WORLD TRADE WT/WGTI/W/25
6March 1998
ORGANIZATION(98-0900)
Working Group ontheRelationship
between Trade andInvestment
THE RELATIONSHIP BETWEEN TRADE AND FOREIGN DIRECT INVESTMENT:
FOREIGN DIRECT INVESTMENT ORIGINATING
INDEVELOPING COUNTRIES
Note bytheSecretariat
I. INTRODUCTION
1. Atthemeeting oftheWorking Group ontheRelationship between Trade andInvestment of
8December 1997, theWorking Group requested theSecretariat toprepare ananalysis offoreign direct
investment ("FDI") originating indeveloping countries tocomplement theSecretariat notecirculated
indocument WT/WGTI/W/7 (which focused onforeign direct investment fromdeveloped countries).
Thepresent notehasbeenprepared inresponse tothisrequest.
2. Itshould beemphasized attheoutset that,since outward FDIfrom developing countries is
arelatively recent phenomenon, forwhich alimited number ofeconomies, principally inAsiaand,
more recently, Latin America, account forthebulk, theliterature onthissubject issmall. The
conclusions inthisnoteshould therefore betreated withduecaution, allthemore sosince the
consequences ofrecent developments inAsian financial markets arenotyetclear.
II. FOREIGN DIRECT INVESTMENT FROM DEVELOPING COUNTRIES
3. Table 1provides some dataonFDIflows toandfrom developing andtransition economies
in1996. Developing countries contributed 15percentofworld FDIoutflows in1996(US$51 billion
outofUS$347 billion), upfrom3percentin1980 (UNCTAD, 1997). Although thetrend isclearly
upward, mostdeveloping countries arestillonlyonthereceiving endofFDI. Three-quarters ofthe
FDIoutflows fromdeveloping countries areaccounted forbyKorea, Singapore, Chinese Taipei and
Hong Kong, China andanother 15percentofFDIoutflows fromdeveloping countries isaccounted
forbyother countries inAsia, suchasMalaysia andThailand. Several countries inLatin America,
including Argentina, Brazil, Chile andMexico, havealsobecome significant regional investors inthe
lastcouple ofyears, ifnotyetworld investors.
4. ThedatainTable 1show significant differences among regions intheratiobetween inward
andoutward FDIin1996. Thisratiois10forLatin America, 6forAfrica, andlessthan2forAsia.1
InthecaseofKorea, Chinese Taipei andHong Kong, China theratioofinward tooutward FDIwas
lessthan1,which means thatthese economies havebecome netoutward investors.
1TherelativelylowFDIinflow-outflowratiofordevelopingAfrica(AfricaminustheRepublicofSouthAfrica)
isexplained bythelarge (presumably oil-related) outward FDIbyNigeria. IfNigeria isexcluded, theFDIinflow-
outflow ratio forAfrica is10,thatis,thesame asforLatin America.WT/WGTI/W/25
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Table 1.Inward andOutward FDIofDeveloping andTransition Economies in1996
Region/Country Inward FDI
(millions ofdollars)Outward FDI
(millions ofdollars)Inward/
Outward
Africa (excl. South Africa1) 4,949 786 6.3
Egypt 740 90 8.2
Nigeria 1,720 455 3.8
Asia 84,283 46,816 1.8
China 42,300 2,200 19.2
Hong Kong, China 2,500 27,000 0.1
Korea, Republic of 2,308 4,188 0.6
Indonesia 7,960 512 15.6
Malaysia 5,300 1,906 2.8
Chinese Taipei 1,402 3,096 0.5
Thailand 2,426 1,740 1.4
Singapore 9,440 4,800 2.0
Europe 12,832 634 20.2
Czech Republic 1,200 80 15.0
Hungary 1,982 58 34.2
Poland 5,196 30 173.2
Russian Federation 1,800 406 4.4
Latin America 38,563 3,850 10.0
Argentina 4,285 246 17.4
Brazil 9,500 971 9.7
Chile 3,140 956 3.3
Mexico 6,963 553 12.6
Total 128,741 51,469 2.5
Source: Annex Table B.1andB.2,UNCTAD (1997)
Note 1:TheRepublic ofSouth Africa isclassified asadeveloped country.
