With some $6.4 trillion in global sales in 1994 (and estimated global sales of $7 trillion in 1995) — the value of goods and services produced by some 280,000 foreign affiliates — international production outweighs exports as the dominant mode of servicing foreign markets (table 1). The growth of global sales has exceeded that of exports of goods and services by a factor of 1.2 to 1.3 since 1987. But as far as developing countries are concerned, despite their growing involvement in international production — of the world’s 44,000 parent firms, 7,900 firms were based in developing countries in the mid-1990s (table 2), compared to 3,800 in the late 1980s — exports continue to be the principal mode of delivering goods and services to foreign markets.Read More
World Investment Report 1997
Transnational Corporations, Market Structure and Competition Policy
The World Investment Report, the seventh in this annual series, provides a comprehensive analysis and policy discussion of international investment issues. This year, the Report examines the interrelationship between transnational corporations, market structure and competition policy. This issue is particularly relevant because the liberalization of foreigndirect-investment regimes allows a greater presence of transnational corporations in host countries, with important implications for market structures and competition.
Major issues discussed in WIR 97 are:
- Global and regional trends as regards foreign direct investment, including its interlinkages with foreign portfolio equity investment.
- The impact of foreign direct investment on market structure and competition in host economies, as well as globally.
- The implications of the interaction between foreign direct investment, market structure and competition for investment and competition policies at the national, regional and global levels.
As countries liberalize their foreign-direct-investment regimes and firms increase their investment activities across borders, maintaining the proper functioning of markets assumes increasing importance. Competition policy has a key role to play in this respect. By focusing on the relationships between foreign direct investment, market structure and competition, and considering policy implications arising from these relationships, this year’s WIR rounds out discussions in previous Reports. These dealt with the reduction of barriers to foreign direct investment and the strengthening of standards of treatment of foreign investors.
In discussing these issues, WIR 97 seeks to contribute to a better understanding of the role of foreign direct investment in the world economy and, in particular, its implications for developing countries.
Kofi A. Annan
Secretary-General of the United Nations
Transnational corporations raise capital from a variety of sources at home and abroad: commercial banks, local and international equity markets, public organizations and their own corporate systems in the form of internally generated profits for reinvestment. Taking all these sources of finance into account, investment in foreign affiliates — the investment component of international production — was an estimated $1.4 trillion in 1996 (figure 1). Of this, only $350 billion, i.e., a quarter, were financed by FDI flows. This means therefore that the weight of international production is also considerably larger: expressed as a ratio of world gross fixed capital formation, about one-fifth was undertaken by foreign affiliates. (This measure does not capture additional investment controlled by TNCs via various non-equity measures, including corporate alliances.)Read More
Returning to FDI flows themselves, the boom that began in 1995 continues, with inflows setting a new record of around $350 billion in 1996, a 10 per cent increase (figure 2). Fifty four countries on the inflow side and twenty countries on the outflow side set new records in 1996. Unlike the two previous investment booms in 1979- 1981 and 1987-1990 (the first one being led by petroleum investments in oil producing countries, and the second one being concentrated in the developed world), the current boom is characterized by considerable developing-country participation on the inflow side, although it is driven primarily by investments originating in just two countries — the United States and the United Kingdom. There are signs that an even greater number of countries will take part in the present boom as it unfolds on the inward side (e.g., developing countries in Latin America), as well as on the outward side (e.g., France, Germany and Asian developing countries). During 1995-1996, the share of developing countries in global inflows was 34 per cent.Read More
Even in the current boom, cross-border M&As, especially in the United States and Western Europe, are playing an important role in boosting FDI, although this time there is no ensuing decline in the developing-country share of inflows. The value of such M&As increased by 16 per cent in 1996, to $275 billion. If majority-held transactions only are taken into account, the value of cross-border M&As in 1996 would be $163 billion, or 47 per cent of global FDI inflows (though the measured values are not strictly comparable) (figure 3).Read More
