EU and BRICs: Challenges and opportunities for. European competitiveness and cooperation

Transcription

1 EU and BRICs: Challenges and opportunities for European competitiveness and cooperation Industrial Policy and Economic Reform Papers No. 13 Peter Havlik Roman Stöllinger Olga Pindyuk Gábor Hunya Bernhard Dachs Carolina Lennon Marcos Poplawski Ribeiro Jayati Ghosh Waltraut Urban Vasily Astrov Edward Christie Enterprise and Industry Directorate-General European Commission

2 EU and BRICs: Challenges and opportunities for European competitiveness and cooperation Peter Havlik 1 Roman Stöllinger 1 Olga Pindyuk 1 Gábor Hunya 1 Bernhard Dachs 2 Carolina Lennon 1 Marcos Poplawski Ribeiro 3 Jayati Ghosh 4 Waltraut Urban 1 Vasily Astrov 1 Edward Christie 1 10 July ) Wiener Institut für Internationale Wirtschaftsvergleich (wiiw), the Vienna Institute for International Economic Studies, Rahlgasse 3, A-1060 Wien. Contacts: havlik@wiiw.ac.at and urban@wiiw.ac.at 2) Austrian Institute of Technology (AIT), Donau-City-Strasse 1, A-1220 Wien. Contact: bernhard.dachs@arcs.ac.at 3) Centre d Etudes Prospectives et d Informations Internationales (CEPII), rue Georges Pitard 9, F Paris Cedex 15. Contact: marcos.ribeiro@cepii.fr 4) Centre for Economic Studies and Planning, Jawahartal Nehru University, New Mehrauli Road, New Delhi, India Contact: jayati@mail.jnu.ac.in

3 Industrial Policy and Economic Reforms Papers are written by the staff of the Directorate General for Enterprise and Industry or by experts working in association with them. This publication series aims to raise the awareness and stimulate the debate on issues in the areas of industrial policy and economic reforms. Views expressed in these papers represent the positions of the authors and do not necessarily reflect those of the European Commission. Contact information European Commission Enterprise and Industry Directorate-General Unit B4 "Economic Analysis and Evaluation" B-1049 Brussels Tel: (32-2) Fax: (32-2) Web page: A great deal of additional information on the European Union is available on the internet. It can be accessed through the Europa server ISBN-13: ISSN: DOI: /36796 Luxembourg: Publications Office of the European Union, 2009 European Communities, 2009 Reproduction is authorised provided the source is acknowledged.

4 Abstract This study explores the opportunities and competitive challenge that the BRIC countries Brazil, Russia, India and China represent for the EU. The BRICs show many common features (big land size, large population, fast economic growth etc.) but important differences as well, due to their different models of economic development. Examples are differences in income levels, in their degree of openness and in their economic and trade structures, which are described in detail in section two of the study. In the first section we analyse trade in goods and services, FDI and knowledge flows between the BRICs and the EU in The emergence of the BRICs as major exporters on international markets is one of the driving forces behind the industrialized countries loss of global market shares. China has clearly become the most serious challenge to the EU s industrial competitiveness. But the BRICs also provide formidable opportunities for exports. EU-BRICs services trade is much less important than goods trade and the BRICs seem to have only few strong advantages at the EU market in this field. Knowledge flows between the EU and the BRICs are gaining significance. Regarding FDI, the EU emerges as the main or one of the main investors in all BRICs while competitive pressure on the EU market via FDI from the BRICs is not very strong yet. In EU-BRICs energy relations, analysed in section three, rising and potentially competing demand for oil and, to a lesser extent, for gas is coming especially from China, but India as well. Russia and Brazil are relevant suppliers of energy (oil, gas, biofuel) with Russia being a less prominent supplier of oil to the EU than of gas. Key words: competitiveness, FDI, trade in goods, trade in services, knowledge flows, energy, EU, Brazil, Russia, India, China JEL codes: F14, F21, G01, O52, O53, O54, O57, Q41, Q42

5 Contents Introduction Trade in goods and services, FDI and knowledge flows Trade in goods Introduction and summary Global trade in goods Bilateral trade relations between Triad countries and the BRICs Country-specific patterns of EU-BRICs trade Sectoral composition of EU-BRICs goods trade Specialization patterns in EU-BRICs manufacturing industry trade Revealed comparative advantages of BRICs and the EU Vertical integration of trade with China Impact of the global crisis on goods trade References Annex Trade in services Summary Introduction Geographical structure of services trade Sectoral structure of services trade Trade balances and specialization indices References Foreign Direct Investment flows between the EU and the BRICs Introduction FDI data analysis Investment project database analysis Impact of the crisis on the EU BRICs FDI relations Summary and Conclusions References Knowledge flows between the BRICs and the EU Introduction Royalties and licence fees Enrolments of foreign students in tertiary education International mobility of professionals Cross-border patents between the EU and the BRICs Summary References... 95

6 2 Different models of BRICs economic development, implications for EU policies Introduction Brazil Political, economic and social structure The Brazilian Development Model at a glance Sectoral analysis Future prospects and challenges EU-Brazil relations Conclusions References Russia Introduction GDP growth and the ambivalent role of energy Future prospects and challenges Challenges for EU-Russian relations Directions of EU-Russia relations References India Background Recent patterns of economic growth Employment and the labour market Education and employability Economic policies External trade and investment Infrastructure Telecom Future prospects EU-India relations References China Background Relative size of the Chinese economy Strong fragmentation of the economy Model of economic development A more detailed picture of the Chinese economy at sectoral level Future prospects and challenges EU-China relations References Future challenges and opportunities for EU competitiveness Summary results and policy implications Summary results Implications for EU policies Annex

7 3 The role of BRICs in EU s future energy needs: partners and competitors Oil, gas and the EU-Russia energy relationship Global oil and gas demand EU net import demand and the Initiative Russian oil and gas reserves and production A Russian perspective on the EU-Russia energy relationship The EU-Russia energy relationship from an EU perspective Biofuels and the EU-Brazil energy relationship Biofuels and biofuels trade Biofuels in the European Union Biofuels in Brazil Conclusions and policy discussion References

8 List of Tables, Figures and Boxes Table Overview of the total EU goods trade... 9 Table Services exports and imports in 2007, % of GDP Table Services export and import in 2007, EUR billion Table Geographical structure of services imports in 2007, % Table Geographical structure of services exports in 2007, % Table Sectoral structure of services exports, 2007, % Table Change in sectoral structure of services exports, 2000 to 2007, in p.p Table Sectoral structure of services imports, 2007, % Table Change in sectoral structure of services imports, 2000 to 2007, in p.p Table Trade balances in 2007, EUR billion Table Specialization indices in trade with the EU15, Table Specialization indices in trade with the NMS12, Table Major EU investor countries in the BRICs. average annual outflow ( ) and outflows in 2007 (EUR million) Table EU outward stocks in the BRICs by economic activity (2006), in EUR million Table EU inward stocks owned by the BRICs by economic activity (2006), in EUR million Table Investment projects in the BRICs, by year Table 1.3.5a Investment projects in the BRICs, by source country Table 1.3.5b EU investment projects in the BRICs, by source country Table 1.3.6a Investment projects in individual BRICs Table 1.3.6b EU15 investment projects in individual BRICs Table Motives of EU15 investors in the BRICs Table Investment projects in the BRICs by economic sectors Table Investment projects in the BRICs by major business activities Table FDI in the EU15 from the BRICs, number of projects and invested capital 72 Table Absorptive capacity of the BRICs Table Trade in royalties and licence fees, 2006 (USD million) Table Enrolment of foreign students in tertiary education (2003), Triad countries detail Table Enrolments in tertiary education (2003), BRIC countries detail Table Enrolment of foreign tertiary students in the EU (2006) Table Foreign-born by country of residence, year Table Structural change in the Indian economy Table Growth rates of employment (per cent change per annum) Table Infrastructure deficits by sector and Eleventh Plan physical targets Table Structure of manufacturing industry in China and in the EU27, 2006/ Table A2.1 BRICs List of Indicators. Year 2007 (if not mentioned otherwise) Table 3.2.1a World Bioethanol Exports ( ) Table 3.2.1b World Bioethanol Imports ( ) Table Projected consumption and exports of Brazilian ethanol Figure Global market shares in goods exports... 3

9 Figure Global shares in goods imports... 3 Figure Shares of the Triad in goods imports of BRICs, in % of total imports... 5 Figure Contribution of the BRICs to the trade deficits of the EU and the USA, in %6 Figure Imports of the BRICs by broad economic categories (2007)... 7 Figure Diversity in EU exports to BRICS, 2007 (deviations from Figure EU average share in exports, in pp) Diversity in EU imports to BRICS, 2007 (deviations from EU average in imports, in pp) Figure Structure of EU imports from BRICs, 2007 by NACE sectors, In % Figure 1.1.9a Structure of EU manufacturing exports to BRICs by NACE 2-digit industries (differences to total exports in pp, 2007) Figure 1.1.9b Structure of EU manufacturing imports from BRICs by NACE 2-digit industries (differences to total imports in pp, 2007, note different scale) Figure a EU27: Imports by industry groups (Taxonomy I) Figure b EU27: Imports by industry groups (Taxonomy II) Figure Revealed Comparative Advantages of the BRICs in trade with the Triad.. 19 Figure a EU27: RCAs by industry groups (Taxonomy I) Figure b EU27: RCAs by industry groups (Taxonomy II) Figure a Competition on EU market in labour-intensive industries, changes in import prices and market shares, compared to Competition on EU market in technology driven industries, changes in import prices and market shares, compared to Figure b Competition on EU market in low-skill industries, changes in import prices and market shares, compared to Competition on EU market in high-skill industries, changes in import prices and market shares, compared to Figure China s trade structure according to broad economic categories ( ) (in % of total trade in goods, balances in billion EUR) Figure China s major trading partners in Parts and Components ( ) (in % of total trade in goods) Figure Total Chinese goods exports and Chinese goods exports of foreign invested firms (share in percentage right scale) Figure Bilateral trade balances of the EU, Japan and the USA with China, EUR billion (industries classified by factor inputs) Figure RCA of China in technology driven goods and share of foreign firms, in total Chinese industry output for respective industry (right scale, in % of total, year 2007) Figure Services exports (total and to the EU27) in 2007, index, 2000= Figure Services imports (total and from the EU27) in 2007, index, 2000= Figure Figure Figure Outward (left) and inward (right) FDI flows of the EU, the United States and Japan (EUR billion) EU outward FDI flows to the BRICs (EUR billion) left Share of the BRICs in the EU s extra-eu FDI stocks (in %) right Comparison of returns on FDI of EU FDI in the BRICs and new EU member states (2007) Figure Share of EU FDI in the BRICs inward FDI, average flows , in % left;

10 Figure Figure Figure Figure Comparison of FDI outflows from the EU, the USA and Japan to the BRICs, average , EUR million right BRIC global FDI outward flows (left) and bilateral flows to the EU (right) (in EUR billion) Comparison of FDI inflows from the BRIC countries into the EU and the USA (average flows ) in EUR million Goods imports from the BRICs and sales of BRIC foreign affiliates in manufacturing in the respective economy (2006), EUR million Goods exports to the BRICs and sales of foreign affiliates in manufacturing of the respective country in the BRICs (2006), EUR million Figure Distribution of BRIC students among main destinations Figure Distribution of BRIC students among main destinations (2003), detail by BRIC countries Figure Distribution of BRIC highly educated workers among main destinations, year Figure Highly educated foreign workers in the EU by country of birth, year Figure Share of active cross-border patent inventions of the EU27 with selected partner regions on all applications, Figure Share of active cross-border patent inventions of the EU 27 Figure with selected partner countries on all applications, Passive cross-border patents of the BRICs; PCT filings, applications at the USPTO and EPO, period averages Figure Population and economic geographical concentration Figure Brazilian official interest rate and exchange rate Figure Selected economic achievements of Putin s era Figure Russia s external sector and oil prices Figure Russian GDP growth and contributions of main components Figure Nominal and real rouble exchange rates Figure Economic growth by sectors, (2002 = 100) Figure Unit Labour Costs (ULC) in Russia: growth and contributions of key components, annual averages in %, Figure GDP, exports and imports of China, 1978 = Figure Oil and gas consumption scenarios, mtoe, Figure EU net import scenarios for 2020 crude oil and solid fuels Figure EU net import scenarios for 2020 natural gas (bcm) Figure Russian oil production and exports (mbd) Figure Russian natural gas production and exports (bcm) Box Unit value ratios to calculate quality positioning Box Methodological approaches Box Is Mauritius really investing more in India than the EU? Box Holding companies, SPEs and the industry distribution of FDI Box Managing China s foreign exchange reserves

11 EU and BRICs: Challenges and opportunities for European competitiveness and cooperation Introduction The term BRICs, first used in 2001 by Jim O Neill, chief economist at the investment bank Goldman Sachs, puts under a common label the four largest fast growing emerging countries (Brazil, Russia, India and China, see Goldmann Sachs, 2003). The BRICs common features include large territory and population, low income levels but also fast economic growth resulting in the emergence of a prosperous local middle class. Notwithstanding the current global crisis, their catching-up process is expected to continue, creating additional new opportunities as well as numerous challenges for the rest of the world and for the European Union (EU) in particular. This study shows that beyond their common features the individual BRIC countries are rather heterogeneous, posing quite different challenges and calling for specific policy responses on the side of their partners, especially the EU. Opportunities for trade and investment in the large and rapidly expanding BRIC markets are obvious and companies from the EU are already well positioned there. Major challenges include the cost competition in product markets, changing patterns in global commodity flows (energy, metals and food), non-tariff barriers to trade, regulative deficiencies e.g. concerning intellectual property rights and various institutional impediments to foreign investment. Distinct political systems, especially regarding state interference in the economy, also require different policy responses towards individual BRICs. This study is organized as follows. Section 1 deals with foreign trade in goods and services, FDI and knowledge flows between the BRICs and the EU. For comparative purposes, the corresponding flows between the BRICs and the rest of the world, in particular with the USA and Japan are reported as well. Section 2 presents the key elements of the individual BRICs models of economic development and points out the major challenges and opportunities for EU competitiveness as well as some implications for EU policies. Section 3 focuses on Russia and Brazil and their respective roles in the EU s energy import needs. This Background Study was edited by Peter Havlik and Waltraut Urban, both wiiw. The individual sections were prepared by Peter Havlik and Roman Stöllinger (section 1.1), Olga Pindyuk (section 1.2) as well as Gábor Hunya and Roman Stöllinger (section 1.3), all wiiw. Section 1.4 was prepared by Carolina Lennon (wiiw) and Bernhard Dachs (ARC). Section 2 is based on contributions from Marcos Poplawski Ribeiro (CEPII, section 2.2), Peter Havlik (section 2.3), Jayati Ghosh (section 2.4) and Waltraut Urban (sections 2.5 and 2.6). Section 3 relies on contributions from Edward Christie (sections 3.1.1, 3.1.2, and 3.3), Vasily Astrov (sections and 3.1.4), both wiiw, and Marcos Poplawski Ribeiro (section 3.2). 1

12 1 Trade in goods and services, FDI and knowledge flows 1.1 Trade in goods Peter Havlik and Roman Stöllinger, wiiw Introduction and summary This section analyses the external trade in goods between the EU and the BRICs. We start with the global position of the EU and the BRICs in world trade (using the IMF DOT and UN COMTRADE databases) and move subsequently to the more detailed analysis of regional (individual EU countries trade with BRICs), commodity and industry-specific trade specialization patterns using Eurostat Comext database. The key findings of this section can be summarized as follows: the EU is the biggest world exporter; in imports it ranked second after the USA (year 2007); Triad countries have lost market shares both globally and in the markets of the BRICs, this has been linked to the emergence of new players in international trade; the EU has been relatively successful in defending its market shares, especially during the period ; the EU plays a more important role in BRICs trade than vice versa; the EU has trade deficits with all BRICs (with the exception of India); among BRICs, Russia has been the most important EU export partner, China is the largest import partner; there is a lot of diversity in EU-BRICs trade: in general, NMS trading patterns with BRICs differ from the rest of the EU and BRICs trading patterns also differ from each other; among BRICs, only China is emerging as a serious challenge to EU s industrial competitiveness because of its dynamic export performance and the composition of its exports which is closer to a developed country than to countries of its peer income group; technological upgrading found in Chinese manufacturing exports is to some extent the result of Triad s foreign companies operating in and exporting out of China; revealed comparative advantages of China are also partly shaped by the comparative advantages of foreign firms that decided to establish subsidiaries in China as well as the high share of processing trade in China s imports and exports the global crisis resulted in a sharp fall of BRICs goods exports and imports in the first quarter of 2009, but signs of a recovery are already visible. Among BRICs, Russia was hit particularly hard. 2

13 1.1.2 Global trade in goods The EU is the world s leading exporter of goods. In 2007, extra-eu exports amounted to EUR 1200 billion about 17% of total world exports - not including intra-eu dispatches. With imports of EUR 1370 billion (18.1% of the world total - not including intra-eu dispatches), the EU is also the second largest importer, only closely behind the United States whose imports totalled EUR 1500 billion in 2007 (18.5%) see Figures and The rapid growth of Chinese exports over the past two decades has made China advance to rank two in the global list of world exporters (11.8% of total; including Hong Kong even 15.3%), overtaking both the USA and Japan (Figure 1.1.1). In terms of imports, China is still behind the EU and the USA but ahead of Japan (Figure 1.1.2). Figure Global market shares in goods exports % of world goods exports EU USA Japan Brazil Russia India China Hong Triad BRICs Kong Source: IMF, Directions of Trade, wiiw calculations. Calculation of market shares based on extra-eu exports only. 3

14 Figure Global shares in goods imports % of world goods exports EU USA Japan Brazil Russia India China Hong Triad BRICs Kong Source: IMF, Directions of Trade, wiiw calculations. Calculation of market shares based on extra-eu imports only. Differing growth rates in exports and imports over the last two decades have caused a significant reallocation of market shares between countries of these two country groupings, mainly from the Triad to the BRICs. 1 Figure shows that the export market shares of the Triad have all significantly decreased over the period 1995 to In the case of the EU, the share in global exports decreased from 19% in 1995 to 17% in 2007 with the strongest decline in the period In fact, the EU global export market shares seem to have stabilized since then and even show a slight increase between 2000 and The loss in export market shares over the last two decades is more pronounced in the case of the USA and Japan. Market shares declined to 11.3% in the case of the USA, down more than 4 percentage points (pp) compared to Japan recorded a loss of 5pp of its share in global exports, leaving it with a market share of 7% in Comparing the losses in market shares of the Triad countries, the EU was relatively successful in defending its market share. The decline of global market shares in goods exports of industrialized countries, which reached its peak around 1993 (WTO World Trade Report, 2008), coincides with the emergence of new players on the world markets. These new players include all four BRIC countries. With regards to merchandise trade, the pre-eminent role of China as an exporter stands out. During the period China s market share in global exports almost tripled, from 4% to 11.8%. Parallel to and mainly caused by the rise of China as a world class export power, the market share of Hong Kong (including re-exports) decreased 1 2 All growth rates, market shares, etc. are calculated from nominal values due to the lack of appropriate deflators. This affects mainly Russian exports and the related trade surpluses due to fluctuating energy prices. Since the interest here is with the EU as an aggregate global export shares are calculated based on world trade excluding intra-eu trade. 4

15 steadily over the period. This is explained by the development of special economic zones (SEZ) in Southern China and the relocation of export-orientated manufacturing production from Hong Kong to these Chinese SEZ. Furthermore, China made intensive use of Hong Kong s port for the dispatchment of its exports. With the development of the ports in Shanghai and Shenzhen the role of Hong Kong as entrepôt for the trade of mainland China decreased (Klau and Fung, 2006). Nevertheless Hong Kong s re-exports are still significant, totalling around EUR 240 billion (3.3% of total) in Bilateral trade relations between Triad countries and the BRICs The EU s leading role in international trade also survives when bilateral relations between the Triad and the BRICs are regarded. The comparison of shares in total imports of the BRICs reveals that the EU has the highest market shares among the Triad countries with the notable exception of China (Figure 1.1.3). In China, Japan accounts for roughly 15% of imports, compared to 12.8% of the EU (and 8% of the USA). This can be explained by the high degree of trade integration in Asia. In Russia, the EU had an impressive import market share of 44% in 2007, up from 40% in the year 2000, and far ahead of the USA and Japan which are not major trading partners for Russia. Japan also has a higher market share in Hong Kong s imports, for the same reason as for China, but in both cases the EU has still a larger market share than the USA. Interestingly, the EU also occupies a higher market share in Brazilian imports than then USA, with the differential in market share increasing from less than 3 pp in 2000 to approximately 6.5 pp in Both the EU and the United States experienced a decline of their market share in Brazilian imports over the period which is in line with the general tendency in the BRICs. Notable exceptions are the rise of the EU s import market share in Russia and the stabilization of the US share in the India s import market. 5

16 Figure Shares of the Triad in goods imports of BRICs in % of total imports EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN Brazil Russia India China Hong Kong BRICs Source: UN Comtrade, wiiw calculations. It appears that the EU companies make intensive use of the trade channel to serve the markets of the BRICs and are also rather successful compared to the USA and Japan, which are less favourable positioned in most of the BRICs in terms of import market shares. Despite falling market shares in the BRICs, their importance as trading partners for the Triad countries is on the rise the result of much faster export and import growth rates of these countries. On the export side Russia has become the main export partner of the EU among the BRICs, absorbing 7.1% of extra-eu exports, slightly ahead even of China (5.8%). For the USA and Japan, in contrast, Russia is less significant as an export market. For them, China is the major export destination among the BRICs. All Triad countries have in common that their shares of both exports destined for and imports from China have increased between 2000 and 2007, with a higher share occupied in imports, surpassing 20% in the case of Japanese imports (2007). In the EU and USA, imports from China have exploded, rising by 8.8 pp and 8.3 pp to reach 16.4% and 16.9% of total imports respectively (2007). On the export side, the increase of the relative importance of China as a trading partner is muss less pronounced, reaching approximately 5.8% of total EU as well as total US exports. For the EU and the USA, a by-product of these developments is the increasing trade deficit, especially with China. In 2007, the bilateral trade with China and Russia contributed 84% to the total trade deficit of the EU, up from 56% in the year 2000 (Figure 1.1.4). The US trade deficit exceeded EUR 700 billion and was much larger than the EUR 260 billion deficit recorded by the EU. 3 US trade deficit was considerably less 3 The EUR 260 billion are the trade deficit for extra-eu trade as calculated from UN Comtrade. Extra-EU trade was derived by deducting intra-eu exports and imports from trade with the world. The EUR 260 billion might exaggerate the extra-eu trade deficit 6

