RESTRICTED
WORLD TRADE WT/WGTI/W/8/Add.4
1October 1997
ORGANIZATION(97-4138)
Original: English Working Group ontheRelationship
between Trade andInvestment
IMPLICATIONS OFTHE RELATIONSHIP BETWEEN TRADE AND INVESTMENT
FOR DEVELOPMENT AND ECONOMIC GROWTH
Work Undertaken inOther Intergovernmental Organizations
Addendum
Atitsmeeting of2and3June1997, theWorking Group requested theWTO Secretariat to
prepare apaper which would present theresults ofwork undertaken inother intergovernmental
organizations onthesubjects covered byItemIoftheChecklist ofIssues Suggested forStudy
(WT/WGTI/M/1, paragraph 11).Pursuant tothisrequest, theSecretariat invited UNCTAD andother
intergovernmental organizations working inthisareatoprovide asummary description ofwork carried
outonthese subjects.
Thisaddendum reproduces thecontribution from theUNIDO.WT/WGTI/W/8/Add.4
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Table ofContents
FACTORS INFLUENCING INDUSTRIAL INVESTMENT PROMOTION
1. TheImpact ofGlobalization ....................................3
2. TheRoles ofForeign Direct Investment (FDI) andDomestic Investment ........3
3. TheNewCompetitive Environment andNewProduction Networks ............4
4. Technological Innovation andtheNewCompetitive Environment .............5
5. Acquiring Foreign Technologies ..................................5
(a) Technology transfer through foreign direct investment ..........5
(b) Technology transfer through strategic alliances ...............6
(c) Technology transfer through outward FDI .................6
6. Increasing Barriers toIndustrial Development ofDeveloping Countries .........7
7. OpportunitiesandtheThreatofMarginalization:AfricanCountriesandLeastDeveloped
Countries (LDCs) ...........................................8
8. ANewRoleforGovernments andtheInternational Community ..............8WT/WGTI/W/8/Add.4
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FACTORS INFLUENCING INDUSTRIAL INVESTMENT PROMOTION
1. TheImpact ofGlobalization
Theevolution oftheworld economy hasreached astatedescribed as"globalization" ofmarkets
forgoods, services, technologies, finance, andlabour. Thisphenomenon hasbeencharacterized by
increased tradeandcapital flows, agreater international division oflabour based onspecialization and
comparative advantage, expanded transnational networks andenterprise alliances, andextensive
communications andinformation systems. Globalization hasaccelerated inthepastfewyears andis
bound tohavearesounding impact onoverall economic andsocial development farintothefuture.
Globalization presents achallenge todeveloping countries intheirefforts tosurvive andgrow
inahighly competitive world. Tosucceed, theyneedtobuildontheirspecific strengths andadvantages
andadopt thetechnologies most suited totheirresources andneeds.
Forenterprises indeveloping countries, access tonatural resources andavailability ofcheap
labour arenolonger theoverriding factors inachieving international competitiveness. Increasingly,
comparative advantage isbeing based ontechnological capability andinnovation; ability toapply and
adapt newtechnologies inproduction processes; continuous upgrading ofhuman skills; flexible
organization andaggressive marketing; andability toestablish appropriate linkages withglobal
corporationsintheformofsubcontracting,productmix,foreigndirectinvestment,licensingandstrategic
alliances.
Itisagainst thisbackdrop ofglobalization thatindustrial investment promotion indeveloping
countries should belooked atinthecurrent years.
2. TheRoles ofForeign Direct Investment (FDI) andDomestic Investment
Thesignificantincreaseininternationalcapitalflowsinrecentyearshasbeenadistinctivefeature
ofglobalization. Since themid-1980s, therehasbeenasurge ininternational capital flows andagrowing
integration ofinternational financial markets. Forexample, global flows offoreign direct investment
(FDI), which totalled US$52 billion in1980, hadrisendramatically toUS$350 billion in1996. The
growth ofFDIandportfolio investment hasinturnallowed firms greater national andworldwide access
tocapital tofinance further development andglobalization.
