Sunday 25 September 2016

Inside the topsy-turvy world of foreign direct investment

Published 05/07/2015 | 02:30

The role of foreign companies in the Irish economy simply cannot be overstated
The role of foreign companies in the Irish economy simply cannot be overstated

The role of foreign companies in the Irish economy simply cannot be overstated. As anyone with even a passing knowledge of the economic history of this State knows, foreign direct investment (FDI) has been central in bringing prosperity levels closer to western European norms in recent decades. The attraction of huge amounts of FDI has been, most would not contest, among the State's great economic policy successes, if not the greatest.

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Given all this, it is somewhat curious that the leading annual analysis of global FDI developments and trends got almost no coverage in the Irish media: mainstream, non-mainstream or social.

'The World Investment Report' by the United Nations Conference on Trade and Development, published 10 days ago, is the bible when it comes to FDI issues. It brings together comprehensive data, analysis of the figures and discussion of the most topical issues in the area.

The main finding of this year's UNCTAD report is that global FDI inflows declined in 2014. This was in contrast to growth in the world's output, employment and trade. After an upturn in 2013, flows fell last year by 16pc, to $1.23trn. The weakening was attributed by the UN team in Geneva to the fragility and uncertainty in the global economy.

But, as might be expected, the fall in FDI flows was not evenly spread. Developing countries, primarily in Asia, managed a small increase in 2014, account for more than half of the global total last year.

China became the largest FDI recipient in the world, with Hong Kong in second place (the latter continues to be treated as a distinct economy, even though it has been almost two decades since sovereignty over the east Asian enclave was returned to Beijing). Of the top 10 FDI recipients, five were developing economies.

Conversely, flows to developed countries dropped by more than one quarter in 2014. Inflows of FDI have now declined for three successive years in these economies, and they are now at their lowest levels since 2004.

This amounts to a significant change in a trend dating back to the beginnings of the current wave of globalisation in the late 1980s and early 1990s.

From that time until the Great Recession, FDI flows were on a strong upward trajectory - in the final decade of the last century alone they grew by a factor of 6.5.

That global flows have not returned to their previous growth trend since the crash suggests that the pace of globalisation has slowed (and there is no better measure of globalisation than FDI, given the scale of the commitment a company makes when it sinks money into a foreign market).

Of course, this still means that massive sums are invested in non-home markets each year worldwide. In terms of the stock of inward FDI (see first graph), the trend over the past two decades is one of increase.

And it is an increase that was maintained throughout the economic downturn as lower levels of new investment far exceeded depreciation and disinvestment.

Along with an increase in the activities of foreign affiliates and international production, as noted in the report, globalisation appears to be in good health - even if its growth rates are lagging.

Further, it is certainly a positive that in the face of economic crisis, countries did not resort to 1930s-style protectionism after 2008.

But it may take several years before global flows' return to the peak 2007 figure of $1.87trn - UNCTAD forecasts flows rising to $1.4trn in 2015 and steady growth thereafter. Though, like all sensible economic forecasters, they qualify their predictions with warnings about emerging market vulnerability, geopolitical risks and uncertainty in the eurozone.

Closer to home, Europe's own FDI inflows declined by 11 pc in 2014, to $289bn. This is a third of the inflow level recorded in 2007. After decades of increase, including two spikes in the late 1990s and 2000s, flows into Europe appear to have stalled since 2008. Although, as the first chart shows, Europe remains the world leader in levels of inward stock.

Inflows fell in 18 European economies, including Ireland. The Irish fall was the steepest: $37bn in 2013 to $7bn in 2014. However, due to activity by multinationals' and the IFSC, FDI flows in Ireland are not a very reliable indicator, and have a history of volatility and research has found that FDI inflows bear little relationship to foreign-owned multinationals in terms of employment, investment and exports*.

And Ireland is not the only economy where this is the case. For instance, inflows into the USA fell by 40pc in 2014, but mainly due to activity in the telecommunications, with Vodafone's divestment of Verizon.

FDI stock as a percentage of GDP illustrates just how FDI intensive Ireland is. Inward stock as a percentage of GDP is 150pc, down from 170.5 pc in 2013 - but over double the figure in 2008. This is far above the EU average of 50pc.

A much more reliable measure of the impact of FDI on the real economy is the number of 'greenfield investments', defined as a company setting up a venture from scratch in another country or adding substantially to an existing subsidiary.

Generally, greenfield projects are considered preferable to other forms of FDI, such as mergers and acquisitions, whereby ownership of domestic assets merely shifts to a foreign entity. In the latter case there may be no investment in plant, machinery and buildings.

In 2014, there was a slight decline in global FDI greenfield projects, and a more significant 15pc fall in Europe. But Ireland performed relatively well. The FDI Intelligence data division of The Financial Times recently reported that Ireland and the UK were the only countries in the top 10 European countries to achieve growth across project numbers, capital investment and job creation in 2014.

Returning to UNCTAD data, the second chart shows Ireland's share of greenfield investments into Europe, which stood at 4.5pc last year. That was above the past decade's average of 3.5pc - and disproportionate, given that Ireland accounts for less than 1pc of Europe's population.

One of the key messages from UNCTAD is the rise of developing countries, in terms of both FDI inflows and outflows. This year's report states that for the first time Asian multinationals have become the world's largest investing group, accounting for almost one-third of the total figure. Capital investment in greenfield projects from China in 2014 totalled $64bn, which is more than three times that of 2013.

Much of Asia's FDI will go to their neighbours or to developing countries, but inflows into developed economies are increasing. Alicia Garcia-Herrero, of the European think-tank Bruegel, estimates that Europe's share of Chinese FDI flows and stock is nearly one-fifth. The economic turbulence faced by Chinese multinationals may be an incentive to diversify and seek investments abroad.

This column has long argued that Ireland should strive to attract Asian multinationals to set up subsidiaries to serve European markets. It is an imperative that the Government and the IDA succeed in emerging markets.

If the success in attracting North American companies is even partly replicated, it would bode very well for the future. The evidence suggests opportunities for Ireland exist right now.

* https://www.tcd.ie/iiis/documents/discussion/abstracts/IIISDP321.php4

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