17 biased towards the BRICs (though bilateral trade with China still accounted for 29% of the total US trade deficit). Figure Contribution of the BRICs to the trade deficits of the EU and the USA, in % 100 Brazil Russia India China Hong Kong EU USA EU USA Source: UN Comtrade, wiiw calculations. There are several factors contributing to China s strong export performance. One of the factors is that the Triad countries provided China with the necessary capital goods, technology and know-how to diversify and upgrade domestic industrial and export capacities. An indication for this is the very high share of capital goods in China s imports from the Triad countries, especially from the EU (Figure 1.1.5). The same is also true for Chinese imports from the United States (although less so for imports from Japan). because reported intra-eu exports are higher than reported imports. The EU trade deficit as reported by IMF s Directions of Trade database amounted to EUR 159 billion in The deficit of the United States is also lower according to this dataset (EUR 623 billion). 7

18 Figure Imports of the BRICs by broad economic categories (2007) Primary Semi-finished Brazil Parts and Components Consumption Capital E U2 7 US A Japan World Russia EU27 USA Japan W orld India EU27 USA Japan W orld China EU27 USA Japan World Source: UN Comtrade. BEC Classification. Motor spirits are not allocated to any of the BEC categories and are therefore omitted. 8

19 The import of capital goods, however, cannot be the sole catalyst for China s exceptional trade performance as the other BRICs have at least equally high shares of capital goods from the Triad countries. A distinctive feature of Chinese trade is the high share of parts and components (P&C), particularly on the import side. The trade in P&C constitutes a deep form of economic integration because it entails the geographic separation of the production process of goods. In contrast, this form of trade integration is much less developed in Russia and also India. 4 The split-up of the trade according to broad economic categories, which reflect different stages of production, also shows that China s and India s trade is characterised by a very low share of imports of consumption goods. Consumption goods only account for 4.4% of China s and 4.6% of India s aggregate goods imports. Compared to these very low shares, both China and India import relatively more consumption goods from the EU (10.7% and 6% respectively). In contrast, consumption goods are the major category in Russian imports accounting for 36% of total imports in trade with the world and only slightly less in bilateral trade with the EU Country-specific patterns of EU-BRICs trade With a share of 17%-18% in world trade the EU is indeed a trading giant. Yet about two thirds of EU trade represent intra-eu dispatches (intra-eu exports and imports) which are not included in the above percentages; for the EU new member states (NMS) which joined in 2004 and 2007 respectively the share of intra-eu trade is even higher (and that of BRICs correspondingly lower). 5 Table provides an overview of the overall EU trade with individual BRICs, the Triad and the rest of the world (RoW), separately for EU15 ( old EU member states prior to 2004 enlargement) and the NMS12, during the period Altogether, the BRICs accounted for just 6% of total EU exports in 2008 less than exports to the USA (6.2%) but their share doubled since the year The growing importance of BRICs is even more visible in EU imports: an increase of import shares from 6.3% in 2000 to 11.6% of total EU imports in 2008, largely thanks to a growing importance of imports from China which accounts for half of EU imports from BRICs. The BRICs gained market shares in the EU mainly at the expense of the USA and Japan (especially in EU imports). Generally, EU exports to BRICs are less important than imports: the latter account for a bigger share of overall EU imports and explain also EU trade deficits. 4 5 For an analysis of the role of trade in parts and components in shaping Chinese trade patterns see section In a similar contrast to China, the role of intra-industry trade in Russia is extremely low see Fertö and Soos (2008). The rest of this section is based mainly on Eurostat Comext database. The subsequent analysis covers total EU trade (both intra- and extra) since we are interested not only in the EU as a whole but in the performance of individual EU countries (e.g. NMS relative to BRICs) as well. 9

20 Table Overview of the total EU goods trade Partne r EU15 Exports Imports Trade Balance EUR bn shares EUR bn shares EUR bn Brazil Russia India China BRICs Japan USA RoW EU NMS EU exeu WORL D Partne r NMS12 Exports Imports Trade Balance EUR bn shares EUR bn shares EUR bn Brazil Russia India China BRICs Japan USA RoW EU NMS EU exeu WORL D Partne r EU27 Exports Imports Trade Balance EUR bn shares EUR bn shares EUR bn Brazil Russia India China

21 BRICs Japan USA RoW EU NMS EU exeu WORL D Source: Eurostat-Comext, wiiw calculations. Note: EU15 and NMS12 do not add to EU27 due to reporting errors. From the perspective of EU trade policies, the analysis of trade statistics shows that China and Russia are the main EU trading partners among BRICs and thus represent key challenges (though, as will be shown below, both for markedly different reasons). 11

22 Figure Diversity in EU exports to BRICS, 2007 (deviations from EU average share in exports, in pp) Brazil Russia India China Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Lux embourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom EU15 NMS Source: Eurostat Comext, wiiw calculations. 12

23 Figure Diversity in EU imports to BRICS, 2007 (deviations from EU average in imports, in pp) Brazil Russia India China Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom EU15 NMS Source: Eurostat Comext, wiiw calculations. 13

24 EU trade with BRICs grew faster than average during the period , especially regarding exports to Russia and India (EU exports to Brazil were rather sluggish). Again, NMS exports have been more dynamic than the EU average. In particular, NMS exports to China and Russia were growing rather fast. Also EU imports from the BRICs (again mainly from China and Russia) were rapidly rising with NMS imports increasing more than EU average (Table 1.1.1). Except for India, the EU has trade deficits with all BRICs (EUR 245 billion in 2008). The largest (and rising) trade deficits have been recorded in trade with China and Russia (the latter is fluctuating in line with energy prices). The NMS have trade deficits with all BRICs and their main BRICs trading partner has not been China (as it is the case for EU15) but Russia (with respect to both exports and imports). In general, the NMS have been trading relatively less with the BRICs than EU15 countries do (except NMS trade with Russia). Indeed, a higher share of BRICs in some EU countries exports and imports results largely from their more trade exposure towards Russia (e.g. the three Baltic States, Finland, Bulgaria, Poland, Slovakia, Slovenia and Germany see Figures and 1.1.7). There is much less diversity in EU s trade exposure regarding other BRICs: Finland, Germany and Luxembourg export relatively more (than EU average) to China. Luxembourg, the Netherlands, Hungary and the United Kingdom import relatively more from China. However, the divisive role of Russia in EU member states trade is exceptional in this respect (crucial for some EU countries, negligible for others). Imports from China are relatively important for Hungary, the Netherlands and United Kingdom yet the differences with respect to other EU countries are much smaller than in the case of Russia (Figure 1.1.7). Obviously, the above differences in relative trade exposure of individual EU member states towards individual BRIC countries have important implications for the formulation of common EU policies: EU member states with lower trade exposure have a lower stake in policy formulation regarding particular BRIC and/or may be guided less by commercial interests than by other issues (security and environmental concerns, human rights, etc) Sectoral composition of EU-BRICs goods trade The bulk of overall EU exports about 91% of the total represent manufacturing industry products. In exports to BRICs, the EU s focus on manufacturing is even more pronounced: about 95% of EU exports to BRICs are manufacturing products. The only exception are exports to India where the share of manufacturing amounted to just 78% of total EU exports in 2007; exports of mining and quarrying accounted for 18.7% of the total (in 2000 even 6 Baltic States and several other NMS may serve as an example: despite their strong trade exposure to Russia they are less prone to compromise trade for other policy issues. 14

25 33.6% of the total). 7 Exports of other industries are small (e.g. agriculture, hunting and forestry: 2.6% of EU exports mostly to Russia) or virtually non-existent. EU imports from BRICs are somewhat more diversified, although manufacturing industry products prevail as well, especially in imports from India and China (Figure 1.1.8). Apart from manufacturing industry, imports of mining and quarrying products are important in particular from Brazil (17.8% of EU imports in 2007, mostly non-energy mining products to Belgium, the Netherlands and Germany) and especially imports from Russia (52.1% of EU imports from Russia mostly crude oil and natural gas). It is interesting to note that imports from China (and Japan) consist almost exclusively of manufacturing products; agriculture plays a more prominent role only in EU imports from Brazil (18.9% of the total see Figure 1.1.8). Figure Structure of EU imports from BRICs, 2007 by NACE sectors In % Brasil Russia India China World Manufacturing Mining Agriculture Other n/a 0 A B C D E K O X Note: including intra-eu trade. A-X represent NACE sectors. Source: Eurostat Comext, wiiw calculations. There is not much difference in broader sectoral structures of NMS and EU15 trade with BRICs. However, the NMS exports are in general even more specialized on manufacturing industry, this specialization pattern is even more pronounced in their trade with the BRICs. As far as imports are concerned, the striking feature are relatively low NMS manufacturing imports from Russia (less than 20% of total NMS imports from Russia in 2007) and the correspondingly high share of mining and quarrying products especially of crude oil and natural gas. This pattern did not change much in the last couple of recent years: the share of manufacturing in NMS imports from Russia even declined between 2000 and These are predominantly non-energy mining products exports from Belgium (presumably diamonds). However, at the end of 1980s before transition the NMS (at that time members of the Soviet-dominated Council of Mutual Economic Assistance) imported much more manufactured products from the USSR (Russia) see Havlik, 1990). Russia complains that its declining share of manufacturing in NMS imports is one of the adverse consequences of their EU (pre)accession trade policies and EU enlargement see Glinkina and Kulikova in Grinberg et al (2008). 15

26 Together with declining import shares from Brazil, this is a unique development regarding not only the structure of NMS overall imports, but also contrasting with the structure of imports from China and India Specialization patterns in EU-BRICs manufacturing industry trade Owing to its overwhelming role, the rest of this section will focus on EU-BRICs manufacturing industry trade. We start with the analysis of commodity composition of manufacturing exports and imports at 2-digit NACE level, and then move on to more detailed specialization patterns (at NACE 3-digit industry-group level) while trying to identify EU competitive strengths and weaknesses with respect to the BRICs. EU manufacturing trade has been fairly diversified, yet the following 3 industries (at 2-digit NACE level) play the leading role in both EU exports and imports: chemicals (NACE 24), machinery and equipment (NACE 29) and motor vehicles (NACE 34). Besides, trade with food products and beverages (NACE 15), basic metals (NACE 27) and electrical machinery (NACE 31) is also fairly important in the overall EU trade. 9 Figures 1.1.9a and 1.1.9b show the relative specialization patterns in EU s manufacturing trade with the BRICs and the rest of the world (extra-eu). In exports to BRICs, the EU is underrepresented (in terms of differences in individual industries shares in exports to BRICs relative to the structure of overall EU exports Figure 1.1.9a) mainly in food products and beverages (NACE 15 except Russia), in coke and refined petroleum (NACE 23), and in chemicals (NACE 24, except Brazil). Besides, with a difference in export share of about -10 pp, there was very little EU exports of motor vehicles (NACE 34) to India. On the other hand, the EU has a huge positive specialization (above average export shares) with regard to BRICs in exports of machinery and equipment (NACE 29 especially to India and China), and in other transport equipment (NACE 35, except exports to Russia). China represents also an important market for EU exporters of electrical machinery and apparatus (NACE 31 see Figure 1.1.9a). The structure of EU imports from BRICs is much more focused on just a few industries (Figure 1.1.9b; note the different scale of the two figures). Food and beverages (NACE 15) dominate EU imports from Brazil, coke and refined petroleum (fuels: NACE 23) as well as basic metals (NACE 27) EU imports from Russia (note that this is in addition to unprocessed energy products such as oil and gas). The office machinery (NACE 30) and radio, TV, communication equipment (NACE 32) dominate imports from China. EU imports from India display a relative specialization on textiles (NACE 17), wearing apparel (NACE 18) and other manufacture, including furniture, games and toys, sports goods and 9 The structure of extra-eu trade is rather similar except that extra-eu exports concentrate even more on chemicals (NACE 24), machinery and equipment (NACE 29), and other transport equipment (NACE 35) whereas extra-eu imports focus less on machinery (NACE 29), motor vehicles (NACE 34) and more on wearing apparel (NACE 18), coke and refined petroleum (NACE 23), office machinery (NACE 30) and instruments (NACE 33) see Annex I. 16

27 jewellery (NACE 36). In relative terms, EU imports much less motor vehicles from the BRI Cs. Already at this level of detail one can see an impressive technological upgrading of China s exports (i.e. EU imports from China) compared to other BRICs and also compared to the rest of the world (including USA and Japan); we shall illustrate this feature with more detailed arguments below. Figure 1.1.9a Structure of EU manufacturing exports to BRICs by NACE 2-digit industries (differences to total exports in pp, 2007) Brazil Russia India China EU-extra M hi Transport eq Source: Eurostat Comext, wiiw calculations Figure 1.1.9b Structure o f EU manufacturing imports from BR ICs by NACE 2-digit industries (differences to total imports in pp, 2007, note different scale) Brazil Russia India China EU-extra 30 Metals Cars Source: Eurostat Comext, wiiw calculations. 17

28 Figure a 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% EU27: Imports by industry groups (Taxonomy I) 1. Mainstream 2. Labour intensive industries 3. Capital intensive industries 4. Marketing driven industries 5. Technology driven industries Brazil Russia India China Japan USA RoW EU27 World Source: Eurostat Comext, wiiw calculations. Figure b EU27: Imports by industry groups (Taxonomy II) 1. Low skill industries 2. Medium skill/blue collar workers 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 3. Medium skill/white collar workers 4. High skill industries Brazil Russia India China Japan USA RoW EU27 World Source: Eurostat Comext, wiiw calculations. The analysis of EU trade at the more detailed (NACE 3-digit) level employs the classification of industries according to factor inputs (Taxonomy I) and labour skills (Taxonomy II) inputs (see Peneder, 2003). 10 Figure a shows the structure of EU imports from BRICs, Japan, USA, the rest of the world and the EU (intra-eu trade) by industry groupings classified according to factor inputs and the shares of individual 10 The list of 3-digit NACE industries and their allocation to industry groupings according to both taxonomies is in Annex 1. 18

29 groupings in total imports (Taxonomy I). 11 In EU imports from Brazil (and even more so in imports from Russia) the capital-intensive industries prevail, just as labour-intensive industries prevail (though their share is diminishing) in imports from India. However, the share of this group of industries in EU imports from China is much lower whereas the technology-driven industries increasingly dominate: the share of this group of industries in EU imports from China was in 2007 already higher than in intra-eu imports. Needless to say, the shares of this group of industries are even higher in EU imports from Japan and USA, but in contrast to China they both have declined between 2000 and Regarding the industry classification by labour skills (Taxonomy II), the low-skill industries dominate in EU imports from Brazil and India (Figure b), medium-skill industries in imports from Russia (refined petroleum is included here). EU imports from China are divided into low- and medium-skill industries (both with declining shares) while the group of high-skill industries recorded rapidly rising shares between 2000 and again providing evidence for Chinese technological upgrading. The labour skills structure of EU imports from China is becoming similar to the structure of intra-eu trade Revealed comparative advantages of BRICs and the EU The diversification and upgrading of exports from the BRIC countries have resulted in their comparative advantage gains. 12 Although all BRICs maintain revealed comparative advantages (RCAs) in Triad s trade in labour-intensive industries, 13 the positive RCAs are not limited to these. Trade data of the BRICs indicate that they have comparative advantages (positive RCAs) also in marketing driven industries (except for Russia in trade with the EU and the United States and Brazil in trade with Japan; Russia s positive RCAs in marketing driven industries in trade with Japan can be largely attributed to fish product exports), which are predominantly food and beverages. In the case of China, the RCA calculations for 2007 already points towards a (small) comparative advantage in technology driven industries. In contrast to trade developments with other BRIC countries, the RCAs of We do not discuss here the structures of EU exports because there are not larger differences among BRICs and other regions (technology driven, capital intensive and mainstream industries prevail in EU exports). The RCA analysis here is again based on industry classification by (Peneder, 2003). Not captured is the possibility that within, for example, a technology-driven industry, the labour-intensive steps of productions are located in the BRICs with the intention to re-export. UN Comtrade database is used for computing BRICs RCAs. RCAs are calculated according to the Balassa s formula RCAci X M ln i i M ci ci ci 100 ; where X (M) are exports (imports), c X denotes a partner country and i the respective industry-grouping (RCAs were calculated from individual 3-digit NACE industry trade data) see Balassa (1965). ). Positive (negative) RCA values indicate a comparative (dis)advantage. The use of a different version of RCA index (e.g. Lafay s see Baumann and di Mauro, 2007) would lead to similar conclusions regarding comparative advantages. Russia is an exception among BRICs in this respect since it has a comparative disadvantage also in labour-intensive industries in trade with the EU and the United States. = ci 19

30 the Triad countries are frequently shrinking in trade relations with China between 2000 and 2007; in the case of the EU this part of RCAs has already been lost. This may explain the worries about the EU s capacity to keep its competitive edge in high tech products (cf. European Commission, 2008). The above analysis has shown that BRICs trading and trade specialization patterns are far from identical: Brazil has positive RCAs in marketing-driven (food processing) and, though less so, labour-intensive (textiles) industries (Figure ). Russia has positive RCAs only in capital-intensive industries, mostly due to strong exports of refined petroleum and diverse metal products. This indicates that Russia was much less successful in diversifying its exports than the other BRICs. There are highly negative RCAs in mainstream and especially in technology-driven industries in Russia. Note that positive RCAs in labourconsequence of the rapidly rising unit labour costs in Russia). China s RCA patterns are less intensive industries trade with the EU and the USA disappeared by 2007 perhaps a pronounced, but there is a comparative disadvantage in capital-intensive industries with all Triad countries, whereas China holds positive RCAs in labour-intensive industries (e.g. wearing apparel) and marketing-driven industries (e.g. games and toys, sports goods). Chinese negative RCAs in technology driven industries are much smaller than those observed in other BRICs; comparative disadvantages in trade with the USA disappeared in this group of industries; in trade with the EU it became even positive by This feature of Chinese trade, i.e. the relative strength in exporting technology-driven industries, may be surprising but is fully in line with the literature on Chinese trade which found that China s exports are indeed technologically more advanced than its level of income would suggests (Rodrik, 2006) and that its export bundle is more similar to those of developed countries than those of countries with similar levels of income (Schott, 2006). India s distribution of RCAs is very similar to those of Brazil (except the former slightly negative RCAs in capital-intensive industries, especially in trade with the USA). From the EU point of view (and using the same definition of RCAs), but this time using again trade data from the Eurostat Comext database), the RCA patterns in EU trade with BRICs are also rather diverse (Figure a and b). There were positive RCAs in mainstream and technology driven industries in EU trade with Brazil and India (Figure a). There were also positive RCAs in all industry groupings except capital-intensive industries in EU trade with Russia (and still an overall trade deficit). Last but not least, negative RCAs in both labour-intensive and marketing-driven industries persisted in EU trade with China. Moreover, the (small) positive RCA in technology-driven industries turned negative between the years 2000 and 2007 another sign of Chinese technological upgrading. As shown in Figure b, the latter can be traced virtually in all groups of industries classified by labour skills. In contrast to other BRICs, the EU s RCAs in trade with China (and less so with India) are diminishing this is true even for EU s positive RCAs in medium- and high-skill industries. Nevertheless, the EU still enjoyed positive 20

31 RCAs in trade with BRICs in these two groups of industries in contrast to the EU trade with both Japan and the USA where RCAs were negative. Figure Revealed Comparative Advantages of the BRICs in trade with the Triad Brazil RCA2000 RCA2007 Mainstream Labour int.ind. Capital int.ind. Marketing driv.ind. Technol. driven EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN Russia RCA2000 RCA EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN India RCA2000 RCA EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN 21

32 China RCA2000 RCA EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN EU27 USA JPN Source: UN Comtrade, wiiw calculations. Figure a 400 EU27: RCAs by industry groups (Taxonomy I) 1. Mainstream 2. Labour intensive industries 3. Capital intensive industries 4. Marketing driven industries 5. Technology driven industries Brazil Russia India China Japan USA Source: Eurostat Comext, wiiw calculations. 22

33 Figure b EU27: RCAs by industry groups (Taxonomy II) Low skill industries 2. Medium skill/blue collar workers 3. Medium skill/white collar workers 4. High skill industries Brazil Russia India China Japan USA Source: Eurostat Comext, wiiw calculations. Last but not least, we analyse also patterns of competition at EU markets by looking at changes in import prices (so-called unit value ratios UVR see Box the definition) and market shares during the period by the same industry groupings used above. We compare the performance of individual BRICs with Japan, USA, NMS and the EU15 on the overall EU market (consisting of both extra and intra-eu trade). It is often claimed that BRICs (especially China) compete at EU markets mainly with low prices and correspondingly low quality products ( that means with below average prices and thus negative UVRs) and in this way increase their market shares. On the other hand, if both prices (positive UVRs) and market shares increase, one can speak of successful quality competition (see Landesmann and Wörz, 2006). In this purpose, we have calculated the average changes in UVRs and market shares for each country for the periods and in order to smooth out possible outliers. The results for selected industry groupings by Taxonomy I are shown in Figure a (labour-intensive and technology-driven industries) and in Figure b (Taxonomy II: low-skill and high-skill industries see Annex 1). In labour-intensive industries, there was a uniform trend of declining import prices at the EU market except for imports from old EU member states (EU15) where UVRs increased above average. At the same time, only China (and so India) gained market shares whereas the USA and Japan (and even more so EU15) suffered considerable market share losses. India, and even more China, gained both market shares in the EU in labour-intensive industries with a successful price competition. Brazil and Russia just kept their market shares despite falling prices of their labour-intensive exports. In technology driven industries, EU imports from the BRICs (except Russia) became also much cheaper during the period with falling UVRs, but only China enjoyed a sizeable market share gain (also the NMS recorded market share gain with unchanged UVRs). In contrast, Brazil and India s 23

34 market shares did not change, and both the USA and Japan lost market shares, despite falling export prices, in the EU. Russia (and even more so the EU15) managed to gain market shares in the EU with rising export prices. Box Unit value ratios to calculate quality positioning Source: Landesmann and Wörz (2006). 24

35 Figure a Competition on EU market in labour-intensive industries changes in import prices and market shares, compared to Brazil China EU15 India Japan NMS Russia USA 0.5 Change in UVR NMS Brazil India China -2 Russia Change in market share Competition on EU market in technology driven industries changes in import prices and market shares, compared to Brazil China EU15 India Japan NMS Russia USA 0.2 Russia Change in UVR India Brazil NMS -0.6 China Change in market share Source: Eurostat Comext, wiiw calculations. 25