The1990s havealsobeencharacterized byradical changes inthecomposition ofcapital flows
tomany developing countries. Incontrast toearlier periods thatweredominated byofficial aidflows
andcommercial banklending topublic sector borrowers, recent capital flows haveincreasingly consisted
ofprivate direct investment andportfolio flows toprivate sector borrowers. By1994, private flows
represented 57%ofnetresource flows todeveloping countries, areversal ofthesituation inthe1980s,
when private financing accounted foronlyonethirdofexternal financing.
Developing countries andeconomies intransition haveexperienced asignificant increase in
inflows ofFDIinrecent years. More thanathird oftotalworld FDIcurrently goestodeveloping
countries, compared to20%inthefirsthalfofthe1980s. FDIflows toeconomies intransition reached
$11billion in1993, much oftheinflow being invested inprivatized manufacturing enterprises. The
inflow ofFDIhascontributed tothegrowth ofmanufacturing exports, which haveincreased much
more rapidly thantotalmanufacturing output.WT/WGTI/W/8/Add.4
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Attheglobal level, thedistribution ofFDIisheavily concentrated inasmall number of
developing countries, the10largest recipients accounting for88percentofallFDIflows todeveloping
countries in1994. Onaregional basis, Asiaaccounts formore thanahalfofFDI, andsub-Saharan
Africa forabout 3percent.
Toaddsome perspective ontheabove, evenifFDIflows gainfurther momentum andaremore
evenly spread among developing countries, thebulkoftotalcapital formation willstillhavetocome
fromdomestic investors andsavings. Forregions suchasAfrica, where savings ratesarelow,meeting
thisrequirement fordomestic investment andcapital formation isproblematic; notsurprisingly, higher
overall growth rateshavebeendifficult toattain.
Global FDIflows haveindeed beenrising since themid-1980s, butinrecent years theyhave
accounted foronlyasmall percentage oftotalinvestment. Forexample, in1992theyprovided about
10%oftotalinvestment (likely tobechanging rapidly ifre-investment isalsoincluded).
Ontheother hand, since 1986 theshare ofdomestic private investment intotalinvestment
hasremained stable atabout 60%, making itthemostimportant source ofinvestment indeveloping
countries. Thesituation issimilar intheeconomies intransition, where there isincreasing evidence
thatprivate investment isthefastest-growing component oftotalinvestment. InPoland, forexample,
therateofgrowth ofprivate investment istwice therateofpublic investment (5.8% compared with
2.2% in1993).
Thus, while FDIisimportant fortheindustrial development ofdeveloping countries and
economies intransition, itshould berecognized from theoutset thatindustrial aswellasother
investments willhavetobefinanced predominantly fromdomestic sources, andthattheroleforforeign
capital, when available, isonlytosupplement national efforts.
Nevertheless,FDIisessentialtotheestablishmentorrebuildingofcompetitivemarketstructures
bydeveloping countries andeconomies intransition. Itprovides much needed managerial skills,
know-how, newtechnologies and,mostimportantly, market access. Itcantherefore beanimportant
catalyst forsustained economic growth.
3. TheNewCompetitive Environment andNewProduction Networks
Theemergence ofmore flexible approaches toproduction combined withtheescalating costs
ofresearch anddevelopment (R&D) andshorter production lifecycles, hasforced firms tosearch for
wider markets andtocombine theircompetitive advantage withthoseofotherfirms instrategic alliances
andinterfirm networks. Concentration byfirms onexploiting theircorecompetencies -thatis,their
mainlineofbusiness expertise -hasrequired theforging ofnewrelationships withpartners intheprivate
andthepublic sector. Theconclusion ofalliances withother firms enables companies toacquire new
product orprocess technologies, toshare thecosts, tospread therisksofhighcapital outlays, particularly
forR&D, andtogainaccess tonewdistribution channels andmarkets.
Transnationalcorporations(TNCs)haveincreasinglydevelopedintra-firmnetworksandalliances
onaregional basis, using aregional headquarters forthecoordination ofoperations. Asaresult, the
clustering ofFDIaround major regional locations hasbecome more pronounced inrecent years.
Relatively fewmanufacturing activities orfirms aretrulyglobalized (thatis,operating inallormost
regions oftheworld), andalarge partofthedeveloping world hasnotbeenabletoderive significant
benefits from theresource flows.
