent of global FDI flows. Especially given the recent decrease in new FDI projects, countries should pay due attention to investor aftercare and retention, and work directly with existing companies to help resolve problems, strengthen retention, and encourage expansions.
» Third, targeting and promoting specific sectors for FDI can have a powerful effect. Naturally, different countries target different sectors depending on their comparative advantages and industrial composition of their economies. Sectors with strong growth potential and relevance for many developing economies include clean energy, agribusiness, business process outsourcing, healthcare, and tourism.
In the medium- and long-run, countries should aim to improve their overall competitiveness for sustained investment and economic growth. Here the strategic needs of each country will be different and dictated by a mix of socio-economic realities and political priorities.
In 2010 and beyond, foreign companies are likely to pursue further geographic diversification. While the larger developing countries will continue to have strong appeal for investors, other developing countries with improving investment climates, including in regions such as Sub-Saharan Africa or North Africa, are also likely to benefit from companies’ regained confidence.
Foreign direct investment in the appropriate economic sectors should result in a win-win situation for all parties. For the recipient countries, it brings foreign capital, technology and managerial know-how resulting in enhanced access to foreign markets and increased competition. For multinational and regional corporations, FDI can mean greater efficiency, lower costs and access to new markets and resources resulting in more efficient and effective global production networks. As FDI flows rebound and within a few years regain pre-crisis levels, both countries and companies stand to benefit. Keeping markets open and appropriately regulated should increase the likelihood of renewed FDI flows.
Pierre Guislain and Peter Kusek are director and investment policy officer at the Investment Climate Department, World Bank Group