Regional Integration and Foreign Direct Investment in Developing Countries Dirk Willem te Velde and Dirk Bezemer Dirk Willem te Velde and Dirk Bezemer dw.tevelde@odi.org.uk dw.tevelde@odi.org.uk Overseas Development Institute Overseas Development Institute Seminar 3 September 2004 Seminar 3 September 2004 EC- -PREP project on PREP project on “ “Regional Integration Regional Integration EC And Poverty” ” funded by DFID funded by DFID And Poverty
Introduction � Regional Integration and Poverty: Attraction of FDI through formation of region is one possible route to development when appropriate policies and economic conditions are in place. � Examine relationship between Regional Integration and Foreign Direct Investment relevant for negotiators of RTAs, moving beyond most econometric studies that measure regions as a black box
Regional Integration and FDI: theory � Regional trade rules (tariffs, rules of origin, non-tariff barriers, services provisions) � Regional investment rules (national treatment and market access pre/post establishment, dispute settlement procedures) � Other regional links (regional public goods, investment funds, joint promotion)
� � � � � � � � � � � Econometric studies on Regional Integration and FDI Study Research question; Explanatory variables Findings Region, countries and years; Methodology Levy, Stein and How do RTAs affect the location of FDI? FTA membership, Extended market host, Extended. FTA membership doubles FDI stocks on average Daude FDI from 20 OECD countries to 60 market source, capital/worker FDI increases upon joining a FTA with: (2002) OECD/non-OECD countries, distance, market size, bilateral trade, inflation more trade/GDP (openness) 1982-1998: trade/GDP, privatization more similar capital/worker capital/worker, investment. environment, common better investment environment border, common language larger market UNCTAD (1993) How does the EC Single Program (SEM) Level and change in income, domestic .invest, FDI flows increases with affect the location of FDI? exchange rate(t), exch rate volatility less exchange rate volatility OECD countries, 1972-1988 This may affect way in which a currency union would affect FDI. Srinivasan and Which factors determine US and Market size, labour costs When split by periods (77-81; 82-86; 87-92), no evidence Mody Japanese FDI? capital costs. previous FDI that SEM increased US & Jap. FDI (But we should bear in (1997) 35 OECD and non-OECD countries, infrastructure (telephone, electricity), country risk mind that SEM was complete only in 1993) 1997-1992, split out in groups of openness low-middle, high income countries; and EEC, Latin America, East Asia Brenton et al (1998) Does European integration increase FDI? Population, distance, trade/FDI agreement dummies, Single European Act (1992) and Iberian enlargement : more Does it divert FDI? Are trade host country economic freedom dummies, FDI but no observed FDI diversion and FDI substitutes or CEE dummies, host country Eu membership complements? dummy, FDI residual (in trade regression) FDI in and outflows, imports, exports for Eu and CEEC countries, Pain and Lansbury How has intra- and extra EC FDI by UK Sector output, factor costs, currency volatility, (1996) and German forms in different corporate finance conditions, non-tariff FDI determinants differ over sectors sectors changed with the barriers (1-3 scale), SEM dummy, sector IMP introduction boosted FDI introduction of the Internal dummies IMP redirected UKFDI from US to EC Market Programme (SEM)? UK and German outward FDI for seven sectors, 1980/81-1992
Econometric studies on Regional Integration and FDI � Positive correlation between intra/ extra FDI and Regional Integration � BUT, Regions often seen as black box and static, and often identified by 0/1 dummies (Dee & Gali, 2003, offer recent exception, but include few developing countries) � Even recent studies that account for regional “market size” do not fully account for factors that can be influenced by negotiators: e.g. tariffs
Market size and initial MFN tariffs Market size Unweighted average Approximate market size (bn$, 2001) applied MFN tariffs “gained” by regional (latest year available) tariff preferences NAFTA 11400 8.2 935 MERCOSUR 797 13.6 108 ANDEAN 287 11.2 32 ASEAN 548 7.9 43 SAARC 605 23.6 143 COMESA 181 16.9 31 SADC 171 15.6 27 CARICOM 33 11.6 4 Source: WTO, WDI • The higher the initial MFN tariffs, the larger the regional market size that can be gained through intra-regional tariff reductions
Thinking outside the black box � Regional investment provisions differ in two fundamental respects: � Over time when regions change or add investment related provisions � Across regions when investment related provisions differ at one single point in time � Differences can be categorised as � Extent of regional tariff preferences � Restrictiveness of Rules of Origin � Investment rules, including national treatment for pre and post establishment and presence of effective dispute settlement mechanisms � Regional co-ordination on investment.
