5.2.1. Necessity, Role, and Advantages of FDI in Economic Development:
Global Trends and Features
History of world economic development has many interesting and useful lessons for all transition economies. If Uzbekistan has committed to follow liberalization in the foreign economic sector with the purpose of closer integration into the world community, it becomes of a particular significance to realize those tendencies which have driven the world community for the last decades. International experience is rich in the cases of withdrawing benefits from the division of labor and cooperation. Intense cross-border movements of capital has become one of the crucial aspects of such development.
336 Alimov A., Muminov R. Liberalizatsiya Vneshneekonomichskoy Deyatelnosti (Mirovoy Opyt i Problemy Uzbekistana). Magazine Rynok, Dengi, Kredit, 2000, No 11; Agarwal J., Laughannen R., Luecke M.,
Mannerkamp P. Export Expansion and Diversification in Central and Eastern Europe: What can be learnt from East and South East Asia? Institut fuer Weltwistschaft, Kiel, November, 1995.
It is common knowledge, for instance, that one of the main components of sustainable development in South East Asia (SEA) was played by the substantial inflows of foreign capital and appropriate domestic policies. However, the impact of Asia’s attractiveness for FDI on its export-oriented development is difficult to quantify. Nevertheless, the proposition that large and rising inflows of foreign capital have significantly contributed to sustainable export growth, seems to be well-grounded. Some empirical analysis showed, for instance, that FDI and trade flows were positively correlated.337 Higher outflows of FDI from Germany, USA and Japan, the largest sources of the global FDI, to industrialized and developing host countries went hand in hand with higher exports from host to home countries of foreign investors. The steep increase of world-wide FDI over the last two decades, and close links beween trade and FDI could be attributed to globalization strategies of multinational enterprises. Innovative production techniques dramatically reduced transaction and communications costs. The liberalization of capital markets and related developments have added new dimensions to the international division of labor. Production processes could increasingly be fragmented and relocated to countries offering the most favorable conditions for producing certain goods or parts thereof, which could be supplied on world markets at competitive terms.338
These FDI to South East Asia were mainly world-market oriented, rather than domestically oriented, and, thus, were directly linked with export expansion and export diversification at the host countries. Japanese firms which were among leading investors in SEA, are especially well-known for their world-market orientation. In countries, like Malaysia, the Philippines and Thailand, foreign firms accounted for more than half of manufacture exports.
Furthermore, much of the region’s export activity has been in sectors in which FDI and the associated transfer of technology and industrial know-how have been substantial. In this
337 Nunnenkamp P., Gundlach E., Agarwal J. (1994) Globalisation of Production and Markets. Kieler Studien, 262, Tuebingen.
338 In 2002, for example, FDI to developing countries of Asia, including NIC, China and India, amounted to more than 11 times the figure of 1987. The region’s share in total world-wide FDI flows soared to 26% in 1993 and went down to about 14% in 2002, mainly because of severe competition from other regions, especially Central and Eastern Europe, as well as a result of massive financial crisis in 1997-1998. See for more details Agarwal J., Laughannen R., Luecke M., Mannerkamp P. Export Expansion and Diversification in Central and Eastern Europe: What can be learnt from East and South East Asia? Institut fuer Weltwistschaft, Kiel, November, 1995. p.21; Foreign Direct Investments: New Trends in Transition Countries. The World Bank/William Davidson Institute, Transition, October 1999, p.7; UNCTAD Handbook of Statistics 2003;
UNCTAD World Investment Report 2003, http://www.unctad.org/en/docs/wir2003overview_en.pdf
respect, both FDI in, and manufactured exports of SEA shifted to more skill-intensive industries.339
It needs to be stressed that one of the strongest benefits of FDI comparing to other forms of investments is that they are carried out on the long-term basis and mainly directly into production. This makes their influence on host economies more sustainable and prevent any negative short-term outflows of capital which may damage so far the fragile system of economic relations in small economies similar to Uzbekistan.
