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World Investment Report 2001

Key Messages

THE GEOGRAPHY OF INTERNATIONAL PRODUCTION
FDI flows reached record levels in 2000

Foreign direct investment (FDI) continues to expand rapidly, enlarging the role of international production in the world economy. FDI grew by 18 per cent in 2000, faster than other economic aggregates like world production, capital formation and trade, reaching a record $1.3 trillion (table 1). FDI flows are, however, expected to decline in 2001. The global expansion of investment flows is driven by more than 60,000 transnational corporations (TNCs) with over 800,000 affiliates abroad.

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But a mapping of the geography of FDI patterns shows that international production is highly concentrated

A mapping of FDI inflows indicates the extent to which host countries are integrating into the globalizing world economy. It also indicates indirectly the distribution of benefits from FDI. The mapping of outward FDI shows which countries control the global distribution of this investment. Understanding the pattern of FDI flows and stocks and its driving forces is important for the formulation and implementation of economic strategies and policies. A comparison of the world maps of inward and outward FDI in 2000 and 1985 reveals that FDI reaches many more countries in a substantial manner than in the past.

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With countries varying greatly in terms of their success in attracting FDI, as revealed in the new Inward FDI Index

The concentration of FDI reflects the concentration of economic activity more generally. Thus, exports, domestic investment and technology payments are also highly concentrated. Richer and more competitive economies naturally receive and send more international direct investment than other economies. To gauge the underlying attractiveness of a country for international investors, it is useful to take its relative economic size and strength into account.

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The expansion of international production is taking place in a new international setting

The rapidly changing international setting is changing the drivers of FDI. While the main traditional factors driving FDI location – large markets, the possession of natural resources and access to low-cost unskilled or semi-skilled labour – remain relevant, they are diminishing in importance, particularly for the most dynamic industries and functions. As trade barriers come down and regional links grow, the significance of many national markets also diminishes. Primary industries account for a shrinking share of industrial activity, and natural resources per se play a smaller role in attracting FDI for many countries. The role of cheap “raw” labour is similar: even labour-intensive activities often need to be combined with new technologies and advanced skills. The location of TNC activity instead increasingly reflects three developments: policy liberalization, technical progress and evolving corporate strategies. Changes in the international policy environment have a strong impact on locational decisions.

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And leads to a concentration at the sub-national level as well

The growing spread and mobility of TNCs are making local conditions more, not less, important. The increased freedom for factors and functions to move does not mean that international production spreads equally to all locations. Mobile factors only go and “stick” in places where efficient complementary factors exist. Thus, FDI tends to be fairly concentrated geographically within countries, responding to the agglomeration economies that also influence domestic firms. These economies relate to proximity to markets and factors of production, and the availability of specialized skills, innovatory capabilities, suppliers and institutions. Intensifying competition forces firms to specialize more in their core competencies and rely more heavily on links with external partners (suppliers, buyers or even competitors) than in the past.

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Which calls for a new generation of investment promotion policies

Using and strengthening clusters to attract FDI calls for new approaches, going beyond the first and second generations of investment promotion policies. In the first generation of investment promotion policies, many countries adopt market friendly policies. They liberalize their FDI regimes by reducing barriers to inward FDI, strengthening standards of treatment for foreign investors and giving a greater role to market forces in resource allocation. Virtually all countries – to varying degrees – have undertaken steps in this direction. Some countries, can go a long way in attracting FDI with these steps, if the basic economic determinants for obtaining FDI are right. In the second generation of investment promotion policies, governments go a step further and actively seek to attract FDI by “marketing” their countries.

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PROMOTING BACKWARD LINKAGES
Backward linkages from foreign affiliates to domestic firms can enhance the benefits from FDI

Part One of WIR01 mapped the locational pattern of the extent to which countries attract FDI. A key factor determining the benefits host countries can derive from FDI are the linkages that foreign affiliates strike with domestically owned firms. Backward linkages from foreign affiliates to domestic firms are important channels through which intangible and tangible assets can be passed on from the former to the latter. They can contribute to the upgrading of domestic enterprises and embed foreign affiliates more firmly in host economies. Given the role that backward linkages can play in these respects, WIR01 analyses how host country governments can best promote efficient backward linkages by foreign affiliates. The approach is pragmatic. It draws on practical experience as to what firms have done to forge linkages, and the measures that governments have adopted to encourage linkages and their deepening.

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TNCs have a self-interest in forging links with domestic suppliers

Organizational changes are making supply chain management more critical to the competitiveness of firms, including TNCs. On average, a manufacturing firm spends more than half its revenues on purchased inputs. In some industries, such as electronics and automotive, the proportion is even higher. Some firms are contracting out the entire manufacturing process to independent “contract manufacturers”, keeping only such functions as R&D, design and marketing.

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But governments can play an important role in promoting linkages

Although foreign affiliates have an interest in creating and strengthening local linkages, their willingness to do so can be influenced by government policies addressing different market failures at different levels in the linkage formation process. For example, TNCs may be unaware of the availability of viable suppliers, or they may find it too costly to use them as sources of inputs.

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Perhaps best in the framework of a special linkage promotion programme

Another approach goes further in that it involves the establishment of a specific linkage promotion programme combining a number of the measures just mentioned. This is a proactive approach which is typically focused on a selected number of industries and firms, with a view towards increasing and deepening linkages between foreign affiliates and domestic firms. As with other policies that span a range of productive factors, activities and enterprises, it is advisable for policy makers that choose this approach to “start small” (perhaps with a pilot scheme) and to build policy monitoring, flexibility and learning into the programme.

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