36 Figure b Competition on EU market in low-skill industries changes in import prices and market shares, compared to Brazil China EU15 India Japan NMS Russia USA Chan g e in U V R Russia NMS Brazil India -0.4 China Change in market share Competition on EU market in high-skill industries changes in import prices and market shares, compared to Brazil China EU15 India Japan NMS Russia USA 0 Change in UVR Brazil India NMS -0.8 Russia China Change in market share Source: Eurostat Comext, wiiw calculations. 26

37 China, but also India and even Russia (as well as the NMS) have been successful in the price competition also in high-skill industries and gained market shares in the EU whereas both Japan and USA lost market shares the former despite declining export prices of its high-skill products (Figure b). 14 China has been quite successful in the price competition on the EU market as it recorded the most impressive market share gains in virtually all industry groupings with falling UVRs. Moreover, China has been also quite successful in the technological upgrading of exports and emerges as the most serious competitive challenge for the EU Vertical integration of trade with China China has gained the reputation of being the workshop of the world (Sauvant, 2005) meaning that China is an attractive location for multinational firms (MNCs) to perform labour-intensive steps of the production process because of the abundant supply of relatively cheap labour. As a consequence, China has become a major platform for reexports of international firms. The unbundling of the value chain implied by the described off-shoring strategy of MNCs results in the creation of intra-industry trade, that is, countries exchange goods of the same industry but in different stages of production. Countries engaging in this type of trade are then said to be vertically integrated. A possibility to track the intensity of the vertical trade integration of China is to decompose Chinese trade by broad economic categories (BEC), which include primary goods, semifinished goods, parts and components, consumption goods and capital goods. The centre of interest in the context of vertical trade integration is the share and development of parts and components (P&C) in total trade (Gaulier et al., 2007). In the case of China, the trade in (P&C) is clearly on the rise, both in exports and imports (Figure ). It has a more prominent role, however, in imports, where together with semi-finished goods it is the main economic category, accounting for 27% of total imports. The higher share of P&C in imports is explained by the fact that final assembly in many industries is a labour-intensive process and therefore often located in a low-wage country. For China s trade structure this implies strong imports of P&C and relatively more exports of final goods, especially consumption goods but increasingly also capital goods. Consumption goods in turn, are China s most important economic category on the export side, although losing ground to capital goods and P&C. China s trade structure, including the trade balance, confirms China s role as a manufacturing base for re-exports. 14 Needless to say, EU import prices from Japan and USA (as well as import prices from EU15) are much higher than average import prices in virtually all groups of industries. 27

38 Figure China s trade structure according to broad economic categories ( ) (in % of total trade in goods, balances in billion EUR) China - Exports according to BEC China - Imports according to BEC China - trade balances according to BEC(in EUR billion) Primary Semi-finished Parts & Components Co nsumption Capital Goods Source: UN Comtrade, wiiw calculations. Figure China s major trading partners in Parts and Components ( ) (in % of total trade in goods) Exports Imports EU USA Japan Indien Dragons Tigers World Source: UN Comtrade, wiiw calculations. A concept closely related to vertical trade integration is that of processing trade. Processing trade consists of the import of intermediate inputs which are further processed or finished and the re-export. Processing exports may include intermediate goods (semi-finished goods, P&S) as well as final goods. In the case of China, processing exports accounted for more than half of Chinese total exports in 2007 (China Statistical Yearbook, 2008). Going back to the analysis of trade by economic categories and using trade with P&C as an indicator for the degree of vertical trade integration, one finds that this form of international division of labour is most advanced in regional trade, i.e. trade between South-East Asian trading partners (Figure ). For exports as well as imports, China s trade in P&C is most intensive with the Asian Dragons (Hong Kong, Singapore, South Korea and Taiwan), 28

39 followed by the Asian Tigers (Malaysia, Philippines, Thailand) and Japan. In comparison to China s Asian trading partners, the EU and the USA seem to make lesser use of China as a location for assembling and other labour-intensive tasks. This is in line with the finding of the section on foreign direct investment (FDI) that EU FDI in China (as well as in the other BRICs) is mainly market seeking and only to a lesser extent efficiency seeking. The finding of strong vertical trade integration in South East Asia is also in line with the results of other studies on this issue which also find evidence for the existence of an Asian network of intermediate goods suppliers to China (see for example Dean et al., 2008 and Gaulier et al., 2007). With respect to the extent of vertical trade integration between China and the EU, there is evidence that increased trade is not mainly driven P&C. Whereas many middle income economies including many European countries increased their market share in the EU and did so by expanding exports in semi-finished goods, P&C and final goods, the increased share of China in total EU imports is mainly driven by final goods and to a much lesser extent by P&C (Landesmann Stehrer, 2009). This leads to the conclusion that vertical integration and off-shoring of individual tasks of the production chain has a geographical component, so that in the case of the EU, China is not the primary candidate as an off-shoring destination. Figure Total Chinese goods exports and Chinese goods exports of foreign invested firms (share in percentage right scale) Total exports Exports of foreign invested enterprises Foreign invested enterprises' share in total Chinese exports billion EUR % of total Exports Source: China Statistical Yearbook (2008). The intra-industry trade created by the unbundling of the production process is interrelated with the revealed comparative advantages of China. Since the more developed Asian economies, including Japan and to a lesser extent also the EU and the United States use China as an export-platform, a high share of Chinese goods exports are on the account of foreign invested firms (Figure ) or constitute processing trade. There is a close link 29

40 between Chinese exports by foreign invested firms and the notion of processing trade because processing trade is carried out largely by foreign invested enterprises (Dean et al., 2009). Chinese data document that since 2002 more than half of Chinese exports can be attributed to the activity of foreign invested firms, with a peak in 2005 where their share increased to almost 60%. In 2007, the share of foreign invested firms in Chinese exports was still 57%. This high value as such already serves as an indication that the activities of foreign invested firms in China are strongly influencing Chinese trade patterns. The impact of the activities of MNCs on the Chinese foreign trade has to be borne in mind when interpreting export patterns. In the context of competitiveness it certainly makes a difference whether EU firms loose or actually relocate export shares to their Chinese affiliates or whether these market shares are truly lost to genuine Chinese manufacturers. Figure Bilateral trade balances of the EU, Japan and the USA with China, EUR billion (industries classified by factor inputs)* balance1995 balance2000 balance2007 Japan Technologydriven USA industries EU27 Marketingdriven industries Capitalintensive industries Labourintensive industries Mainstream Industries Japan USA EU27 Japan USA EU27 Japan USA EU27 Japan USA EU * Industry classification according to Peneder (2003). Source: UN Comtrade, wiiw calculations. Indeed, much evidence points in the direction that China s bilateral trade balances and RCAs to a large extent reflect the comparative advantages and competitiveness of foreign firms exporting out of China. Reflecting shifts in RCAs that have occurred over the past twelve years, the EU s and the United States bilateral trade deficits with China of the EU and the United States are no longer the result of negative balances in labour-intensive industries but are increasingly due to a negative balance in technology-driven industries 30

41 (Figure ). In 2007, the EU and the United States both had the largest deficit in trade with China in the exchange of goods attributed to technology driven industries. This feature of EU-China trade relations (which is not found for bilateral trade with Russia, India and Brazil) is, apart from the sheer size of the deficit, another source of concern for the EU. In order to get an idea of what might drive the development of the trade balances in technology driven industries and underlying RCAs, a comparison between Chinese (global) RCAs in technology driven industries and the importance of foreign invested firms in these Chinese industries is endeavoured. Due to the fact that a geographical split-up of foreign invested firms operating in China is not available, this type of comparison can only be made for China s aggregate trade. Chinese industry data allows calculating the share of foreign invested firms in total industry output in several industry or industry clusters. For the NACE industries most relevant for technology-driven industries (NACE 30 and NACE 32-35), the share of foreign invested firms in total industry output can be calculated for a computer and electronics cluster (including NACE divisions 30, 32 and 33) and for manufactures of transport equipment (including NACE divisions 34 and 35). The RCAs of the technologydriven industries within these NACE divisions 15 show that, although far from giving a perfect match, the RCAs that China occupies in technology-driven industries are found i n th e computer and electronics cluster where foreign firms account for the bulk, 82%, of total industry output 16 (Figure ). In contrast, China still maintains a revealed comparative disadvantage in manufacture of vehicles (341) and manufacture of aircraft and spacecraft (353), the two technology-driven industries within the transport industry where the share of output of foreign invested firms, although still considerable, is much lower (45%) than in the computer and electronics cluster. Assuming that foreign invested firms rather export a higher than a lower share of their output, we read this as an evidence that the improving RCA of China in technology-driven industries are to a large extent driven by the exporting activities of foreign invested firms. This in turn means that the technological upgrading of genuine Chinese exports might have been be less pronounced than suggested by RCAs of trade statistics. This result also fits well with the finding from other studies that processing trade is not only carried out predominantly by foreign-invested companies but also concentrated within technologically relatively advanced products (Dean et al., 2009). Estimates suggest that 25%-46% of every dollar s worth of Chinese merchandise exports are made up by previously imported intermediate inputs. The share of the foreign content varies considerably from industry to industry with the highest shares found in electronic computers, telecommunication equipment, computer peripheral equipment, electronic The classification used here is based on 3-digit NACE industries, whereas the share of foreign firms in total Chinese industry output is available on the level 2-digit NACE industries or clusters thereof. The technology-driven industries in computer and electronics cluster where China has a comparative advantage in trade with the world are office machinery and computers (300), manufacture of TV and radio transmitters (322) and manufacture of TV and radio receivers (323). 31

42 elements and devices, radio /TV/other communication equipment. As can easily be seen, these industries coincide with those for which Figure indicates a RCA for China. Figure RCA of China in technology driven goods and share of foreign firms in total Chinese industry output for respective industry (right scale, in % of total, year 2007) RCA RCA Share of foreign firms in industrial Output Computer & electronics cluster (NACE 30, 32, 33) Transport equipment (NACE 34, 35) Source: UN Comtrade, China Statistical Yearbook (2008). Previous work on the analyses of genuine Chinese exports, that is excluding exports by foreign invested firms, suggest that their skill content has not changed substantially so that China in some sense is continuing to specialize mainly in labour-intensive goods (Amiti and Freund, 2008). Certainly, when analysing bilateral trade figure between countries, total exports must be considered, because from a balance of payments perspective the ownership status of exporting firm does not matter. It is, however, interesting to see that a considerable part of Chinese economic activity in manufacturing is on the account of foreign owned firms and that these may influence the developments of revealed comparative advantages Impact of the global crisis on goods trade Initial hopes that the BRICs will be able to de-couple from the global crisis have not materialized. The main mechanisms of transmission are rapidly declining exports and the respective multiplier effects, decreasing FDI and plummeting stock markets. The immediate impact of the global crisis was a deep contraction in BRICs foreign trade, visible in the data for the first quarter of 2009 (for the year 2008 as a whole, EU s trade with the BRICs still grew much faster than average see Table above). During the first three months of 2009, BRICs exports and imports shrank by double digit rates (especially in Russia, but 32

43 in China as well), though there are some recent signs of bottoming out since April (the same applies to stock markets). Another effect of the global crisis has been growing protectionist tendencies for supporting domestic industry worldwide and in the BRICs in particular, such as the imposition of higher import tariffs on used cars (and a delayed accession to WTO) by Russia and the buy Chinese initiative in China. References Amiti, M. and C. Freund (2008), The anatomy of China's ex port growth, Policy Research Working Paper Series 4628, The World Bank. Balassa, B., (1965), Trade Liberalisation and Revealed Comparative Advantage. The Manchester School of Economic and Social Studies, No. 33, pp Baumann, U. and di Mauro, F. (2007), Globalisation and Euro Area Trade. Interactions and Challenges. Occasional Paper Series, European Central Bank, No. 55, March. China Statistical Yearbook (2008). Dean, J, Fung, K.C., Wang, Z., (2009) How vertically specialized is Chine se trade?, BOFIT Discussion Papers 31/2008, Bank of Finland, Institute for Economies in Transition. European Commission (2008), Global Europe. EU performance in the global economy, Directorate General for Trade, Brussels. Fertö, I. and Soos, K. A (2008)., Intra-Industry Trade Between the Old EU and the NMS Before Enlargement. In Grinberg et al. (2008), pp Gaulier, G., F. Lemoine and D. Unal-Kesenci (2007), China's emergence and the reorganisation of trade flows in Asia, China Economic Review, Vol. 18, No. 3, Elsevier, pp Glinkina, S. and Kulikova, N., (2008), Impact of EU Enlargement on Economic Restructuring in Russia. In Grinberg, R., P. Havlik and O. Havralyshyn (eds) (2008), Economic Restructuring and Integration in Eastern Europe. Experiences and Policy Implications, Nomos, Baden-Baden, pp Havlik, P., (1990), Disintegration of the CMEA and Its Consequences. OECD, Paris. Klau, M. and S.S. Fung (2006), The new BIS effective exchange rate indices, BIS Quarterly Review, March. Landesmann, M. A. and J. Wörz (2006), Competitivene ss of the CEECs in a Global Context, wiiw Research Reports, No. 327, The Vienna Institute for International Economic Studies (wiiw), Vienna. Landesmann, M. A. Stehrer, R. (2009), Trade and Growth: South-North Integration, Outsourcing and Skills in International Trade & Domestic G rowth: Determinants, Linkages and Challenges, in Workshops Proceedings of OeNB Workshops N 14, Vienna. Peneder, M. (2003), Industry Classifications. Aim Scope and Techniques, Journal of Industry, Competition and Trade, Vol. 3, No. 1-2, pp Rodrik, D., (2006) What s so special about China s Expo rts?, NBER Working Paper N

44 Schott, P.K., (2006). The Relative Sophistication of Chinese Exports, NBER Working Papers 12173, WTO (2008), World Trade Report Trade in a Globalizing World, Geneva. 34

45 Annex 1 Taxonomy used in industry classifications (by factor and skill intensities) NACE rev.1 Taxonomy Taxonomy I II factor labour inputs skills Meat products Fish and fish products Fruits and vegetables Vegetable and animal oils and fats Dairy products; ice cream Grain mill products and starches Prepared animal feeds Other food products Beverages Tobacco products Textile fibres Textile weaving Made-up textile articles Other textiles Knitted and crocheted fabrics Knitted and crocheted articles Leather clothes Other wearing apparel and accessories Dressing and dyeing of fur; articles of fur Tanning and dressing o f leather Luggage, handbags, saddlery and harness Footwear Sawmilling, planing and impregnation of wood Panels and boards of wood Builders' carpentry and joinery Wooden containers Other products of wood; articles of cork, etc Pulp, paper and paperboard Articles of paper and paperboard Publishing Printing Coke oven products 231 Refined petroleum and nuclear fuel Nuclear fuel 233 Basic chemicals Pesticides, other agro-chemical products Paints, coatings, printing ink Pharmaceuticals

46 Detergents, cleaning and polishing, perfumes Other chemical products Man-made fibres Rubber products Plastic products Glass and glass products Ceramic goods Ceramic tiles and flags Bricks, tiles and construction products Cement, lime and plaster Articles of concrete, plaster and cement Cutting, shaping, finishing of stone Other non-metallic mineral products Basic iron and steel, ferro-alloys (ECSC) Tubes Other first processing of iron and steel

47 Taxonomy Taxonomy I II NACE rev.1 factor inputs labour skills Basic precious and non-ferrous metals Structural metal products Tanks, reservoirs, central heating radiators and boilers Steam generators Cutlery, tools and general hardware Other fabricated metal products Machinery for production, use of mech. Power Other general purpose machinery Agricultural and forestry machinery Machine-tools Other special purpose machinery Weapons and ammunition Domestic appliances n. e. c Office machinery and computers Electric motors, generators and transformers Electricity distribution and control apparatus Isolated wire and cable Accumulators, primary cells and primary batteries Lighting equipment and electric lamps Electrical equipment n. e. c Electronic valves and tubes, other electronic comp TV, and radio transmitters, apparatus for line telephony TV, radio and recording apparatus Medical equipment Instruments for measuring, checking, testing, navigating Optical instruments and photographic equipment Watches and clocks Motor vehicles Bodies for motor vehicles, trailers Parts and accessories for motor vehicles Ships and boats Railway locomotives and rolling stock Aircraft and spacecraft Motorcycles and bicycles Other transport equipment n. e. c Furniture Jewellery and related articles Musical instruments Sports goods

48 Games and toys Miscellaneous manufacturing n. e. c Taxonomy I factor inputs 1..Mainstream 2..Labour intensive industries 3..Capital intensive industries 4..Marketing driven industries 5..Technology driven industries Taxonomy II labour skills 1..Low skill industries 2..Medium skill/blue collar workers 3..Medium skill/white collar workers 4..High skill industries Source: Peneder (2003). 38

49 1.2 Trade in services Olga Pindyuk, wiiw Summary Trade in services is much less important than trade in goods, measured by both absolute volumes and shares in GDP. BRICs share in global services trade is much lower than of the EU27; in the EU15 and NMS12 the shares of BRICs in services import are only about 4%, which is less than their shares in goods import. Howev er, if we compare BRICs services trade with extra-eu imports of the EU27, than the share of BRICS in the EU27 import increases to about 9%. Among BRICs, it s China and India, which are the biggest services traders together they acco unt for about 60% of total BRICs services export. The situation of low market sha res of BRICs may change in the future, as all the BRICs (apart from Hong Kong) have been increasing their services e xports much faster than the EU27, US or Japan. India is the absolut e leader in terms of growth rates its annual services export increased during by more than 5 times. Services export of China and Russia increased d uring that period by 4 times. The EU has been quite an important market for service exporters of all BRICs apart from India (shares of the EU27 range from 13% for China to 40% for Russia), and the share of the EU27 in services export of China and Hong Kong has been growing. On the other hand, importance of BRICs (in particular, of China, India, and Russia) for the EU service exporters has been increasing as well; in 2007, the share of BRICs in the total EU27 services export exceeded the NMS12 share (4.6% versus 4.2%), while the share of BRICs in extra-eu services exports has reached 11%. BRICs have rather diverse services structures, however a similar trend for all the countries can be observed they have in general decreased shares of traditional services in their exports. New patterns of specialization have been developing in Brazil and China, which increased significantly their shares of other business services, and also in India where computer and other information services gained a lot of importance for exports. So far, BRICs appear to have quite few strong advantages at the EU market. China, Hong Kong and Russia specialize in transportation services at the EU15 market, with Russia having created additional strong specialization over in construction services. The current pattern of BRICs specialization at the NMS12 market is similar to one at the market of the old member states. However, in contrast to the EU15, the pattern of specialization changed noticeably at the NMS12 market since 2000, when China, Hong Kong and India specialized in export of other business services. 39

50 1.2.2 Introduction In this section we analyse developments of services trade of BRICs. In our analysis we use the database of international trade and FDI in services (Trade in Services Database TSD), compiled from a number of sources (Eurostat, OECD, IMF), as well as data from national banks and statistical offices. Trade in services is much less important than trade in goods, measured by both absolute volumes and shares in GDP (less than 10% of GDP in the case of services trade compared to 32% in goods trade on EU a verage). Services are characterized by lower tradability than goods, thus shares of s ervices trade in GDP are usuall y much lower than goods ones, even though services nowa days account fo r the bulk of GDP. Ceteris paribus, big countries tend t o have lower shares of servic es trade than sm all ones since mos t of the trade oc curs inside the countries (much higher shares of services trade in the EU15 and NMS12 as compared to the US and Japan are explained by high degree of the int ra-eu trade around 60% of total services trade). Hong Kong is an outlier among BRIC s in terms of services trade openness, which reflects the peculiar nature of the country s economy. 17 India ranks second in terms of services openness, and the fact that services export ratio to GDP of the country exceeds indicators of the USA and Japa n more than twice clearly indicates global sp ecialization of India s economy in serv ices. B razil, on the other hand, has q uite low share of services export in G DP only 1.7%; the country is more op en to services import which share in GDP is 2.6%, but still lags behi nd all the other BR ICs countries (see Tabl e 1.2.1). Table Services exports and imports in 2007, % of GDP Brazil China Hong Kong India Russia EU27 EU15 NMS1 2 Japan USA Services exports Services imports Source data: TSD, NSOs and central banks. The share of BRICs in global services trade is much lower than that of the developed countries in the benchmark: e.g., total BRICs services export is about 4.5 times smaller than that of the EU27 (see Table 1.2.2). However, it is worth noting that most of the EU27 services trade is concentrated mostly inside the EU, and if we compare BRICs services trade with extra-eu trade, than the difference is significantly smaller. 17 Hong Kong has high degree of re-exports of goods (about 90% of merchandise imports), and as a consequence high level of related services trade. 40

51 China and India are the biggest services traders among BRICs together they account for almost 60% of total BRICs services export and import. Table Services export and import in 2007, EUR billion Services exports Services imports Source data: TSD. Brazil China Hong Kong India Russia Total BRICs EU NMS EU EU27-extra EU NMS12-extra EU EU15-extra EU US JPN Geographical structure of services trade With regard to BRICs market shares, Japan is the only country where the share of BRICs in services imports is relatively high about 10% in 2007, mostly due to imports from China and Hong Kong (see Table 1.2.3). In the EU27 and US the shares of BRICs in services import are only about 4%. However, if we compare BRICs services trade with extra-eu imports of the EU27, than the share of BRICS in the EU27 import increases to about 9% (since most of the EU27 services trade is concentrated inside the EU). The NMS12 import relatively more services from BRICs than the old member states: the share of BRICs in total NMS12 services import is 4.2%, which is 0.5 p.p. higher than in the EU15. However, the situation of low market shares of BRICs may change in the future, as all the BRICs (apart from Hong Kong) have been increasing their services exports much faster than the EU27, US and Japan. India is the absolute leader in terms of growth rates its services export increased during by more than 5 times; China and Russia increased their services exports during that period by 4 times, and Brazil by 2.5 times. 41

