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World Investment Report 2003

Key Messages

FDI FALLS AGAIN - UNEVENLY
Global FDI flows fall again in 2002 amid weak economic performance

Global FDI inflows declined in 2002 for the second consecutive year, falling by a fifth to $651 billion-the lowest level since 1998 (table 1). Flows declined in 108 of 195 economies (see figures 1 and 2 for the economies that experienced the biggest decline, as well as the top recipients). The main factor behind the decline was slow economic growth in most parts of the world and dim prospects for recovery, at least in the short term. Also important were falling stock market valuations, lower corporate profitability, a slowdown in the pace of corporate restructuring in some industries and the winding down of privatization in some countries. A big drop in the value of cross-border mergers and acquisitions (M&As) figured heavily in the overall decline.

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Prospects remain dim for 2003, but should improve thereafter

All in all, UNCTAD predicts that FDI flows will stabilize in 2003. Flows to the developing countries and developed countries are likely to remain at levels comparable to those in 2002, while those to CEE are likely to continue to rise. In the longer run, beginning with 2004, global flows should rebound and return to an upward trend. The prospects for a future rise depend on factors at the macro-, micro- and institutional levels. The fundamental economic forces driving FDI growth remain largely unchanged. Intense competition continues to force TNCs to invest in new markets and to seek access to low-cost resources and factors of production. Whether these forces lead to significantly higher FDI in the medium term depends on a recovery in world economic growth and a revival in stock markets, as well as the resurgence of cross-border M&As.

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Government policies are becoming more open, involving more incentives and focused promotion strategies

Facing diminished FDI inflows, many governments accelerated the liberalization of FDI regimes, with 236 of 248 regulatory changes in 70 countries in 2002 facilitating FDI (table 5). Asia is one of the most rapidly liberalizing host regions. An increasing number of countries, including those in Latin America and the Caribbean,are moving beyond opening to foreign investment to adopting more focused and selective targeting and promotion strategies. Financial incentives and bidding wars for large FDI projects have increased as competition intensified. IPAs, growing apace in recent years, are devoting more resources to targeting greenfield investors and to mounting after-care services for existing ones.

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As well as participation in more investment and trade agreements

More countries are concluding bilateral investment treaties (BITs) and double taxation treaties (DTTs), as part of a longer trend, and not solely in response to the FDI downturn. In 2002, 82 BITs were concluded by 76 countries, and 68 DTTs by 64 countries. Many countries are concluding BITs with countries in their own region to promote intra-regional FDI. Asian and Pacific countries, for instance, were party to 45 BITs, including 10 signed with other countries in that region.

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Converging patterns of FDI links and investment and trade agreements are generating mega blocks

The global stock of FDI, owned by some 64,000 TNCs and controlling 870,000 of their foreign affiliates, increased by 10% in 2002 – to more than $7 trillion. Technology payments, mostly internal to TNCs, held steady in 2001 despite the near halving of FDI flows. Value added by foreign affiliates in 2002 ($3.4 trillion) is estimated to account for about a tenth of world GDP. FDI continues to be more important than trade in delivering goods and services abroad: global sales by TNCs reached $18 trillion, as compared with world exports of $8 trillion in 2002. TNCs employed more than 53 million people abroad.

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ENHANCING THE DEVELOPMENT DIMENSION OF INTERNATIONAL INVESTMENT AGREEMENTS
To help attract FDI, countries increasingly conclude IIAs

Countries conclude international investment agreements (IIAs) – at the bilateral, regional and multilateral levels – for various reasons. For most host countries, it is mainly to help attract FDI. For most home countries, it is mainly to make the regulatory framework for FDI in host countries more transparent, stable, predictable and secure – and to reduce obstacles to future FDI flows. In either case, the regulatory framework for FDI, at whatever level, is at best enabling. Whether FDI flows actually take place depends in the main on economic determinants.

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Which, by their nature, entail a loss of policy space

Experience shows that the best way of attracting FDI and drawing more benefits from it is not passive liberalization alone. Liberalization can help get more FDI. But it is certainly not enough to get the most from it. Attracting types of FDI with greater potential for benefiting host countries (such as FDI in technologically advanced or export oriented activities) is a more demanding task than just liberalizing FDI entry and operations. And, once countries succeed in attracting foreign investors, national policies are crucial to ensure that FDI brings more benefits. Policies can induce faster upgrading of technologies and skills, raise local procurement, secure more reinvestment of profits, better protect the environment and consumers and so on. They can also counter the potential dangers related to FDI. For example, they can contain anticompetitive practices and prevent foreign affiliates from crowding out viable local firms or acting in ways that upset local sensitivities. The instruments needed to put these policies in place tend to be limited – or excluded altogether – by entering into IIAs.

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The challenge for developing countries is to find a development-oriented balance

What are the issues? For developing countries, the most important challenge in future IIAs is to strike a balance between the potential contribution of such agreements to increasing FDI flows and the preservation of the ability to pursue development-oriented FDI policies that allow them to benefit more from them – that is, the right to regulate in Overview 19 the public interest. This requires maintaining sufficient policy space to give governments the flexibility to use such policies within the framework of the obligations established by the IIAs to which they are parties. The tension this creates is obvious. Too much policy space impairs the value of international obligations. Too stringent obligations overly constrain national policy space. Finding a development-oriented balance is the challenge – for the objectives, structure, implementation and content of IIAs.

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When negotiating the objectives, structure and implementation of IIAs

Many IIAs incorporate the objective of development among their basic purposes or principles, as a part of their preambular statements or as specific declaratory clauses articulating general principles. The main advantage of such provisions is that they may assist in the interpretation of substantive obligations, permitting the most development friendly interpretation. This promotes flexibility and the right to regulate by ensuring that the objective of development is implied in all obligations and exceptions thereto – and that it informs the standard for assessing the legitimacy of governmental action under an agreement.

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And especially their content

The quest for a development friendly balance plays itself out most importantly in the negotiations of the content of IIAs. Central here is the resolution of issues that are particularly important for the ability of countries to pursue development-oriented national FDI policies – and that are particularly sensitive in international investment negotiations, because countries have diverging views about them.

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By making development objectives an integral part of international investment agreements

These issues are all complex. Because the potential implications of some provisions in IIAs are not fully known, it is not easy for individual countries to make the right choices. The complexities and sensitivities are illustrated by the experience of NAFTA for the regional level, that of the MAI negotiations for the interregional level and that of the GATS and the TRIMs Agreement for the multilateral level. Given the evolving nature of IIAs, other complexities tend to arise in applying and interpreting agreements.

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