II.1 Developing Asia
5. Inthelasttwodecades, developing Asiahasemerged asasignificant outward investor. Its
share ofworldwide FDIoutflows hasgrown from 2percentin1980 tosome 13percentin1996.
Asmentioned above, Korea, Chinese Taipei andHong Kong, China havebecome netoutward investors,
while several other developing countries inAsia, including Malaysia, Singapore andThailand have
been approaching abalance ofinward andoutward FDI. Thisdevelopment reflects their rapid
accumulation ofcapital, technology andknow-how inthepastdecades oftwo-digit economic growth.
Thedevelopment ofintangible assets thatcanbeexploited inmany markets atthesame time(theWT/WGTI/W/25
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"ownership" advantage intheOLItheory), together withtrade barriers abroad andrising production
costs athome, haveinduced multinational enterprises from these countries toinvest inproductions
units abroad inthesame fashion asmultinational enterprises based indeveloped countries.
6. Thefollowing points canbemade regarding thepattern ofoutward FDIfromeachofthelargest
outward investors inAsia-Singapore, Korea, Chinese Taipei andHong Kong, China.2
7. Hong Kong, China isbyfarthelargest outward foreign direct investor among theeconomies
indeveloping Asia.3About athirdofHong Kong, China 'soutward FDIisundertaken byaffiliates
offoreign enterprises using Hong Kong, China asagateway totheregion. China isthedominant
destination ofHong Kong, China 'soutward FDI,absorbing morethanahalf.Manufacturing industries
based inHong Kong, China invest inChina andother neighbouring countries totakeadvantage of
lower production costs, especially forlabour-intensive stages oftheproduction process ("vertical FDI").
Theother, andincreasingly more important legofoutward investment from Hong Kong, China is
services, including telecommunications, banking, hotel andtrading services.
8. Thecaseofoutward FDIfromSingapore isverysimilar. Under pressure ofincreasing domestic
wages, manufacturing industries haverelocated labour-intensive production toneighbouring countries
withlower wages. Theeconomy ofSingapore hasalsogradually moved towards more high-technology
production andespecially services. Theriseofaworld classservices industry isreflected intheFDI
statistics. Infact,more than50percentofSingapore 'soutward FDIistoday infinancial services.
Thelion'sshare oftheinvestment ismade inneighbouring countries inAsia, while theUnited States
andtheEuropean Union attract onlysome 7to10percenteach.
9. Outward investment fromKorea isverysimilar tooutward investment fromJapan initsfocus
ontraditional manufacturing. Thebiggest recipient ofKorean FDIiscurrently theUnited States, which
accounts forsome 40percent. TheEuropean Union isalsoanimportant location forKorean
manufacturing, although itsshare ofnewinvestment hasdeclined inrecent years. AsforJapanese
firms, (actual orfeared) trade barriers have been amajor factor explaining theestablishment of
production units byKorean enterprises intheUnited States andtheEuropean Union.
10. Outward FDIfrom Chinese Taipei isdominated bysmall andmedium-sized manufacturing
firms, andtoalesser extent bylargefirms andconglomerates. Again, theprime motivation forinvesting
inneighbouring countries istocutcosts inthefaceofrising domestic wages andanappreciating
currency. Another motivation hasbeentosecure thesupply ofnatural resources. Interms oflocation,
AsiaandtheUnited States receive roughly onethirdeach. Onlyasmall fraction ofoutward FDIfrom
Chinese Taipei iscurrently going totheEuropean Union.
11. Inregard toLatin America, theSecretariat isnotaware ofsimilar studies thatelucidate the
pattern ofoutward FDIfrom particular countries. Should theSecretariat become aware ofsuchstudies,
itwillbring them totheattention oftheWorking Group.
