RESTRICTED
WORLD TRADE WT/WGTI/W/12
3November 1997
ORGANIZATION(97-4803)
Original: English Working Group ontheRelationship
between Trade andInvestment
SUBMISSION BYTHE EUROPEAN COMMUNITY AND ITSMEMBER STATES
Thiscommunication wasreceived fromthePermanent Delegation oftheEuropean Commission
on7October 1997, withtherequest thatitbecirculated toMembers.
________________
APaper Submitted bytheEuropean Community anditsMember States drawing
ontheFindings ofaSurvey onForeign Investment ofFirms Undertaken
intheUnited Kingdom during 1994-1995
Purpose ofthepaper
1. TheWorking Group ontheRelationship between Trade andInvestment agreed attheendof
itsfirstmeeting inJunetotakeitswork forward byconsidering anumber ofaspects onthetrade and
investment relationship assetoutinanagreed checklist ofissues. TheCommunity presents thispaper
withaviewtoaidthework oftheGroup bylooking intocertain aspects ofthecorrelation between
tradeandinvestment flows asoutlined inSection IIofthechecklist. Thepaper isbased onthefindings
ofasurvey of900companies inaCommunity member State, theUnited Kingdom. Therefore, itis
notaCommunity study strictly speaking nordoesitprejudice theCommunity position. Ittherefore
provides abusiness-oriented perspective, andassuch, should assist theGroup initsstudy ofbusiness
strategies,practicesanddecision-makingasdeterminantsoftherelationshipbetweentradeandinvestment
flows.
TheUnited Kingdom study onoutward investment
2. Alsoinother member States oftheEuropean Community similar research hasbeencarried
out.Thefindings ofthose studies, although sometimes different inthedetails, correspond totheresults
oftheUnited Kingdom study.
3. TheStudy onOutward Investment, published in1996, wasundertaken inthree stages, over
theperiod ofayear,during 1994-1995. Thestudy covered thethreecoreelements of:internal literature
anddatasearch, andcirculation ofaquestionnaire toUnited Kingdom postsabroad; surveys ofliterature
byacademic consultants; asurvey of900firms.
4. Thestudy'sfindings must beassessed inthecontext ofthekeycaveat thatthemain survey
isnotarepresentative sample ofUnited Kingdom companies forforeign investors. Thesurvey sought,
however, toachieve quotas ofanumber ofrespondent categories, suchasinvestors innon-OECD
countries.WT/WGTI/W/12
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5. Company sizeinterms ofnumber ofemployees wasfairly evenly splitbetween small, medium
andlarge companies. Inthecontext ofcompany turnover, overthree quarters ofcompanies had
worldwide turnover oflessthan£50m. Almost halftherespondents indicated thattheirlastinvestment
wasofasales/marketing/distribution function, which carried lower riskandwasthemore common
typeofinvestment. Thesurvey made itclear thatforeign investment wasnotthepreserve oflarge
Multinational Enterprises, butthatmany Small- andMedium-Sized Enterprises alsoinvested abroad.
Foreign direct investment
6. Globally, Foreign Direct Investment (FDI) hasgrown rapidly inrecent years. In1995, world
FDIflows increased by40percenttoarecord level of$315 billion. Thishascoincided witha
particularly impressive growth indeveloping countries inbothinward andoutward investment. Inflows
intodeveloping countries rosein1995 toarecord $100 billion, while outward investment from
developing countries reached $47billion.
7. TheEuropean Community isanimportant actorassource andhostcountry forFDI. Thirty per
centofinward andoutward flows worldwide arrive ororiginate intheCommunity. Inorder toput
thestudy intoperspective itshould benoted thattheUnited Kingdom isamong themost important
member States oftheCommunity inthisrespect.
Relationship between exports andinvestment: findings oftheUnited Kingdom study
8. Interms oftherelationship offoreign investment onexports, research indicates thatinvestment
doesnotingeneral displace export activities ofinvestors buttends tohaveacomplementary roleand
mayinfactleadtoincreased export flows. Itistherefore seentobeimportant forcompanies seeking
toincrease theirmarket share.
9. Thestudy onUnited Kingdom foreign investment revealed thatinvestment isoften apoint
inachain which starts with exports, moving toasmall office presence, building uptoa
sales/marketing/distribution investment andfinally toaninvesting inproduction facilities. However,
whilethesurveyshowedthatthemajorityofcompaniesexportedabroadpriortoundertakinginvestments,
almost athird didnotsellinthelocal market prior toinvestment inthecountry. Foranumber of
thesecompanies, theapproach wasdictated bylegislation which prevented exporting without investing.
