RESTRICTEDWORLD TRADE
ORGANIZATIONWT/WGTI/W/38
5 June 1998
(98-2290)
Working Group on the Relationship
between Trade and Investment
SYNTHESIS OF THE INFORMATION MADE AVAILABLE TO THE WORKING GROUP ON
THE LINKS BETWEEN FOREIGN DIRECT INVESTMENT AND DEVELOPMENT
Note by the Secretariat
Table of Contents
I. INTRODUC TION ................................................................................................................. ..2
II. RECENT TRENDS IN FOREIGN DIRECT INVESTMENT HAVING A BEARING
ON ITS IMPACT ON DEVELOPM ENT ...............................................................................2
III. EFFECTS OF INWARD FDI ON ECONOMIC DE VELOPMENT ......................................5
III.1 Capital formation ...........................................................................................5
III.2 Technological and ma nagerial know-how .....................................................7
III.3 Access to expo rt mark ets ...............................................................................9
III.4 Domestic entreprene urship and linkages .....................................................11
III.5 Compe tition .................................................................................................12
III.6 Employment.................................................................................................14
III.7 Balance of payments a nd macroeconomic  stabil ity.....................................14
IV. EFFECTS OF OUTWARD FD I ON DEVELOPMENT.......................................................17
V. POLICIES TOWARDS FDI HAVING A BEARING ON ITS IMPACT ON
DEVELOPM ENT..................................................................................................................17
V.1 Policies in the cu rrent environment .............................................................17
V.2 Have optimal policies changed over time? ..................................................20
VI. CONCLUDING REMARKS.................................................................................................21WT/WGTI/W/38
Page 2
I. INTRODUCTION
1. The present note has been prepared by the Secretariat in response to a request made by the
Working Group for a synthesis paper based on the information received so far from Members and
intergovernmental organizations on the links between foreign direct investment and development,
both historically and in the present situation.  It was understood that the paper would not be regardedas exhaustive, but rather as capable of further evolution as the work progresses.
1
2. In accordance with the mandate under which the Note has been prepared, the focus is onforeign direct investment (hereinafter "FDI"), as distinguished from other forms of investment.
2
However, the Note takes into account that, in some instances, for example in regard to the
macroeconomic implications of FDI, reference has be en made to other forms of investment to provide
a context that facilitates the understanding of the specific effects of FDI.
3. The Note deals successively with:  first, certain general themes that have been raised
regarding recent trends in FDI having a bearing on its impact on development (section II);  the
contribution of inward FDI to development, viewed as a vehicle for the transfer of a range of tangible
and intangible assets to host economies (section III);  the impact of outward FDI on development
(section IV);  and policies for maximizing the development return from FDI (section V).
4. It will be recalled that the Working Group initiated its work on these matters by first asking
intergovernmental organizations to make contributions summarizing the results of relevant analytical
work carried out in these organizations.3  Accordingly, the structure of the individual sections of this
Note is generally that of, first, a summary of the information contained in these contributions,
followed by points made in written contributions by Members and in statements made at the meetings
of the Working Group.
II. RECENT TRENDS IN FOREIGN DIRECT INVESTMENT HAVING A BEARING ON ITS
IMPACT ON DEVELOPMENT
5. Several key features of recent trends in the volume and pattern of global FDI flows have been
highlighted in the contributions by the intergovernmental organizations:
- Global FDI inflows and outflows increas ed almost fourfold between 1983-1988 and
1996.4  The growth rate of worldwide FDI fl ows during this period exceeded that of
world trade by a considerable margin and constitutes in the view of some
intergovernmental organizations a key motor of international economic integration.
                                                     
1 M/3, paragraph 10.  Documents issued in the WT /WGTI/M/- series are referred to in this Note as
"M/..".  Documents issued in the WT/WGT I/W/- series are referred to as "W/..".
2 As defined in a contribution by an intergovernmental organization, FDI is an investment involving a
long-term relationship and reflecting a lasting interest and control by a resident entity of one country (the
foreign direct investor or parent enterprise) in an enterp rise resident in a country other than that of the foreign
direct investor (foreign affiliate). W/8/Add.1, p.3
3 Such contributions have been made by the OECD (W/8 and W/26), UNCTAD (W/8/Add.1), World
Bank (W/8/Add.2), IMF (W/8/Add.3), and UNIDO (W/8/Add.4).
4 Worldwide FDI flows increased from $92.9 b illion in 1983- 1988 to $349.2 billion in 1996 measured
in terms of inflows and from $93.7 billion in 1983-1988 to $346.8 billion in 1996 in terms of outflows.
W/8/Add.1, pp.29-30WT/WGTI/W/38
Page 3
- A notable aspect of this rise in FDI flows has been the recent increase in FDI flows to
developing countries, both in total and as a proportion of global FDI.5
- FDI inflows to developing countries have been concentrated on a limited number of
countries, but many developing countries have experienced significant increases of
FDI relative to the size of their economies.6
- The relatively small volume of FDI flows to a large number of developing countries
in Sub-Saharan Africa, South Asia, the Middle East and North Africa has been
highlighted.7
- The surge of FDI flows in the 1990s has al so been marked by the growing importance
of developing countries as sources of outward FDI. 8
6. Contributions by intergovernmental organizations point to the close relationship between therecent developments in the volume and pattern of FDI and the process of growing economicintegration of the world economy.  An increasing number of multinational enterprises are pursuing
complex integration strategies that favour closely integrated production and distribution networks
under which such firms engage in considerable cross-border specialization through a vertical and
horizontal intra-firm division of labour across borders, including increasingly at the functional level.
9
Key points made in this connection are:
- The importance of the widespread liberalization of international trade and investment
policies, improvements in transportation and communications technologies, and the
growing role of knowledge and other specia lized intangible assets in production and
marketing as the principal factors explaining this development.10
- Empirical evidence cited has included the growing share of world output accounted
for by cross-border production by multinational affiliates, the increasing orientation
of overseas production by multinational affiliates towards exports rather than the
domestic market of the host country, the increasing importance of intra-firm trade in
world trade, and growing international out-sourcing.11
- The expansion of the participation in this international organization of production of
developing countries, where the average share in GDP accounted for by the affiliates
of multinationals has increased particularly rapidly in recent years (from 4.3 per cent
in 1992 to 6.3 per cent in 1995).12
                                                     