Accelerated FDIasaprominent feature ofglobalization reflects theincreasing importance of
integrated cross-border value-added activities ofTNCs.WT/WGTI/W/8/Add.4
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Underlying andreinforcing theglobalization process have been technological advances in
bio-technology, microelectronics andnewmaterials, aswellastheneworganizational structure of
enterprises. Newtechnologies haveledtotheintroduction offlexible production systems inthecontext
ofmasscustomization, anewformofindustrial organization which provides forlarge-scale production
while atthesame timemeeting consumer demand forquality anddiversity. Mass customization is
furthercharacterizedbytheuseofflexiblemachinery,oftenapplyingmicroelectronics-basedtechnologies,
andbyproduction insmall customized batches inresponse tospecific consumer requirements.
Theimperatives ofcompetitiveness haveledmany firms toreduce theemphasis ontheirown
value added tofinalproducts, andtoconcentrate ontheircorecompetencies. Theyhavethuscontracted
out,or"outsourced", non-core value-added activities -suchastheproduction ofcomponents andthe
provision ofservices. Thishasledtonewandinnovative sub-contracting possibilities withsmall- and
medium-scale industries (SMIs) indeveloping countries andeconomies intransition, aprocess which
should result inafurther extension ofglobal manufacturing networks. Therequirements ofproduction
insmallcustomizedbatches-particularlytheflexibleinputanddeliveryschedules-andthenewemphasis
onquality, reliability andzerodefects havemade itnecessary forfirms todevelop close relationships
withtheirsuppliers, bothdomestic andforeign.
4. Technological Innovation andtheNewCompetitive Environment
Thegrowing integration oftheglobal economy andtheaccelerating rateoftechnological change
havecreated anewcompetitive environment forallcountries. Competition hasbecome increasingly
borderless, encompassing nearly allsectors oftheeconomy inbothdomestic andexport markets. At
thesame time, thecontinuous andrapid improvement ofavailable technologies hasmade national
innovationsystemsandthetechnologicalandinnovativecapabilitiesofindividualenterprisesincreasingly
important asdeterminants ofcompetitiveness.
Under suchconditions, international competition istaking aformdistinctly different fromthe
traditional oneofprice competition. Competitiveness nowarises from possessing technological
knowledge, rather thanfrom minimizing thecosts ofproduction using agiven typeoftechnology.
Effective application ofknowledge leads toimproved machinery, newproducts, reduction ofcosts
andimprovements inproductivity, allofwhich areimportant parameters ofcompetitiveness. Tosurvive
inthenewenvironment, traditional approaches tocompetition willneed toberadically altered.
Continuous efforts musttherefore bemade bydeveloping countries, nolonger abletorelysolely on
lower prices andwages asthebasis fortheir competitiveness, toupgrade their technological
capabilities.
5. Acquiring Foreign Technologies
Thetransfer offoreign technologies canbeconducted invarious ways. Theformal channels
include suchmethods astheimport ofmachinery andcapital goods, non-equity licensing andother
contractual modes, FDI, strategic alliances andoutward FDI. Theinformal methods, ontheother
hand, include theexchange ofviews, information flows through publications andpublication networks,
migration ofskilled workers, various forms ofofficial government assistance andcooperation,
demonstrations andimitation.
(a) Technology transfer through foreign direct investment
FDIisgrowing inimportance asachannel oftechnology transfer. Technologies, inthiscase,
arepackaged withtheorganizational structure andmanagerial systems oftheforeign investors. In
addition totransferring technology, FDIcanalsobeaveryefficient means ofsharing capital, skills,
brand names andaccess tointernational markets under appropriate conditions. ItalsohasbeneficialWT/WGTI/W/8/Add.4
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spillover effects onlocalskillformation through demonstration, technological learning andcompetition.
Thereliance ofdeveloping countries andareas onFDIasamode oftechnology transfer varies
considerably. Brazil, Hong Kong, Mexico, Singapore andtheASEAN countries havedepended highly
onthisformoftechnology transfer, andtheyhaveconsistently ranked among thetenleading recipients
ofFDIinflows during thepastdecade. Incontrast, theRepublic ofKorea andChinese Taipei show
relatively lowlevels ofdependence onFDI. However, many Least Developed Countries (LDCs) appear
nottohavefeltthebeneficial effects ofFDI.