Despite the growing number of small and medium-sized enterprises with investments abroad, a good part of FDI continues to be concentrated in the hands of a small number of companies. The largest 100 TNCs (table 3), ranked on the basis of the size of foreign assets, own $1.7 trillion assets in their foreign affiliates, controlling an estimated one-fifth of global foreign assets. In the United States, 25 TNCs are responsible for half of that country’s outward stock, a share that has remained almost unchanged during the past four decades. For six out of nine developed countries for which such data are available, 25 TNCs account for more than a half of their respective countries’ outward stocks (table 4). For the first time, two developing-country TNCs, Daewoo Corporation (Republic of Korea) and Petroleos de Venezuela S.A. (Venezuela), have entered the list of the top 100 TNCs. Daewoo Corporation also tops the list of the 50 largest TNCs based in developing countries (table 5) for the second year running, while Royal Dutch Shell (United Kingdom/Netherlands) continues to top the list of the largest 100 TNCs for the fifth consecutive year.Read More
The expansion of international production would not have been possible if it were not for the ongoing liberalization of FDI regimes. The trend towards greater liberalization was sustained again in 1996, with 98 changes in the direction of investment liberalization and promotion of a total number of 114 changes in investment regimes introduced during that year in 65 countries (table 6). Over the period 1991-1996, indeed, some 95 per cent of a total of 599 changes in the regulatory FDI regimes of countries were in the direction of liberalization. They mostly involved the opening of industries previously closed to FDI, the streamlining or abolition of approval procedures and the provision of incentives (figure 4). The desire of governments to facilitate FDI is also reflected in the dramatic increase in the number of bilateral investment treaties (BITs) for the protection and promotion of investment throughout the 1990s. As of 1 January 1997, there were 1,330 such treaties in the world, involving 162 countries, a threefold increase in half a decade. Around 180 such treaties were concluded in 1996 alone — one every second day.Read More
The ongoing globalization of production begs the question of whether the upward trend in FDI flows witnessed to date will continue into the next century. A survey of foreign investors suggests that this may, indeed, be the case. More specifically, foreign sales are expected to increase as a proportion of total sales, especially for Japanese and United States’ firms. Production by foreign affiliates is also expected to increase as a proportion of total production by TNCs, while home-country exports are expected to remain constant. Mergers and acquisitions, joint ventures and other equity and nonequity types of inter-firm agreements are expected to go hand in hand with the growth in FDI. Although smaller firms will be stepping up investments abroad, large firms will continue to account for the lion’s share of outward investments. Corporate restructuring in developed countries, aimed at improving efficiency and modernization, is expected to continue, giving rise to efficiencyseeking investment. However, accessing markets will remain the principal motive for investing abroad: survey respondents placed twice as much weight on production for local markets than on labour cost factors.Read More
Developed countries’ investments abroad reached an all-time high of $295 billion in 1996. The investment picture for developed countries is dominated by the United States, which, with $85 billion is by far the largest home country (by a margin of $31 billion over the United Kingdom, the second largest home country), as well as, with $85 billion, the largest recipient country (by a margin of $42 billion over China, the second largest recipient) in 1996 (figure 5). Around two-fifths of United States outflows go to the European Union and around 30 per cent to developing countries. Growing consumer markets have encouraged United States investments in the latter, while sluggish growth in the former has led to a decrease in its share of United States outflows. Investment flows into the United States — mostly in the form of M&As — were stimulated by its strong and sustained growth performance and potential for high profits. Western Europe received $105 billion in inflows and invested $176 billion abroad in 1996. More European Union investment is now directed to non-European Union countries than in 1992, when the internal market was completed.Read More
Although developed countries received a record $208 billion in FDI flows in 1996, there has been a steady decline in their share of global inflows since 1989. That decline can be attributed partly to the increasing attractiveness of developing countries, especially those that are growing rapidly and have large domestic markets. Furthermore, some developed countries that are large outward investors are small investment recipients, especially in relation to the size of their economies; notable examples are Germany, Italy and Japan. And as the rationalization of production through FDI in response to regional integration arrangements among developed countries (notably, the European Union) has reached a high level, firms are turning increasingly towards untapped markets found mostly in the developing world.Read More