Notwithstanding significant foreign stocks in Asia in the mid-1990s, some new trends in the world distribution of financial flows were seen due to alternating financial and economic crises in Asia, Russia, Brazil in the second half of the last decade, and the measures undertaken in other recipient-countries. Total volumes of FDI inflows in Central and Eastern Europe hit a new record - almost $29 bln.USD, yet FDI flows were uneven across the region by increasing in 9 and falling in 10 economies in 2002. Moreover, this figure is much less than the corresponding indicator in China which alone proved to be the second largest recipient of FDI (about $53 bln.USD) and the largest economy by FDI stocks in the world in 2002.340
However, it changed little when traditional geographical movements of FDI across the world are concerned. Although, for instance, outflows from the EU to Asian developing economies increased significantly, when the periods of 2000-2001 and 1986-1987 are compared, the region remained a minor host for EU investors who preferred intra-regional engagements during the process of European enlargement towards East. There seems to be developing consequent and severe competition for foreign investments between the regions, who are potential recipients, as well as between those, who serve as a source of world-wide investments. While Eastern Europe consolidates its positions in targeting Western European markets and investors, Asia remains abiding to the US and Japanese markets.341 On the other hand, the distance between recipient and donor countries is also taken into account. So called
“gravity models” reveal, for example, that for each doubling of distance, trade between two
339 Agarwal J., Laughannen R., Luecke M., Mannerkamp P. Export Expansion and Diversification in Central and Eastern Europe: What can be learnt from East and South East Asia? Institut fuer Weltwirtschaft, Kiel,
November, 1995. p.22
340 UNCTAD World Investment Report 2003, http://www.unctad.org/en/docs/wir2003overview_en.pdf
341 Some researches in the past revealed that within the regions, further division of places of investment location between the main contributors was further continuing. So, US FDI stocks in manufacturing industries of SEA reached 7,2% of US world-wide FDI stocks, while share of Japan reached 1/3 of total outflows in manufacturing industries of Asia in 1992. When main recipients of US FDI were Singapore, Hong Kong, then Japan shifted from initial new industrialized countries to ASEAN (Indonesia, China, Malaysia. Agarwal J., Laughannen R., Luecke M., Mannerkamp P. Export Expansion and Diversification in Central and Eastern Europe: What can be learnt from East and South East Asia? Institut fuer Weltwirtschaft, Kiel, November, 1995.
countries of similar size diminishes by two thirds. A common border, on the contrary, tends to increase trade links between corresponding states by a factor of 2,5.342 Thus, the competition between the regions seems to be further under way with the emergence of new transition economies to behave as the viable alternatives to European and Asian companies in various industries.
Nevertheless, the aforesaid tendencies worldwide do not diminish, but reinforce that crucial role which FDI could play in Uzbekistan too. Such a reliance on foreign capital should coincide with the whole strategy of national reforms in the foreign sector. In particular, this interrelationship is seen in the following important aspects:
a) FDI may contribute to the liberalization campaign, pledged by Uzbekistan, especially through further reforms in the foreign sector. That would imply demonopolization of foreign trade by encouraging the more active involvement of domestic private sector and giving support for foreign investors. The latter are able to assist in reinforcing domestic competitive environment and finding out national competitive advantages of the country in international perspective. 343
b) The 2004 Investment Programme of the government was about to reduce centralized state investments into the domestic economy, in view of expected higher volumes foreign assistance. In particular, $1,028 bln.USD of investments for 92 projects were expected to be attracted, a little bit more than in the previous year.344
c) International experience is rich in successful examples which point at the key role of FDI in pursuing efficient structural changes, developing export industries through further expansion and diversification, creating competitive environment, as well as encouraging further modernization of branches and providing products of better quality.345 Therefore, the country needs consequent strategy with proper national actions to keep up sustainable inflows of capital.
342 For more details see Balassa B., Bauwens L. (1989) The Determinants of Intra-European Trade in
Manufactured Goods. In Jacquemin A., Sapir A. (eds) The European Internal Market. Trade and Competition, Oxford.
343 See more about the role of FDI in UNCTAD World Investment Report 2002: Transnational Corporations and Export Competitiveness. http://www.unctad.org/Templates/WebFlyer.asp?intItemID=2477&lang=1
344 In 2003, the volumes of suggested foreign investments in the Government’s investment programme was equal to $860,44 mln.USD. However, two thirds of these investments were due to be attracted under government guarantees. Therefore, much work needs to be done to improve legal conditions and the mechanism of applying other forms of guarantees required for foreign investors.Zarudnaya V. Pravitelstvo Delayet Stavku na Investitsii.
www.zamon.info 18 December 2003
345 Rojec M. The restructuring of firms in foreign privatizations in Central and Eastern European countries.
Magazine Transnational Corporations, Vol.10, No 3
http://www.unctad.org/Templates/webflyer.asp?docid=1776&intItemID=2926&lang=1; Rajah R. Systemic
d) In terms of the limited domestic resources, FDI would allow not only to cushion the given problem by providing necessary funds, but also ease the burden of expenses on domestic budget. The freed state funds could be efficiently used in pursuing more ambitious and targeted reforms in other fields, such as the development of legislative and court system, the improvement in designing guarantees for private domestic and foreign investors, the improvement in national governance and tools of macroeconomic policy, targeted welfare programmes, etc.