Thedirection ofFDIflows isdetermined byvarious factors. Themore important determinants
include political andeconomic stability, anestablished industrial infrastructure, theavailability ofa
pooloflow-cost labour, natural resources, asizeable market andexport-processing zones. Proximity
totechnology support isoften another important factor inattracting FDI. Investments willalsotend
toflowtohostcountries which cansupply high-quality partsandcomponents, askilled labour force
andagood information infrastructure. Countries which lackthese advantages willloseFDItothose
which havethem, resulting inanevengreater concentration ofFDIinthemore advanced developing
countries.
ThepossibilityandpaceoftechnologytransferthroughFDIdependsonthetechnicalcompetence
andlearning ability ofthehostcountries. Italsodepends onthewillingness oftheforeign investors
toincrease theparticipation oflocalpersonnel. Increased levels oflocalrecruitment inkeytechnical
andmanagement positions willhasten thetransfer.
(b) Technology transfer through strategic alliances
Anewform oftechnology partnerships, involving inter-enterprise cooperation orstrategic
alliances, hasrecently emerged, andisrapidly gaining importance. Although suchalliances maytake
many forms, theyusually involve atwo-way flowofresources, incontrast toconventional FDIand
licensing. Theprecise terms ofsuchagreements mayinclude cross-licensing between firms with
complementary assets ortechnologies, orthetransfer ofresources through anexchange ofequity stakes
between thepartners.
However, developing countries, especially LDCs, donothaveasignificant presence inthis
formoftechnology transfer. More than95%ofthestrategic technology partnerships areconcentrated
within theindustrialized countries. Among theindustrialized countries, thetriadofWestern Europe,
Japan andtheUnited States accounted fornearly 92%. Partnerships between thetriadandtheNIEs
(Newly Industrializing Economies) accounted for2.3% ofthetotalnumber ofalliances, while those
between thetriadandtheLDCs accounted foramere 1.5%.
New generic technologies dominated strategic technology alliances within thetriad. Such
technologies aremore commonly transferred toLDCs through technology transfer agreements. More
than50%ofstrategic alliances entered intobyNIEsinvolve generic technologies. Thepattern supports
theviewthatthedistribution oftechnological cooperation isrelated tothefactor endowment ofthe
partners, particularly human capital. Italsosuggests thatstrategic partnerships inhightechnology
industries areasuboptimal means oftransferring technology ifthestages ofeconomic development
ofthepartners differ considerably.
(c) Technology transfer through outward FDI
Another newwayofgaining access tokeytechnologies andotherstrategic assets fordeveloping
countries isthrough direct investments inindustrialized countries. Thismethod ismore applicable
totheadvanced developing countries which haveaccumulated sufficient capital surpluses asaresult
oftheirrapid economic growth. During thepastfewdecades, thriving venture capital markets intheWT/WGTI/W/8/Add.4
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industrialized countries, especially intheUnited States, haveledtoaproliferation ofinnovative start-ups
andspin-offs fromexisting firms invarious technologies. Thedifficulty inraising thecapital required
tocommercialize theinnovations havecreated opportunities forNIEstoinject equity intotheinnovative
firms. Anumber offirms fromtheRepublic ofKorea andChinese Taipei havethusacquired equity
stakes insmall electronic firms inSilicon Valley andelsewhere intheUnited States.
FDIflows originating indeveloping countries havegrown significantly since themid-1980s.
Their sources aremainly themore advanced developing economies, particularly theAsian NIEs.
Although theirshare inworld FDIinflows isstillsmall, thistrend isexpected toincrease withthe
growing participation ofmore developing countries suchasChina, India andthenear-NIEs inthe
globalized production system. Thetrendhaswidened theoptions forotherdeveloping countries looking
forFDIinflows andtechnology, atleastinstandardized andmature industries. TheLDCs mayfind
iteasier toattract FDIoriginating indeveloping countries thanFDIfrom industrialized countries.
Prior tothemid-1980s, suchFDIoutflows weremotivated mainly bythequest forexpanded
markets. Therecent increase ofoutward FDIfromdeveloping countries totheindustrialized countries
seems tosuggest, however, thatinternational competitiveness increasingly outweighs market-seeking
asadriving force intheinvestment strategy ofmany donor developing countries. Theshiftintrends
coincides withaperiod ofrising protectionist tendencies andtheemergence ofregional trading blocs
intheglobal economy. Inaddition, theinternational competitiveness ofEastAsian NIEs suchasHong
Kong, Republic ofKorea andChinese Taipei hasbeenaffected bycurrency appreciation, rising domestic
wages andexhaustion oftheirquotas under theMulti-Fibre Arrangement.