52 The EU27 has been increasing its services exports noticeably faster than the US and Japan, however this increase occurred due to the intra-eu trade, while extra-eu trade during the period analysed has grown twice slower in case of the EU15 and declined in case of the NMS12. Enlargement of the EU, which lead to lower barriers in services trade between the old and new member states, may provide partial expl anation of this trend. Table Geographical structure of services impo rts in 2007, % Importers by columns Brazil China Hong NMS1 K ong* India Russia Japan US EU27 EU15 2 Brazil China Ho ng Kong India R ussia Total BRICs Japan US EU EU NMS Other Total * Data are for Source data: TSD. An analysis of the current geographic structure of services exports shows (see Table 1.2.4), that the EU27 is more important market than the US or Japan for Brazil, China and Russia, while in Hong Kong and India the US has higher shares in the exports structures than the EU. Russia is the most dependent on the EU as a market for its services export the EU27 share in Russia s services exports exceeds 40%. It is China and Hong Kong where the shares of the EU in services exports are likely to increase in the future if the trends of recent years growth of exports to the EU outpacing significantly total services export growth continue (see Figure 1.2.1). In India, Brazil and Russia other destinations but the EU account for increased services exports. If we look at the markets for the EU27 services exports among BRICs countries, it s China and Russia which have the highest shares in the EU services export among BRICs. 42

53 Shares of the EU27 in services imports of China, Russia, and India have been increasing (see Figure 1.2.2) during , growth of services imports from the EU27 was higher than growth of total services imports by 1.5 times in China and by 1.4 times in Russia. Thus the EU is likely to continue increasing its market share in China and Russia in the future. Figure Services exports (total and to the EU27) in 2007, index, 2000= Total To EU Brazil China Hong Kong India Russia EU27 US JPN Source data: TSD. 43

54 Table Geographical structure of services exports in 2007, % Exporters by columns Brazi l China Hong NMS1 Kong* In dia Russia Japan US EU27 EU15 2 Brazi l China Ho ng Kong India Russi a Total BRICs Jap an US EU , EU NMS Other Total * Data are for Source data: TSD. Figure Services imports (total and from the EU27) in 2007, index, 2000= Total From EU Brazil China Hong Kong India Russia EU27 US JPN Source data: TSD. 44

55 1.2.4 Sectoral structure of services trade In this sectio n we look at the sectoral structure of services trade, distinguishing between traditional services (tou rism and transportation), and commercial services (such as financial, communication, and computer services, royalties and license fees), which are producer- their shares in global services trade significantly over the related and have been increasing last years. BRICs have rather diverse structures of services exports. China a nd Russia ha ve th eir services exports being dominated by traditional transportation and travel servic es similar to NMS12, which services export structure differs drastically from the EU15 one (see Table 1.2.5). Hong Kong has the highest specialization in financial services export among all the countr ies analysed; India specializes in exports of computer and information services; Russia exports relatively mu ch of construction services. Interestingly, all the BRICs countries apart from India have relatively high shares of other business services which comprise of such types of services as merchanting and other trade-related services, accou nting, legal, advertising, architectural, enginee ring services and some others. Other types of producer-related serv ices are exported by BRI Cs at a relatively low sc ale (with exception of financial services in Hong Kong). Over the period , BRICs countries have in general decreased shares of traditional services in their exports, with exception of Brazil and China for transportation services, and Hong Kong for travel services (see Table 1.2.6)). New patterns of specialization have been developing in Brazil and China, which increased significantly their shares of other busines s services, and also in India wher e computer and other information services gained a lot of importance for exports. 45

56 Table Sectoral structure of services exports, 2007, % Brazil China Hong Kong India Russia Japan US EU27 EU15 NMS TOTAL SERVICES Transportation Travel Communication services Construction Insurance Financial services Computer and information 262 services Royalties and license fees Other business services Personal, cultural and 287 recreational services Government services Other Source data: TSD. Table Change in sectoral structure of services exports, 2000 to 2007, in p.p. Brazil China Hong Kong India Russia Japan US EU27 EU15 NMS Transportation Travel Communication services Construction 253 Insurance Financial servic es Royalties and license fees Other busin ess services Personal, cultural and 287 recreational services Government services Other Source data: TSD Computer and information 262 services

57 Table Sectoral structure of services imports, 2007, % Brazil China Hong Kong India Russia Japan US EU27 EU15 NMS TOTAL SERVICES Transportation Travel Communication services Construction Insurance Financial services Computer and information services Royalties and license fees Other business services Personal, cultural and recreational services Government services Other Source data: TSD. Table Change in sectoral structure of services imports, 2000 to 2007, in p.p. Brazil China Hong Kong India Russia Japan US EU27 EU15 NMS Transportation Travel Communication services Construction Insurance F inancial services Computer and information 262 s ervices Royalties and license fees Other business services Personal, cultural and 287 recreational s ervices Government services Other Source data: TSD. 47

58 BRICs have a quite diverse services import structures as well (see Table 1.2.7). Transportation services have relatively high shares in imports of China and Hong Kong, while travel services are more intensively imported by Russia and Hong Kong. Russia appears to import relatively much of construction services (which also have high share in its exports). India outperforms others in terms of other business services import their share in its import is 32%. The share of other business services in India s imports increased significantly during , primarily at the cost of major decline in share of transportation services (see Table 1.2.8). Brazil, on the other hand, has experienced decline in the share of other busine ss services in its import. All the BRICs countr ies apart from India re corded a decline in the share of transportation services Trade balances and specialization indices An analysis of the sectoral trade balances allows a first glance at the count ries competitiveness in different services (see Table 1.2.9). Am ong the BRICs, only Hong K ong and India are net exporters of services. All BRICs countries except India have pos itive balances in other business services. India, as it may be expected, h as a positive balanc e in trade of computer and information services. Hong Kong and Russia are net exporters of transportation services, with Hong Kong also having a positive balance in trade of financial services. Table Trade balances in 2007, EUR billion Brazil China Hong Kong India Russia Japan US EU27 EU15 NMS TOTAL SERVICES Transportation Travel Communication services Construction Insurance Financial services Computer and information services Royalties and license fees Other business services Recreational, cultural and 287 recreational services Government services Other Source data: TSD. 48

59 To assess the countries specialization on the EU market, we estimate specialization indices (SIs) for the years 2000 and 2007, in order to find out which sectors gained or lost market shares (see Tables and ). We estimate the indicators separately for the EU15 and NMS12 to see whether the patterns of BRICs specialization differ in those two markets. 18 (Since the EU27 services trade is dominated by the EU15 the share of which exceeded 90% both in exports and imports in 2007 specialization patterns of BRICs in the EU27 as a whole are approximately the same as in the EU15). In general, BRICs appear to have quite few strong advantages at the EU market. China, Hong Kong and Russia turn out to have high SIs in transportation services at the EU15 market, with Russia having created additional strong specialization over in construction services. Brazil and India do not have any strong SIs at the EU15 market. There were no major changes in SIs of BRICs at this market over The current pattern of SIs of BRICs at the NMS12 market is similar to one at the market of the old member states: China and Hong Kong have strong SIs in transportation services, Russia in construction (but not in transportation). Brazil turns out to have strong specialization in one sector at the NMS12 market personal, cultural, and recreational services. Table Specialization indices in trade with the EU15, 2007 Brazil China Hong Kong India Russia 205 Transportation Travel Communication services Construction Insurance Financial services Computer and information services Royalties and license fees Other business services Personal, cultural and recreational services Source: TSD; wiiw calculations. 18 We calculate the specialization index (SI) for country i good j at the market k as SI ijk = (X ijk /X itk )/( X kj /X kt ), where t = total for all goods. The index compares the composition of exports of one country to a certain market with the composition of total exports that are absorbed by the market; it can be considered a relative market size measure and thus a measure of countries specialization revealed by trade flows. Sectors in which the share of a given sector in a country s export noticeably exceeds the share of this sector at the given market (usually the index value being equal to 2 is selected as a benchmark) are considered to have strong specialization at this market. 49

60 However, in contrast to the EU15, the pattern of SIs changed more significantly at the NMS12 market over In 2000, strong SIs had only China, Hong Kong and India in other business services. Over 7 years they lost their specialization in these services; instead China and Hong Kong developed specialization in transportation services. Besides, Russia strengthened its position at the construction services market, and Brazil created strong SIs in personal, cultural, and recreational services. Table Specialization indices in trade with the NMS12, 2007 Brazil China Hong Kong India Russia 205 Transportation Travel Communication services Construction Insurance Financial services Computer and information services Royalties and license fees Other business services Personal, cultural and recreational services Source: TSD; wiiw calculations. These trends (together with much faster development of intra-eu services trade than extra- EU one with extra-eu trade of the NMS12 having actually fallen during ) may reveal that the recent EU integration has resulted so far in stronger services trade diversion effects than trade creation ones possibly due to relative increase of barriers to services trade with the rest of the world in the NMS12 after the EU accession. References: Chanda, R. (2006). Inter-Modal Linkages and Services Trade. OECD Trade Policy Working Paper No. 30. De, P., Raychaudhury, A. (2007). UNESCAP Research Workshop,10-12 December 2007, Macao. Hussain, M., Faes-Cannito, F. (2008). Surplus in EU trade in services with BRIC countriesin Statistics in focus, 40. Kox, H., Nordas, H.K. (2007). Services Trade and Domestic Regulation. OECD Trade Policy Working Paper No

61 Lipsey, R. (2006). Measuring International Trade in Services. NBER Working Paper OECD (2008). Globalization and Emerging Economies. Brazi, Russia, India, Indonesia, and South Africa. Panagariya, A. (2006). Trade and Foreign Investment: Comparing India and China. Paper presented at the Stanford Pan Asia Conference, October. Pindyuk, O., Woerz, J. (2008). Trade in Services: Note on the Measurement and Quality of Data Sources. FIW Research Report series, Nr. 001, June. 51

62 1.3 Foreign Direct Investment flows between the EU and the BRICs Gábor Hunya and Roman Stöllinger, wiiw Introduction Foreign direct investment (FDI) has become the major pillar of internationalization for firms. Albeit global FDI flows are still much lower than trade flows, FDI can be seen as the main channel of international competition. Firms undertake FDI primarily to expand and compete with domestic and other firms on the respective markets. An adequate measure of the relative importance of international trade and FDI in the international competition of firms is the ratio of sales of foreign subsidiaries (affiliates) established by multinational companies (MNCs) in foreign markets to exports. Such a comparison shows that sales of foreign affiliates surpass by far world exports (Sauvant, 2005). For the United States the ratio between sales of foreign affiliates abroad and exports stood at over 2.5 in 2006 and in the case of Germany (still holding the title of the world export champion) outward foreign affiliate sales clearly surpass exports of goods and services. 19 In the case of services, a local presence often represents the sole possibility to enter a market because of the high degree of personal contact required (e.g. retail banking, restaurants, hotellery etc.). A local presence, however, might also turn out to be essential for manufacturing firms because the size of the market share that can be conquered by exporting is typically limited. Further gains in market shares often requires some form of local presence such as a subsidiary which ensures production of products adapted to local needs and preferences. FDI activities are therefore an important indicator for international competitiveness as MNCs not only compete internationally via exports but increasingly by setting up or acquiring subsidiaries abroad. The magnitude of EU outward FDI flows reflects the capability and propensity 20 of EU firms to internationalize their business activities. It is therefore a valuable indicator for the corporate competitiveness, that is, the relative productivity of firms in the EU vis-à-vis foreign competitors. On a global level, the EU emerges as the most important FDI investor, also if considering extra-eu outflows only. In 2007 extra-eu FDI reached EUR 484 billion. In comparison, FDI by US and Japanese firms amounted to EUR 229 billion and EUR 54 billion respectively (Figure 1.3.1, left). Since 2005 the EU has also been the largest Important EU investors such as the United Kingdom, France, Spain and the Netherlands do not report outward foreign affiliate sales (FAS) to Eurostat yet. FAS will be available for all EU member states as of A firm s capacity to undertake FDI is determined by its profits, access to and cost of outside finance, the technological sophistication of its products and managerial skills. The propensity to invest means the extent to which a firm finds it advantageous to invest abroad which typically depends on the attractiveness of potential host markets (market size and growth, political risk, investment climate) but also home market factors such as the regulatory regime. The capacity to invest is closely related to ownership advantages in the terminology of Dunning (2005), whereas the propensity to invest relates to internalization advantages. 52

63 recipient of FDI, attracting EUR 360 billion from outside its territory in 2007, more than twice the amount of the inflows into the US economy (Figure 1.3.1, right) 21. Figure Outward (left) and inward (right) FDI flows of the EU, the United States and Japan (EUR billion) 1200 EU Extra-EU USA Japan 1200 EU Extra EU USA Japan Remark: EU is EU27 for and EU25 for Source: Eurostat, US Bureau of Economic Analysis. The link between inward FDI and competitiveness is a complex issue. The presence of foreign firms in the EU market likely means some loss of market shares for domestic firms in their home market and some firms also risk being taken over by MNCs. From a macroeconomic perspective, however, the entry of foreign firms increases average productivity in the industry concerned, thereby creating a more competitive environment. Since the competitiveness of the EU depends decisively on the corporate competitiveness of both domestic and foreign firms operating in the EU market, there is a positive relationship between inward FDI and the competitiveness of the EU as an economy. Moreover, inward FDI is a potential source of technology spillovers for the EU economy. In the case of new investments and extensions of existing production facilities, FDI also constitutes additional employment and investment opportunities 22. The second subsection of this section will present the FDI relations between the EU and the BRICs based on FDI statistics, the third subsection will analyse company data. (for methodologies see Box 1.3.1). In the subsection four we investigate the possible impacts of the global crisis on FDI in the BRICs, and in the final subsection we summarize our findings and draw conclusions If intra-eu FDI flows are included, the FDI of the EU exceeds by far those of all other countries, totalling EUR 1130 billion outflows and EUR 952 billion inflows in The impact on employment of mergers and acquisitions may be very different. 53

64 Box Methodological approaches This chapter on FDI relies on two main data sources. The first one is the Eurostat Foreign Direct Investment Database (henceforth Eurostat ) which provides consistent data on aggregate and bilateral FDI flows and stocks. Eurostat data are based on national data compiled by EU member states following balance of payments principles and international benchmark definitions of foreign direct investment. Eurostat data are used for the analysis of both inward and outward bilateral FDI relations between the EU (and also the United States and Japan) and the BRIC. Eurostat data allow for a comparison between the FDI of the EU, the United States and Japan. For the United States, data from the US Bureau of Economic Analysis are used in some instances to get more up-to-date data. Eurostat provides a sectoral split-up of the EU s bilateral FDI with the BRICs. Unfortunately, this sectoral break-up is not available for the United States and Japan and also for the EU it is not very detailed. Moreover, there are no long time series available for sectoral data that is why this report uses only FDI stocks for the most recent year, The second major data source tapped for this chapter is FDI Intelligence from Financial Times Ltd ( called the fdi database, which allows for the most up-to-date analysis of FDI flows possible. The information are based on press reports thus the data can be taken as investment commitments. They refer to individual investment projects by source and destination country which are then added up to countries and regions. The number of investment projects is especially important for information about services with low capital intensity which often fall out from the balance-of-paymentsstatistics. FDI Intelligence data differ principally and significantly from the FDI data reported in the balance of payments. While balance of payments data are published with one or two years delay and are backward looking, the fdi database is continuously updated and it is forward looking. The fdi database is incomplete concerning the amount of investments and the employment generated by FDI as this kind of data are only sporadically reported. In most cases, only the new equity investment projects enter the database, therefore the UNCTAD World Investment Report uses the fdi data for information on greenfield investments. Another feature of the database is that it operates with a different industry classification than Eurostat nomenclature, which is in many respects more detailed especially in terms of services and corporate functions. Each of the two main data sources Eurostat and the fdi database has its merits and shortcomings. We are confident that the parallel use of these two high quality but methodologically very distinct data sources helps to arrive at a realistic picture of FDI relations of the EU with the BRIC countries. Sporadic reference is made to other data sources such as OECD foreign affiliate trade statistics (FATS). UNCTAD data on FDI are used to calculate the share of the EU, the USA and Japan in total inward FDI of the BRIC countries. 54

65 1.3.2 FDI data analysis EU FDI in the BRICs and comparison to FDI by the United States and Japan Bilateral investment flows document the coincidence of two ways of competitiveness: it requires corporate competitiveness, i.e. high relative productivity of firms on the side of the source country and locational competitiveness, i.e. the relative attractiveness of an economy for investors, on the side of the host country. In the case of the BRICs, large domestic markets coupled with very high growth rates over the last years and efforts albeit in varying degrees to improve the investment climate in their economies advanced them to the top five of the most attractive locations for FDI in recent UNCTAD surveys 23. The EU, on the other hand, is the world s most important provider of FDI and has 55 of the 100 largest non-financial MNCs domiciled in its territory (UNCTAD, 2008b) 24, far more than any other economy. Consequently, EU FDI flows to the BRICs have increased steadily over the period , especially to Russia and Brazil, where flows reached EUR 16.7 billion and EUR 15.3 billion in 2007 respectively. The growth path of flows to India and China is flatter and flows remained at a low level in 2007 (Figure 1.3.2, left). Figure EU outward FDI flows to the BRICs (EUR billion) left Share of the BRICs in the EU s extra-eu FDI stocks (in %) right Brazil Russia India China Brazil Russia India China Hong Kong Remark: EU is EU27 for and EU25 for China excludes Hong Kong. Source: Eurostat According to UNCTAD (UNCTAD, 2008a) China is perceived as the most attractive location for FDI by investors globally, followed by India. As the sole non-bric country among the top 5 destinations, UNCTAD lists the United States in third position, followed by Russia and Brazil which occupy rank 4 and 5 respectively. China s lead in locational competitiveness rests upon two pillars. The first is that MNCs take advantage of China s large supply of cheap labour and use China as a manufacturing platform for labour-intensive parts of production. The second is that high growth rates led to the emergence of a Chinese middle class in the order of 300 million which makes China also an attractive destination for market-seeking investment. The latter seems to gain in importance as rising wages in China s coastal regions have significantly reduced China s cost advantage in labour-intensive manufacturing (Bartlett, 2008). Ranking according to foreign assets in 2006 including assets owned by EU firms in other EU member states than their country of incorporation. 55

66 The share of the BRICs in extra-eu FDI stocks has not increased strongly in recent years, with the notable exception to Russia. Over five years, the combined share of the BRICs plus Hong Kong in extra-eu outward FDI stocks increased only by 2.5 percentage points to 10% in 2007 (Figure 1.3.2, right). Hong Kong s share in extra-eu FDI decreased between 2002 and 2007 which can be explained by the increased attractiveness of China as a destination for FDI so that the detour via Hong Kong is not necessary anymore. China s share in extra-eu stocks increased only marginally, to 1.23% in 2007, the combined share of China and Hong Kong actually declined slightly to 4% in Thus one can consider this country with rapidly increasing inward investment a place where EU companies were relatively reluctant in their FDI activities. The slow pick-up of the BRIC s share in EU outward FDI stocks is indeed surprising and it can only partially be explained by attractive investment opportunities elsewhere, such as in the close-by new EU member states. The overwhelming majority of FDI stocks continues to be in the advanced countries with high asset prices and a long history of FDI. This can change only very gradually by flows shifting to emerging economies. Other explanations for relatively low EU FDI in the BRICs can be associated with the risks and obstacles related to FDI in the individual BRIC countries. Figure Comparison of returns on FDI of EU FDI in the BRICs and new EU member states (2007) Czech Rep. Hungary Poland Slovakia NMS-10 Bulgaria Romania Brazil Russia India China Hong Kong Extra-EU world New EU member states BRICs Extra-EU World Remark: EU is EU27. NMS10 includes Czech Republic, Hungary, Poland, Slovakia, Slovenia, Estonia, Latvia, Lithuania, Cyprus and Malta. China excludes Hong Kong. Returns on FDI in 2007 are calculated as the ratio of FDI income in 2007 to FDI stocks at the end FDI includes income on FDI equity and interest payable on inter-company debt. Income on equity consists of dividends due for payment to the direct investor, gross of 25 The same pattern is found for the US FDI stocks in China and Hong Kong, where the combined share of the two territories dropped from 3.15% to 2.71% between 2002 and The share of US stocks held in the BRICs stagnated at around 5.2% between 2002 and

67 withholding taxes, plus the direct investor s share of the investment company s reinvested earnings. Source: Eurostat, wiiw-calculations. FDI is driven to some extent by returns on investments and the BRICs are very attractive in this respect (Figure 1.3.3). Taking the ratio of income earned on EU FDI abroad in 2007 to accumulated stocks until end of 2006 as a crude measure for the returns on FDI, FDI in the BRICs appear to be more profitable than FDI in the new EU member states. In 2007 EU firms earned returns on their FDI engagements above 13% in China and Hong Kong, well above the average of EU-extra FDI but also above the returns achieved in the most profitable new member states, Bulgaria and Slovakia. Profitability of EU FDI in Russia and Brazil is somewhat lower, 11.3% and 11.8% respectively, which is similar to the returns on FDI in the most profitable new member states but well above their average 26. With returns on FDI exceeding 18%, India emerges as the by far most profitable location among the BRICs for EU firms. Locational factors such as the perception of country risk 27, which was found to be a decisive factor for FDI in emerging markets (Frenkel, Funke and Stadtmann, 2004), may explain the modest increase of EU FDI especially in the Asian BRICs. This would suggest that in several cases EU firms consider risk adjusted returns on FDI to be higher in the new EU member states (which also provide good investment opportunities because of privatization programmes) than in the BRICs. Other locational factors are specific to individual BRICs. For example, inefficient bureaucracy and a poorly developed infrastructure figure am ong th e most important barriers for FDI in India (Bartlett, 2008). In China, investors concer ns about property rights and remaining restrictions and caps to foreign ownership in the service sectors restrict E U investments in banking and telecommunications. Another f actor favouring FDI in the new EU member states vs. the BRICs is geographic proximi ty in combination with industry structure. Especiall y small and medium sized enterprises tend to limit their FDI engagement in geographi cally close countries (Hunya, 2008) NMS10 includes the Czech Republic, Hungary, Poland, Slovaki a, Slovenia, Eston ia, Latvia, Lithuania, Cyprus and Malta. In Russia, for example, anxieties about the foreign investment conditions in the natural resources sectors prevail and even deepened after the dispute over the ownership structure in the Sakhalin-2 oil field project (Bartlett, 2008). In addition, FDI in sectors considered to be of strategic interest by the Russian government is restricted. 57