II.2.1 Trade effects ofoutward FDIfrom developing countries
12. Unfortunately, there appear tobeveryfewstudies ofthetrade effects ofoutward FDIfrom
developing countries, presumably because oftherecency ofsuchinvestment andlackofgood data.
2Thissummary draws onUNCTAD (1996).
3Data for1996 show thatHong Kong, China isalsothefourth largest investor intheworld after theUnited
States, theUnited Kingdom andGermany.WT/WGTI/W/25
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13. Twostudies ofFDIfrom Chinese Taipei inAsiaestablish thefollowing familiar pattern of
vertical FDI.4First, theexports fromChinese Taipei tofourAsian hostcountries (Indonesia, Malaysia,
thePhilippines andThailand) aredominated byintermediate products forlabour-intensive processing.
Secondly, bothexports toandimports fromthehostcountries havegrown faster thanChinese Taipei 's
overall trade. Thus, theout-sourcing oflabour-intensive production hasincreased thebilateral trade
between Chinese Taipei andthehostcountries concerned. Itshould beemphasized, however, that
thesestudies onlycover FDItoneighbouring developing countries. FDIfromChinese Taipei toOECD
countries ispresumably ofadifferent type, andmayhence haveadifferent trade effect.
14. Some evidence ofsuchadifference intrade effects between FDIinneighbouring developing
countries andFDIindeveloped countries isprovided inastudy ofKorean outward FDI.5Korean
FDIindeveloping countries wasupto1986mainly innatural resource sectors, andthereafter inlabour-
intensive sectors. These investments reflected therelatively scarcity ofdomestic natural resources
andincreases indomestic production costs. Incontrast, Korean FDIindeveloped countries hasbeen
driven inlarge partby(actual orfeared) non-tariff trade barriers, suchasanti-dumping actions and
voluntary export restraints. Although thisstudy doesnotinvestigate thetrade effects perse,thefact
thatoutward FDIfromKorea indeveloping countries waspredominantly ofavertical nature (securing
access tonatural resources andout-sourcing oflabour-intensive production) suggests thatitincreases
trade; bysubdividing theproduction process invertical stages between specialized production units
indifferent countries, trade isobviously created between these units. Incontrast, theemphasis on
"tariff-jumping", horizontal FDIinthecaseofFDIfromKorea indeveloped countries suggests amore
mixed tradeeffect. Products thatarenowproduced locally replace previous exports ofthesameproducts
(ifany). Atthesame time, theremaybeoffsetting tradeinpartsandcomponents fromthehome base
totheforeign production unit(s). Inaddition, alocalmarket presence mayboost demand forother
products oftheKorean firms. Ifthetwolatter effects dominate, trade maystillriseonbalance. For
example, assembly ofKorean carsinOECD countries maypossibly increase salesenough sothatany
reduced exports ofcarsfrom Korea areoffset byincreased exports ofautoparts andother models
stillexported from Korea.6Unfortunately, there isinsufficient empirical evidence oftheeffects of
outward FDIfrom Korea totestthese theoretical arguments.
15. There arealsosome studies ofoutward FDIfrom Hong Kong, China toChina. Apaper by
Tuan andNg(1995) studies therelocation andcross-border operations ofmanufacturing firms from
Hong Kong, China since theearly1980s. Some 85percentofallmanufacturing firms inHong Kong,
Chinahaveoperationsabroad,foremostinnearbyChineseprovinces.Themajorityofthemanufacturing
investment hasbeeninlabour-intensive operations. Surveys indicate thatlower production costs in
combination withtheproximity toHong Kong, China havebeenessential determinants forlocating
innearby Chinese provinces. Thisdevelopment hasbeenfollowed byarapid expansion ofbilateral
tradeoftheexpected kind, thatisexports ofpartsandmaterial forlabour-intensive processing inChina,
andsubsequent re-imports fordomestic consumption inHong Kong, China orfurther processing and
exports totheworld market. Itisestimated thatroughly three quarters ofthebilateral trade between
Hong Kong, China andChina isoftheabove kind. Thisillustrates again thatvertical FDIandtrade
arecomplementary. Or,putinanother way,trade allows firms tolocate eachstage oftheproduction
process wherever theconditions arethemostsuitable, witheachsubdivision oftheproduction process
generating additional intra-firm trade.