e) Uzbekistan remains underperformed in some specific areas with the potential still to be tapped. It seems that the government also see the bottom of the given issue. “We can not be happy with the state of affairs in attractinng foreign investments into the processes of privatization of large-scale enterprises. It is especially true for the enterprises in the frame of the National Oil and Gas Holding “Uzbekneftegas”, Company
“Uzstroymaterialy” (construction materials), the State Joint Company
“Uzkimyosanoat” (chemical industry) and many others”.346 Let alone the quality dimension of the privatization process, the point concerns poor FDI performance in lucrative mining industry which can give an additional impetus for higher foreign investment.347
In general, for the whole Central Asian region and Uzbekistan in particular, it is crucial to become beneficiaries of the world capital inflows, as SEA succeeded in doing so in its time and what Eastern European countries have been trying to do after the 1990s. Significant distance from the main sources of FDI in the world, however, puts on the agenda a number of socio-political, macroeconomic, legal issues to be addressed on the national level. In its turn, this requires appropriate analysis of factors and conditions to drive FDI inflows.
5.2.2. Driving Forces of FDI Inflows
In order to perceive the reasons and motivations of foreign investors on whether to invest or not into particular country under specific conditions and time, one needs to set out the forces under which investment decisions are taken. Besides, it is also crucial that the major
coordination and the development of human capital: knowledge flows in Malaysia´s TNC-driven electronics clusters. Magazine Transnational Corporations, Vol.11, No 3.
http://www.unctad.org/Templates/webflyer.asp?docid=3334&intItemID=2926&lang=1
346 Translated by the author from the speech of the President of Uzbekistan Karimov I. delivered at the annual meeting of the Cabinet of Ministers on the socio-economic developments in the country in the first half of 2003.
Newspaper “Narodnoye Slovo”, 19 July 2003.
347 The question of efficient state policy with regard to proportional distribution of FDI among the sectors of the economy in line with national priorities is another aspect which needs particular consideration.
contemporary international trends in worldwide FDI requires the clear assessment and reactions on the high level, i.e. by designing and pursuing national investment strategy.
Let us start with some theoretical issues. There is vast amount of literature explaining FDI movements between countries. The inflow of FDI in transition economies, therefore, stands on various factors in both host and home countries of investors. Given the range of potential motives, it is very difficult to provide a single model covering all possible circumstances, because they may differ substantially from country to country. Thus, we try to define and generalize the factors which could be subsequently attributable to Uzbekistan.
The issue why FDI movements worldwide have become so huge for the last three decades among other factors has much to do with the theoretical explanations. One of them stems from the Heckscher-Ohlin theorem on the differences of the production factors endowment in various economies.348 It states that under the conditions of identical and homothetic preferences, balanced trade and non-reversals of factor intensities, each country exports commodity which requires for its production the relatively intensive use of the factor found in relative abundance in that country. In other words, the question is about the relative availability of capital (K) and labour (L) in the host countries for foreign investments to be competitive in production of goods and services. In transition economies, in this respect, the proportion between these two factors, i.e. K to L is much lower than in the developed countries, due to lack of capital and excess of labor. That means that any additional injection of capital unit would mean high return per unit of capital invested, or higher marginal productivity of K, in comparison with investments at home. Consequently the strategy of profit maximization makes investors to seek for such places where they can reap the benefits from more efficient use of their capital.
The new classical theory of economic growth backed mainly by the international institutions is based upon the assumption that real interest rates differentials adjusted to the fluctuations of foreign exchange rate is the main driving force for FDI, i.e. where the interest rates are higher, then, FDI will move into these countries. However, this theory does not explain, why the FDI move in opposite directions too, i.e. into the countries with lower interests rates.349
Severe competition between transnational corporations (TNC) in the regional and international markets gave rise to the theories of product cycle on the basis of technological
348 The Pattern of Trade and the Heckschler-Ohlin Theorem, in Mikic M. International Trade, New York, 1998, pp.76-81.
349 Abdurahmanov M. Faktory Privlecheniya Pryamyh Inostrannyh Investitsiy. Magazine Ekonomicheskoye Obozreniye. 2003, No 11.
gap between various countries: a country in which an innovative process occurs will thus have a comparative advantage to export the new product to technologically less developed economy even with no clear evidence of comparative advantage in terms of factor endowments.350 The product-cycle theory then states that due to the fact that throughout the life cycle of the product its input requirements change, the comparative advantage will shift from one to another, less developed country depending on their overall factor endowments and production conditions. It finally means that after the technology of production to become completely standardised and universally available, TNC look for the transfer of technology to the least-cost producing country to increase their profits and remain competitive.
