Direct message: OECD and FDI

2 July 2018

The Organisation for Economic Co-operation and Development (OECD)’s interactive database contains the most up-to-date information on foreign direct investment (FDI). Its head of investment policy reviews at the Investment Division, Stephen Thomsen, tells Martin Morris about FDI in an unstable geopolitical climate.

Foreign direct investment (FDI) has long been viewed as a necessary means of greasing the wheels of the global economy. Yet geopolitical risk is never far from the surface, as major powers continue to fight their proxy wars across the world.

Despite this, hundreds of studies examining the determinants of FDI patterns have shown that foreign investment is focusing on the size of the market, and openness and proximity to foreign customers. This is the view held by Stephen Thomsen, head of investment policy reviews at the Organisation for Economic Co-operation and Development (OECD)’s Investment Division.

“OECD members are quite open to foreign investment, but if you go to other parts of the world, like China, India, Indonesia and other emerging markets, there’s still an enormous amount of restrictions,” he explains.

Many states, for example, apply screening mechanisms that limit the amount of foreign equity investment in local companies. “That can have an important dissuasive impact on investors,” Thomsen adds. “They often like to be able to control any possible leakage of their technology to local firms, so it also depends on the protection of intellectual property (IP); that’s another policy area that affects investment decisions and impacts how much foreign investment economies receive.”

Factors to consider

However, there are other factors to consider beyond IP protection, such as safeguards against expropriation and the right to international arbitration. A crucial point, therefore, is whether a would-be FDI destination is a signatory to international treaties that can provide such protections. This is for good reason, according to Thomsen. “In some countries, foreign investors have very little faith in the domestic court system; it might be inefficient, it might take too long or it might be corrupt or lack impartiality.”

The OECD also looks at policy factors, including “what governments can do to improve the climate to attract more investment and to stimulate domestic investment. Governments are often obsessed with ranking and doing business, which measures the time and cost involved in starting a business”.

Thomsen says, “this is certainly relevant”, but he thinks it has taken on too much importance when it comes to the reforming priorities of governments. “It can affect how much of a burden it is to set up a business”, he says, but he notes that “most large multinationals hire lawyers to do this, but there’s a one-off cost in terms of red tape”.

When it comes to crunching the numbers on these and other factors impacting FDI, the OECD’s ‘FDI Regulatory Restrictiveness Index’ examines the statutory restrictions placed on it in 22 industries across 62 countries, including all OECD and G20 nations.

Does Trump pose a geopolitical risk?

When looking at wider political risk, Thomsen cites investor concerns regarding policy changes in foreign and host countries. The rise of ‘Trumpism’, and its implications for global free trade, is an obvious case in point, especially as the US is looking increasingly inwards.

Trump’s pre-election pledge, which is now being implemented, concerned bringing jobs back to the US. This may yet have ramifications for the North American Free Trade Agreement (NAFTA), which the country has with Canada and Mexico. Although the likelihood of it being torn up is small, people are expecting it to be revised.

Many see the president as a pantomime villain who poses a global risk, but evidence of negativity related to the emergence of populist and anti-globalisation movements – which are supposedly spearheaded by Trump and Brexit – is scant at best.

In the 2017 ‘Foreign Direct Investment Confidence Index’, management consultancy A.T. Kearney was surprised by its findings that followed on from its 2016 report, which stated that in the “unlikely event of Trump and Brexit happening”, respondents would reduce their investments in the US and UK economies.

In fact, the US continued to be the FDI destination of choice, while the UK moved up one place in the index’s rankings to fourth. Part of the reason for this finding may be because both economies are large, open and have efficient market regulatory regimes. Moreover, these countries have transparent tax rates and strong technological capabilities, factors investors consider when determining where to invest.

According to A.T. Kearney, FDI investments typically have “a longer gestation period and even longer payouttime horizons”. Decision-makers are therefore less concerned about “ short-term” political developments.

Against a backdrop of antiglobalisation and protectionism, FDI, unlike international trade, enables a company to establish a local presence. Going forward, such a strategy could prove beneficial if markets like the US continue to focus inwards.

Similarly, Trump and Brexit have been viewed as good for business, at least in the short term, as government regulations are being slashed on both sides of the Atlantic, particularly in the US.

In addition, Trump may, eventually, take a 2016 study from the International Trade Administration (ITA) into account, which quantified the impact FDI had on employment in the US. Economists from the ITA’s Office of Trade and Economic Analysis estimated that 12 million jobs, or 8.5% of the US’s labour force, can be attributed to FDI. Trump will want to build on these numbers, principally by making the US more economically attractive to foreign investors.