In light of the above, it is not surprising that developing countries received $129 billion of FDI inflows in 1996 and invested $51 billion abroad — both amounts are all-time highs. Their share of world inflows rose to 37 per cent in 1996 (from 30 per cent in 1995), while their share of outflows was 15 per cent in that year. With $42 billion, China was the largest developing-country recipient (figure 5); the country’s success can be attributed mostly to its large and growing domestic market, “soft landing” and macroeconomic reforms, as well as to measures to promote investment in provinces other than those in the coastal areas. Every developing region saw an increase in inflows. Even the 48 least developed countries experienced an increase in inflows of 56 per cent in 1996, to $1.6 billion.Read More
With $81 billion in inflows in 1996, South, East and SouthEast Asia received about two-thirds of the developing-country total in that year. The 25 per cent increase in these inflows over 1995 was also in sharp contrast with the large decline in the rate of growth of exports and, to a lesser extent, of the gross domestic product, in that year. China accounted for over two-fifths of the $16 billion increase in investment inflows in the region. Next to China, Singapore was the second largest investment recipient, with inflows worth $9 billion, exceeding the combined inflows of the other newly industrializing economies (Hong Kong, China, Republic of Korea and Taiwan Province of China). Flows into Hong Kong, China, were $2.5 billion in 1996. Foreign-investor confidence in Hong Kong, China, after its reversion to China on 1 July 1997 is strong, as indicated by a number of surveys of foreign (and local) companies. Indonesia, Malaysia, Philippines and Thailand together received some $17 billion in 1996, an increase of 43 per cent over 1995.Read More
Investment flows into Latin America and the Caribbean increased by 52 per cent in 1996, the highest increase of any developing region, to a record level of nearly $39 billion. Far-reaching changes in the region’s FDI regimes — both at the national level and through the conclusion of bilateral investment treaties — have certainly contributed to this performance. Even during the turbulence in portfolio investment flows into that region in 1994 and 1995, FDI flows registered small but steady increases. Latin America and the Caribbean now account for 30 per cent of all developing country inflows. Investment inflows into Argentina tripled in 1996 to $4.3 billion, propelled by the country’s membership in MERCOSUR (which contributed particularly to automobile investments), the liberalization of mining legislation and privatization schemes. But the most noteworthy performance has been that of Brazil. With nearly $10 billion, Brazil has surpassed Mexico (with around $8 billion) as the star performer in Latin America in 1996. (In the first four months of 1997, inflows were over $4 billion — two and a half times higher than inflows in the same period in 1996.) This represents a dramatic reversal: in 1992, with $2 billion, Brazil ranked third in the region (after both Mexico and Argentina). The upswing in Brazil’s inflows is the outcome of large investments in automobiles (in the context of intra-regional production rationalization triggered by MERCOSUR) and the reactivation of its privatization programme. Foreign-investor confidence in Brazil (and in the region as a whole) is high: in a recent survey, company executives expressed more confidence in Latin America’s prospects now than five years ago, placing Brazil, Mexico and Chile in top places.Read More
Africa continues to receive small levels of investment flows (nearly $5 billion in 1996), an increase of only 5 per cent, the smallest of any developing region. On average, Africa’s share of developingcountry inflows has more than halved between 1986-1990 and 1991- 1996 — to 5 per cent in the latter period. Political unrest, armed conflict, low domestic investment levels and frequent changes in economic policies that affect business calculations of expected risks and returns have contributed to this relative decline. However, Africa’s investment performance looks less gloomy when put into perspective. In relation to the size of a number of economies, those investments can be fairly significant. For the region as a whole, the ratio of investment inflows to gross fixed capital formation was 5.4 per cent, compared with 5.5 per cent for Asia and 5.9 per cent for Western Europe during the first half of the 1990s. Putting the size of Africa’s FDI stock in relation to the size of Africa’s domestic market (GDP) yields a share of 10 per cent — compared with 14 per cent for Asia, 18 per cent for Latin America and the Caribbean and 13 per cent for Western Europe in 1995. While these figures suggest that the significance of the investment that Africa receives (without the benefit of large intra-regional investment) is certainly not negligible, they do not say anything about Africa’s need for investment nor, for that matter, the continent’s potential.Read More