5 FDI inflows to developing countries rose from  an average of $20 billio n annually during 1983-88 to
an average of $95 billion in 1994-1995, to reach $129 billion in 1996.  The share of all developing countries inworldwide FDI flows rose from 21.6 per cent in 1983-88 to 36.9 per cent in 1996. W/8/Add.1, p.29
6 In the five most recent years for which data were available, the leading ten non-OECD recipients of
FDI accounted for three quarters of total flows to n on-OECD countries (W/8, p.4).  However, the simple
average of FDI to GDP ratios for low and middle income countries nonetheless doubled between 1990 and1994.  W/8/Add.2, p.10
7 W/8/Add.1, p.7;  W/8/Add.2, pp.19-20;  W/8/Add.4, p.7
8 The share of worldwide FDI originating in developing countries rose from 3 per cent in 1980 to 15
per cent in 1996.  Most of the outflows from developing countries are accounted for by countries in East Asia,but such outflows are increasingly important also in other regions, notably Latin America (W/25).
9 W/8/Add.1, p.4
10 W/8/Add.2, pp.5-8;  W/8/Add.4, p.5
11 W/8/Add.2, pp.8-12.  An analysis of the growing internationalization of production in some major
industrial sectors is contained in W/8, Annex 1.
12 W/8/Add.2, p.8WT/WGTI/W/38
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7. A common theme in the contributions by the intergovernmental organizations is that the link
between FDI and the growing inte gration of the world economy has important implications for the
analysis of the relationship between FDI and devel opment.  The main points that have been made in
this connection are:
- The enhanced opportunities for countries to benefit from closer integration in the
international economy and the key role FDI can play in improving the capacity of a
host economy to respond to such opportunities.  As FDI is increasingly oriented
towards the cross-border integration of value-added activities by multinational
enterprises13, countries can participate in global production by mastering a slice of the
value-added chain in a given industry rather than waiting to master all the different
stages, resulting in a wider range of options for production and trade.14
- The greater emphasis placed by host countries on the benefits to be derived from the
intangible assets associated with FDI, such as technology, the stimulus that FDI often
gives to competition and increased efficiency, and its role in promoting integration in
the world economy, as compared to the contribution of FDI to capital formation, tax
revenue and balance of payments.15
- The increasing importance of factors such as technological capability, human skills,
quality of infrastructure and openness of trade policies as determinants of inward FDI
as compared to factors such as size of domestic markets and the availability of natural
resources.16
8. Several contributions by intergovernmental organizations draw attention to the relatively lowlevel of FDI inflows to many developing and least developed countries.  However, they also point outthat, although such FDI flows may be relatively small in absolute terms, they are not necessarily small
in relation to the GDPs and gross domestic capital formation of the countries concerned.  For
example, inflows into African countries as a whole, relative to African GDP, are about the same order
of magnitude as flows to developed countries.
17  Moreover, the point has been made that the ratio of
FDI to GDP increased in the first half of the 1990s in every region except East Asia, where it wasalready high.
18
9. Members, in their written contributions and in discussions at the meetings of the WorkingGroup, have generally endorsed the above-mentioned analysis of the implications for the relationship
between FDI and development of the changing global environment.  Points that have been
emphasized in this respect include the shift in attitudes of many developing countries towards a
recognition of the positive contribution of FDI;  the growing importance to host economies of FDI as
a vehicle for the transfer of intangible assets and as a means of greater integration into the worldeconomic system;  the increasing competition among countries to attract FDI;  and the declining
importance of market size and natural resources as determinants of the location of FDI, as compared
to technological capability, human resource development and other created assets that affect the
competitiveness of countries.
19  The need to pay special attention to the situation of the least
developed countries has also been stressed.20
                                                     
13 W/8/Add.1, pp.3-4
14 W/8/Add.1, p.4.;  W/8/Add.2, p.13;  W/26, pp.4-5
15 M/2, paragraphs 4-5
16 W/8/Add.2, pp.19-20 and p.26;  W/8/Add.4, p.3
17 W/8/Add.1, p.7
18 W/8/Add.2, p.9
19 M/2, paragraphs 11 and 12
20 M/2, paragraph 14WT/WGTI/W/38
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10. In the discussions in the Working Group and in some contributions, it has been argued that
the changing international economic environment m eans that caution should be exercised in drawing
lessons from the restrictive FDI policies pursued by some relatively more advanced countries at
earlier stages of their development.  In particular, the points have been made that the accelerating pace
of technological change means that such policies, if pursued today, would deprive countries of thevital technological spillover accompanying fo reign capital, leading to a weakness in the
competitiveness of domestic industries, as well as have a negative effect on trade given the
increasingly important role that multinational corporations play in world trade.
21  Some other
Members have indicated that, nonetheless, they believe that it is important to study the experience of
these countries, while taking account of the changed economic environment.  These issues are further
treated in section V of this Note.
III. EFFECTS OF INWARD FDI ON ECONOMIC DEVELOPMENT
11. This section looks at the effects of inward FDI on development in terms, successively, of its
impact on capital formation, the transfer of technological and other know-how, access to export
markets, domestic entrepreneurship and industry, competition, employment and the balance of
payments and macroeconomic stability.  The point, however, is made in a contribution by an
intergovernmental organization that one of the defining characteristics of the multinational enterpriseis that it embodies and organizes as a single package a range of factors of production - labour, capital,
technology and accumulated management and marketing expertise - and that a common view of the
multinational enterprise is that the whole is greater than the sum of its parts.
22
III.1 Capital formation
12. By way of background to the role of FDI as a source of development finance, severalcontributions by intergovernmental organizations point to the reversal since the mid-1980s in the
overall composition of capital flows to developing  countries between private and public flows:  FDI
and other private capital flows now account for some three quarters of net resource flows to
developing countries whereas in the 1980s they represented one third of those flows.
23  Data on total
net resource flows from OECD countries to deve loping countries show that, while FDI flows to
developing countries have increased greatly, their share in total flows has remained static at some
20 per cent, with the largest increases being in international bank lending and bond issues.24
13. Data contained in the contributions by intergovernmental organizations show that the share ofFDI in capital formation in developing countries has increased
25, and that FDI accounts for a
significantly greater share of capital formation in developing countries than in developed countries.26
At some 8.2 per cent (in 1995), FDI makes a significant contribution to the gross fixed capitalformation of developing countries and, in some individual countries, a major contribution.
27 The point
has been made that, nonetheless, the bulk of both domestic industrial investment as well as other
investment in developing countries has to be financed predominantly from domestic sources.28
                                                     
21 See the contribution by Japan (W/18, p.2).
22 W/26, p.30
23 W/8, p.7;  W/8/Add.4, p.3
24 W/8, p.8
25 FDI was 5-6 per cent of aggregate investment in developing countries in the early 1990s, compared
to the 1-2 per cent of the previous fifteen years.  W/8/Add.2, pp.13-14
26 The ratio of FDI inflows to gross fixed capital formation in developing countries in 1995 was 8.2 per
cent as compared to 4.4 per cent in developed countries.  W/8/Add.1, p.5
27 For example, in China FDI accounted for over one third of gross domestic investment in 1994.
W/8/Add.2, p.14
28 W/8/Add.4, p.4WT/WGTI/W/38
Page 6
14. The contributions from intergovernmental orga nizations make the point that FDI, even if
often a relatively minor part of capital formation and capital imports, is a particularly valuable part.
This is not only because it frequently carries with it a range of intangible assets that have important
positive spillovers for the rest of the economy (points discussed in later subsections), but also because
of its financial characteristics.  Although FDI app ears as just another capital flow in the balance of
payments, it differs from other capital flows in im portant respects:  FDI involves more stable and
smaller amounts of capital than other types of capital flows, does not create obligations for debtors to
make fixed interest payments and to reimburse the principal at a determined date, and contributes
more to the financing of productive investment than other capital flows.29
15. Several contributions examine and reject the argument that FDI may simply substitute fordomestic investment and thus does not contribute to an expansion of the capital stock in host
countries.  The point is made that such empirical evidence as there is on this relates to investmentinflows generally and not specifically to FDI.  FDI is less likely than other capital inflows to
encourage domestic consumption and reduce domestic investment through its impact on the exchange
rate and prices of stocks and real estate.  It is pointed out that countries where FDI dominates capital
inflows have experienced more significant increases in total investment than countries where capital
inflows have mostly been of the financial variety.
30  Reference has also been made to empirical
studies that show that FDI not only does not subs titute for domestic investment but may lead to
additional domestic investment.31
16. One contribution questions the view that FDI is likely to have more favourable effects oncapital formation if it is in the form of greenfield investments than that of mergers and acquisitions.
This is not only because the proceeds from such mergers and acquisitions will often be used to makeother investments, either of a financial or real nature, but also because the merger or acquisition will,
more often than not, be followed by sequential FD I, in modernization and capacity expansion, which
may well be larger than the original purchase.
32  Indeed, several contributions by intergovernmental
organizations as well as by Members stress the importance of the capital contribution of FDI in the
context of infrastructure privatization and modernization.33  It has been estimated that FDI inflows
accounted for more than half of infrastructure privatization revenues in developing countries from
1988 through 1995.34
17. The significant role of FDI in capital formation in host countries is emphasized in severalcontributions by Members, although they also stress the value of the flows of the intangible assets
associated with FDI.
35  Reference has also been made to the preference for FDI over other sorts of
foreign capital inflows, not only because of the associated intangibles but also because it is less likely
to create repayment and balance-of-payments problems.36
                                                     