Despite the advent of Trumpism, based on what he has seen over the past 12 months, Thomsen is cautiously optimistic. “I don’t know if investors are bullish or not on the global economy; there’s a lot of uncertainty, of course, but it seems to be the first time in a long while that all the economies are growing,” he explains. Thomsen adds that while economic activity is still below pre-crash 2007 levels, principally due to a sharp decline in investment into Europe, it is expected to get back where it was 11 years ago.

Global economic uncertainty or not, FDI, for many developing countries, is providing the largest source of external finance, surpassing that of official development assistance (ODA), remittances or portfolio investment flows.

In its ‘Global Investment Competitiveness Report 2017/2018: Foreign Investor Perspectives and Policy Implications’, World Bank Group noted that, in 2016, more than 40% of the $1.75 trillion of global FDI flow was directed to developing countries, providing much-needed private capital.

Yet the financing required to achieve sustainable development goals (SDGs) remains prohibitively large and can’t necessarily be met by current FDI inflows, particularly in fragile and conflict-affected situations (FCS).

Despite increasing tenfold over the past two decades, the ‘Global Investment Competitiveness Report’ chapter, FDI in Fragile and Conflict- Affected Areas, stated that “FDI is still mostly concentrated in a handful of fragile countries – all middle-income or resource-rich or both.”

It added, “Differences in FDI potential and dependence within the FCS group are also stark: FDI inflow as a share of gross national income ranges from more than 40% in Liberia to virtually zero in South Sudan.”

Business as usual for China

In China, FDI during the first quarter of 2018 rose by 0.5% to 227.54 billion yuan ($36.2 billion). The country’s annual FDI increase was previously 0.4%. This rise reflects Beijing’s adoption of new rules and regulations that tighten control on capital leaving the country, which places an emphasis on overseas investment in “sound assets”. Chinese FDI in the US, for example, slumped to $29 billion in 2017 against $46 billion the year before.

Of course, investment is a twoway street, and China, despite global geopolitical uncertainties, continues to pursue its broader “One Belt, One Road” initiative that was announced in 2013 by President Xi Jinping.

The $900-billion plan aims to reconstitute the old Silk Road trading route between China and Europe via Central Asia and the Middle East, and could see Beijing disburse as much as $8 trillion in loans for infrastructure in more than 60 countries, according to the Center for Global Development.

Management consultancy McKinsey found that the plan could impact 65% of the world’s population, which is about a third of the world’s GDP, and roughly a quarter of all the goods and services shifted globally.

As the initiative powers ahead, the more pressing concern for Beijing is whether Donald Trump’s ‘America First’ policy will lead to a Sino- US trade war in the short term, as selected import tariffs are markedly increased.

Thus far, the announced measures and countermeasures amount to just 1–2% of the countries’ annual trade. Additional proposals remain at a standstill, with both parties seemingly prepared to use the dispute procedures available to them at the World Trade Organisation (WTO).

While Trump’s unpredictability is well documented, the current skirmishes between Washington and Beijing may amount to little, as both sides conclude it is in their interests to dial down the rhetoric.

As for the Trump effect over the next three years, Thomsen states that the fundamentals for investment are still in place, and “If you’re going to locate in the US or acquire a US asset, you’re thinking beyond three years”, in any event.

Meanwhile, Europe has its own investment elephant in the room, with Brexit and what type of agreement will be made between the UK and EU. With competing factions within the UK Government arguing over the best negotiating strategy for achieving ‘frictionless’ trading between the UK and the EU, Thomsen argues it isn’t going to be a case of investors pulling out of the UK. It is more likely they will expand their operations in France, if they have factories there and in the UK, for example.

He adds, “Brexit supporters will dispute it and only time will tell, but certainly, yes, the uncertainty might be holding back investment in the short term and, depending on what market access is given to exporters in the future, this might affect the relative attractiveness of the UK as a destination for investment.”

It’s hoped European economic activity will grow in the coming years, reaching pre-crash 2007 levels.
Donald Trump’s divisive foreign policy may have an impact on FDI in America.
Stephen Thomsen holds a PhD in international economics from The Graduate Institute in Geneva, Switzerland. He is head of investment policy reviews at the OECD’s Investment Division and previously worked as a consultant in France, as well as a research fellow at Chatham House in London.