Responses fromsectors suchascarleasing, radioandinsurance showed thatsetting upforeign operations
inorder tocomply withlocalregulations wastheonlywaytoexpand abroad.
10. Theprocess ofbuilding upfromexports tosales/marketing/distributive investment compared
toproductive investment wasmore apparent within manufacturing thanservice sector countries. The
reason whymany service sector companies gostraight fromthedomestic market toforeign investment
isvaried. Sometimes theproducts thattheyofferaresimply lesstradeable across borders andhave
ineffect tobedelivered locally. Forexample, aconsulting engineering company could serve aforeign
market onaproject basisformany years, though eventually setupanoffice toserve themarket more
systematically. Afund management company, incontrast could only realistically develop any
relationships withclients bybeing permanently ontheground. Regulatory requirements alsodictate
direct investment byaservice company more often thanmanufacturing.
11. Within themanufacturing sector, adistinction could befound between those companies that
produced lesstechnologically advanced goods ("low-technology" manufacturing) asopposed tothose
companies which produced highly sophisticated goods ("high-technology" manufacturing). Low-
technology manufacturing companies ingeneral followed theprocess ofexports before investment more
frequently thanhigh-technology companies. Themain reason forthiswasthattheoriginal market
focus oflow-technology companies wasintheUnited Kingdom. Exporting andinvestment activityWT/WGTI/W/12
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abroad were often driven bysaturation ofthedomestic market and/or strong domestic competition.
Bycontrast, formany high-technology manufacturing firms thedomestic demand wasinfactinsufficient
andtherefore export andforeign investment wasarequirement aspartoftheinitial commercial strategy.
12. Forsome markets where thedemand forimported products from theUnited Kingdom was
low, many companies found itnecessary toestablish asales presence andthereby facilitate the
development ofrelationships withpotential customers. Thiswasparticularly important intheservice
sector.
Rationale forforeign investments
13. Economic theory identifies fourconditions which mustbesatisfied forafirmtogoabroad:
- thecompany mustpossess sustainable ownership advantages suchasmarket expertise,
product innovations, etc.;
- thecompany should becapable ofinternalizing advantages;
- foreign production should beconsistent withlong-term strategy;
- foreign countries mustofferlocation advantages including supply ofmaterials, labour,
political stability, infrastructure, etc.
However, these conditions maybemore easily recognized forproduction rather thanservice sector
investment abroad. Theconditions donotaccount forthefactthatmany service sector investments
appear tobemade because theservices arenon-tradeable (i.e.non-exportable).
14. Asreferred toabove, theexport-investment process waslesswell-supported byhigh-technology
manufacturing companies withthemainreason putforward forthisthatthedomestic demand forsuch
products insome cases wassolimited thattheriskofrelying onlyonthedomestic market overtime
wasinfactgreater thanexporting andinvesting.
15. Thesurvey onforeign investment alsohighlighted thefactthatsome companies maygostraight
toanacquisition. Thiscould bemotivated bythecomparative speed ofaccess thismaygivetoamarket
compared withestablishing agreen-field site.Acquisition ofacompany involved inasimilar business
abroad wasfelttocomplement thedomestic activities andalsoavoided tariffs andquotas andother
export barriers inthehostnation.
Motivations forinvestment
16. Theoverall motivation toinvest inaparticular country isthemarket potential. Responses
fromtheUnited Kingdom survey showed theoverwhelming driver forforeign investment tobetogain
newcustomers andincrease market share. Thisobjective, together withnewmarket entry andthe
aimofimproving customer service, wasgiven asthekeyreason forover90percentofsales, marketing
anddistribution investments, and82percentofproductive investments.
17. Thekeymotivating factor forbothofthese categories istomaintain orincrease profitability
and,ultimately, return ongross capital employed. Many companies stated thatforeign investment
inorder tofindnewopportunities tosupplement aweak domestic market oruseexcess domestic supply
wasanessential requirement tofulfil corporate objectives tomaximize shareholder value.WT/WGTI/W/12
Page4
18. Theimportance offactors which could beseento"push" companies intoinvesting inorder
toprotect profits ismuch lower thanthemore "expansionary" motivations. Inparticular, theincentives
toreduce coststoimprove profit anddefend market share against competition wereseenasbeing key
objectives byonlyasmall minority ofcompanies. Theresults ofthesurvey differed fromthegeneral
perception thatforeign investment reduces costs anddisplaces production.