RTAs: classifying regions Without investment related provisions except trade 1. rules (most RTAs); Towards a more restrictive common policy toward 2. investment (ANDEAN in the early 70s); Developing a common approach gradually over time 3. introducing provisions that stimulate regional investment co-operation and regional investment promotion and national and MFN treatment to foreign firms (e.g. ASEAN); With comprehensive investment provisions from the 4. beginning, including pre-establishment national treatment and effective investor-state dispute mechanisms (e.g. NAFTA).
USFDI (% of GDP) in ANDEAN Categena Decision 24 Decisions Andean free 0.15 Agreement 291and 292 trade area 0.10 0.05 0.00 1966 1971 1976 1981 1986 1991 1996 2001
USFDI (% of GDP) in MERCOSUR Treaty Investment 0.08 of Protocols 0.07 Asuncion 0.06 0.05 0.04 0.03 0.02 0.01 0.00 1966 1971 1976 1981 1986 1991 1996 2001
USFDI (% of GDP) in ASEAN-5 Inv Signing Improved 0.12 protection protection AFTA AIA agreement 0.1 0.08 0.06 0.04 0.02 0 1966 1971 1976 1981 1986 1991 1996 2001
FDI and ASEAN FTA: Effect? (Inward FDI stock as per cent of GDP) Signing Signing Improved AIA AFTA invcestor 80 rules ASEAN-5 60 40 Vietnam (1 995) Cambodia (1 998) ASEAN- 5 (excl. S'pore) 20 Myanmar (1 997) 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Formal statistical evidence � Need to account for other factors affecting FDI � Policy (e.g. bilateral investment treaties) � Economic (human capital, infrastructure, market size) � Need to derive a regression equation with policy induced regional provisions as one of the measurable explanatory variables: FDI = f (GDP,OTHER, RTA) Similar equation has been used before
Measuring provisions in RTAs Investment Trade 1970s 1980s 1990s 1970s 1980s 1990s 0 NAFTA 0 3 (1994) 2 MERCOSUR 0 0 2 (1994) 0 0 3 (1991) CARICOM 0 1 (1982) 2 (1997) 1 (1973) 2 3 ANDEAN 1 2 (1991) 1 1 2 (1993) -1(1970) ASEAN 0 1 (1987) 2 (1996), 3 (1998) 1 1 1 SADC 0 0 1 (1992) 0 0 1 (1992) COMESA 0 0 1 (1994) 0 0 1 (1994) Index = 0 if not member of group Index = 0 if not member of group = 1 if some investment provisions, = 1 some trade provisions, = 2 if advanced inv prov = 2 low MFN, zero intra-reg tariffs = 3 if complete inv prov + dispute settl =3 high MFN, zero intra-reg tariffs = -1 if more restrictive provisions
Set up of empirical model � Extra regional FDI: UK and US real stock of FDI in developing countries (extra-regional FDI accounts for majority of FDI in developing country regions such as ASEAN, SADC, SAARC) � As many developing countries as possible; in practice many gaps; 75 countries for UKFDI and 99 for USFDI (of total 142) � Max period: 1980-2002, in practice many gaps, availability differ by host/home country � Also gaps in explanatory variables � In principle interested in LR model, but present static model only
FDI = f (GDP,OTHER, RTA) US and UK FDI in developing countries I II III IV V VI VII VII Region 0.12 Region7 0.68* SADC -0.37* COMESA 0.35 CARICOM 1.31** ASEAN 1.42** ANDEAN 1.07** NAFTA 1.48** MERCOSUR 0 Regional 0.41** 0.17** 0.39* 0.63** Investment Provisions Regional 0.43** Trade Provisions INVPROV*G 0.80** DPRATIO INVPROV*G 0.08 DPpcRATIO INVPROV*D -0.0001** ISTANCE
Implications of regressions � Moving away from region measured by a 0/1 dummy and a “black box”, to an RTA indicator that includes measurable and negotiable regional provisions � Approach successful: � Only advanced regions attract more extra regional FDI as a result of forming a region � But effect depends on introduction of trade and investment provisions � And: the closer to the main market in region (in economic size or in distance) the more FDI
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