29 W/8, p.21
30 W/8/Add.1, p.15
31 W/8/Add.2, p.14
32 W/8/Add.1, pp.15-16
33 W/8/Add.1, p.16
34 W/8, p.9.  A detailed analysis of the experiences of individual countries in Latin America and South
East Asia with respect to the role of FDI in privatization is contained in the OECD study on Foreign DirectInvestment and Economic Development.  W/26, pp.16-20
35 See, for example, the contributions by Japan (W/11, p.4);  Colombia (W/15, p.1);  Korea (W/16,
pp.3-4) and Bolivia (W/20, pp.1-2).
36 M/4, paragraph 12WT/WGTI/W/38
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III.2 Technological and managerial know-how
18. Several of the contributions of intergovernmental organizations, as well as that of the WTO
Secretariat, recall that a fundamental feature of  the multinational corporation is its ownership of
specialized intangible assets related to technological and management know-how.  Given that such
assets are often not easily exploitable by the company which controls them through contractual arms-length relationships, the exploitation of them in foreign markets is frequently carried out through FDI.
However, the value of such assets remains imperfectly appropriable even in an FDI context and their
transfer to foreign affiliates usually generates important positive spillover effects for the host
economy at large.
37
19. The intangible assets in question, here summarized as "technological and managerialknow-how", are diverse, ranging from technology that  is the subject of intellectual property titles,
through related technical know-how and human skills to managerial and marketing techniques.
20. The contribution that FDI makes to the transfer and diffusion of such intangible assets is
considered in the papers presented by intergovernmental organizations to be possibly the most
important contribution that FDI makes to the development of host countries, especially developing
countries.  In this connection, attention is drawn to the concentration of technology and other
know-how within multinational enterprises a nd the relative backwardness of many developing
countries in this area of critical importance for economic development.
38  The observation is made
that FDI has become more prominent relevant to other modalities of technology transfer.39
21. Two main types of contribution to development are identified in the contributions:
- first, those which flow from the introduction and use by the investor of the
technology and know-how itself;
- second, the spillovers or externalities to other parts of the host economy which
result.40
22. The indirect benefits or spillovers have been identified as follows:
- Labour market spillovers.  The diffusion of technical and managerial skills as
employees trained by the foreign investor move to other parts of the domesticeconomy.
- Supplier spillovers.  These result from the collaboration of the foreign affiliate with
local suppliers, especially on such matters as product design, technical support,
production process planning and quality control.  Several of the contributions report
on empirical work which indicates the prevalence of such forms of cooperation
between affiliates of multinationals and their domestic subcontractors.
41
- The stimulation of domestic innovation.  Th e point is made that domestic innovation
depends on the number of ideas available in the economy.  Thus the introduction of
new ideas increases the stock of ideas and stimulates domestic innovation.42
                                                     
37 W/8/Add.1, pp.3 and 16-17;  W/8/Add.2, pp.4, 7;  W/7, pp.8-9;  W/26, p.30
38 W/8/Add.1, p.17;  W/26, p.35
39 W/8/Add.4, p.5
40 W/8/Add.1, pp.17-18;  W/8/Add.4, pp.5-6
41 W/8/Add.1, p.19;  W/8/Add.2, pp.14-15
42 W/8/Add.1, p.17WT/WGTI/W/38
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23. Significant differences have been noted between countries regarding the extent to which they
have relied on FDI as a mode of transfer of technology.43  In this connection it is noted that, contrary
to what neo-classical models postulate, technology is not a free good that is clearly specified and
readily available for use by any firm anywhere, but, in important respects, technological assets contain
a tacit element that is not easily transmittable or replicable in another environment.  Further, the
observation is made that technology markets are opaque and subject to informational failures.44  I n
discussing whether it is preferable to obtain te chnology through FDI, including joint ventures, as
compared to other means, such as licensing, it is argued that much depends upon whether the
technology in question is available in a more unpackaged form than through FDI, which is not always
the case, and upon the availability in the host country of entrepreneurial and technical skills to operate
new technologies and earn profits doing so.45
24. The contributions by intergovernmental organizations identify several kinds of factors that
affect the extent to which FDI contributes to the transfer and diffusion of technical and other know-
how in host countries:
- First, the technical competence and learning ability of host countries and the level of
local recruitment in key technical and management positions.46
- Second, evidence has been adduced demonstrating that more competition in host
country markets increases the pressures on and incentives for multinational
enterprises to transfer more and better quality technology to their affiliates.47  More
specifically with respect to trade policy, it has been noted that import substitution
policies may enable multinational enterprises to undertake market-seeking
investments that fail to incorporate state of the art technologies, whereasexport-oriented policies, under which production has to be internationally
competitive, are more likely to encourage the introduction of the most advanced
technology.
48  In the latter regard, the point has also been made that technology
transfer may be limited when export production takes place in enclaves that have no
linkages with domestic enterprises.49
- Third, on the basis of empirical studies, some contributions call into question the
effectiveness of specific host country policies designed to augment the transfer of
technology, such as requirements to operate through joint ventures with local firms,
mandatory transfers of technology and compulsory licensing. 50
25. The contribution of an intergovernmental organization discusses concerns regarding theaccentuation of structural heterogeneity in host coun tries that may result from foreign affiliates and
domestic firms with links to multinational enterprise s increasing their technological lead over small
and medium-sized domestic enterprises and points to the case for active government policies to
overcome the relative backwardness of small and medium-sized enterprises.
51  This concern is
endorsed in the contribution of a Member, which draws attention to the challenges that the growth of
inward FDI by technologically advanced companies as well as increased trade liberalization poses for
domestic companies who may find their technology rapidly rendered obsolete.  It states that the
                                                     
43 W/8/Add.1, p.17;  W/8/Add.4, p.6
44 W/8/Add.1, p.16;  W/7, pp.8-9
45 W/8/Add.1, pp.17-18
46 W/8/Add.4, p.6
47 W/8/Add.2, p.17
48 W/8/Add.1, p.17
49 W/26, p.36
50 W/8/Add.2, pp.17-18;  W/26, pp.35-36
51 W/8/Add.1, p.18WT/WGTI/W/38
Page 9
effectiveness of the technological transformation process by these companies depends on their ability
to acquire and develop technology from external sources on optimum terms, based on equitable and
well-negotiated contracts, and the domestic technological support infrastructure.52
26. Contributions by Members endorse the idea that the contribution of FDI in the area oftechnical and other know-how is one of the key contributions that FDI can make to economicdevelopment of host countries.
53  Empirical evidence supporting the importance of the contribution of
FDI to host country technological development is contained in a contribution by a Member which
refers to national studies of technology transfer from parents to affiliates and technology diffusion
arising from linkages between affiliates and local firms and from the research and development
spending by affiliates.54
27. In discussions at meetings of the Working Group, Members have underlined the significanceof the contribution of FDI in the area of technology transfer and diffusion and human resourcedevelopment.
55  Support has been expressed for the observations made in some contributions by
intergovernmental organizations regarding the impact of open trade policies on the quality of
technology transfer and the counterproductive effect of certain policies aimed at regulating transfer of
technology.56  Attention has been drawn to the relationship between the role of FDI in the area of
transfer of technology and the adequate protection of intellectual property rights.57  It has also been
argued that the potential beneficial impact of FDI on technological development of host countries is
sometimes negated or limited by particular business practices, for example in the context of restrictive
licensing arrangements between parents and foreign affiliates.58
III.3 Access to export markets
28. Several of the contributions by intergovernmental organizations discuss the changingcomposition of FDI in developing countries from that which is motivated more by market-seeking
considerations (often behind barriers to imports) to that which is more motivated by efficiency-
seeking considerations, where the primary concern is to locate each stage of production or corporate
function, for supply of the world or a regional market, in the country where it can be most efficiently
undertaken due to the availability of relevant factors of production, such as natural resources, labouror technology.
59  The latter form of FDI offers more by way of facilitating access to export markets,
both directly and indirectly, by host countries.  Indeed, the point is made that it enables developing
countries to participate in the international division of labour without having to master the technology
involved in producing the complete product and has contributed importantly to the diversification of
the exports of many developing countries which previously were focused essentially on primary
products.60  In this respect, a contribution makes the point that FDI can serve to integrate national
markets into the world economy far more effectively than could have been achieved by traditionaltrade flows alone.
61
29. It is also noted in the contributions by intergovernmental organizations that FDI has in somecases been importantly stimulated by the creation or development of regional economic integration
arrangements, enlarging the "domestic" market and providing assurances of a host country's
                                                     