68 Figure Share of EU FDI in the BRICs inward FDI, average flows , in % left; Comparison of FDI outflows fro m the EU, the USA and Japan to the BRICs, average , EUR million right EU USA Japan Brazil Russia India China Hong Kong Hong Kong China Remark: EU is EU27 for China excludes H ong Kong. Source: Eurostat, UNCTAD, US Bureau of Economic Analysis. Brazil India Russia While the share of EU FDI going to the BRICs remains small, the EU is an important source of FDI for all BRICs. This constellation mirrors trade, as the EU is a more important trading partner for the BRICs than vice vers a. In terms of FDI flows, the EU is by far the most important investor in Russia and Brazil accounting on average for 57% and 53% of the total FDI going to these countries in the period (Figure 1.3.4, left). In the Asian BRIC economies the share of the EU in inward FDI is much lower, ranging from 31% in India to only 10% in China. This is explained by the large intra-regional FDI flows in South and South-East Asia. In the case of China, Hong Kong stands out as the largest investor accounting for 37% of total inflows in the period FDI flows originating from Singapore, Taiwan and South Korea make up another 13% 28. The high share of intra-regional FDI in Asian countries is linked to the high degree of vertical trade integration. In the case of Hong Kong, however, a part of the FDI flows to China constitutes round-tripping capital, i.e. Chinese investments taking a detour via Hong Kong for tax or other reasons (Poncet, 2008). This phenomenon is also found in India and Russia. Since round-tripping inflates a country s aggregate FDI, the role of the EU as a provider of FDI to India and China might be higher than suggested by the statistics; in the case of Russia the situation is different because much of Russian round-tripping capital enters via Cyprus which is an EU member state (see Box 1.3.2). Regardless of the precise share of EU member states in Russia s inward FDI, EU firms show a very high presence in Russia. A major reason for this is Russia s proximity which is one of the major determinants of the intensity of bilateral FDI flows to emerging markets (Frenkel, Funke and Stadtmann, 2004). 28 The shares of Asian countries in total inward FDI of China are from Chinese sources and therefore not entirely comparable to the indicated EU share of 10% which is based on Eurostat data (see Box 1.3.2). 58

69 The EU emerges as the largest provider of FDI among the Triad countries in each of the BRICs (Figure 1.3.4, right). In Russia and Brazil, the amount invested by EU firms equalled seven to eight times the amount of FDI undertaken by US firms in these countries (average ). The average annual FDI flow from the EU to China in amounted to EUR 6.6 billion, more than twice the amount pouring in from the United States. Japan, which has a strong Asian focus in its outward FDI, recorded on average EUR 4.9 billion to China during the same period. In Hong Kong, the magnitude of FDI flows from the EU and the United States are on a more similar level amounting to EUR 4.9 billion and EUR 3.7 billion respectively. EU flows to India were the lowest among the BRIC countries amounting to EUR 3.9 billion on average for the period , albeit the EU is the number one investor in India if Mauritius is neglected (see Box 1.3.2). Whereas the strong FDI links between the EU and Russia could be expected due to the proximity of the two markets and was also found in the trade in goods and services, the favourable position of EU firms in Brazil compared to US firms is more surprising and in contrast with the result found in services trade. The strong position of EU firms in the BRICs is mainly the result of FDI from Spain which has close historical links with South America 29 and Germany which is a major and geographically well diversified provider of FDI. Table Major EU investor countries in the BRICs Average annual outflow ( ) and outflows in 2007 (EUR million) Brazil Russia Spain 2946 Spain Germany 2190 Germany France 1331 France 0 Netherlands 2075 Austria United United 195 Germany 1102 Germany 6 Kingdom 1287 Kingdom 8 United United Kingdom 553 Kingdom 4 Austria 985 Belgium Belgium 502 Netherlands 559 Sweden 804 Sweden 4 Share in EU total 83% India Share in EU total 76% China Portugal which is the former colonial power in Brazil does not show up as a major investor in Brazil in terms of values but has several smaller MNC operating in Brazil. 59

70 172 United 166 Germany 883 Germany 1 Germany 1934 Kingdom 9 United United United 153 Kingdom 608 Kingdom 975 Kingdom 972 Germany France 281 Netherlands 495 France 758 France 3 Netherlands 276 France 366 Denmark 434 Denmark 752 Sweden 102 Sweden 192 Netherlands 395 Finland 499 Share in EU Share in EU total 86% total 82% United Kingdom 3770 France Hong Kong BRIC (including Hong Kong) United Kingdom 650 Netherlands United Kingdom 7190 Germany 182 United 3 Germany 6684 Kingdom Netherlands 581 France 937 Spain 3879 Spain Germany 575 Germany 716 Netherlands 3730 France Spain 567 Spain 567 France 3604 Austria Share in EU Share in EU total 94% total 78% Remark: EU is EU27. China excludes Hong Kong. BRIC includes Hong Kong in this table. Source: Eurostat A closer look at the individual EU member states investment engagement in the BRICs and Hong Kong (Table 1.3.1) reveals that in 2007 Germany was the most important investor thanks to strong involvement in all five markets with FDI flows ranging from EUR 716 million in Hong Kong to EUR 6.7 billion in Russia. Germany figures among the top 5 investors in all BRICs and Hong Kong. FDI by France and the Netherlands to the BRICS is rather diversified by target country, whereas Spain s FDI activities are highly concentrated in Brazil. The United Kingdom, traditionally the largest investor among the EU member states in the BRICs with average FDI flows of EUR 7.2 billion during the period , has a focus on Asian, especially on Hong Kong. The United Kingdom is also among the top five EU investors in the remaining BRICs. Next to the activities of the five top EU investors mentioned, there is some important FDI from Austria, Belgium and Sweden going to Russia. 60

71 Box Is Mauritius really investing more in India than the EU? In the balance of payments FDI flows are recorded according to the principle of residence. This means that flows are allocated to the countries where the two entities that engage in a direct transaction are domiciled. This is at the origin of the possible discrepancy between the actual (ultimate) source of an FDI transaction and the source country recorded in statistics based on balance of payments principles such as Eurostat. In the case of Russia, India and China the use of holding compa nies and special purpose entities (SPE) in arranging FDI transactions drives a wedge between the recorded source country of FDI and the ultimate source cou ntry. In Russia, for example, Cyprus, one of the smallest EU member states, is among the top investors according to Russia s Federal State Statistics Service. The Cyprus-effect inflates the EU s share in Russian inw ard FDI to approximately three thirds. This is a much higher share than recorded by Eurostat because investments thro ugh some SPEs in Cyprus (in particular empty holding companies with no economic activity in Cypru s) are not covered by Eurostat. Since a part of Cypriote FDI into Russia is expected to be roundtripping capital, that is capital from Russian sources invested via the detour of Cyprus for tax or other reasons, Eu rostat data better reflect the role of EU firms as FDI investors in Russia. The differences between Eurostat dat a and national data sources can be seen by comparing Figure with the Figure below which shows the country-break down of inward FDI f or India, China and Russia based on national data sources. Inward FDI flows b y main investors (average ) India China Russia Singapore 8% other 16% Mauritius 44% off -shore 26% other 9% EU 27 7% Japan 7% USA 4% Virgin Isl. 3% Switzerl. 4% Singapore 8% EU 74% Japan 3% USA 3% USA 8% EU 21% Asian NI Cs 13% Hong Kong 34% Remark: For India figures are average flows for April 2000 to November 2008 In Russian figures EU includes only United Kingdom, Cyprus, the Netherlands, Luxembourg, Germany, France. Off-shore centres include Virgin Islands, Cayman Islands, Barbados, Bahamas, Samoa. Asian NICs (Newly- industrialized countries) include Singapore, Taiwan, Korea Source: Department of Industri al Policy & Promotion for India, China Statistical Yearbook, Rosstat for Russia. Round-t ripping capital also inflates inward FD I figur es of China a nd India, primarily through inflows from Hong Kong and Mauritius, respectively. I n the case of India, Mauritius shows up as the number one investor country accounting for 44% of the inward FD I. Different treatment of these flows can explain some of the existing differences between Eurostat da ta and national data sources. As in the case of round-tripping capital, the use of holding comp anies and SPEs domiciled in off-shore centres can make important investor countries disappear in bilateral FDI statistics. F or example, an US MNC mig ht find it advantageous to use a SPE in Barbados to finance the acquisition of a Chine se firm. The acquisitio n of the Chines e company in this case is recorded as an Chinese inflow from Barb ados. The use of holding companies and SPEs is clearly on the rise. For the US, foreign affiliates abroad classified as holding companies already accounted for 33% of the US outward stock in 2007 (Ibarra and Koncz, 2008). These problems do not appear in the fdi database of the FDI Intelligence from Financi al Times Ltd whi ch records the home country of the investor and not the financial intermediate. 61

72 Sectoral structure of EU FDI in the BRICs Global EU outward FDI takes place predominantly in service industries accounting for more than three thirds of the EU s total outward FDI stock in The dominance of services over manufacturing is in line with the structure of the EU economy but in stark contrast to the relative importance of these two broad sectors in international trade. While the ratio between the EU's global goods exports and services exports stands at over 3 (3.3 in 2007), the ratio between FDI flows in goods producing sectors 30 to FDI flows in services sectors is just over one third. (0.36 in 2006). So the relative importance of goods and services are precisely reversed in the context of FDI when compared to trade. The EU s FDI stocks in the BRICs are skewed to the service sector as well, but the manufacturing sector occupies a much larger share relative to global and extra-eu FDI stocks. In India and China manufacturing and service industries both account for approximately half of the total stock (Table 1.3.2). In the case of India and China the relatively high share of manufacturing can to some extent be explained by restrictions to FDI, including limitations of foreign ownership in industries considered as strategic, which are more severe in services industries and infrastructure such as electricity, transport and telecommunication (Koyama and Golub, 2006). The sectoral composition of EU FDI stocks in Brazil resembles very much the structure of FDI in industrialized economies with roughly two thirds attributable to services. Investments in the primary sector only play a marginal role in Brazil, India and China. In Russia, the large FDI stock in the primary sector which includes exploration of oil and gas stands out. It represents 18% of the EU s FDI stock in Russia, leaving 30% to manufacturing and 50% to services. The significance of the primary sector in inward FDI in Russia, however, is expected to have declined after the adoption of the new law on strategic sectors in April In Hong Kong, the situation is very different from China and the other BRICs. Basically the entire FDI stock, amounting to EUR 86 billion, owned by EU firms is attributed to the service sector. 30 Goods producing secto rs include agriculture and fishing, mining and quarrying, manufacturing and electricity, gas and water. 62

73 Table EU outward stocks in th e BRICs by economic activity (2006), in EUR million Brazil Russia Agriculture and fishing Mining and quarrying Manufacturing Food products Textiles and wearing apparel Wood, publishing and printing Refined petroleum products and other treatments Manufacture of chemicals and chemicals products Rubber and plastic products Metal products Mechanical products Office machinery and computers 13-5 Radio, television, communication equipments Vehicles and other transport equipment Electricity, gas and water Construction Services Trade and repairs Hotels and restaurants Transport and storage Telecommunications Post and courier activities Financial intermediation India China Hong Kong

74 Real estate and business activities Real estate Renting of machinery and equipment Computer activities Research and development Other business activities Total Remark: EU is EU27. China excludes Hong Kong. Economic activities according to Eurostat nomenclature. Numbers do not add up to Total because of non-allocated activities.. FDI outward stocks are classified according to the activities of the non-resident enterprise, i.e. the enterprise in the respective B RIC country. Source: Eurostat. 64

75 Financial intermediation is the most important FDI activity for EU firms in the BRICs with its share ranging from approximately 20% in China to one third in Brazil (Table 1.3.2). In Brazil and in Russia, where financial intermediation accounted for 25% of total stocks in 2006, the dominant position of the financial sector is the result of the internationalization of European banks, also in retail banking 31. EU banks are less dominant in the banking sectors of India and China, mainly because of ownership restrictions in these countries. Financial intermediation is nevertheless the leading industry in these countries mostly due to the wholesale financial sector and the emergence of new financial centres such as Shanghai or Mumbai. In Hong Kong essentially all FDI activities of EU firms is in financial services reflecting Hong Kong s role as a global financial centre. Real estate & business activities and trad e & repairs follow financial services in terms of EU FDI stocks in all BRICs. This may be less the result of similar strategies of EU MNCs or similarities of economic structures on the side of the BRICs than the low level of disaggregation of data in the category of business services, albeit in the case of India the focus on computer activities stands out. There is more variation within the manufacturing sector. Similar patterns across BRICs, however, also exist in manufacturing not only because capital-intensive industries usually get more FDI than others, but also due to the competitive advantages of EU firms. The section on trade revealed a huge positive specialization of the EU on machinery and equipment and other transport equipment in bilateral exports to the BRICs reflecting the EU s comparative advantages. 32 Therefore machinery and equipment and transport equipment are also found among the top five industries in each of the BRICs in terms of FDI stocks in 2006 (with the exception of machinery and equipment in Russia.) The same is true for the chemical industry, another stronghold of EU firms and globally the most important sector for the EU in terms of FDI. Reflecting the match of some large EU MNCs and a large and growing market size, the food industry is among the top five manufacturing industries in Brazil, Russia and India. In the latter the EU food industry has even accumulated the largest FDI stocks within manufacturing. In Russia, the FDI stocks owned by EU firms also reveal the high dependency of Russia on its natural resources. Natural resources, comprising mining and quarrying which in turn includes oil and gas exploration and refined petroleum account for EUR 17 billion or one third of the total EU FDI stocks in Russia 33. The major role of petroleum in EU-Russia relations is also highlighted by the fact that 8% of the global EU FDI stock in refined petroleum is located in Russia (2006) In the case of banks, the set-up or acquisition of an affiliate bank abroad generally induces large FDI flows since inter-company loans are recorded as FDI. This means that all loans provided by EU parent banks to their foreign affiliates are recorded as FDI and add to the EU s FDI stock abroad. Although this is also the case for all other enterprises, loans between affiliated banks are of a much higher magnitude because typically foreign affiliates have their parent banks as an important refinancing source for their entire banking operations. Machinery and equipment (NACE division 29) is the equivalent to mechanical products (2900) which is the terminology used in the Eurostat nomenclature for FDI. The large share of FDI related to natural resources in the EU FDI outward stock in Russia mainly reflects 2-3 large projects by leading EU petroleum companies. 65

76 Box Holding companies, SPEs and the industry distribution of FDI Some caution is warranted when interpreting data on FDI stocks by industry. Much like in the case of the geographical split-up of FDI, the structuring of FDI transaction can drive a wedge between the actual industry in which a firm undertakes FDI and the industry under which the transaction is recorded. In line with international guidelines (IMF, Balance of Payments Manual), the allocation of an FDI tr ansaction to a specific economic activity is made on the basis of the direct transaction, not the entity that is ultimately acquired. The complex company structures of MNCs and the possibility to create empty holding companies or special purpose entities (SPEs) can easily blur the relative importance of industries for both inward and outward EU stocks as reported by Eurostat. In the case of EU inward FDI stocks the FDI transactions undertaken by enterprises from the BRICs are recorded according to the activity of the direct investment enterprise, i.e. the EU entity which is acquired or established. In case such a transaction, for example the acquisition of an EU manufacturing company by a Russian enterprise, is made via an SPE in Luxembourg, it would be recorded under financial intermediation unless the reporting authority can group the SPE to the investor company. Likewise, the EU s outward FDI stocks are allocated according to the economic activity of the acquired company (direct investment enterprise), i.e. the enterprise located in the BRICs. Structuring the transaction via an SPE or a holding company may obscure the economic activity the FDI transaction is really related to, i.e. the industry in which the acquired company ultimately operates. Finally, complex company structures create significant and increasing amounts of FDI that neither relate to mergers or acquisitions nor to a new project (greenfield investment). All crossborder transactions that entail a change in ownership between affiliated companies are equally recorded as FDI. In case of EU inward FDI, if the direct investment enterprise is a financial holding, this kind of transaction is recorded under financial intermediation. If the direct investment enterprise is a holding company providing management functions, this transaction is recorded under other business activities. The bottom line is that FDI data by sectors and industries may be biased towards services (financial intermediation and business activities) because of the underlying methodology for allocating transactions and stocks to industries. The relatively bigger importance of manufacturing in the FDI relations between the BRICs and the EU found in the analysis of investment projects (see below) also point in this direction. The fdi database does not have the bias of the balance of payments statistics, although its reliability is weakened by relying on incomplete information provided by companies FDI of the BRICs in the EU in comparison to the United States and Japan Outward foreign direct investment undertaken by MNCs of emerging markets including the BRICs is a rather new phenomenon. FDI outflows from the BRICs picked up in the early 1990s and its growth accelerated markedly only with the beginning of the new millennium (Figure 1.3.5, left). This gives all of the BRICs, excluding Hong Kong, a latecomer status with regards to outward FDI. Rapid growth of outward FDI flows since the beginning of the decade has made Russia the most important FDI investor among the BRIC countries in Brazilian global outward FDI is rather volatile but shows a clear positive trend and a strong pick-up is observable 66

77 for China and India. Much less of an upward trend is discernible in the FDI flows of the BRICs directed towards the EU, with the important exception of Russia (Figure 1.3.5, right). Rather than a steady upward trend, the EU inflows originating from Brazil, India and China show single peaks in different years such as Brazil with EUR 4 billion in Russian FDI flows to the EU, amounting to EUR 9 billion in 2007, constituted the largest inflow recorded from any of the BRICs during the period Hong Kong used to be an active FDI investor in the markets of the EU but has lost this position due to disinvestments over the last three years. Figure BRIC global FDI outward flows (left) and bilateral flows to the EU (right) (in EUR billion) Brazil India Russia China Brazil India Russia China Remark: EU is EU27 for and EU25 for China excludes Hong Kong. Source: UNCTAD, Eurostat. The BRICs are not a major source of FDI for the EU. Flows from the BRICs and Hong Kong taken together, on average, accounted for only 5.5% of extra-eu inward FDI flows during the period Moreover, their share is not really increasing, mainly because of falling flows from Hong Kong 34. This makes the BRIC countries underrepresented in the EU market in terms of FDI flows when compared to their share in global FDI which stood at 7.1% in The same is true for inflows received by the US from the BRICs. BRIC FDI flows including those from Hong Kong as recorded by the United States started from insignificant levels in 2002 (0.11% of total US FDI inflows), reached a peak of 2.8% in 2005 due to a mixture of very low total US inflows and an increase of FDI received from the BRICs, but declined again to 0.58% of total inflows in The comparison between FDI inflows to the EU and the United States originating from the BRICs shows that Russia and Brazil invested on average much larger amounts in the EU than in the United States during the period (Figure 1.3.6). The same is true for China but not for Hong Kong because of Hong Kong s disinvestments in the EU in recent years. Finally, FDI flows suggest that Indian investors have a preference for the United States which received on average 34 FDI flows from the BRICs, excluding Hong Kong, accounted for 3.5% of extra-eu inflows into the EU over the period. But even their share show no clear upward trend. The significance of the BRICs as an investor for the EU is even smaller when stocks are considered because of the late start of any sizeable outward FDI by the BRIC countries. 67

78 EUR 945 million annually in the period This represents the highest inflow from any of the BRIC countries to the United States, whereas Indian average annual flows to the EU were only EUR 628 million during the same period, the least among all of the BRICs. Figure Comparison of FDI inflows from the BRIC countries into the EU and the USA (average flows ) in EUR million EU 27 USA Brazil Hong Kong Russia 0 China India Remark: EU is EU27. China excludes Hong Kong. Source: Eurostat, US Bureau of Economic Analysis. Recalling the three major objectives for firms to undertake FDI distinguished by FDI theory, i.e. market seeking investment, resource-seeking investment and efficiency-seeking investment (UNCTAD, 1998) gives a first hint on why the EU is of rather low priority in the BRICs outward FDI activities. First of all, resource-seeking FDI which aims at securing needed raw materials and other natural resources is a major investment motive for the BRICs, in particular for China and India. In volume terms China s outward FDI is dominated by state-controlled enterprises in natural resources or telecommunication most of which enjoy a monopoly or monopoly-like situation in the Chinese economy (Morck et al., 2008). Obviously, resource-seeking type of FDI by the BRICs is directed predominantly to resource-rich countries of Africa, South America and Asia and not to the EU. Secondly, no significant efficiency-seeking FDI can be expected to pour into the EU from the BRICs as labour-costs are generally much higher in the EU than in the BRICs 35. This means that access to new markets remains as the major motive, supplemented by additional motives such as access to new technologies 36 (Holtbrügge and Kreppel, 2008). In the In general, efficiency-seeking is not the major motive for outward FDI by the BRICs but there is anecdotic evidence for such investments. For example, Chinese companies have started to transfer the production of some of its low-tech manufacturing products to countries with lower wages such as the offshoring to Indonesia of the production of DVDs (Sauvant, 2005). FDI motivated by the access to new technologies or the acquisition of an existing brand name is often subsumed under resource- and assetseeking FDI. Assets in this context refer to values created by firms in contrast to raw materials or natural resources. 68

79 case of Russia the geographical diversification of investment also appears as an investment motive (Deutsche Bank, 2008). Outward FDI activities of the BRICs have a strong regional focus. Especially in Asia a lot of socalled South-South investment, meaning FDI between developing or emerging markets, is taking place. The same appli es to Brazil which is a big investor in South America, and Russia which is an important investor in the Commonwealth of Independent States ( CIS). The major reason for this pattern is the role of geographical distance w hich, as ment ioned earlier, is an important determinant of bilateral FDI flows. Hence as is the case for most MNC in the EU, the US and Japan many firms from the BRICs start their internationaliza tion strategies in neighbouring countries where culture and the legal and administrative environment are more similar. The Russian telecom provider Vimpelkom which has nation-wide licences in a series of CIS-countries such as Kazakhstan, Tajikistan, Ukraine, Uzbekistan, Georgia and Armenia but is not present in the EU can serve as examples in this respect. In some instances the regional focus may also be grounded by the lack of competitivene ss, i.e. of the capability to successfully enter the highly competitive markets of developed count ries. Finally, FDI flows from the BRICs to the EU may also be hampered by restri ctions to FDI on the side of the EU. Albeit the EU in general appears to be very open towards inward FDI according to OECD s FDI regulatory restrictiveness index (Golub, 2003, Koyama Golub, 2006), restrictions do exist, mainly in infrastructure sectors such as electricity, transport and telecommunications but al so in finance. According to the OECD index, in EU member states ( and other OECD countries, including the United States and Japan) the p redominant form of restrictions is screening and approval procedures. In contrast, most EU member states maintain hardly any formal limitations to foreign ownership. A shortcoming of the O ECD index is that it mainly captures overt restrictions but miss informal and tacit forms of restrictions such as proc edural del ays or lack of transparency on the award procedure in public tenders. Natio nal resentments and anxieties against foreign investors as, for instance, those of the activi ties of sovereign wealth funds (SWF) 37 in the EU increase the possibility of informal ways of discrim ination against unwanted foreign direct investors. Moreover, several EU member states including Germany, the United K ingdom and France have legal frameworks that enable them to block FDI projects in sectors deemed as strategic for national safety or security reasons. The same, however, also applies to the United States and Japan (UNCTAD, 2008b) Sectoral structure of BRICs F DI in the EU The late start of outward FDI undertaken by MNCs from the BRICs and the mediocre priority given to the EU as a target country means that as of 2006 stocks owned by BRICs firms in the EU are modest. Accumulated stocks of Brazil and Russia, both equal to approximately EUR 15 billion each, are much larger than those of China and India which amount to 37 Russia (Stabilization Fund and National Welfare Fund), China (China Investment Corporation) and Hong Kong (Hong Kong Monetary Authority Exchange Fund) all have significant SWFs. 69