4SeeChow (1996) andLin(1996).
5Jeon (1992)
6Itwillberecalled thatmany studies ofoutward FDIbydeveloped countries suggest anetcomplementary
relationship alsobetween horizontal FDIandhome country exports (seesection III.3.1 ofWT/WGTI/W/7).WT/WGTI/W/25
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III. CONCLUSION
16. While theevidence isstillscanty onoutward FDIfrom developing countries, there are
nevertheless afewpoints thatcanbemade. First, outward FDItends toincrease withthedevelopment
level. Most oftheoutward FDIfrom developing countries isaccounted forbycountries inAsia.
More recently, outward investment from countries inLatin America hasalsoincreased. Secondly,
itappears thatthemotivations forinvesting abroad arelargely thesameasforfirms based indeveloped
countries. OnetypeofFDIismade forefficiency orcostreasons (vertical FDI). Forexample,
increasing wages inSingapore, Korea, Chinese Taipei andHong Kong, China haveinduced firms to
relocate labour-intensive production tolower costdeveloping countries inthesame region. Thistype
ofoutward FDIinvestment parallels therelocation oflabour-intensive operations toLatin America
byfirms fromtheUnited States, toEastern Europe byfirms fromtheEuropean Union, andtoSouth
EastAsiabyJapanese firms. Suchvertical outward FDIclearly expands trade. Another typeofoutward
FDIisdriven bytradebarriers. Acaseinpoint isKorean FDIwhich isverysimilar toJapanese FDI.
Both countries have been subject tofrequent dumping allegations andpressure toreduce exports
"voluntarily", andbothcountries haveresponded bymoving production unitstotheirexport markets
intheUnited States andtheEuropean Union.7Thetradeeffects ofsuchhorizontal FDIaretheoretically
ambiguous because oftheoffsetting tradeinpartsandcomponents. Empirical studies ofoutward FDI
bydeveloped countries tendtoconfirm thateveninthiscasetheoverall effects ontrade arepositive,
andthispresumably alsoholds foroutward FDIbydeveloping countries. However, there appear to
benoempirical studies toverify thisconjecture atthecurrent stage.
References
Chow, Peter (1996), "Outward Foreign Investment andExport Structure: ACaseStudy ofTaiwan 's
FDIinMalaysia", Journal ofInternational Trade andEconomic Development ,Vol.5(2),
pp.183-205.
Jeon, Yoong-Deok (1992), "TheDeterminants ofKorean Foreign Direct Investment inManufacturing
Industries", Weltwirtschaftliches Archiv ,Vol.128(3), pp.527-42.
Lin,An-loh (1996), "Trade Effects ofForeign Direct Investment: Evidence forTaiwan withFour
ASEAN Countries", Weltwirtschaftliches Archiv ,Vol.131(4), pp.737-47.
Tuan, Chyau andLinda Ng(1995), "TheTurning Point oftheHong Kong Manufacturing Sector: Impact
ofOutwardInvestmenttothePearlRiverDelta",TheJournalofInternationalTrade&Economic
Development ,Vol.4(2), pp.153-170.
UNCTAD(1996),"SharingAsia'sDynamism:AsianDirectInvestmentintheEuropeanUnion",United
Nations, NewYork andGeneva.
UNCTAD (1997), "World Investment Report 1997: Transnational Corporations, Market Structure
andCompetition Policy", United Nations, NewYork andGeneva.
Zhang, Z.andC.Ow(1996), "Trade Independence andDirect Foreign Investment between ASEAN
andChina", World Development ,Vol.24(1),pp.150-170.
7Forareview ofthestudies showing thestrong influence ofanti-dumping actions andVERs onJapanese
FDIintheUnited States andtheEuropean Union, seeSection IV.1 ofWT/WGTI/W/7.