52 See the contribution by Bolivia (W/20, p.4).
53 See the contributions by Poland (W/13, p.3), Colombia (W/15, p.1) and Bolivia (W/20, p.4).
54 See the contribution by Korea (W/16, p.3).
55 M/2, paragraph 14
56 M/4, paragraph 9
57 M/2, paragraph 16
58 M/4, paragraphs 18-19
59 W/8/Add.1, pp.9-11
60 W/8, p.15;  W/8/Add.1, p.4;  W/8/Add.2, pp.4 and 13
61 W/26, p.36WT/WGTI/W/38
Page 10
commitment to stable trading arrangements.  Al though such FDI is often primarily motivated by
"market-seeking" considerations, it nonetheless frequently leads to increased trade within the region
as a result of the restructuring of production on a regional basis.62
30. The papers presented by intergovernmental organizations indicate that the direct contributionof foreign investors to facilitating access to international markets by host countries derives not onlyfrom their role in dividing stages of production between countries and linking those stages through
international trade flows, but also because of thei r international distribution channels for final goods
and, in some cases, services produced by their foreign affiliates.  Evidence is advanced to the effect
that foreign firms, with their greater knowledge of world markets and access to international
marketing channels, tend to be more involved  in international trade than local firms.
63  Empirical
evidence of the direct effect of FDI on export performance of host countries through the activities of
foreign affiliates has been provided through data on the share of host country exports accounted for byforeign affiliates.
64
31. The information supplied by intergovernmental organizations indicates that the contributionof multinational enterprises to host country export performance is not only a function of the exports
realized by foreign affiliates, but is also indirect in that it stimulates exports by other companies in the
host country.  This is partly because linkages with the production and distribution networks ofmultinational enterprises that facilitate access to international markets may be established through a
variety of contractual interfirm arrangements, such as subcontracting, licensing and production-
sharing agreements.
65  In addition, the presence of export-oriented foreign affiliates has been shown to
have demonstration and informational spillover effects which enhance the export performance of local
firms in host countries.66  The WTO Secretariat Note on "The Relationship between Trade and
Foreign Direct Investment"  also concludes, on the basis of a review of empirical studies, that inward
FDI contributes to the export performance of developing countries both directly through multinational
enterprises' own export activities and indirectly by  reducing the costs and informational obstacles for
domestic firms to start or expand exporting.67
32. Some of the contributions by intergovernmental organizations discuss the question of whether
inflows of FDI might have a negative effect on over all exports by leading to an appreciation of the
exchange rate.  In general, they make the point that  inflows of FDI are less likely to have such effects
than inflows of other forms of foreign capital, be cause FDI inflows are frequently associated with
counter-balancing outflows of foreign exchange to purchase capital equipment and supplies.
However, one contribution suggests that excessive exchange rate appreciation could result from a
sudden large increase of FDI into a small host countr y and argues that this may provide a rationale for
phasing in FDI at a slower rate than the rate determined solely by market forces.68
                                                     
62 W/8/Add.1, pp.9-10;  W/8/Add.3, p.4;  W/7, paragraphs 86-97;  W/26, pp.14-16
63 W/8/Add.2, p.14;  W/7, paragraph 58
64 Thus, one study reports that in 1994 US-owned foreign affiliates accounted for one tenth of the total
exports in Argentina, Brazil, Chile, Indonesia, Malaysia and the Philippines and that, if other foreign affiliatesare included, the foreign-owned share could exceed one half  of the total exports for some countries.  In certain
sectors, such as electronics and computer chips, the sh are of exports represented by foreign affiliates sometimes
exceeded 90 per cent (W/26, p.31).  A study of FDI in China found that the share of foreign affiliates in exportsincreased from 17 per cent in 1991 to 31.3 per cent in 1995.  W/8/Add.2, p.14
65 W/26, p.32
66 W/8/Add.2, p.14
67 W/7 and Corr.1, paragraphs 10 and 56-60.  (See  also Job No 7172 which responds to comments
made at the second meeting on the points made in W/7 on the link between FDI and export performance.)
68 W/8/Add.1, pp.13-14WT/WGTI/W/38
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33. The contributions of a number of Members endorse, on the basis of their national experiences,
the positive, direct and indirect, effects of inward FDI on the volume and structure of their exports.69
34. In discussions, some Members have emphasized the role of FDI in export growth anddiversification and in improving the capacity of host countries to respond to the challenges of
globalization.
70  Concern has been expressed about the danger that some developing countries might
remain locations for simple assembly operations.71
III.4 Domestic entrepreneurship and linkages
35. The contributions by several intergovernmental organizations discuss the impact that FDI has
on the development of indigenous entrepreneurial talents and domestic industry.  On balance, they
point to a generally positive impact.  Most empirical studies point to positive spillovers for domestic
industry.72
36. The channels through which FDI has positive impacts on domestic entrepreneurship and
industry are identified in the contributions by intergovernmental organizations as follows:
- the domestic purchases of foreign affiliates from local suppliers, which tend to
increase as companies gain experience in host environments73;
- the spillover effects of subcontracting arrangements with such suppliers (see
paragraph 22 above);
- the generation of a local entrepreneurial class drawn from the ranks of the local
partners of foreign investors and their managerial and skilled employees74;
- other spillover effects on the domestic economy from the training of manpower and
diffusion of know-how, notably through the movement of personnel;
- lowering the price and increasing the quality and reliability of inputs used by
domestic firms.75  In this regard, evidence has been provided of the efficiency gains
resulting from FDI liberalization in a range of infrastructure services76;
- as already discussed, through facilitating exports even by unrelated domestic firms.
37. Some of the contributions note that it has sometimes been argued that in certain situations
FDI may have a "crowding out" effect on domestic firms in those sectors of the economy whereforeign investment takes place.
77  The point is made, however, that the results of policies to favour
domestic entrepreneurship have not always been positive, in that domestic entrepreneurship did not
fare well even though FDI was discouraged and that today the constraint is mostly one of the domestic
availability of human resources and entrepreneurial talents.  One of the contributions also discusses a
more general "crowding out" effect that could arise if large foreign firms are able to borrow on
                                                     