80 EUR 3.6 billion and EUR 2.2 billion, respectively. All BRICs have in common that their outward FDI in the EU is highly concentrated in the service sector (Table 1.3.3). Hong Kong s outward FDI stock in the EU is mainly in telecommunications. This is explained by the activities of Hutchison Whampoa, the largest MNC in emerging markets in terms of foreign assets (UNCTAD, 2008b) which, within the EU, is active in Austria, Denmark, Ireland, Italy, Sweden and the United Kingdom. In the case of Brazil, Russia and India industries related to business activities have accumulated the largest outward FDI stocks in the EU as of 2006 (Table 1.3.3). For India the dominant role of business activities in outward FDI towards the EU is to some extent the result of the increasing internationalization of the Indian IT and software cluster, led by firms such as Tata Infotech and Infosys Technologies. Computer services account for EUR 286 million or 39% of the EUR 741 million FDI stocks in real estate and business activities owned by Indian firms. In Brazil also a sizeable number of IT and software development firms (such as Itautec) have emerged and started to go abroad (Gouvea, 2007) but the FDI stock owned in the EU in business activities are predominantly the result of Brazilian business and management consultancy firms that within the EU concentrate their activities in Spain 38. The second most important service industry for Brazil, Russia and India in bilateral FDI relations with the EU is financial intermediation. In the case of Russia, a part of the FDI stock owned in the EU can be attributed to the activities of Vneshtorgbank (VTB), the second largest bank in the country. VTB s has wholly owned subsidiaries in Austria, Cyprus and subsidiaries (majority-owned) in France, Germany and the United Kingdom. The internationalization strategy of VTB in the EU is to follow CIS companies on the European market. For China, financial intermediation is by a wide margin the dominant industry in terms of outward stocks in the EU as of This can partly be attributed to the fact that major banks such as Commercial Bank of China, Bank of China, China Construction Bank, Bank of Communications all have established branches or representative offices in several EU member states Business and consultancy services include activities of holding companies with active management functions. The importance of the financial sector in the BRIC s outward FDI activities in the EU is nevertheless surprising. Part of the explanation may be the bias towards services in the recording of FDI stocks (see Box 1.3.3). 70

81 Table EU inward stocks owned by the BRICs by economic activity (2006), in EUR million Brazil Russia India China Hong Kong Agriculture and fishing Mining and quarrying Manufacturing Food products Textiles and wearing apparel Wood, publishing and printing Refined petroleum products and other treatments Manufacture of chemicals and chemicals products Rubber and plastic products Metal products Mechanical products Office machinery and computers Radio, television, communication equipments Vehicles and other transport equipment Electricity, gas and water Construction Total services Trade and repairs Hotels and restaurants Transport and storage Telecommunications Post and courier activities Financial intermediation Real estate and business activities Real estate Renting of machinery and equipment Computer activities Research and development Other business activities Total Remark: EU is EU27. China excludes Hong Kong. Economic activities according to Eurostat nomenclature. Numbers do not add up to Total because of non-allocated activities.. FDI inward stocks are classified according to the activities of the resident enterprise, i.e. the EU enterprise. Source: Eurostat. EU is EU27. 71

82 There is very little outward FDI undertaken by BRIC manufacturing firms with the exception of India. In several cases, the existing stocks match well with a documented single transaction. For example, the food industry is the most important manufacturing sector in the Indian FDI stocks in the EU (EUR 408 million) due to the takeover of a British tea company (Tetley Tea) by Indian Tata Tea in 2000 (Sauvant, 2005). The growing Indian pharmaceutical industry, which is a major player in producing generic drugs, expanded into the EU via the acquisition of RPG Aventis in France by Ranbaxy Technologies. In case of China most manufacturing FDI in the EU is in the computer industry which matches well with the activities of the Chinese top notch computer manufacturer Lenovo. The company has, for instance, established a production facility in Poland. 40 Russian manufacturing outward FDI in the EU is very limited. The Russian investment activities in electricity, gas and water, with Gazprom being the main investing company, led to the accumulation of EU inw ard stocks from Russia of EUR 900 million which easily exceeds the FDI stocks accumulate d in all manufacturing industries FDI and competitive positions A local presence o f firms from the BRICs in the EU market is still more the ex ception than the rule. Despite single examples, over all, MNCs from the BRICs exert only very limited competitive pressure via subsidiaries established in the EU and competition is much fiercer via the trade channel. For the manufacturing sector this can be seen by comparing the manufacturing sales of foreign affiliates of BRIC MNCs in the EU member states, as recorded by the OECD Foreign Affiliates Trade Statistics (FATS), with the imports of goods from the BRICs into the EU. In many EU member states, the sales of BRIC foreign affiliates in their domestic market are reported to be zero 41. In all cases where positive foreign affiliate sales (FAS) of BRIC firms are recorded such as Indian (EUR 360 million) and Chinese affiliates sales (EUR 751 million) in France, Indian affiliates sales in the United Kingdom (EUR 316 million) or Russian affiliates sales in Italy (EUR 481 million), these amounts are minuscule in comparison with the imports of these EU member states from the respective BRIC country (Figure 1.3.7). This suggests that in manufacturing, companies from the BRICs rely largely on exports in the competition for market shares in the EU and hardly compete via affiliates established there. The almost complete absence of foreign affiliates of the BRICs in the EU market can be seen as a competitive advantage for EU manufacturing firms in their home market. At the same time, however, this also means that the BRICs FDI activities hardly create any additional employment opportunities in the EU. The same is true for BRICs MNCs on the Japanese and the US markets Lenovo has expressed intere st in the takeover of the S iemens share s in the Fujitsu Siemens C omputer joint venture ( EE Times Europe, 2008). This intention is of course not reflected in Eurostat data. Information of sales of foreign affiliates is not yet obtainable for all EU membe r states. Member states such as Germany, Spain or the Netherlands do not provide this kind of info rmation. It is therefore not possible to ar rive at an EU aggregate. 72

83 Figure Goods imports from the BRICs and s ales of BRICs foreign affiliates in manufacturing in the respective economy (2006), million EUR Brazil Russia India China Hong-Kong Im ports FAS* Imports FAS** Imports FAS Imports FAS*** ImportsFAS****Imports FAS***** France Italy Sw eden United Kingd om United S tates Japan Remark: China excludes Hong K ong. Companies are considered as foreign affiliates if a foreign firm holds majority ownership. * value for Russia ** values are *** values 2005 except for India. **** value for China ***** value for India Source: U N Comtrade, OECD Foreign Affiliate Trade Statisti cs. Figure Goods exports to the BRICs and sales of foreign affiliates in manufactu ring of the respective country i n the BRICs (2006), million EUR Brazil Russia India China Hong Kong Exports FAS Exports FAS Exports FAS Exports FAS Finland Germany United States Japan Remark: China excludes Hong Kong. Companies are considered as foreign affiliates if a foreign firm holds majority ownership. Source: UN Comtrade, OECD Foreign Affiliates Trade Statistics. 73

84 In contrast, EU FDI in the BRICs has led to a strong local presence of EU firms in these markets and EU firms seem to compete intensively via the sales of affiliates in the markets of the BRICs. Comparing FAS of EU MNCs in the BRICs with EU exports to these markets shows that in several instances FDI has become the primary mode of entry and channel of competition for EU firms. Sales of German affiliates in Brazil, for example, exceed by far the volume of German merchandise exports to Brazil, and the same is true for Finish FAS in China (Figure 1.3.8). FAS play an extremely important role for US MNCs as well, particularly in Brazil and China. For Japanese firms exports to and sales of Japanese affiliates in China, Hong Kong and India are both important. In China and Hong Kong exports still exceed FAS but the reverse is already true in Japan s trade and investment relations with India Investment project database analysis This section is based on the fdi database which covers overseas investment projects recorded by between 2003 and First we look at the FDI of the world in the BRICs (Brazil, Russia, India, China and Hong Kong), than at the investments of the EU15 in these countries. Compilation of data for other EU members failed due to methodological problems, but it is quite sure that the overwhelming majority of EU27-related projects are covered. (For detailed methodological notes see Box ) Table Investment projects in the BRICs, by year Year Total no. of projects FDI EUR mn From EU, projects EU in total projects % From EU, FDI EUR mn EU in total FDI % , , , , , , ,642 64, , , , , ,546 92, , ,449 97, , Total 17, ,638 6, , Source: FDI Intelligence from Financial Times Ltd Global and EU15 investments in the BRICs resilient to global crisis until 2008 The BRICs received more than 17.5 thousand FDI projects in the past six years out of a worldtotal of 73.6 thousand projects registered in the fdi database (Table 1.3.4). The highest number of projects was recorded in 2008; this was also the year with the most significant increase compared to the previous. As to the amount of investment in reporting projects, the total was EUR 592 billion over six years. The highest amount was achieved in 2003, highest growth in Annual fluctuations like the setback in 2005 followed global trends. But the expansion of FDI in the BRICs in 2008 was against the world-wide trend. The impacts of the crisis came to these 74

85 countries with some delay and less intense than to other parts of the world. The BRICs may have attracted investors in search of still expanding markets. Table 1.3.5a Investment projec ts in the B RICs, by source country Source country Total USA ,086 Japan , 945 Germany ,455 UK ,258 France Italy South Korea Taiwan Netherlands Hong Kong Source: FDI Intelligence from Financial Times Ltd. Table 1.3.5b EU investment projects in the BRICs, by source country Source country Total Germany ,455 UK ,258 France Italy Netherl ands Sweden Finland Spain Austria Belgium Denmark Portugal Luxembourg Ireland Greece EU Total ,11 1,016 1, ,179 Source: FDI Intelligence from Financial Times Ltd. 75

86 Major investors in the BRICs: role of EU increasing The major source of FDI in the BRICs is by a large distance the US with more than 5 thousand investment projects, 29% of the total (Table 1.3.5). The highest number of investments occurred in 2006 followed by Last year the share of US projects was lower than before while that of Japan, second in the overall ranking, increased. The main EU investors, Germany, the UK, France and Italy occupy the ranks 3 to 6, with Germany coming close to Japan. The joint share of the four largest EU economies amounts to 24% for the whole observed period and 26% in 2008 which is a slight increase in concentration. The share of the EU15 increased from 32% in 2003 to 38% in 2008 which points to a growing importance of the EU among the investors in the BRICs. In terms of reported investment capital the lead of the USA is much smaller than for the number of projects, with 15% for the whole observed period and only slightly higher in Germany comes second while Japan is further down the list. Investing countries with relatively high amounts of investments relative to the number of projects include Korea and Hong Kong. Those with relatively small sums per project are France and Italy. Still, the share of the four leading EU investors is 22%, higher than that of the USA for the whole observe d period, reaching as much as 27% in the year As to the EU15, their share in the invested sum increased from 33% in 2003 to 40% in This is another strong argument supporting the increasing role of the EU investors in the BRICs Most foreign projects in China, for the EU also Russia and India important Almost half of the FDI projects realized in the BRICs went to China, together with Hong Kong 54.5% of the total (Table 1.3.6). The second target was India with half as many projects as China, than again with great distance Russia and finally Brazil was the peak year for all the countries and 2007 was the weakest year. As all BRIC destinations and all major investing countries show the same fluctuation in the number of projects over time, the fluctuations must have to do with general and not country specific processes. As to the amount of invested c apital, the lead of China is smaller than in terms of the number of projects, and the investments in Hong Kong is of very small size. Russia has received the second largest amount of FDI. The relatively large size of investm ents in Russia can be linked to the capital-intensive oil and gas sector. Low capital intensity in Hong Kong and in India is a characteristics of the services sectors. 76

87 Table 1.3.6a Investment projects in individual BRICs Destination country Total China 1,323 1,545 1,244 1,402 1,190 1, ,251 India ,423 Russia ,673 Brazil ,279 Hong Kong Total 2,582 3,010 2,642 3,089 2,546 3, ,486 Source: FDI Intelligence from Financial Times Ltd. European investment projects in the BRICs differ from the global first of all because EU15 countries invest relatively less in China and more in Russia than the rest of the world. China is the most important destination for EU investors but they give only 29% of the projects and 25% of the invested capital in that country in But the EU share has been on the rise and in 2008 almost 35% of the projects in China came from the EU15. The picture we get on EU FDI in China from the fdi database largely differs of what we get from the Eurostat statistics. This may have primarily methodological reasons. Table 1.3.6b EU15 investment projects in individual BRICs Destination country Total China ,398 India ,497 Russia ,446 Brazil Hong Kong Overall Total ,11 1,016 1, ,179 Source: FDI Intelligence from Financial Times Ltd. For Russia, the EU is more importan t than for China: more than half of the projects and 40% of the invested capital came from the EU and the trend is increasing. India is alm ost as important as Russia for the European investors both in terms of project nu mber and investment capital. But India receives also lots of projects from other countries and the share of the EU there is rather low Investors target mainly local and regional markets Of the more than six thousand EU investment projects 1382 provided information concerning the markets their activities serve. One third of these investment projects targeted only the domestic market of the host country, another one third the Asia-Pacific market, and 7% had global destination. Only 63 projects had the aim to serve European markets, which shows that the role of 77

88 outsourcing is rather small. Most projects serving the EU market were in Russia, the geographically nearest of the BRICs. The motives of EU investments in the BRICs were related to the market conditions in the host country and the direction of sales (Table 1.3.7). Of the 1445 projects which supplied information 45% chose the location due to the growth potential of the destination market, 17% due to the proximity to customers and only 7% due to low costs. The motivation of investors and the markets of their products reveal that European FDI in the BRICs is primarily market seeking. It is the growth of the market, less the production cost which motivates investments. This structure of motivations suggests that when in the wake of economic growth wages will increase, this will not deter investors due to rising costs, but rather attract them due to growing demand. Table Motives of EU15 investors in the BRICs Location determinants (motives) Projects % of projects Domestic Market Growth Potential ,6 Proximity to markets or customers ,4 Lower Costs 104 7,2 Skilled workforce availability 94 6,5 Industry Cluster / Critical Mass Infrastructure and logistics Regulations or business climate Presence of Suppliers or JV Partners ,3 4,6 4,3 2,3 IPA or Government support Natural Resources Attractiveness / Quality of Life ,6 1,5 1,0 Universities or researchers Language Skills ,9 0,8 Finance Incentives or Taxes or Funding Technology or Innovation Facilities Site or Real Estate ICT Infrastructure ,7 0,6 0,6 0,3 Total January 2003 January ,0 Source: FDI Intelligence from Financial Times Ltd EU strong in financial services and manufacturing, weak in IT According to the distribution of projects (all investors) in the BRICs by economic sectors (Table 1.3.8) the software and IT services are in the first place and financial services in the second 42. Services together including also business services and real estate, account for 37% of the projects. The rest are in manufacturing branches, most importantly in the automotive industry (original equipment manufacturing, OEM and car component industry together), machinery and equipment, chemicals and food. As to the investors from the EU, financial services are in the first 42 In this classification there are no data for wholesale and retail trade, thus the manufacturing branches cover not only production but also distribution. 78

89 place by the number of projects. These are followed by manufacturing industries like machinery, textiles and automotive. Software and IT services rank only fourth and also electronic components and communication have lower shares than the average. This allows to conclude that EU investors are relatively weak in the most modern services and products. There are some remarkable changes over time like the shift of total FDI towards services. But this does not relate to all activities. In the software and IT sector the peak years were Financial service projects had the highest number in 2008 after steady growth for five years. A similar trend can be observed for machinery and equipment manufacturing, business services and especially the real estate sector which became the fifth most important activity in 2008 after having occupied place 15 in The automotive OEM had its peak in 2004 and the components industry in 2008, a clear shift from the one to the other type of car component production. In the case of EU investors the shift to services is weaker, especially to IT while it is more pronounced in business services and real estate. There is also a strong shift to machinery and textiles industries which are less frequented by investors from other parts of the world. Table Investment projects in the BRICs by economic sectors Sector Total no. World % of Total % of FDI capital Total no. EU15 investors % of total % of FDI capital Software & IT services 1, Financial Services 1, Machinery, Equipment Business Services Chemicals Food & Tobacco Textiles Electronic Components Metals Communications Consumer Products Transportation Automotive Components Real Estate Automotive OEM Source: FDI Intelligence from Financial Times Ltd By the amount of invested capital, the capital-intensive sectors lead the list: metals (14% of total), real estate, oil and gas (10%), automotive OEM (7.8%). For the EU these shares are even more pronounced, 20% for the metal sector and 12.5% for chemicals. Services have only low shares as they are not capital-intensive. Financial services have especially low equity, although they may transmit high amounts of investments in the form of credits. 79

90 Another classification is by business activity (Table 1.3.9) which contains broad categories for the functions of the investment project. Manufacturing, separated from the related wholesale and retail activity, still comprises the largest category with one third of the projects and 59% of the invested capital invested in the BRICs from the world and 35% of the projects and 68% of the capital invested from the EU. This outlines the strength of EU investors in production while other investors are stronger in sales, and construction. Typical offshore services, like call and support centres are also less common with European investors. At any rate, the fdi database seems to provide a more realistic and more divers picture about the specialization of EU investments in the BRICs. The role of manufacturing is higher and that of financial and business services more constrained. Table Investment projects in the BRICs by major business activities Business Activity Total number Total Numbe r % Investe d Capital % EU number EU number % EU invested capital % Manufacturing Sales, Marketing & Support Business Services Retail Design, Development & Testing Construction Logistics, Distribution & Transportation Research & Development Headquarters Extraction Shared Services Centre Education & Training ICT & Internet Infrastructure Maintenance & Servicing Technical Support Centre Customer Contact Centre Electricity Recycling Overall Total Source: FDI Intelligence from Financial Times Ltd The specialization of the EU investors in the BRICs follows the general comparative advantage of each country (see highlight reports below). Manufacturing activities are most prominent in Brazil and China, less in Russia and India. Trade and distribution are most widespread in Russia and China. The Software and IT sector is concentrated in India. The largest EU companies are the 80

91 main investors first of all from Germany, except in Brazil where a Portuguese real estate developer is the top investor EU FDI highlights in individual BRIC countries 43 Brazil Report Highlights Between January 2003 and December 2008, fdi Markets recorded a total of 539 investment projects from 306 EU15 companies The leading sector was Chemicals, which accounted for 8% of projects. The leading business activity was manufacturing, which accounted for 46% of projects. The top ten companies accounted for 18% of all investment projects with Sonae (Portugal), Fiat (Italy) and Akzo Nobel (Netherlands) among the top 10 companies. The key influencing factors behind the location of investment projects were Domestic Market Growth Potential and Proximity to markets or customers, cited by 42% and 38% of companies respectively. Russia Report Highlights Between January 2003 and January 2009, fdi Markets recorded a total of 1446 investment projects from 696 EU15 companies The leading sector was Food & Tobacco, which accounted for 10% of projects. The leading business activity was manufacturing, which accounted for 33% of projects. The top ten companies accounted for 17% of all investment projects with Metro (Germany), IKEA (Sweden) and Raiffeisen Zentrabank (Austria) among the top 10 companies. The key influencing factors behind the location of investment projects were Domestic Market Growth Potential and Proximity to markets or customers, cited by 76% and 20% of companies respectively. India Report Highlights Between January 2003 and January 2009, fdi Markets recorded a total of 1497 investment projects from 709 EU15 companies The leading sector was Software & IT services, which accounted for 11% of projects. The leading business activity was manufacturing, which accounted for 33% of projects. The top ten companies accounted for 11% of all investment projects with Deutsche Post (Germany), cargo-partner (Austria) and Volkswagen (Germany) among the top 10 companies. The key influencing factors behind the location of investment projects were Domestic Market Growth Potential and Proximity to markets or customers, cited by 61% and 20% of companies respectively. 43 Results based on FDI Intelligence from Financial Times Ltd. 81

92 China Report Highlights Between January 2003 and January 2009, fdi Markets recorded a total of 2398 investment projects from 1108 EU15 companies The leading sector was Financial Services, which accounted for 9% of projects. The leading business activity was manufacturing, which accounted for 40% of projects. The top ten companies accounted for 13% of all investment projects with HSBC (UK), Siemens (Germany) and Carrefour (France) among the top 10 companies. The key influencing factors behind the location of investment projects were Domestic Market Growth Potential and Proximity to markets or customers, cited by 65% and 24% of companies respectively BRICs expand to Europe All BRICs are on an international expansion course for some years now (Table ). By the number of projects India is ahead of China: Not only in the period as a whole, but also in 2008 Indian companies established more project in the EU15 than Chinese. For instance, the Tata Group has IT and telecom services centres in several larger European cities. As to the invested capital, Russia is the largest investor ahead of China and Hong Kong; all in all very few projects report the amount of investment. Table FDI in the EU15 from the BRICs, number of projects and invested capital Source Country Total India China Russia Hong Kong Brazil Total The main target countries of BRICs investments are the UK (248 projects), Germany (118) and France (75); in 2008 also Spain. The UK is on the top due to its business and language links and serves as distribution centre to the rest of the EU Impact of the crisis on the EU BRICs FDI relations World trade and FDI have developed hand in hand in recent decades, with FDI outpacing trade in boom periods, and declining more than trade in slowdown or recession periods. Much of the international trade is a result of FDI, generated by the intra-firm trade of multinational companies. The question is what happens to the FDI in the current global economic contraction? 82

