2.2.4 Foreign Direct Investment

Issues
Given the decline in official development assistance, observers have focussed on the importance of foreign direct investment in technology transfer. Along with commercial lending, FDI is the primary investment vehicle for longer term, private-sector technology transfer. While FDI flows involve financial inputs, they also involve the capitalisation of technology, knowledge, skills, and other resources that represent a stock of assets for production (ICC, 1998; see also Section 5.3 and 5.4, which provide a qualitative analysis of private sector finance and private firm investment decisions).

Most analysts agree that FDI, like other private flows, promotes technology change. The question is whether FDI is linked to the transfer of environmentally sound technologies and if so how to strengthen the link. UNCTAD (1998) notes that there is a "... close relationship between FDI and intangible technology flows, as well as ... [a] strong proprietary asset base of FDI." Goldenman (1999) notes that FDI flowing into Central and Eastern Europe manufacturing facilities has gone for upgrading technologies and remedying past environmental damage. Investors have brought new equipment and skills, "introduced more efficient methods of production, and demonstrated the link between good environmental practices and profitability". FDI also generates technological spill-over to national businesses through imitation, employment turnover, and the higher quality standards demanded of supplier companies by Multinational Corporations (MNCs).

Although most payments for technology take place between parent companies and foreign affiliates, FDI from many countries (the U.S. for example) is concentrated in investments that have climate impacts, such as energy, industry, and manufacturing. Data collected by the U.S. Bureau of Economic Analysis show a sharp rise in the 1990s in the amount of U.S. FDI invested in foreign electric utilities, caused in part by deregulation of the electricity industry in many developing countries (U.S. Department of Commerce, 1998).

An increase in FDI does not always generate an immediate increase in technology flows to the recipient country as the relationship between FDI and technology transfer is complex. In China, technology payments did not increase in line with FDI inflows during the mid-1990s, in part because of the gap between the actual investment and the payments for the technology. It is also possible that foreign affiliates do not always pay fully for the technology they receive or that perhaps they are not always permitted to do so (UNCTAD, 1998). In developing countries, royalty payments for manufacturing technology generally reach their peak only three to four years after the initial investment has taken place. In the case of royalties for patents that can be absorbed rapidly in new products and processes, as is often the case for patent-related transactions among developed-country companies, the time gap between the initial investments and payments received for technology is smaller (UNCTAD, 1998).

FDI data do not reflect the actual size of investments by foreign affiliates as they include only funds directly tying a parent company and its foreign affiliates. Given the many external sources of finance available, the quantity of funds used in direct investment projects raised outside multinational relationships is quite significant. UNIDO (1997) has estimated that in 1995 foreign capital accounted for only six per cent of total investment in developing countries.

As a source of funding for technology transfer, FDI is highly selective. The World Business Council for Sustainable Development has identified a number of "more intractable" impediments to FDI (WBCSD, 1998). In its view, FDI is less likely to go to countries that have small potential markets, have few skilled or well trained workers, are subject to endemic corruption or are vulnerable to social and civil disruption, or have very limited stocks of natural resources of commercial interest. That many of these conditions apply to the poorest developing countries makes it difficult for them to attract private investment, further emphasising the continued importance of ODA for establishing favourable conditions for technology transfer to least developed countries (LDCs).

Just as some donor governments have emphasised the transfer of environmentally sound technologies in their ODA programmes, some developing country recipients of FDI have attempted to channel private sector investment into ESTs. In 1998 China issued foreign investment guidelines that favour investment in some 200 industries, mostly through preferential ownership rules and tax regimes (Goldenman, 1999). Their purpose is mostly to encourage the entry of better technologies. Gentry (1999) has noted that more "environmental policy leverage" exists over FDI than over other forms of private investment, but that FDI often goes into resource extraction, infrastructure, or manufacturing operations, all with environmental (and climate change) implications. Reviewing studies on FDI and the environment, Zarsky (1999) determined that the picture was mixed. Some studies have found foreign ownership associated with increased energy efficiency and reduced emissions per unit of output resulting from the introduction of advanced technologies and better management. Other studies have found no such links. Zarsky's conclusion is that it is unwise to make overarching conclusions about FDI-environment linkages "on average".

FDI Trends
The global FDI stock, a measure of the investment underlying international production, increased fourfold between 1982 and 1994; by 1996 it was valued at $3.2 trillion. The rate of growth of FDI during the period 1986 to 1995 was more than twice that of gross fixed capital formation, indicating an increasing internationalisation of national production systems. The worldwide assets of foreign affiliates, valued at $8.4 trillion in 1994, have in recent years also increased more rapidly than world gross fixed capital formation, indicating that international production is becoming a more significant element in the world economy (UNCTAD, 1998). Despite its rapid growth, however, FDI still represents a relatively small share of total investment in developing countries. UNCTAD (1996) reports that FDI exceeded 10 per cent of gross fixed capital formation in only eight countries, and in most it is much less than seven per cent of the total, the balance primarily coming from domestic sources.

During 1995 to 1996, the share of developing countries in global inflows of FDI was 34 per cent. Although this is not much higher than the developing-country share during the investment boom at the beginning of the 1980s, qualitatively it reflects a wide variety of location-specific advantages enjoyed by developing countries over and above natural resources. The composition of the top developing-country recipients has also changed dramatically between these two investment booms, with oil producing countries now featuring far less prominently among the top recipients (UNCTAD, 1998). Also significant in the Asian context are the rapid increase in inward FDI to China and the ASEAN countries coming from newly industrialising economies in Asia. This South-South private investment, one quarter of the total in 1992 (UNCTAD, 1996), highlights the error of focusing only on technology transfer from OECD members to developing countries.

During the 1990s, every developing region saw an increase in FDI inflows; even the 48 least developed countries experienced an increase in inflows of 56 per cent in 1996, to $l.6 billion, with Cambodia the largest recipient in this group of countries. FDI to aid-recipient countries, however, dropped in 1998 to US$100 billion (from US$242 billion in 1997) in the wake of the Asian financial (OECD, 1999c). Despite the small size of inflows (both in absolute values and as a share of all developing-country inflows), FDI is still important for many of these economies. Table 2.3 shows the increase in net private capital flows (of which FDI is a component) to low and middle income countries by country group and region during the period 1990 to 1996. Notable is the low share of FDI in countries in Africa, the poorer Asian countries, and the Pacific Islands.

A survey of foreign investors conducted by UNCTAD suggests that the ongoing globalisation of production will continue into the next century. Mergers and acquisitions, joint ventures and other equity and non-equity types of inter-company agreements are expected to go hand in hand with growth in FDI. Corporate restructuring in developed countries, aimed at improving efficiency and modernisation, is expected to continue, giving rise to efficiency-seeking investment.

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