69 See the contributions by Japan (W/11, pp.2-3), Poland (W/13, p.3), Korea (W/16, p.5) and Costa
Rica (W/31, pp.2-3).
70 M/4, paragraph 9
71 M/4, paragraph 18
72 W/8/Add.2, p.15;  W/8/Add.1, p.20
73 W/8/Add.1, p.19
74 W/8, p.14
75 W/8/Add.1, p.19
76 W/8/Add.2, p.16;  W/26, pp.25-30
77 W/8, p.14;  W/8/Add.1, pp.18-19WT/WGTI/W/38
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domestic financial markets, raising domestic interest rates and reducing the profitability of investment
projects for small and medium-sized domestic firms without access to international capital markets.  It
argues that this is a possible rationale for monitoring the domestic borrowing of large foreign firms.78
38. The point is made in some contributions that the extent of the linkages that may stimulateeconomic activity in other parts of the economy will depend on the nature of the FDI, for examplesuch linkages are more likely to be generated when FDI is in the manufacturing or services sectors
than in natural resources, particularly mining.
79
III.5 Competition
39. Two main aspects of the relationship between FDI and competition have been raised in the
contributions by international organizations:  first, the impact of FDI on the degree of competition in
host countries and, second, the importance of policies that enhance the degree of competition in host
country markets in maximizing the gains from FDI.
40. Contributions by several international organizations point out that the entry of new
competitors through FDI can enhance competition and efficiency in the domestic market of host
countries not only by introducing a new competitor in many cases but also by prompting domestic
firms to adjust to remain competitive.  Empirical ev idence has been referred to showing that the entry
of multinational enterprises into an industry has had a positive effect on the productivity of domesticfirms in a number of countries.
80
41. However, some contributions from intergovernm ental organizations also indicate that there
may be situations in which FDI can lead to greater concentration and reduce competition in host
country markets.81  An example that has been mentioned in one of these contributions is FDI in the
form of the acquisition of a domestic producer by a foreign producer already exporting into themarket of the host country.
82  Another contribution points out that multinational enterprises by their
very nature operate in concentrated industries a nd that they may wind up displacing smaller and less
efficient domestic firms, rather than prodding them to increase their efficiency.  According to this
contribution, the risk of monopolization may be particularly acute in some non-tradable services,
where the option of liberalizing imports in order to check the monopoly power of producers is nottechnically feasible.
83
42. A second aspect of the relationship between FD I and competition that has been raised in the
contributions by intergovernmental organizations is that host countries can maximize the gains from
FDI by adopting policies to enhance the level of competition in domestic markets.  As previously
noted, empirical studies referred to in some contributions show that the incentive to transfer more
advanced technology to affiliates is influenced by the degree of competition in host country markets.
43. In regard to any anti-competitive practices of  multinational enterprises, the view has been
expressed in the contributions by intergovernmental organizations that, since anti-competitive
practices are not unique to foreign firms, the appropriate response to such practices lies in the non-
discriminatory enforcement of competition policies in host countries, with the cooperation of other
competition authorities where necessary, rather than in specific restrictions of FDI.  It is noted that the
presence of foreign firms in a domestic market may complicate the task of the national competition
                                                     
78 W/8/Add.1, p.19
79 W/8/Add.1, p.19
80 W/8/Add.1, p.20
81 W/8, p.19;  W/8/Add.1, p.20
82 W/8, p.19
83 W/8/Add.1, p.20WT/WGTI/W/38
Page 13
authority, particularly if cartel activity is suspected, as information necessary to the investigation of
the practice may be spread across the jurisdiction of several countries.  It is further suggested that the
removal of any remaining restrictions on the entry of foreign firms as well as of barriers to trade in the
sectors in question can greatly help the task of na tional competition agencies in this regard as the
entry of additional firms is the best long-term strategy to prevent the acquisition of excessive marketpower.
84  In regard to certain service sectors, characterized by "natural" monopoly conditions, the
point has been made that, to realize the potential benefits of increased competition generated by FDI,
it may be necessary to establish an adequate regulatory framework.85
44. A contribution by a Member refers to the promotion of domestic competition and productivityas an explicit objective of its FDI policies.  It points out that inward FDI is expected to enhance
efficiency by inducing specialization of local companies, reducing the concentration of economic
power and facilitating the exit of less competitive companies from markets.
86  The contribution of
another Member draws attention to competing views that have been advanced on the effect on
competition of certain restrictive FDI policies pursued by its government in the post-war period.87
45. In meetings of the Working Group, it has been argued by some Members that anti-competitive effects on host country economies may sometimes arise from particular practices and
business strategies of multinational firms.  For example, foreign affiliates might be prevented fromundertaking certain activities by their parents, for example exporting, including by restrictions in
transfer of technology arrangements.  Concern has also been expressed about possible political
interference by foreign affiliates, for example to seek protection from competition.
88  A Member has
stated that its experience was that anti-competitive practices were not typical of foreign firms and
wondered if there was evidence to the contrary.  In its view, the non-discriminatory application ofcompetition law was the appropriate remedy.
89
46. A contribution by an intergovernmental organization discusses possible concerns regardingtransfer pricing.  It argues that the danger of transfer pricing has diminished as foreign exchange
constraints in developing countries have eased and corporate taxes have fallen but that the issue still
merits attention insofar as the ability of multinatio nal firms to extract their profits from host countries
via intra-company transactions at artificial prices may reduce the benefits of FDI to host countries.  It
makes the point that bilateral double taxation treaties may go a long way towards resolving this
problem by removing the incentive for abusive transfer pricing except where, as is the case in some
developing countries, corporate taxes are higher in host countries than in home countries.  It states,
furthermore, that double taxation treaties are not an effective remedy where profits are channelled
through tax havens.  It suggests that the issue of transfer pricing needs to be followed closely at the
national and international levels and emphasizes the importance of developing country legislationincluding clear accounting rules on this matter.
90  Another contribution by an intergovernmental
organization also suggests that policy-makers may wish to consider greater international coordination
in setting national policies and standards in this area.91
                                                     
84 W/8, p.19
85 W/8/Add.2, pp.18-19
86 See the contribution by Korea (W/16, p.4).
87 See the contribution by Japan (W/18, p.2).
88 M/4, paragraphs 18-20.  One of the documents before the Working Group contains a report on a
debate held in the context of the UNCTAD Commission on Investment, Technology and Related FinancialIssues at its second session (29 September-3 October 1997) as to whether or not liberalization of investmentpolicies  needs to be accompanied by implementation of competition policies.  See W/21, pp.45-47.
89 M/4, paragraph 22
90 W/8/Add.1, pp.14-15
91 W/8/Add.2, p.21WT/WGTI/W/38
Page 14
III.6 Employment
47. With regard to the contribution of FDI to em ployment in host countries, the contributions by
intergovernmental organizations make a distinction between a direct effect, which  relates to the
number of persons employed by foreign affiliates, and an indirect effect, which arises from the
purchase by foreign affiliates of goods and services from local firms and from the contribution of FDIto the economic growth of host countries.  While quantitative estimates have been provided of the
direct employment effect of FDI in a number of countries
92, it has been pointed out that the indirect
employment effect may be greater and longer lasting.93
48. It is pointed out in a contribution that the employment effects of FDI vary by sector of
economic activity and that, while significant direct employment effects arise from FDI in export-
oriented, labour-intensive activities, FDI in capital-intensive activities, such as mining, has limited
direct effects on employment.94
49. Some written and oral contributions by Members, discussing the employment effects of
inward FDI in their countries, point to a posit ive relationship between inward FDI and employment
creation.95
50. Several contributions by intergovernmental organizations point out that foreign affiliates tendto pay higher wages than local firms.
96  One contribution observes that there is little information on
the impact of FDI on income distribution in host co untries but that one can speculate that, if  FDI
leads to the introduction of new skills or to the training of human resources, it is likely that it will
make income distribution in developing countries less unequal given that the accumulation of human
capital has an equalizing effect on income distribution.  The effect of FDI on income distribution
varies by sector and on the whole may not be very significant, except in countries where FDI is largerelative to the size of the economy.
97
III.7 Balance of payments and macroeconomic stability
51. A contribution by an intergovernmental organization makes the general observation that the
issue of the balance-of-payments effects of FDI, once a prominent theme in the literature on FDI in
the 1970s mainly because most developing countries faced a binding foreign exchange constraint togrowth, is now less pressing as, in the present time s of much higher international capital mobility,
growth in developing countries is not as constrained by foreign exchange availability as it was in the
1970s and 1980s.  It adds, however, the point that this does not mean that balance-of-payments effects
are unimportant for all countries or that they could not become important again in the future.
98
Another contribution questions the continued relevance of the results of earlier studies that had foundnegative balance-of-payments effects of FDI in some developing countries in the light of the recent
shift from import-substituting to export-promoting de velopment strategies and refers to more recent
studies that show positive balance-of-payments effects of FDI.
99
                                                     