93 According to the World Bank (2009), global industrial production contracted by 20% in the last quarter of In 2009 advanced economies are estimated to contract by at least 2% and their imports by 3%. This will trigger the contraction of close to 1% of the exports from emerging and developing economies. In addition, trade finance has shrunk by some 40% and its costs increased substantially. Countries dependent on exports to the US are especially hard hit. In December 2008 Brazil reported 29% plunge of exports and a trade deficit first time in this decade. According to a more recent forecast issued by the OECD (2009), the global economic decline will be as much as 2.7% while the OECD members will contract by 4.3% in In the Euro-area, GDP is going to drop by 4.1% in 2009 and 0.3% in World trade is going to contract by as much as 13% in The crisis will not only be deeper but it will also last longer than assumed earlier. Among the BRICs the Russian economy is expected to contract by 5.6%, but Brazil only by 0.3%, while India will grow by 4.3% and China by 6.3% according to OECD. Although the two largest emerging economies will grow much less than earlier, their results will be the bright spot. What can be expected for FDI under there circumstances? Economic decline will most likely trigger a drop in FDI due to falling global demand, excess capacities, difficulties of investment financing, drop of subsidiary profits, etc. Overcapacities will hinder FDI and cause its volume to shrink perhaps even more than the volume of global trade. Export oriented industries, many of them foreign subsidiaries are already cutting output and putting their capacities idle. Tight credit conditions will also diminish FDI. This will happen in two ways, credit-type FDI will shrink and the financing of equity FDI will become more rare and costly. Ongoing projects can be cancelled or delayed due to the lack of affordable financing. In additions, FDI in the oil, gas and metals industries decline due to low commodity prices. An important part of FDI is reinvested profits, and when profit shrinks, less can be reinvested. In addition, profits may be withdrawn by parent companies from more affluent locations to finance losses elsewhere. On a sectoral dimension, the drop in FDI flows is expected to be most significant in financial services, automotives industries and building materials (UNCTAD, 2009). The BRICs may have a privileged position in many respects. First of all they are large economies where FDI is mainly attracted by the local markets with growth expectations above world average, with the possible exception of Russia. Local economic growth will allow for FDI to grow if companies from crisis-hit countries are in the position to invest there. Larger multinationals may just concentrate on the very few countries in the world where they can expand sales such as China, India, Brazil and shift investments there. Also for European companies the expansion to the BRICs remains a major attraction if economic growth continues there. Due to the size of the BRICs and their distance to Europe, only larger or more specialized investors may benefit from this opportunity. A major driving force of global FDI in recent years has been mergers and acquisitions. European banks, telecom companies, etc. have acquired positions in Brazil and elsewhere. M&A deals usually flourish when capital is abundant and relatively cheap and they are to contract in times of 83

94 falling stock markets and high costs of financing. Due to the current crisis, there will be a lack of capital in European companies for expansion. One can expect the number and even more the value of M&As to contract. If BRICs companies fare better than Europeans and their financial situation stays more robust, they will even invest in relatively cheap EU companies. Thus outward FDI from the BRICs may increase 44. The decline of global FDI may come with some delay following the decline of output and trade. This was shown by OECD quarterly figures for 2008 (OECD 2009a). OECD FDI inflows declined by 25% per quarter in 2008 but outflows only by 5%; they even increased in the last quarter. This shows that developed countries still had the capital to invest and found attractive targets, most probably in the BRICs. The same source refers to the expectation that FDI will be more resilient than other capital flows to developing countries. It also concludes that global M&A may increase especially from developing countries. Current economic growth and FDI forecasts suggest that competitiveness of EU companies will not be endangered by US or Japanese firms as the declines there will be at least as harsh as in Europe. In the BRIC economies developed countries will compete with each other and also with domestic and other BRIC companies Summary and Conclusions On a global level, the EU emerges as the most important foreign direct investor, also if considering extra-eu investments only. This reflects the capability and propensity of EU firms to internationalize their business activities. The size and specialization of both inward and outward FDI of the EU shows the results of internationalization, the strong and weak points in terms of competitiveness. A joint analysis of two methodologically very distinct databases, Eurostat FDI data and the fdi database on investment projects (FDI Intelligence from Financial Times Ltd.) made it possible for the period and , respectively, to reveal several facts and trends concerning the competitive position of EU firms in the BRICs and vice versa. Many findings of the two databases are similar. In other cases the results complement each other. One of the most robust results is that the EU is among the main investors in each of the BRICs and the dominant investor in Brazil and Russia. According to Eurostat the EU provided on average 53% and 57% of the FDI inflows in Brazil and Russia, respectively ( average). This dominant role is confirmed by the number of projects as reported in the fdi database, 42% in Brazil and 54% in Russia. In China and India, the EU has less weight. But after correcting for particularities in FDI data, such as the prominent role of Hong Kong and off-shore centres in Chinese FDI and of Mauritius in Indian FDI, the EU ranks higher also in these countries. The 44 In Brazil the expectation is that, in three to five years, five banking giants will control 85% of the market, one public bank (Banco do Brasil), two Brazilian-owned private banks (Itaú Unibanco and Bradesco), and two foreign banks (Santander and HSBC) (see: There are two potential consequences that may arise as a result of such a significant merger: a stronger wave of consolidation in Brazil, and an international expansion. Itaú Unibanco, now the 17th largest company in the world, declared plans to become the first Brazilian financial institution to become a global player, starting with Latin America. The company anticipates its first move out of the region in five years, after consolidating its position in Latin America, where Itaú already has operations in Argentina. Similar trends can be seen in the case of larger companies from other BRICs. 84

95 analysis of the number of projects confirms this finding, the role of the EU in China is much greater (29% of all reported projects in the country) than those suggested by FDI data. China emerges as the main BRICs target for EU projects, but in terms of FDI inflows China occupies rank three after Russia and Brazil. Divergent results can be explained by a small number of very large projects in the natural resource sector of Russia and the great number of finance and trade related small investments in China. The magnitude of EU FDI flows to the BRICs relative to the United States and Japan suggests that EU firms are well positioned to compete with other MNCs in the BRICs: among the Triad countries, the EU is the leading FDI investor in each single BRIC country, in the case of Brazil and Russia by a wide margin. The EU is even better positioned in the BRICs when it comes to internationalization via FDI than via trade in goods and services. Moreover, the magnitude of sales by foreign affiliates in comparison to exports suggests that, in some cases, FDI has become the major entry strategy of EU firms into the BRICs markets. FDI is important for entering into the markets of the BRICs for US and Japanese firms as well. EU FDI flows to the BRICs have increased steadily over the period However this growth was more or less in line with the overall expansion of EU FDI. The share of the BRICs in the EU s outward FDI stocks increased by only 2.5 percentage points over the period to reach approximately 10% in 2007, more slowly than what the growth performance of the BRICs would suggest. The exception is Russia, where EU outward stocks increased rapidly, while the share of China plus Hong Kong even declined. It is difficult to find reasons why the EU is not more prominently present in China. Returns on EU FDI in the BRICs is higher than in the new EU member states thus low profitability or better investment opportunities elsewhere (such as in the new EU member states) cannot explain the slow pick-up of the BRICs weight in EU outward stocks. But the fdi database paints a somewhat different picture with a very dynamic increase in the number of projects in all BRIC countries. The share of the EU-15 in the total number of projects to these countries increased from 32% in 2003 to 38% in This points to a growing importance of the EU as an investors in the BRICs. Half of the EU FDI projects went to China and Hong Kong all through the period. Methodological differences explain to a large extend why the two databases give such diverging picture of EU FDI in China, but also the country of origin and the sectoral structure play some role. The larger countries of the EU account for the bulk of FDI flows. These are, in sequence of importance the United Kingdom, Germany, France, Spain, and the Netherlands. Especially the United Kingdom and Spain have strong focus of their FDI activities on the BRICs. In the case of the United Kingdom, Hong Kong is the primary target whereas for Spain it is Brazil. As to the number of new projects, Germany and United Kingdom lead the list. Italy emerges to be very involved in new projects, whereas Spain much less. Such differences can be connected to the size and industry structure of investors in the two countries. For similar reasons, Portugal emerges by the number of projects as the top investor in Brazil (numerous real estate projects), while it is absent from the top five list in terms of invested capital. 85

96 The split-up of EU investment in the BRICs by economic activities reveals that approximately one third of the EU FDI is in manufacturing and about 60% in the services industry. This distribution across broad economic sectors is similar in both databases but major differences emerge at a more detailed level. Especially, the role of financial services, which is the dominant industry for EU FDI in each of the BRICs, is suggested to be much smaller according the number of projects in the fdi database than in terms of FDI flows. A good part of this difference can be explained by the fact that Eurostat data contain other capital flows, including intercompany loans which are typically very important between affiliated banks and not covered by the fdi database. The latter, in turn, mark trade and distribution activities very important especially in Russia and China. In terms of EU FDI stocks in China and India, services and manufacturing are of equal importance. In both countries existing barriers to FDI are most prominent in service and infrastructure industries that may contribute to the relatively large share of manufacturing. As to the number of projects, manufacturing is strongest in China and Brazil. The analysis of fdi data also reveals that EU firms have more projects in manufacturing industries than other investors. They are strong in machinery and chemical industries but relatively weak in IT. EU investments in the IT and software sector is concentrated in India but also there their investments fall behind those of the USA. Concerning the motives for FDI, the fdi database reveals that EU investors target mainly the local and regional markets of the BRICs, thus they can be considered as market seeking. Exporting the products of the investments back to the EU is negligible, although manufacturing investors usually follow a mixed strategy. This structure of motivations suggests that when in the wake of economic growth wages increase, this will not deter investors due to rising costs, but rather attract them due to growing demand. Balance of payments data are unable to identify the motives for FDI but the industry distribution of FDI as it emerges from Eurostat, in particular the strong focus on services, makes the market-seeking motive plausible. It is also important to stress that global and EU-15 investments in the BRICs, as measured by the number of investment projects, were resilient to the global crisis until With regards to the current economic downturn and the expected drop in global FDI, the BRICs may find themselves in a privileged position in several respects. First of all they are large economies where FDI is mainly attracted by the local markets with growth expectations above world average, although not in Russia. Local economic growth especially in China and India will allow for FDI to grow if companies from crisis-hit countries will be in the position to invest. Larger multinationals may increasingly concentrate on the very few countries in the world where they can expand sales such as China, India, Brazil and shift investments there. Also for European companies the expansion to the BRICs remains a major attraction. Due to the size of the BRICs and their distance to Europe, only larger or more specialized investors may benefit from this opportunity. 86

97 Turning to the FDI activities of the BRICs in the EU, the most important conclusion is that the investment activities of the BRICs remain at a low level. All BRICs are on an international expansion course recently. By the number of outward FDI projects India is ahead of China. The EU is not the primary destination of the expansion as confirmed by both databases. The share of the BRICs (including Hong Kong) in total EU inward FDI flows is small, amounting to only 5.5% on average during the period with no clear trend over time. This is lower than their share in global FDI which stood at 7.1% in One major explanation for this pattern is that a large part of the BRICs FDI is resource-seeking, particularly of China and India which targets Asia and Africa. Brazil is still rather a regional than a global player. For Russia the neighbouring EU is a major outward FDI target region, and by the amount of invested capital it is the most important BRIC investor there. The main EU target countries of BRICs investments are the United Kingdom, Germany and France; in 2008 also Spain by the number of projects. The United Kingdom is on the top due to its business and language links and serves as distribution centre to the rest of the EU. The services sector is very dominant leaving only marginal amounts to manufacturing (with the partial exception of India). Business services and financial intermediation emerge as the major industries. The low level of FDI activity of the BRICs in the EU leads to the conclusion that the preferred channel of competition for BRICs firms in the markets of the EU (but also the US and Japanese markets) remains exports. For the EU this means that EU firms experience only very limited competition from the BRICs via the FDI channel. The downside of this is that the BRICs as FDI investors only create limited additional investment and employment opportunities. The main conclusion based on the statistical analysis is that the EU is well positioned as a direct investor both on the global level and in the BRICs. In the fast growing markets of China and India, however, the share of EU firms in total FDI is rather low and not particularly dynamic. As investments in such geographically more distant places are mainly realized by large corporations and SMEs typically limit their foreign operations to nearby countries, policy levers may be necessary to expand EU presence there. This is all the more desirable as China and India have high market potential and EU firms can expect high returns on FDI. Policy obstacles to EU FDI in the BRICs exist in the form of various restrictions. FDI is limited in several industries important to the EU investors, such as finance or telecommunication. EU trade policy should seek to eliminate such obstacles, including caps to foreign ownership. Restriction of foreign ownership can also not be in the interest of the BRICs in instances where it blocks the transfer of technology. The EU is a much more open economy to FDI than the BRICs but obstacles to investment nevertheless exist. Critical in this respect is the informal discrimination against investors from the BRICs. Especially asset-seeking FDI is considered strategic and undesirable because it would give investors access to EU technologies and cause dependence. As China s outward FDI is dominated by state-controlled enterprises in natural resources or telecommunication most of 87

98 which enjoy a monopoly or monopoly-like situation in the Chinese economy their expansion abroad may distort fair competition. The guidance for EU policy has been its strong commitment to open markets and fair competition and this may prevail over other concerns when dealing with investment issues of the BRICs. The EU may thus be interested in a process of further mutual and balanced liberalization in the area of FDI to eliminate obstacles on both sides. References Bartlett, D. (2008), Economic Trends in the BRIC Countries, 7 April, Deutsche Bank (2008), Russia s outward investment, Current Issues, Deutsche Bank Research, 30 April. Dunning, J. H. (ed.) (2005), Foreign Direct Investment and Governments: Catalyst for Economic Restructuring, Routledge Studies in International Business and the World Economy, 3, Taylor & Francis Ltd. Frenkel, M., Funke, K., Stadtmann, G. (2004), A Panel Analysis of Bilateral FDI Flows to Emerging Economies, Economic Systems, Vol. 28, 2004, Golub, Stephen S. (2003), Measures of Restrictions on Inward Foreign Direct Investment for OECD Countries, OECD Economic Studies, No. 36 Gouvea, R. (2007) The Transnationalization of Brazil s Software Industry, Transnational Corporations Journal (TNCJ), Unctad, Vol.16, No.1, April, p , April 2007 Holtbrügge, D., Kreppel, H. (2008), Determinants of Outward Foreign Direct Investment from BRIC countries. An explorative Study, University of Erlangen-Nuremberg, Department of International Management, Working Paper No. 1/2008, Nürnberg 2008 Hunya, G. (2008), Austrian FDI by main Countries and Industries, FIW Study N 015. Ibarra, M., Koncz, J. (2008) Direct Investment Positions for Country and Industry Detail, Survey of Current Business, BEA, July Koyama, T., Golub, S. (2006), OECD's FDI Regulatory Restrictiveness Index: Revision and Extension to more Economies, OECD Economics Department Working Papers, No. 525, OECD Publishing. Lenovo mulls Fujitsu Siemens investment, EE Times Europe, London Economics (2008), The Importance of Wholesale Financial Services to the EU Economy 2008, July 2008, London. Morck, R., Yeung, B., and Zhao, M. (2008), Perspectives on China s outward foreign investment, Journal of International Business Studies, 39(3): Nowak, O. (2009), The United States was the main location of EU-controlled affiliates. International activities of EU-controlled foreign affiliates, Eurostat Statistics in focus, n 21/2009 OECD (2009), OECD Economic Outlook, Interim Report, March OECD (2009a), Investment News, Issue 9, March 2009 Poncet, S. (2008), Inward and Outward Investment in China, in Greenaway, D. et. al. (ed.) China and the World Economy: consequences and challenges. Edited by David Greenaway Palgrave. London. 88

99 Sauvant, K. P. (2005), New Sources of FDI: The BRICs. Outward FDI from Brazil, Russia, India and China, Journal of World Investment & Trade, vol 6, no 5, pp UNCTAD (1998), World Investment Report. Trends and determinants, Geneva. UNCTAD (2008a), World Investment Prospects Survey , New York and Geneva. UNCTAD (2008b), World Investment Report. Transnational Corporations and the Infrastructure Challenge, Geneva. UNCTAD (2009), Assessing the impact of the current financial and economic crisis on global FDI flows, January World Bank (2009), Swimming Against the Tide: How Developing Countries are Coping with the Global Crisis. Background Paper for G-20 meeting March

100 1.4 Knowledge flows between the BRICs and the EU Bernhard Dachs and Carolina Lennon, ARC and wiiw Introduction The ongoing integration of the BRIC countries into the world economy has also increased knowledge flows between the BRICs and the EU27. This is, at first, a consequence of more foreign trade and more foreign direct investment, which have also raised demand for various types of knowledge at both sides. Exporters to the BRICs have to know about regulation, consumer preferences, environmental conditions to adapt their products. Moreover, increasing knowledge flows also indicate that scientific and technological capabilities of the BRICs have increased considerably in recent years. Before we examine knowledge flows between the BRICs and the EU, it is important to say a few words about some characteristics of knowledge as well as the way they affect knowledge flows. Knowledge, like information, is partly non-rival and non-excludable (Foray 2004, p. 91 ff). Despite its public good character, the transfer and reproduction of knowledge is a far more expensive process than the reproduction of information for two reasons; first, it involves learning, which is time-consuming and often needs proximity and interaction between people. Second, knowledge is context-specific, local and tacit to some extent. Tacitness results from the fact that cognitive capabilities and abstract concepts are not easy to articulate explicitly and to transfer between people (Cowan et al., 2000; Breschi and Lissoni, 2001). Tacitness both allows and limits the transferability of knowledge. It makes the transfer and reproduction of knowledge easy within a group of people ( epistemic community ) who share a common vocabulary or codebook, but increases the cost of transferring it to outsiders (Cowan et al., 2000). The creation of such an epistemic community is a long process and involves mutual learning, for example, in masterapprentice relations. The tacit, local, and context-related characteristics of knowledge require specific channels for international knowledge flows. We will analyse four of these channels: the mobility of students; migration of highly skilled people; transborder payments for royalties and licence fees; and crossborder patent inventions. Transborder licensing is an alternative way, besides exports and foreign production, to commercialize knowledge at international markets and represents flows of codified knowledge. Migration mirrors the fact that knowledge is embodied in people and travels with them. The common cultural background of migrant communities enables them to transfer knowledge at very low cost over distance. Moreover, staff mobility is an important means to exchange knowledge within multinational enterprises (MNEs). The mobility of students creates knowledge flows from the host country to the country or origin of students; moreover, it is an important pre-requisite to build epistemic communities and allow future knowledge transfer. Finally, cross-border patent inventions indicate overseas innovative activities of MNEs, which are a major source of spillovers, and knowledge flows between MNEs and organizations in the host country. 90

101 The magnitude of the knowledge transfer strongly depends on the capabilities of individuals; in order to make the most of the international knowledge flows, individuals need to be able to understand, internalize and exploit knowledge developed elsewhere (Cohen and Levinthal, 1989, 1990). Gertler (2003, p. 81) notes that the ability of workers and firms to absorb tacit and codified knowledge may depend inter alia on their prior investments in research and development, training, and the general level of education and skill of the workforce. Without this prior investment, individual workers and firms will likely be poorly prepared for engaging in learning by doing and interacting. These previous investments in R&D and education have been commonly referred in the literature as the countries absorptive capabilities. Turning to Table 1.4.1, we can observe that BRIC countries have increased their absorptive capacity considerably in recent years. BRIC countries present a growing large pool of new tertiary students. In 2003, national enrolments in tertiary education in Brazil, Russia, India and China more than doubled the number of tertiary enrolments in the European Union; moreover, over , BRIC s enrolment growth rate surpassed that of the European Union. However, in per capita terms and with the exception of Russia, the BRICs are still far behind the European averages. In this context, the proportion of the BRIC s total population aged with tertiary education was of 11.4% in India, 9.5% in China, and 7.8% in Brazil, while the European average was 24%, which was only surpassed by Russia 54.6%. Similarly, the ratio of researchers to labour force in India, China, and Brazil are still far behind the European average. Table Absorptive capacity of the BRICs Gross expenditure on R&D as a % of GDP Targets for R&D spending Target Target date Rate of tax subsidies for USD 1 of R&D Tertiary education enrolments (thousands) Tertiary education enrolment growth rate ( ) Percentage of population aged with tertiary degree Total researchers per persons employed Brazil ,579 13% 7.8 (2004) (2004) China % of GDP ,186 11% 9.5 (2004) (2006) India ,295 9% 11.4 (2004) 3.07 (2000) Russia % of GDP ,671 9% 54.6 (2003) (2006) EU % of GDP ,594 3% 24 (2006) (2006) Source: OECD (2008a). Even though during the last decade ( ) R&D intensity (the ratio of R&D expenditure to GDP) in each of the BRIC countries has been increasing, the R&D growth rate in China has been particularly impressive. China s R&D expenditure increased at an annual average rate of 19% in real terms, situating it as the third R&D spender worldwide (in purchasing power parity) after the 91

102 United States and Japan. Moreover, as the R&D expenditure of China has been increasing much faster than its economy, then its R&D expenditure intensity has more than doubled over the period, almost catching-up with the EU level. Regarding national measures intended to boost investment in R&D; Brazil, China and India has currently in place tax incentive schemes to facilitate business R&D as well as to enhance attractiveness for R&D-related foreign direct investment (OECD 2008a). Additionally, China and Russia have set targets to increase their R&D intensity to 2% by In this context, given the Chinese R&D growth pace over the last ten years, it is highly likely for this country to achieve its R&D objective by Differently, for the case of Russia, relatively more affected by the current crises, it is uncertain whether it would be able to attain its R&D objective Royalties and licence fees The United States is the main exporter of Royalties and Licence Fees (RLF) 45 in the world followed by the EU 46 and Japan. In 2006 the total exports of the United States represented USD 62 billion, while total EU exports attained USD 49 billion (of which USD 20 billion represented intra-trade exports), and Japan s exports reached USD 20 billion 47. BRICs exports in RLF were worth USD 766 million, representing a relative small share (less than 1%) in RLF world exports. While the EU was a net importer of RLF over the 2003 to 2006 period, the USA and Japan presented trade surpluses. In 2006, EU trade balance of RLF presented a deficit of USD 17 billion, whereas the USA and Japan presented surpluses of USD 35.9 billion and USD 4.6 billion respectively. Over the period, each of the BRIC countries presented trade deficits in its RLF trade balance. In total, BRIC countries imported 15 times as much of RLF as they exported in 2006; moreover, their trade balance worsened by an annual rate of 21%. With respect to the EU, BRIC countries were also net importers in RLF. In 2006 they imported 20 times as much as they exported to the region and their trade deficit with respect to the EU increased by 35% over Although the BRIC countries share in EU exports of RLF is relative small, it has been increasing. Over the 2003 to 2006 period, EU exports of RLF increased on average by 12%, while the EU exports of RLF to BRIC countries increased by 31%. This resulted in a raise of the BRIC countries share to 4.5% in 2006 up from 2.6% in Moreover, as total BRIC imports expanded at a lower rate (21%) than BRIC imports from the EU (31%); therefore, over the period, the EU was relative more successful in attracting the growing BRIC s international demand for RLF Royalties and license fees cover the exchange of payments and receipts between residents and non-residents for the authorized use of intangible, non-produced, non-financial assets and proprietary rights (such as patents, copyrights, trademarks, industrial processes, franchises, etc.) and with the use, through licensing agreements, of produced originals or prototypes (such as manuscripts and films). Source: Balance of payment statistics, OECD (2008). EU25. World receipts of royalties and licence fees amounted to USD 155 billion in 2006 representing about 11% of world exports of other commercial services. 92