After large disinvestments in West Asia in 1995 that resulted in negative inflows, particularly in Saudi Arabia and Yemen, inflows attained a level of nearly $2 billion in 1996. Excluding these two countries, investment flows into West Asia show a much more stable trend. In fact, the volatility of inflows to these two countries — albeit important ones — masks considerable improvements in the investment performance of other countries in the region in response to successful efforts to create business-friendly environments.Read More
In 1996, FDI flows to Central and Eastern Europe experienced a decline — to $12 billion from $14 billion in 1995, partly reflecting declines in privatization-related investments in Hungary and the Czech Republic. As long as investment flows to that region depend to a large extent on the participation of foreign investors in privatization programmes, a certain degree of “lumpiness” — yearto-year volatility — is to be expected. The decline might also stem from other problems related to the transition to a market economy. Foreign investors, for example, might have overestimated the region’s ability to absorb investments and might have temporarily shelved their plans for expansion. However, despite the decline, flows in 1996 were still more than twice as high as the annual average during 1992-1994. The estimated FDI stock in Central and Eastern Europe was $46 billion in 1996 — almost comparable to the 1996 investment flows to China ($42 billion).Read More
Substantial flows of foreign portfolio equity investment to emerging markets is a recent phenomenon dating only from the early 1990s. The year 1993 was the watershed for such flows when their level trebled, to $45 billion, from the previous year. However, the level of these flows fell in the two subsequent years in response to the Mexican peso crisis — by 27 per cent and 2 per cent in 1994 and 1995, respectively — but recovered in 1996. The volume of new equity raised on international capital markets by emerging markets in that year increased by 34 per cent, reaching some $15 billion. In principle, foreign portfolio equity investment and direct investment are quite distinct. By definition, foreign portfolio equity investment is distinguished from FDI by the degree of management control that foreign investors exercise in a company. Portfolio equity investors usually provide only financial capital without any involvement in a company’s management, and typically have a shorter-term investment horizon than direct investors.Read More
Two major factors lie behind the rise in foreign portfolio equity investment flows into emerging markets: the liberalization and globalization of financial markets and the concentration of substantial financial resources in the hands of institutional investors. Investments into emerging markets have been facilitated by the rapid provision of market information made possible by improvements in communications technology and the willingness of portfolio equity investors to bear greater risks in the expectation of reaping higher returns in these new and fast-growing markets. The higher returns have been made possible by the sustained superior growth performance of emerging markets in comparison to that of developed economies during the 1990s.Read More
As countries liberalize their FDI regimes and firms increase their investment activities across national borders, maintaining the proper functioning of markets assumes increasing importance. Freer flows of FDI mean a greater reliance on market forces to determine the volume and distribution of FDI and its economic impact. Countries, especially developing countries that are liberalizing rapidly, are therefore interested in ensuring that the reduction of regulatory barriers to FDI and the institution of standards of treatment are not accompanied by the emergence of private barriers to entry and anti-competitive behaviour of firms. Competition and competition policy in relation to FDI need, therefore, to be better understood. Part Two of WIR 97 focuses on the relationships between FDI, market structure and competition, and considers policy implications arising from these relationships, especially as they concern developing countries.Read More
Governments rely on several policy tools to ensure that their markets remain contestable and that competition in markets is maintained as far as possible, so that economic growth and welfare are not adversely affected by the inefficient allocation or use of resources. The tools of such policy include trade policy, FDI policy, regulatory policy with respect to domestic economic activity, and competition policy. While the first three comprise rules and regulations that serve several purposes and not only that of maintaining competition with a view to fostering efficiency, the last relates specifically to the rules and regulations — implemented by competition authorities — with respect to arrangements among firms/suppliers and the conduct of individual firms/suppliers, generally but not exclusively, in national markets.Read More
Even as barriers between national markets are reduced and producers can locate anywhere in the world (or in a region) to transact with buyers also located anywhere, the markets for many products remain national in scope. These include markets for products that can only be delivered through the presence of the producer at the location of the buyer — notably, services — and markets in countries that have significant restrictions on trade. The interaction of TNCs with the structure of these national markets, the process of competition and the performance of firms and industries within host countries all therefore continue to be of interest, especially for developing countries.Read More