92 See, for example, the figures on employment by foreign affiliates in W/8/Add.2, p.14 (China), W/26,
p.34  (Brazil, Argentina, Chile, Indonesia, Malaysia and the Philippines) and W/16, p.2 (Korea).
93 One contribution refers to a study which estimates that for every job created by foreign investors
another 1.6 jobs are generated in the rest of the economy.  W/26, p.34
94 W/8/Add.1, p.20
95 See, for example, the contributions by Korea (W /16, p.2) and Costa  Rica (W/31, p.2), and M/3,
paragraph 6.
96 W/8/Add.2, p.14;  W/26, p.34
97 W/8/Add.1, pp.20-21
98 W/8/Add.1, p.13. A detailed analysis of the balance-of-payments effects of FDI is contained in the
UNCTAD World Investment Report 1997 , Chapter II.
99 W/26, p.33WT/WGTI/W/38
Page 15
52. In discussing factors that are relevant to an assessment of the balance-of-payments
implications of inward FDI, contributions by intergovernmental organizations point out that:
- The balance-of-payments impact of an investment project cannot be assessed only by
comparing the inflow of foreign exchange a ssociated with an investment project with
the present value of future outflows of profits. Account should also be taken of othereffects, such as the generation of exports or the saving of foreign exchange by
substituting domestic production for imports.  The point is made that the effect on the
capital account, which results from the repatriation of profits once the affiliate has
become profitable, is likely to be mirrored by a positive effect on the trade balance as
the project becomes less dependent upon imported components over time and, in the
case of export-oriented projects, exports will come to represent a substantial share of
the output.  The net effect on the balance of payments from these offsetting currentand capital account flows is difficult to determine a priori .
100
- FDI most often takes the form of equity capital, which, as opposed to debt-creating
instruments, imposes no obligations on the debtor to make fixed interest payments
and to reimburse the principal at a determined date.  Rather, FDI contributes to the
financing of productive investments in a higher proportion overall than portfolioinvestment and credits, thereby enhancing the host country's capacity to assure the
service of its debt through increased exports at a later stage.
101
- The balance-of-payments effects of FDI cannot be properly assessed by limiting the
analysis to individual investment projects.  FDI is a continuous process in that, as
some older investors begin to repatriate profits, new investors inject equity capitalinto the host country and existing investors expand their presence through retained
earnings.  In addition, to focus only on the direct balance-of-payments effects of the
activities of foreign affiliates ignores the indirect contribution of FDI to the overall
export potential of the host country and its economic growth.
102
- The impact of FDI on the balance of payments is inherently difficult to determine in
the absence of knowledge of the most likely counterfactual.103
53. Several contributions by Members discuss the relationship between FDI and the trade balanceof host countries.  Some Members have shared the view that, in the present environment of more
export-oriented FDI, flexible exchange rates and m obile capital, the analysis of FDI in terms of its
effects on the trade balance and balance of payments was no longer a key policy issue.
104  O n e
Member's contribution refers to research showin g that its outward FDI to a number of developing
countries had a positive impact on the trade balance of these host countries.105 A contribution by
another Member contains data demonstrating the positive effect of inward FDI on the trade balance of
that Member.106  The possibility of a negative effect of FDI on the trade balance and the balance of
payments of host countries has been mentioned in general terms in a contribution by a Member which
states that, at the initial stage of FDI, imports from a host country are likely to increase and that in the
mid- and long term the repatriation of profits from foreign subsidiaries to a home country may haveadverse effects on the balance of payments of a host country.
107  At the meetings of the Working
                                                     
100 W/26, p.32
101 W/8, p.21
102 W/26, pp.32-34
103 W/8/Add.1, p.13
104 M/3, paragraph 21;  M/4, paragraph 17
105 See the contribution by Japan (W/11, pp.2-3).
106 See the contribution by Korea (W/16, p.5).
107 See the contribution by Japan (W/11, p.5).WT/WGTI/W/38
Page 16
Group, this Member has stressed that this point is based on theoretical reasoning and not on its own
experience or empirical studies.108
54. In regard to the relationship between FDI and the macroeconomic stability of host countries, a
contribution by an intergovernmental organization discusses the concern that large capital inflows
may complicate the conduct of monetary and exchange rate policies by causing an appreciation of theexchange rate and that excessive reliance on external financing may make an economy vulnerable to
sudden reversals in financial market conditions and in foreign investor sentiment.  It argues that
evidence suggests that FDI is less likely to raise such problems than other types of capital flows
because it involves much more stable and generally smaller amounts of capital than portfolio
investments and credits.
109
55. A contribution by an international organization discusses concerns about a possibledestabilizing effect of FDI liberalization in financia l services.  It makes the point that allowing greater
foreign participation in domestic financial service sectors helps reduce the risk of banking crises in
host countries by enhancing competition and efficiency and improving the quality of banking
regulation.  To illustrate these benefits, it refers to the stabilizing role of the presence of foreign banks
in the recent financial crisis in Argentina
110, a view supported by the representative of that country.111
56. In meetings of the Working Group, some Members have endorsed these views.112  S o m e
others mentioned the possible adverse implications of FDI in the context of the recent experience of
some countries in South East Asia.  The Working Group has been informed of the results of a study
undertaken by UNCTAD of actual and prospective FD I flows to the countries most affected by the
Asian financial crisis, which confirms the greater stability of FDI flows compared to other capital
flows.113
IV. EFFECTS OF OUTWARD FDI ON DEVELOPMENT
57. As previously noted, one significant feature of recent trends in FDI flows is the substantial
increase in the share of global ou tward FDI flows accounted for by de veloping countries, from 3 per
cent in 1980 to 15 per cent in 1996.114  A Note by the WTO Secretariat on outward FDI from
developing countries notes that outward FDI tends to increase with the level of development.115
Outward FDI from developing countries tends to be oriented towards countries within the same region
although there are some notable exceptions, for ex ample outward FDI from Korea and Chinese Taipei
in developed countries.  The Note by the Secretaria t concludes, on the basis of a review of FDI from
each of the largest outward investors in Asia, that the factors explaining such FDI are largely the same
as for outward FDI from developed countries. Thus , vertical outward FDI from developing countries
is driven by cost and efficiency factors, while horizontal outward FDI appears to be motivated by the
effect of trade protection in host countries.
58. Contributions to the Working Group do not provide a comprehensive analysis of the impact
of outward FDI on the growth and development of developing home countries.  A contribution by an
intergovernmental organization discusses concerns about possible negative effects of outward FDI on
jobs and wages in home countries on the basis of the experience of developed countries in this regard.
                                                     