Thetrend ofincreasing concentration inindustrialized countries doesnot,however, diminish
theimportance ofthedonor developing countries assources ofFDIforother developing countries.
Except foracouple ofcountries, thebulkofFDIfrom developing countries isstillconcentrated in
other developing countries. Forexample, FDIflows fromdeveloping countries account forbetween
30and65%ofinward FDIstocks incountries andareas suchasChile, China, Indonesia, Malaysia,
Paraguay, SriLanka andChinese Taipei.
6. Increasing Barriers toIndustrial Development ofDeveloping Countries
Economic liberalization andrapid technological change have changed theconditions of
industrialization andinternational trade. Theneedforevermoresophisticated technologies andahighly
skilled workforce hasmade itmore difficult fordeveloping countries toparticipate inglobalized
production.Atthesametime,theprocessofglobalizationhasaccentuatedtheconcentrationofinnovative
capabilities intheindustrialized countries, increasing thegapinsuchcapabilities between industrialized
anddeveloping countries, largely asaresult ofawave ofdomestic andcross-border mergers and
acquisitions byTNCs, andtheensuing build-up ofaninternational supply structure.
Various assessments oftechnological capabilities starkly reveal theinferior status ofdeveloping
countries, particularly theLDCs, intheglobal system ofcompetition. TheUnited States, Japan and
western Europe areestimated toaccount forabout twothirds ofglobal R&D activities, while developing
countries onlyundertake 5%oftotalworld R&D. Even among developing countries, thedistribution
ofinnovative capabilities ishighly uneven. TheEastAsian countries appear tobethemostadvanced,
withrapidly rising levels ofR&D, while theother developing countries show astagnating ordeclining
trend. Inthecountries ofcentral andeastern Europe andoftheformer Soviet Union, where military
andspace programmes accounted foralargepartofR&D expenditures inthepast,themove toamarket
economy inrecent years hasbrought arapid decline intheirshare inworld R&D.
Recent trends inglobal flows ofFDI, which reflect thepotential fortechnology transfer to
thehostcountries, show asimilarly unbalanced pattern ofdistribution. Although totalglobal flowsWT/WGTI/W/8/Add.4
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ofFDIhaveincreased tremendously since the1980s, from anaverage ofUS$54.5 billion peryear
between1981and1985toanaverageofUS$180.4billionperyearbetween1991and1994,industrialized
countries accounted formore than60%oftheinflows during theearly 1990s. Ontheother hand,
theshare ofdeveloping countries intotalglobal flows ofFDIdeclined from32.7% between 1981and
1985to15.2% between 1986and1990, before picking upto36.1% during theearly1990s. Theshare
ofsub-Saharan Africa dropped from 1.7% to1.3% during thesame period, while thatoftheLDCs
remained atarelatively lowlevel, between 0.2and0.5%.
Ananalysis ofprivate technology flows shows thatEastandSouth-East Asia, including China,
accounted forabout 65%ofthetotalimports ofcapital goods bydeveloping countries in1994, thereby
gaining thebestaccess tothetechnologies associated withsuchimports. Latin America andthe
Caribbean came insecond, while theshare ofsub-Saharan Africa dropped sharply from11.1% in1970
to1.9% by1994.
7. Opportunities andtheThreat ofMarginalization: African Countries andLeast Developed
Countries (LDCs)
Formany African countries andLDCs theability toattract FDI, soessential forgrowth, is
compromised byother difficulties: domestic savings andincomes arelowandmarkets small; growth
isslow, butpopulation growth ishigh, sopercapita GDPs arefalling; andpopulation issparse in
many LDCs. These countries are,moreover, heavily burdened byexternal debtandareapparently
being bypassed byFDIflows. Onaverage, African countries received US$3 billion ofFDIeachyear
in1986-1994. Butinvestment flows toAfrica continued toaccount forlessthan5%oftotalFDIflows
todeveloping countries in1991-1994.