Wider effects ofinvestment
19. Existing literature oninvestment suggests thatexports arenotingeneral displaced byforeign
investment. Theoverriding results oftheUnited Kingdom survey werethatcompanies feelthewider
effects interms ofemployment levels, marketing, production levels, domestic andexport salesand
quality ofsalestobebroadly neutral. Thisisconsistent withthebasic motivation forinvestment as
themost effective wayofincreasing salesinamarket.
20. Theeffect offoreign investment ontheemployment levels ofthesource countries commonly
raises popular concern. However, themajority ofcompanies surveyed reported thattheeffect offoreign
investment onemployment levels waspositive. United Kingdom investments indeveloped aswell
asindeveloping markets arelikely toincrease United Kingdom production levels.
Concerns facing outward investors
21. TheUnited Kingdom survey alsoquestioned investors about obstacles toforeign investment.
Theobstacles ofgreatest significance forinvestors innon-OECD countries wereconcentrated onthe
needforlocalpartners, political andeconomic stability andlocalbureaucracy. Legal requirements,
inparticular ownership andcurrency restrictions, andprofit repatriation werealsoseenasanobstacle
byinvestors.Industrial/employeerelationswerecitedasanimportantissuewheninvestinginnon-OECD
countries. Investors, however, alsoindicated concerns, forexample, ondifferential regulatory measures
within OECD countries.
22. Importantly, however, thestudy suggested thatgoodpreparatory workcangofarinminimizing
thepotential significance oftheobstacles referred toabove.
23. Establishing ajointventure wasalsoseenasanattractive wayofminimizing riskbyasignificant
number ofcompanies, especially those companies inthesamesector whose products arecomplementary
andnotcompetitive. Larger companies considered thatthere wasnoparticular advantage orneedfor
themtoshare facilities. Jointventures wereseeninmany emerging markets asthemostpractical way
forward intheshort term, given thelackofexperience ofthemarket outside thecountry andtheneed
forinside knowledge onhowthemarkets work. Inemerging anddeveloping economies having local
partners wasoften seenasessential.
24. Theneedforgood localstafforanagency which iseffective inrepresenting thecompany 's
interest wasalsoidentified asakeyfactor forsuccessful investment. Good localmanagement will
provide aknowledge oflanguage, culture, themarket environment andlocalconditions. Understanding
potential customers isalsoseenasahighpriority. Theincorporation ofgoodlocalinvolvement with
sound planning andfinancial control willincrease thechance ofsuccess ofaforeign investment.
25. Implicit forsuccess ofanyforeign investment isofcourse anexisting demand foraproduct
orservice. Therisksassociated withexports andforeign investment compared tothedomestic market
areprogressively greater, butsotooaretheexpected rewards. Foreign investment istherefore driven
bymarket opportunities andthedesire toexpand.WT/WGTI/W/12
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26. Theviewofcompanies isthatgovernment hasaroletoplayinremoving obstacles totrade
andbarriers toinvestment. Inthemindofmostinvestors, tradebarriers represent asignificant constraint
andremain ahighpriority.
Summary ofkeyfindings ofthesurvey
27. Keypoints identified bythesurvey canbesummarized asfollows:
- exports arenot,ingeneral, displaced byforeign investment;
- foreign investment hastraditionally followed asomewhat evolutionary process, moving
fromexports toasmall office presence, sales/marketing/distribution investment, and
finally production investment;
- service sector andhigh-technology companies takeamuch more direct route toforeign
investment;
- themain driver forforeign investment wasseen tobemarket expansion and
development;
- keyobstacles toforeign investment come intheshape oflocal legal andregulatory
requirements andbureaucracy; theneedtofindtherightlocalpartners; andconcerns
about political andeconomic stability;
- themostimportant factor increating anattractive climate forinvestment isstrong and
sustainablegrowth,supportedbymacroeconomicandpoliticalstability,andtransparent,
predictable andopentrade andinvestment policy regimes;
- theneedforpredictable andliberal frameworks forinvestment isalsounderlined by
theglobalization ofmarkets andthefactthatbusiness decisions arenowbeing made
tomove much more directly toforeign investment.
28. TheCommunity invites theWorking Group, ifitsowishes, toconsider theimplications of
these findings inthecontext ofitsexamination oftherelationship between trade andinvestment from
adevelopment perspective.