108 M/4, paragraph 19
109 W/8, p.21
110 W/26, p.27
111 M/4, paragraph 11
112 M/4, paragraph 9
113 M/4, paragraph 23
114 W/25, p.1
115 W/25, p.2WT/WGTI/W/38
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It makes the point that available evidence indicates that these effects have been relatively minor, that
outward FDI in the context of globalization generates higher trade and incomes at an aggregate level,
which will have a positive indirect income effect on the demand for labour, and that outward FDI is a
way for firms to remain competitive and hence to be able to maintain employment levels in the home
country.  It is suggested that FDI flows should be seen as part of the process of structural
transformation of economies towards higher value-added activities.  Reference is made to the
deliberate policies in some developing countries to encourage some more labour-intensive activities to
move abroad.116  A contribution from a Member reports that a domestic survey of outward FDI found
that the predominant effect on domestic employment was positive.117  A contribution by another
international organization points to the role of outw ard FDI from developing countries as a vehicle for
transfer of technology to home countries, as illustrated by FDI from Korea and Chinese Taipei in the
United States.118
59. Data contained in some contributions by Memb ers point to a positive effect of outward FDI
on the exports and trade balance of home countries although it is noted in one of these contributions
that this effect may decline in the long term.119  A contribution by a developing country Member
describes the role of its outward FDI in esta blishing distribution channels for its exports.120  Another
contribution by a Member, based on a study of the pattern of parent-affiliate trade in the bilateralrelationship between that Member and another Member,  points out that parents have large surpluses
with foreign affiliates, which confirms the co mplementarity of trade and outward FDI and home
country exports.
121  At recent  meetings of the Working Group, a Member has drawn attention to its
experience regarding the beneficial effects of outward FDI in enhancing the competitiveness of  firms
and creating domestic employment. 122
V. POLICIES TOWARDS FDI HAVING A BEARING ON ITS IMPACT ON
DEVELOPMENT
60. Two main issues have been discussed in relation to policies to FDI from a development
perspective:
- First, what are the most appropriate policies in the current situation?- Second, have the appropriate policies changed over time, in particular what lessons
should be learnt from the experience of countries which adopted more restrictive
policies at earlier stages of their development?
V.1 Policies in the current environment
61. Contributions by intergovernmental organizations emphasize the importance of the regulatory
environment in host economies as one of the key factors affecting both the volume of FDI received by
a country and its contribution to development.  This includes both policies relating specifically to FDIand policies affecting the wider environment for pr ivate enterprise activity including political and
macroeconomic stability.  One contribution illustrates the impact of host country regulation on the
volume of FDI inflows by comparing the recent experiences of certain countries.
123
                                                     
116 W/8, pp.17-19
117 See the contribution by the European Community and its member States (W/12, p.4).
118 W/8/Add.4, pp.6-7
119 See the contributions by Japan (W/11, p.2) and Korea (W/16, p.5).
120 See the contribution by Cuba (W/35).
121 See the contribution by the United States (W/14, p.61).
122 M/3, paragraph 6;  M/4, paragraph 14
123 W/8/Add.2, pp.26-27WT/WGTI/W/38
Page 18
62. The contributions by intergovernmental organizations emphasize that, to be effective both in
attracting FDI and in maximizing benefits from it, the liberalization of specific FDI legislation needs
to be embedded in generic policy reforms designed to improve the overall environment for private
sector activity by enhancing competition and efficiency in domestic markets.  Country case studies
illustrating this point have been provided or referred to.124  The point has been made that these
policies will stimulate not only FDI but  also local entrepreneurship, which will in turn mean that FDI
generates greater multiplier effects on the domestic economy.125  Policy areas that have been
identified in this connection as requiring attention include liberalization of payments and trade,
adequate protection of property rights, privatization, deregulation or, where necessary, well-designed
regulatory policies, competition policy, and, in gene ral terms, a predictable institutional environment
without excessive bureaucracy.  Emphasis is also placed on the importance of general policies to
improve the physical and social infrastructure and, in particular, the development of human skills.
63. The adoption of open trade policies has been viewed as being particularly important in
generating conditions that will both be attractive to FDI and maximize benefits from it.  The point has
been made that policies pursued in the past by some developing countries to attract FDI on the basis
of a protected home market have lost their effectiveness as they have run into market saturation and
foreign investors have shifted to more dynamic countries and markets.  Evidence has been presentedshowing that openness in terms of trade is positivel y related to the amount of FDI inflows and that the
growth impact of FDI increases with the openness of the trade regime. 
126  Thus, developing countries
with more open trade policies tend to have a closer positive relationship between the presence of
foreign firms and total factor productivity growth and the share of high-technology products in
exports than countries with closed trade regimes.127  The following main reasons have been put
forward for this correlation between ope n trade regimes and beneficial FDI:
- trade liberalization makes domestic markets more dynamic, leading to higher growth
and expansion of demand in host countries;
- the reduction of import barriers means that multinational enterprises can import better
or lower-cost inputs, making export-oriented production viable;
- regional or multilateral agreements mean that such exports face fewer trade barriers
abroad;
- trade liberalization reduces economic rents that can be captured by foreign investors
and transferred abroad;
- it also encourages the transfer of the technology necessary for internationally
competitive production.128
64. The contributions from intergovernmental organizations have also discussed the role of more
specific investment policies, including the role of incentives:
- Some of the contributions by intergovernmental organizations urge a cautious
approach to the use of incentives to attract FDI.  One makes the point that empirical
studies have consistently suggested that special tax and other fiscal incentives have
little influence on FDI, although harmonization of corporate tax systems to
                                                     
124 W/8, p.14;  W/26
125 W/8/Add.4, p.9
126 W/7, paragraph 73;  W/8, pp.14-15;  W/8/Add.2, p.18;  W/26, p.37
127 W/7, paragraph 74;  W/8/Add.2, p.18
128 W/26;  M/4, paragraph 8WT/WGTI/W/38
Page 19
best-practice standards is important, and expresses concern that beggar-thy-neighbour
competition between countries to attract more FDI by offering larger tax breaks could
lead to sub-optimal outcomes for all countries.129  Another states that it is important to
weigh the costs and benefits of investment incentives, consider possibilities of
back-loading versus front-loading and ascertain as far as possible to what extentincentives actually make a difference in the locational decisions of multinational
enterprises. 
130  A further contribution warns against incentive policies that
discriminate against domestic entrepreneurs, given the continuing predominant
reliance on domestic investment and the importance of a dynamic domestic
entrepreneurial community if the benefits from FDI are to be fully realized.131
- A contribution suggests that there is a role for pro-active policies aimed at attracting
the kinds of investment that assist in moving up the quality ladder in a country'sproduction structure and that promote export diversification, including FDI in
industries with technological spillovers.  This could be done through encouraging
investment in certain activities (e.g. through tax rebates) or discouraging activities in
some other sectors.  Specific incentives could be offered for expenditures in areas that
lead to important positive spillovers for the rest of the economy (e.g. training andR&D expenditures).
132
- With regard to performance requirements, the point has been made that often they
have been put in place in order to compensate for the negative consequences of trade
protection and other policies that permit sub-optimal behaviour, from a welfare
perspective, by foreign firms.  Trade liberalization and other policies aimed atensuring competitive markets called into  question the rationale for such policies.
Moreover, as FDI becomes more geared to internationally competitive production and
competition for FDI increases, the ability of investors to afford and their willingness
to countenance such requirements diminishes.
133  Evidence has been cited to the
effect that performance requirements may have a counter-productive effect throughdriving away investors and discouraging the transfer of technology.
134
65. A general point that has been made in some contributions by Members and byintergovernmental organizations is the importance of each country adopting policies towards FDI that
take into account its own specific national characteristics and circumstances.
135
66. In discussions in the Working Group, Members have generally endorsed the points made inthe contributions by international organizations rega rding FDI policies, notably in regard to the need
for FDI liberalization to be an integral part of comprehensive economic market-oriented reforms andthe importance of trade liberalization in promoting FDI inflows and enhancing the contribution of FDI
to economic development.
136  Some Members have referred to the need to resist pressure sometimes
exerted by multinationals for tariff and other forms of protection.137  Some Members have referred to
their own national experiences in relation to these matters.
                                                     