Thelackofinfrastructure andsupporting industrial services (repair, maintenance, information,
informatics) arealsoconsidered impediments. These impediments areparticularly problematic asmany
countries arelandlocked orsmall island developing countries. Thus, many ofthebenefits ofFDI-
remembering thatitwillnever, andshould not,taketheplace ofdomestic investors, whoarethereal
long-term builders ofaviable competitive economy -maybebypassing African countries andLDCs.
Recent figures showing thattheratiooftotaltradetoGNPinAfrica hasbeenfalling andislower now
thanitwas20years agoareacause forconcern, especially asthecomparable figures foralmost all
other regions oftheworld show anincrease overthesame period. IfAfrican countries aretobenefit
from globalization, increased trade isamust.
Because oftheirdifficulties inattracting FDI, African countries andLDCs willhavetorely
onODAtosupplementtheirownmeagreresources.Unfortunately,sincetheearly1990s"donorfatigue"
appears tohavesetinandFDIflows havedropped significantly inrealterms. However, insub-Saharan
Africa, themanufacturing value added (MVA) nowappears toberising (1.8% in1995compared with
0.5% in1994). Nevertheless, onlyafewcountries, suchasKenya andthose belonging totheCFA
franc zone, havebeenabletosustain growth atrelatively robust ratesandattract FDIinrecent years.
8. ANewRoleforGovernments andtheInternational Community
Liberalization andderegulation inrecent years havefirmly established theprimacy ofthemarket
system, andtheprivate sector hasincreasingly become theengine driving industrial development.
Thedevelopment ofthatsector, however, indeveloping countries andeconomies intransition alike,
requires anewpolicy framework. Itrequires, inparticular, policies toincrease systemic competitiveness
andexport orientation; tomobilize andsecure newinvestment, especially FDI; toensure theinflow,
absorption, adaptation anddomestic diffusion ofnewtechnologies; toachieve appropriate levels of
privatization; andtoaccelerate human resource development andtraining.WT/WGTI/W/8/Add.4
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Theemerging international environment forenterprises indeveloping countries andeconomies
intransition willthusbeverydifferent fromtheonetheywerenurtured in.They arebeing exposed
toworld competition atatimewhen thepaceofcompetition isintensifying andthetechnologies driving
itareevolving evenmore rapidly. Thegrowth ofglobalized production, under theaegis ofTNCs,
offers awayforward forthose countries thatareabletoattract sufficient amounts oftransnational
interest. Butdoing thisisnotsimply amatter ofopening uptheeconomy inapassive sense; itrequires
thecreation ofproductive factors, skills andsupplier systems. FDIdoesmake acrucial contribution
tothese factors andskills, butitcannot replace indigenous development, fortheveryexistence ofa
dynamic andcompetitive domestic industrial sector attracts higher quality foreign investment andallows
thehosteconomy toreapmuch larger benefits from theinvestment. Itshould beremembered that
theratioofFDIinflows togross domestic capital formation indeveloping countries during 1985-1990
totalled lessthan3%onaverage andreached only4.9% in1992. Thisdemonstrates thateveninopen
economies itisdomestic investment, domestic policies anddomestic entrepreneurial skills thatdrive
industrial development.
There arestrong complementarities between domestic andforeign investment. First, attracting
greater inflows ofFDIalsorequires stimulating localentrepreneurship, andoftenentails theprovision
ofdomestic counterpart funds atthesame time. Theestablishment ofjointventure agreements is
frequently predicated ontheavailability ofactive andcompetent localpartners. Small domestic firms
often actasimportant suppliers ofkeycomponents andparts forlarge firms. Most importantly, it
isonlybyfullysupporting thedevelopment ofdomestic entrepreneurship andinvestment thatFDIcan
haveasignificant multiplier effect, andthusgalvanize overall economic development, particularly in
theprivate sector.
Indesigning FDIpolicies andpromotional measures, governments should thusbecareful not
todiscriminate against domestic investors. Ingeneral, fiscal incentives andtaxrebates given toattract
FDIshould alsobeavailable todomestic investors. Better coordination ofFDIpolicies withdomestic
investment promotion andentrepreneurship development activities isthusessential. Inthatregard,
itmaybeuseful toexplore whether venture capital funds could beameans offostering domestic
investment innewareas ofindustrial activity, particularly insupport ofindustrial restructuring,
privatization andthepromotion ofspin-off SMIs.