The opening up of economies to inward FDI can contribute directly towards increasing the contestability of — or potential competition in — host country markets. Sellers participating in these markets can now include not only domestic producers and (in the case of goods and tradable services) exporters from other countries, but also TNCs from other countries that establish affiliates (as well as contractual arrangements with other firms) to produce in and for local markets. Furthermore, TNCs, with their ownership-specific or competitive advantages, are often better able than domestic firms to overcome some of the cost-related barriers to entry that limit the number of firms in an industry and the market for its products. This potential for increasing competition by allowing FDI entry is particularly important for many service markets, in which competition through arm’s length international trade is not possible or is limited.Read More
Transnational corporations typically participate to a greater extent in industries that are more concentrated, at the national as well as the international level. This is largely due to the fact that industry concentration and the competitive advantages that enable firms to become transnational share common causes. However, inward FDI, when it takes place, can itself affect the concentration of producers in a host-country industry and, hence, of sellers in the market for its products. The nature of this effect depends, initially, upon whether or not the mode of entry is such as to add to the number of suppliers (and the quantity supplied) in a market and, subsequently, upon several factors related to the relative size, competitive strength and mode of competition of foreign affiliates and domestic and other firms competing in a market.Read More
The production efficiency of foreign affiliates is often higher than that of domestic firms in host developing countries. The implications of this for welfare in the host economy depend upon whether competition is maintained when FDI takes place, and markets work efficiently. If competition — between foreign affiliates themselves, between foreign affiliates and importers, and between foreign affiliates and domestic firms — is lacking, and foreign affiliates operate in highly concentrated markets with low contestability, the benefits to consumers from the entry of more efficient TNCs, in the form of lower prices, improved quality, increased variety, as well as innovation and the introduction of new products, may be limited. In addition, there may be scope for TNCs to engage in anticompetitive business practices that serve to keep new entrants out or result in inefficiencies and reduced consumer welfare.Read More
In a liberalizing and globalizing world economy, TNCs operate increasingly in markets that are no longer national but regional or global in scope, with transactions between sellers and buyers of a given product from several different countries taking place across national boundaries. In various industries, TNCs take advantage of the widening scope of markets to restructure their operations and/or integrate their value-added activities internationally, either within their corporate systems or through interfirm alliances and agreements, achieving efficiencies in production through functional specialization and economies of scale and scope.Read More
In today’s world economy, a number of factors facilitate the ease and speed with which TNCs can provide a supply response to a change in market conditions — signalled, for example, by a nontransitory price increase — through the establishment of new production facilities to enter a market. These factors are based on the reality that nearly all countries seek to attract FDI, many firms already have foreign affiliates in place, technological developments make the establishment of new affiliates relatively easy and competitive pressures often make the exploitation of new opportunities irresistible. More specifically, the supply response of many TNCs could be rapid, rivalling that of domestic producers and importers in a country because of the scanning capabilities of TNCs; their experience in trade and FDI; their access to resources within and outside their corporate systems, and access to markets; their ability to spread risks and enter into alliances to overcome entry barriers such as those of R&D; and their ability to draw upon existing affiliates for assistance. If supply response through FDI and nonequity arrangements by TNCs is relatively fast — with, say, not more than one to two years elapsing between the identification of an opportunity and the servicing of a market — it would be deserving of attention when considering the degree of competition in a given market.Read More