129 W/8/Add.2, p.20.  See also W/7, paragraphs 81-83.
130 W/8/Add.1, p.22;  M/4, paragraph 41
131 W/8/Add.4, p.9
132 W/8/Add.1, p.22
133 W/26, p.5;  M/4, paragraph 8
134 W/8/Add.2, pp.17-18
135 W/8/Add.1, p.22
136 M/4, paragraphs 9 and 11-12
137 M/4, paragraph 18WT/WGTI/W/38
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67. Some Members, while recognizing that FDI on the whole has a beneficial impact on
development, have argued that there is a need for appropriate policies in order to minimize negative
effects and maximize the gains from FDI.  In the view of these Members, such policies should
combine openness toward FDI with industrial policy , including sectoral targeting, which in their
experience has proved to be an effective policy in strument and is distinguishable from the concept of
infant industry protection.138  A number of Members have been critical of the use of investment
incentives and have indicated that their own experience calls into doubt the effectiveness of policies
of sectoral targeting.139  Another view has been that, while recognizing their limitations in relation to
more fundamental economic factors and the need for moderation in their use to prevent inefficiencies,
investment incentives can play an important role in compensating for domestic distortions, for
example those arising from tax and labour laws, and in achieving sectoral objectives.140
V.2 Have optimal policies changed over time?
68. In addition to the analysis and discussion of  appropriate FDI policies summarized in the
preceding paragraphs, there has been consideration of the historical evolution of FDI policies, in
connection  with which the question has been raised of the relevance in the current context of policies
pursued by Members in the past.  While the contributions by intergovernmental organizations do not,
in general, address directly the points raised, they do contain relevant information describing theresults of work on the reasons why policies towards FDI have changed, including because of changes
in the global economic environment.  Members in their written and oral contributions have also
addressed these issues, directly or indirectly.  The main points that have emerged are as follows.
69. In describing the evolution of their national policies towards FDI in the direction of greater
openness, a number of Members have said that they believed that the present policies would be moreeffective in attracting FDI and yielding benefits for the development of their economies as a whole.
They have made the point that the changes in investment policies have formed part of a wider package
of policy changes, towards greater reliance on competitive market forces, which have, in their view,
increased the benefits to be gained from an open FDI policy in their countries.  Some of the
contributions by intergovernmental organizations have provided a similar analysis of the evolution ofnational investment policies, including through the use of case studies.  They have pointed to the
declining effectiveness of policies aimed at attracting FDI to protected home markets and the limited
contribution from such investment to growth and development.
141  A Member has said that one of the
reasons for switching to a greater reliance on FDI was the repayment problems associated with its
previous reliance on foreign public and commercial lending that it had experienced.142  The point has
been made that restrictive investment policies, including performance requirements, were sometime
employed to limit the extent to which foreign co mpanies could access and appropriate to themselves
rents created through governmental protective and regulatory policies.  With the reduction in barriers
to trade and other policy adjustments aimed at more competitive and efficient markets, this rationale
for such policies has been called into question.143  These views have been endorsed by some Members
in discussions in the Group.144
70. As indicated earlier in this Note, the contributions by intergovernmental organizations have
also drawn attention towards the greater integration of the world economy as a factor to be taken into
                                                     
138 M/4, paragraphs 18 and 21
139 M/2, paragraph 29;  M/4, paragraph 22
140 M/4, paragraph 39
141 W/8/Add.2, p.18;  W/7, paragraph 74;  W/26, p.5
142 M/4, paragraph 12
143 W/26
144 M/4, paragraph 9WT/WGTI/W/38
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account in designing optimal FDI policies.  A number of components of this have been particularly
highlighted:
- One is the greater role of multinational ente rprises in international trade, linked to the
increasing tendency for foreign direct investment to involve a disaggregation of the
production processes, especially in manufacturing, into stages that are located indifferent countries according to their comparative advantage.  The main explanations
given for this are the reduction in the worldwide barriers to trade and also to
investment, as well as falling transport and communication costs.
145
- A second factor is the growing importance of knowledge and other intangible assets
in world production.  Much of this know-how is in the hands of multinational
enterprises who find it difficult to transfer and exploit through contractual
arms-length relationships but more easily through FDI.  Openness towards FDI, thus,is increasingly important as a vehicle for accessing such know-how and, given
spillover effects, for its diffusion in the rest of the economy.
146
71. The point has been made by Members in meetings of the Working Group that the above-mentioned changes in the global economic environment imply that restrictive policies pursued in the
past by some countries would be counter-productive if applied in the present circumstances.
147  A
Member which previously had restrictive policies towards FDI has expressed the view that, with the
accelerated pace of technological innovation today, shutting out foreign capital from the market
would also shut out any technological spillover accompanying that capital, leading to a weakening in
the competitiveness of domestic industries.  Furt hermore, if the restrictive FDI policies that it
employed earlier were to be used today, they would exert a much more negative effect on its trade.  Inaddition, account should be taken of the vast increase in FDI in recent years;  countries which had
restrictive policies would deprive themselves of access to a much larger supply of capital today.
148
The view has also been expressed that the issue of whether certain policies used in the past are stillrelevant in the present context requires further analysis.
149
VI. CONCLUDING REMARKS
72. A broadly very positive picture of the impact of FDI on development emerges from the
contributions by intergovernmental organizations summarizing the results of work done in their
respective organizations.  Emphasis is put on the bundle of productive assets that multinational
enterprises are capable of deploying in host countries and, in particular, on the contribution made
through the transfer and, as a result of spillover effects, the diffusion within their economies of
technological, entrepreneurial, managerial and ma rketing know-how.  Emphasis is also put on the role
that FDI can play in facilitating the expansion of the exports of host countries and in enabling suchcountries to exploit the opportunities generated by the increasingly integrated world economy.
Empirical evidence supporting the overall link be tween FDI and economic growth is cited in a
number of the contributions of intergovernmental organizations.
150  Another point which emerges
from the contributions of intergovernmental organizations is that FDI is not a zero sum game:  the
evidence points to it yielding benefits both to host countries and to home countries.  A point that hasbeen made is that FDI, although valuable, should not be considered a panacea that would solve the
                                                     
145 W/8/Add.2, pp.5-6;  W/8/Add.4, p.9
146 W/8/Add.2, pp.6-8
147 M/3, paragraph 5;  M/4, paragraph 16
148 W/18, p.2
149 M/4, paragraph 20
150 W/8/Add.2, p.15;  W/8/Add.3, p.4;  W/26, pp.36-37WT/WGTI/W/38
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problems of economic development by itself.  These contributions also address the negative effects
that FDI had, by some observers, been thought to have and which were used to justify the restrictive
policies in some countries in earlier decades.  They find these concerns largely unfounded, although
the need for appropriate policies to deal with anti-competitive practices, transfer pricing problems
and, in some circumstances, excessive exchange rate appreciation or crowding out of domesticentrepreneurs from domestic finance is referred to in one or more of the contributions.
73. This generally positive picture of the relationship between FDI and development has been
endorsed by Members of the Working Group.  Some, while agreeing that FDI has positive effects as a
whole, have pointed to what they consider as possible negative aspects, or at least aspects that limit
the benefits, such as restrictions on transfer of technology arrangements, the impact in certain
situations on the balance of payments and the exchange rate, and the possible crowding out of
domestic entrepreneurial activity.  Some other Members have indicated that they have notexperienced any negative aspects to inward FDI in their countries.
74. Another point which emerges strongly from the contributions of intergovernmental
organizations and from the written and oral contributions of Members is the importance of the correct
policy environment if the developmental benefits that can flow from FDI are to be fully realized.  This
encompasses the overall environment for private entrepreneurial activity, both domestic and foreign,including political, economic and financial stability and the proper functioning, at the micro level, of
competitive domestic markets.  Particular emphasis has been put on the importance of an open and
stable trade regime and the need to resist pressure  from investors for special favours, for example in
the form of trade protection, has been mentioned.  Emphasis has also been placed on the importance
of policies to improve the physical and social infrastructure, in particular the development of humanskills.  In addressing possible negative effects, the importance of effective competition policies to deal
with anti-competitive practices by both foreign and domestic companies has been widely emphasized.
Some other Members have also referred to the areas where appropriate policies may be necessary that
have been referred to in one or more contributions of the intergovernmental organizations.  There has
been a range of views expressed about the role of industrial policy incentives and sectoral targeting,with a view to maximizing benefits or mitigating possible negative effects.  It has been suggested that
there may be a case for enhanced international cooperation to address problems arising from transfer
pricing, anti-competitive practices and the possible "beggar-thy-neighbour" use of investment
incentives.
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