Very similar to that, but more comprehensive and well-accepted theory explanation of FDI worldwide is the Theory of International Production which postulates three advantageous conditions for FDI: in ownership, location, and international advantage. The ownership in the given context means the comparative advantage of the investors before home producers in privileged possession of intangible assets. One example of such assets is technology, which is broadly defined as any kind of economically useful knowledge, for example, on lower production costs and competitive advantage. It may both in form of a patented process and the common knowledge of a group of employees. In most cases locational advantage is explained by the difference in the aforementioned resources (K and L), trade barriers or transport costs, when FDI is economically more viable to fulfil than direct export of goods to these countries.
Internationalisation means that the aforementioned intangible assets exploitation costs should be less of any other means, such as licensing or outright sale of a patent or even export of final product. In addition, one view suggests that the advantages to the TNC from operating productive activities in several locations stem from horizontal and vertical integration between various activities of the given firm. Horizontal integration supposes to locate production process and sales in one country, while providing joint inputs, such as R&D, advertising, accounting, marketing and distribution, from central headquarters to serve production activities in other country. Whenever there are cost incentives for the integration of related activities within a single firm and factor costs or other incentives for the separation of these activities geographically TNC will be encouraged to expand investments in global
350 Every product goes through several stages in its lifetime, i.e. new product stage, maturity stage, and standartised product stage. The factors meeded for its production in each stage are believed to be different. The issue what caues and why innovative process is initiated and takes place in home countries of TNC is linked to their potential to R&D and the availability of factors for it to exist, such as human capital (scientists, engineers, etc.), technical equipment, high level of savings to maintain domestic investments into R&D, and institutional factors (tax incentives, laws, etc.). Given high costs, both innovative and subsequent production, as well as relative uncertainty about sales, first consumers for these products are found in rich countries. See more: Micic M. Technology-based Trade Theories, in International Trade, New York, 1998, pp.230-233.
terms. Vertical integration makes emphasis on intra-firm trade in inputs rather than on the mechanism dividing into immediate production activities and headquarters services. Firms with production facilities in more than one country trade in differentiated products, including intermediate components, finished goods and headquarters services.351
In terms of transition, several other determinants of FDI may also be of particular significance. The most important of those are political and macroeconomic stability, with particular requirements to low inflation and stable exchange rate, institutional and infrastructure development, size and growth of the host market, labor costs and productivity, and trade liberalization.352
What could be derived from the international experience is that the applicability or compatibility of the aforementioned theories may not result in the expected results. That is because the significance of each factor of FDI may vary from country to country, and also over time. Looking once again at the group of South East Asian economies, for instance, one may reveal that even the common picture on the whole shows a success on encouraging FDI and linking it to export promotion strategy, within the group itself countries applied divergent strategies at various development stages. Following the Japanese example, Korea and Taiwan erected barriers against FDI at the early stages on the grounds that it would limit the scope for the build-up of technological capability of nation-owned firms. On the contrary, Malaysia and Thailand actively encouraged FDI. Being much better endowed with natural resources than South East Asia, India and Brazil were marked with less impressive policy for FDI encouragement which did not bring designed results, not the least because of general orientation toward import substitution.
Or even, in case of interest rate differentials between the countries, there were empirical data that FDI inflows had been marked not only towards one direction with higher interest rates, as the theory suggests, but on both directions.353 Thus, cross border movements of TNC are becoming strongly encouraged by the pursuit for lower costs of production and higher profits.
One evidence of this process could be seen in the trend which has been changing steadily for the decades. Although industrial countries themselves remain the largest recipients of FDI flows, their share fell from about 81% of the global FDI in 2001 to 65-70% in 2003. This
351 Foreign Direct Investments and Multinationals, in Micic M. International Trade, New York, 1998, pp.267-272.
352 Blatter T.S. FDI in Transition. Free University Berlin. Institute for Political and Economic History. 11 November 2002.
353 Abdurahmanov M. Faktory Privlecheniya Pryamyh Inostrannyh Investitsiy. Magazine Ekonomicheskoye Obozreniye. 2003, No 11.