The liberalization of FDI regimes facilitates market entry and, therefore, can increase the contestability of markets. As the liberalization process advances, non-traditional barriers that may inhibit FDI are attracting the attention of policy makers. While some of these barriers are due to government measures (e.g., in the case of public monopolies), others — and these are receiving increasing attention — concern anticompetitive private business practices (or restrictive business practices). Some of the latter are normally prohibited per se (e.g., some horizontal cartels or vertical price fixing). The situation becomes more difficult when the practices concerned may have anticompetitive effects but are not considered illegal under the laws of the country in which they occur. While such practices do not necessarily discriminate between domestic and foreign firms, they may nevertheless constitute barriers to competition.Read More
By 1997, some 60 countries worldwide had competition laws (figure 6). Their main objective is to preserve and promote competition as a means of maximizing the efficient allocation of resources in an economy, resulting in the best possible choice of quality, the lowest prices and adequate supplies for consumers. Most competition laws deal with enterprise behaviour by prohibiting restrictive business practices such as competition-restricting horizontal agreements and abuses of dominant positions, as well as certain restrictive vertical distribution agreements. Moreover, an increasing number of competition laws deals with alterations in the structure of markets through the control of mergers and acquisitions, as well as joint ventures, with the aim of avoiding the creation of dominant positions or even oligopolies.Read More
Usually, however, the main interface between competition law and FDI occurs when foreign entry is accomplished by means of a significant merger, acquisition or joint venture. Indeed, countries are increasingly adopting merger-control regulations. Because M&As are dependent on current stock values and are difficult to unscramble once consummated, merger control of such transactions requires a carefully calibrated system of prior notification, rapid analysis, temporary injunctions and prompt decisions. Most countries use turnover or other thresholds to exempt transactions unlikely to have anticompetitive effects in order to minimize unnecessary interference and limit the number of cases screened by the competition authorities. Most interventions by competition authorities occur in the case of horizontal M&As between competitors.Read More
While the liberalization of FDI and trade regimes can be a means of promoting competition, the possibility of anticompetitive practices by firms requires the continuous attention of competition authorities. In fact, even in a national framework in which investment and “trade” are fully liberalized, the possibility of such practices provides one of the rationales for the existence of competition laws. Therefore, while an FDI entry may be unobjectionable from a competition point of view, or even beneficial in itself, it may raise competition issues in the longer term, depending on the behaviour of the firm.Read More
While FDI liberalization can help to enhance the contestability of markets, it is not a sufficient condition: in so far as FDI liberalization creates more space for firms to pursue their interests in markets, competition laws become necessary to ensure that former statutory obstacles to contestability are not replaced by anticompetitive practices of firms, thus negating the benefits that could arise from liberalization.Read More
There are numerous reasons why — in an era of globalization — competition issues as they relate to FDI increasingly involve more than one country and, therefore, require international policy responses. Indeed, they are grounded in the very nature of the transnational character of the firms involved, and relate especially to such issues as access to information and the implementation of decisions. However, a number of obstacles make international responses difficult. With respect to the exchange of information, the largest single obstacle is that of the confidentiality obligations of many competition authorities — which they need to have — regarding information submitted to them by various parties. Closer competition-enforcement cooperation is often impeded by basic substantive and procedural differences between the competitionlaw regimes of different countries; in fact, activities being investigated in one jurisdiction may have been encouraged by a government in another jurisdiction. Moreover, many governments simply may not see it in their country’s interest to facilitate a foreign state’s investigation of one or more of their companies.Read More
While FDI liberalization can increase competition in markets and thereby contribute to economic efficiency, growth, development and, ultimately, consumer welfare, there are limitations to competition. They arise in particular when markets tend naturally towards high level of concentration and when market outcomes conflict with other policy objectives. In the first instance, limitations can arise from the fact that such natural factors as economies of scale, high sunk costs and high riskrelated costs can make some markets, to a greater or lesser degree, difficult to contest (although technological developments can change the importance of some of these natural factors). One of the antidotes to these natural limits to contestability involves an increase in the size of the relevant market, especially through investment and trade liberalization. Where market enlargement is difficult to achieve, regulations can help to prevent abuses of dominant positions of market power.Read More