103 Table Trade in royalties and licence fees, year 2006 (USD million) EU 25 Japan USA Partner Share in the Triad Exports 2006 Exports share 2006 Exports growth rate ( ) Trade balance 2006 World 37% 49, % 12% -16,922 EU25 19,881 40% 10% BRIC 2, % 31% 2,128 Brazil % 30% 350 China 1, % 33% 1,301 India % 23% 204 Russia % 29% 273 World 15% 20, % 16% 4,608 BRIC 1, % 28% 1,531 Brazil % 51% 161 China 1, % 28% 1,144 India % 32% 215 Russia % 13% 11 World 47% 62, % 9% 35,946 BRIC Brazil % 12% 910 China 1, % 20% 1,390 India % 32% 269 Russia Source: OECD Statistics on International Trade in Services (OECD 2008b), own calculations Among BRIC countries, China is the main recipient of EU exports and it is also the destination presenting the highest growth rate. In 2006, China accounted for 60% of the total EU RLF exports to BRIC countries, up from 57% in 2003, and EU exports to China grew by 33% on average over Finally, it is interesting to note that the USA and Japan have also seen their exports to China increase but they have grown at a slower pace (20% and 28% respectively). EU total imports of RLF attained USD 66 billion in The BRICs contribution to EU imports is small and declining to 0.17% in 2006 from 0.29% in Before 2004, the Russian Federation was the main supplier of RLF to the region, but since then it had been surpassed by China, which saw its contribution to EU imports to BRIC countries increase from 24% in 2003 to 37% in EU imports from BRIC countries decreased on average by 10% annually over the period

104 1.4.3 Enrolments of foreign students in tertiary education In 2003, the USA, the EU 49 and Japan registered together 1.64 millions new enrolments of foreign students 50 in tertiary education. From Table we can observe that a growing number of BRIC students are attending tertiary programs in universities hosted in the Triad. During , the number of students from BRIC countries in the Triad grew by 20%, while the total number of foreign students in those countries grew by 8%. This, in turn, resulted in an increase of BRIC s enrolment share in the Triad from 13% in 1999 to 21% in In 2003, the EU was the main destination for foreign students in tertiary education, accounting for 972 thousand new enrolments 51. However, BRIC students still prefer more often to enrol in American universities. In 2003, the United States hosted 53% of the BRIC students, followed by the European Union (32%) and Japan (15%). Table Enrolment of foreign students in tertiary education (2003), 52 Triad countries detail From all nationalities Number of Students Annual growth rate From BRIC countries Number of Students Annua l growth rate Annua l growt h rate Share of BRIC students in total foreign students hosted by countries Distribut ion of foreign students among main destinati ons Distrib ution of BRIC student s among main destinat ions Host country EU 971,778 8% 108,791 28% 23% 11% 59% 32% United States 586,316 7% 182,003 16% 31% 36% 53% Japan 86,505 11% 52,640 17% 17% 61% 5% 15% TOTAL 1,644,59 9 8% 343,434 20% 21% 100% 100% Source: OECD Foreign Student Enrolment Database, own calculations. The growth rate of BRIC student enrolments in the European Union was higher than that of the United States and Japan. Then, even though the USA remained the preferred destination for BRIC students, the EU has been succeeding in attracting an increasing proportion of BRIC enrolments. In this context, the share of BRIC student preferring European universities with respect to American and Japanese universities has increased from 22% in 1999 to 32% in The EU countries included in the analysis are: Austria, Belgium, the Czech Republic, Germany, Denmark, Spain, Finland, France, the United Kingdom, Italy, the Netherlands, Poland and Sweden. Source: OECD Foreign student enrolment database. Figures include intra-eu student mobility. As there is no information on US foreign students enrolments for the past few years, any comparison involving the Triad countries is restrained to 2003; however, with respect to EU enrolment details, for which more recent data are available, we use the year

105 Regarding the destination of students from the point of view of individual BRIC countries, Russian students tend to choose European institutions to carry their tertiary studies abroad; European Institutions hosted 74% of Russian students in the Triad in Differently, students from India, China, and Brazil tend to choose the United States as their main destination; in 2003, The United States hosted 82% of Indian students abroad, 54% of the Brazilian students, and 44% of the Chinese students. Figure Distribution of BRIC students among main destinations Figure Distribution of BRIC students among main destinations (2003), detail by BRIC countries % 53% EU JAPAN USA Brazil 75% 50% 54% 22% 32% 17% 15% 74% Russia 25% 0% 44% China EU USA JAPAN India 82% Source: OECD Foreign Student Enrolment Database, wiiw, own calculations. Among the BRIC countries, China presented the highest number of enrolments in the Triad followed by India. In 2003, to its own, China accounted for 62% of the BRIC students enrolled abroad and India for 26%. These two countries presented also the highest enrolment growth rate; Chinese enrolments abroad increased by 22% over the period and that of India by 16%. If we contrast this information to the national student enrolments in tertiary education in BRIC countries, we can obtain an indicator for the mobility of highly educated students. China presented the highest mobility ratio; per every 71 tertiary students enrolled in Chinese institutions one Chinese student was enrolled in the Triad. India presented the second highest mobility ratio, where per every 125 students in national institutions one student was enrolled in the Triad. Moreover, as for these two countries the growth of foreign enrolments was higher than that of national enrolments; therefore, the mobility of their highly educated students has increased over the period. 95

106 Table Enrolments in tertiary education (2003), BRIC countries detail Foreign enrolments in the Triad Enrolment growth ( ) National enrolments in BRIC countries National enrolment growth in BRICs ( ) Foreign vs. national enrolment Share Brazil 15,455 5% -6% 3,579,252 13% 232 China 212,443 62% 22% 15,186,219 11% 71 India 90,532 26% 16% 11,295,041 9% 125 Russia 25,004 7% 3% 8,671,052 9% 347 BRIC 343, % 17% 38,731,564 10% 113 Source: OECD Foreign Student Enrolment Database, own calculations BRIC students accounted for a relatively small portion of the total foreign students hosted in the EU (compared not only to the share of BRIC students in Japan and in the United States but also to intra-eu student mobility). However, during , enrolments of BRIC students have increased much faster than foreign student enrolments in EU countries. Then, the share of BRIC students in the EU has increased to 14% in 2006, up from 11% in 2003, and 5 % in Similarly to the trend observed in the Triad, also in the case of Europe, China accounted for the highest number of enrolments among BRIC countries, followed by India. In 2006, China absorbed 63% of BRIC students enrolled in the EU and India for 18%. Additionally, the number of students coming from these two countries has remarkably increased over Enrolments of Chinese students in Europe grew on average by 29% annually and that of Indian did by 24%. Table Enrolment of foreign tertiary students in the EU (2006) Enrolments Share in BRIC Enrolment growth ( ) Enrolment growth ( ) Enrolment growth ( ) Brazil 9,334 5% 9% 7% 11% China 109,855 63% 29% 39% 16% India 31,406 18% 24% 25% 23% Russia 25,145 14% 13% 16% 10% BRICs 175, % 23% 28% 16% All countries 1,244,563 8% 8% 8% Source: OECD Foreign Student Enrolment Database, own calculations 96

107 Among the EU countries, the United Kingdom hosted the highest number of BRIC students, absorbing 46% of BRIC new enrolments in Europe in 2006, followed by Germany with 26% and France with 13%. In particular, the United Kingdom received the bulk of Indian students in Europe (76%) as well as Chinese (47%) International mobility of professionals The international payments of royalties and licences fees as well as the mobility of students might help to illustrate the amount of codified international knowledge flows between countries. However, they are only modestly instructive in depicting international flows of tacit knowledge. For this reason, we make use of information on highly qualified migration 53 to describe the part of knowledge that could only be delivered trough face-to-face communication. Moreover, through creation of international networks, mobility of professional might not only allow contemporary knowledge transfer, but also facilitate future international knowledge flows. A more general and thorough discussion of implications of highly skilled migration for the EU can be found in a separate chapter of this report. Table Foreign-born by country of residence, year 2000 Country of residenc e All nationalities (Millions of migrants) Share Highly of Ratio qualifi highly of ed qualifi highly foreign ed in qualifi Foreig worker the ed to n- born Share s Triad total Numb er of foreign -born BRIC (Thousand of migrants) Share Highly of qualifi highly ed qualifi foreign ed worker worker Share s s Ratio of highly qualifi ed EU 21 39% % 13% 1,105 27% % 17% USA 31 59% % 19% 2,575 63% % 39% Japan 1 2% 0.2 2% 18% % 66 5% 17% Triad % % 17% 4, % 1, % 31% Source: OECD Migration Database, own calculations. Unfortunately, since information on skilled migration in the Triad is only available for the year 2000, then we are not able to glean any trend from it. At the end of this sub-section, we try to overcome this limitation by the use of EUROSTAT labour surveys database, but we do it at the cost of reducing the number of EU countries considered (Germany among them) along with losing the benchmark information on inwards migration in the Triad. 53 The present information was obtained from OECD.Stat migration database; this database was originally constructed using information on Census and Labour surveys around the year The countries for which we have information are Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany (partial information), Greece, Hungary, Ireland, Italy, Luxembourg, Poland, Portugal, Slovak Republic, Spain, Sweden, United Kingdom, United States and Japan. 97

108 The Triad recorded 54 millions of immigrants in , of which only 4 millions were born in a BRIC country. Additionally, only a minority of migrants were highly educated (holding at least a tertiary diploma) as well as employed in one of the countries of the Triad (17%). It is worth noting that migration from BRIC countries was relatively more educated than the total migration in the Triad; 31% of the migrants from BRIC countries were highly qualified and employed, while they were only 17% for the average migrant. The USA not only hosted the highest number of migrants (59%), but also its migration was relative more educated, and the later was especially true for the case of migration coming from BRIC countries. The proportion of highly educated foreign workers to total migration in the USA was 19% and the proportion of highly educated BRIC workers to inward BRIC migration in the USA was 39%; that is, migrants coming from BRIC countries were twice as much educated as the average immigrant in the USA. Additionally, the USA hosted the bulk of the foreign skilled workers in the Triad, hosting 66% of the highly qualified foreign workers and 80% of the highly qualified BRIC workers. The position of EU countries stayed far behind, especially with respect to BRIC migrants. The EU hosted 32% of the highly qualified foreign workers in the Triad and only 15% of the highly qualified foreign workers from BRIC countries. From the point of view of individual BRIC countries, the USA was, except for Russia, the preferred location of highly educated workers, attracting 83% of the highly qualified Chinese workers, 82% of the Indians, and 50% of the Brazilian. Differently, Russian workers tended to locate in Europe (especially in Germany). 54 Information on Germany was excluded for the total figures since only information on labour surveys was available and it does not provide any information on immigrants from Brazil and India. However, for the individual country analysis, in the case of China and Russia, it was included. 98

109 Figure Distribution of BRIC highly educated workers among main destinations, year 2000 Europe USA Japan Brazil 75% 50% 50% 25% 56% 83% Russia 0% China India 82% Source: OECD Migration Database, own calculations Compared to the Triad figures, BRIC s share in EU highly qualified foreign workers was relatively small; while the share of BRIC highly educated migrants in the Triad was 14%, it was only 7% in the EU. Indeed, most of the highly qualified foreign workers in the EU came from other European countries (42%). Among the BRIC countries, India was the major country of origin of the highly qualified workers both in the Triad and in the EU. China was the second country of origin in the Triad and Russia was the second in the EU. Figure Highly educated foreign workers in the EU by country of birth, year 2000 Source: OECD Migration Database, own calculations 99

110 BRIC migration is not evenly distributed in the EU, and it is clearly determined by cultural, language and proximity considerations. Among EU countries, the United Kingdom absorbed most of the highly qualified Indian workers in the EU (88%), followed far away by France (3%). More than a half of the Chinese highly qualified workers were located in the United Kingdom (36%) and in Germany (21%), Brazilians tended to locate in Portugal (29 %), and Russians mainly in Germany (75%). Using information on EUROSTAT labour surveys, we can obtain some trends for the European inward migration of the highly qualified workers form BRICS countries. Unfortunately, we have comparable data only for 10 European countries 55, and information on migration to Germany and the rest of the Triad countries are not provided. Over the period , BRIC skilled migration employed in the EU grew at an annual average rate of 10%. Migration from Brazil presented the highest annual growth rate (21 %), followed by that from China (12%) and Russia (12%). Among European countries, Spain experienced the highest annual growth rate of inward BRIC migration of highly qualified workers (27%), followed by Belgium (17%) and France (15%) Cross-border patents between the EU and the BRICs Finally, we measure transborder knowledge flows between the EU27 and BRIC countries with patent data. Patents are intellectual property rights issued to protect a technological invention. One specific feature made patent data increasingly popular for studies of the internationalization of innovation in recent years (Patel and Pavitt, 1991; Patel and Vega, 1999; le Bas and Sierra, 2002; Criscuolo et al., 2005): Patent documents contain information on the location of the applicant (owner) and on the inventor s place of residence. By comparing these two locations, we derive a measure for the ownership of cross-border patent inventions, which can be used as an indicator for the internationalization of R&D activities between two countries. We speak of a cross-border patent (CBP) when the applicant and at least one inventor reside in different countries. Patents owned by EU residents invented in the BRICs will be counted as active CBPs; patents owned by BRICs applicants invented in the EU are passive CBPs for this report. Cross-border patent innovations originate mostly from the activities of multinational enterprises who locate innovation activities abroad. The motives for these overseas operations are twofold (Kuemmerle, 1999; Narula and Zanfei, 2005); first, enterprises focus on adapting existing products to local needs and supporting local production for the host markets. Overseas innovation activity is therefore a by-product of the internationalization of production and sales. Second, enterprises create new knowledge and technologies abroad because they benefit from spillovers from competitors, clients, universities, or public research centres and other favourable framework conditions for innovation in the host country. 55 The European countries considered in the analysis were: the United Kingdom, Spain, France, Greece, Netherlands, Sweden, Austria, Belgium, Denmark and Luxembourg. 100

111 Patent data has a number of advantages such as availability for a large number of countries, easy access, and the possibility to work with firm-level data. There are, however, also some limitations of patent data which may lead to an over- or underestimation of knowledge flows. We therefore suggest to consider results based on patent indicators as lower bounds rather than as an unbiased proxy for the extent of knowledge exchange. The first limit of patent indicators is the fact that not every invention necessarily leads to a patent. The propensity to patent varies considerably between sectors (Cohen et al. 2000; Blind et al. 2006); firms in some sectors only rarely patent but rely on secrecy, lead time or other protection mechanisms. In other sectors, firms increasingly apply strategic patenting and use patents to block competitors, which boost the number of patent applications for a given invention. Moreover, overseas inventions of MNEs are, to a considerable degree, concerned with adaptations of existing products to the host country market. The results of these activities may only be protected at the host country patent office or not protected at all. Cross-border mergers and acquisitions are another factor that may lead to an underestimation because ownership change is not reflected in patent files. Data for this analysis have been retrieved from the European Patent Office and cover the period Total numbers for 2004 and 2005, however, seem less reliable than for previous years because a number of patent applications from these years are still under examination and not yet published as final grants. A first important result from the analysis is the fact that knowledge creation is still much less internationalized than the production of goods. Patents owned by EU27 organizations are also predominantly invented in the EU27 (Figure 1.4.5). This holds also true at the level of individual EU member states (OECD 2007). Only less than 10% of all EU27 patent applications originate from outside the Union. The most important partner country of the EU27 for these overseas innovation activities is by far the US, followed by Switzerland, Japan, and Canada. About 6% of all EU27 patents are invented in the US, we find similar share for US patent applications invented in Europe. US-EU integration in science and technology has intensified considerably during the last decade and US based innovation activities have become an important source of European competitiveness, contrary to the belief that the US should be regarded as a rival to Europe in science and technology. 101

112 Figure Share of active cross-border patent inventions of the EU27 with selected partner regions on all applications, % 6% Share of all EU patent applications 5% 4% 3% 2% BRICS US-CA NON EU EUROPE NON-BRICS ASIA 1% 0% Source: European Patent Office, own calculations. The role of the BRICs as source for EU27 patent applications, in contrast, is small. EU27 patents with at least one inventor from a BRIC country account for less than one per cent of all EU27 patent applications. This is considerable less than the share of EU27 patents invented in European non-eu countries (mainly Switzerland and Norway) on all EU27 patent applications. The importance of the BRICs as host countries for EU overseas innovation activities, however, is growing considerably, as can be seen from Figure Their share on all EU27 patent applications has nearly doubled since 1999 and already equals the share of other non-bric Asian countries including Japan. We take a closer look at this development in Figure where the important host countries of EU27 overseas patent inventions are compared at the country level. The share of the US (5.6% in 2005) is not shown in Figure to improve readability. The illustration reveals that gains of the BRICs on the share of foreign-invented EU patents can be attributed to China for the most part. EU cross-border patent activities with Brazil, India, and the Russian Federation, in contrast, have changed only little in relative terms since In 2005, China s significance as a host country for overseas innovative activities of EU organizations is similar to that of Japan or Canada. The data do not allow concluding that China has already overtaken these countries because there is considerable time lag between application and final grant of a patent and many patents applied for in 2005 are still under examination. It is, however, fair to say that China will pass these countries in the next years and also the other BRIC countries will increase their shares in the future. The vast majority of foreign-owned innovation activities in the BRICs are still relatively young compared to similar activities in the US or other European countries. Building up innovative 102

113 capacities takes time since corporate innovation processes are inherently uncertain, complex, and cumulative (Pavitt, 2005) and need time to establish links to the local innovation systems. Figure Share of active cross-border patent inventions of the EU 27 with selected partner countries on all applications, ,4% 1,2% Share on all all EU patent applications 1,0% 0,8% 0,6% 0,4% 0,2% BRA: Brazil CHN: China IND: India RUS: Russian Federation AUS: Australia CAN: Canada ISR: Israel JPN: Japan KOR: Korea MYS: Malaysia NOR: Norway SGP: Singapore CHE: Switzerland 0,0% Source: European Patent Office, own calculations We now turn to passive cross-border patent applications and the question how attractive the EU is as a host location for foreign-based innovative activities of the BRICs vis-à-vis other countries, in particular the US. An important issue in such cross-country comparisons of patent data is the choice of the patent office (Hinze and Schmoch, 2004). Enterprises, universities, as well as private inventors tend to apply for a patent in their home country first. Therefore, a comparison of country shares based on data from the US Patent and Trademark Office (USPTO) will look very differently from a similar exercise with data from the EPO. To overcome this home office bias we will use patents filed through the Patent Cooperation Treaty (PCT) of the World Intellectual Property Organization (WIPO) in addition to USPTO and EPO data (Differences are explained in detail in OECD 2009). The PCT is not a patent office, but an alternative way to apply for a patent. After filing by the PCT (international phase), applications enter a national phase of examination at a national patent office or the EPO. The PCT allows a patent applicant to obtain patent protection in some or all of the 138 PCT member states by a single procedure with a single patent office. PCT applications are therefore much less distorted by the home office bias than applications originally filed a national patent office. Figure depicts overseas patent inventions of the BRIC countries for PCT, USPTO and EPO data. We have calculated the ratio between patent inventions located in the EU and US owned by various BRIC countries to reveal the relative attractiveness of the EU27 vis-à-vis the US (value greater than one indicates that the EU is a more important host country than the US). Hong Kong 103

114 has been included in the analysis as a location of various holding companies with noticeable patent portfolios related to Chinese enterprises. Figure Passive cross-border patents of the BRICs; PCT filings, applications at the USPTO and EPO, period averages 2,5 2,0 Ratio EU/US inventions 1,5 1,0 Brazil China Hong Kong India Russian Fed. 0,5 0,0 PCT (1997/06) USPTO (1997/04) EPO (1997/04) Source: European Patent Office, US Patent and Trademark Office, OECD, own calculations The data reveal a consistent ranking of the four BRIC countries; Brazil and the Russian Federation are more oriented towards the EU, while India and China tend to apply more inventions made in the US. We conclude that the US is a more attractive location for Indian and Chinese overseas innovation activities than the EU. The number of overseas patent inventions owned by BRIC countries, however, is still very small. China files only about 200 patents based on overseas inventions each year at the EPO, compared to a total number of 150,000 patents applied for at the EPO each year. Our conclusion is therefore based on very few patents. Organizations from Brazil and the Russian Federation apply two EU-invented patents for every US-invented patent. This ratio is even higher if we look at the EPO, but considerably lower if we go to the USPTO. This reflects the fact that patents invented in the US or the EU are also commercialized and protected there Summary By and large, knowledge transfer ties between the EU and BRIC countries are becoming increasingly important (though they started from very low levels). BRIC countries have also been preparing themselves by investing in R&D and education to benefit from the global pool of knowledge. Particularly impressive has been the case of China. China has become one of the major investors in R&D in the world in absolute terms. Moreover, the country has also remarkably intensified its knowledge ties with the world as well as with the EU. Even though knowledge ties between each of the BRIC countries and the EU have become stronger, the 104

115 impressive pace of China and, at lesser extent, of India, has resulted in an increase in their relative importance with respect to the EU, outpacing, in turn, the traditional privileged position of Russia. Regarding trade in royalties and licence fees (RLF), the USA was the main provider of the world as well as a net exporter of RLF. Differently, the EU, the second biggest provider of RLF, was a net importer. However, with respect to BRIC countries, the EU presented growing surpluses, implying that most of the knowledge flows, through the RLF channel, mainly originated in the EU to be supplied to the BRICs. Additionally, EU imports of RLF from BRIC countries have been declining (from a very low level), while EU exports to the BRICs have been increasing. Even though the BRICs represented a relative small share in EU exports (4.5%), the EU has been succeeding in attracting a higher portion of the growing demand for RLF of the BRICs. The latter was largely due to the EU s success in attracting China s demand, which, among the BRIC countries, has been the major purchaser of EU RLF, as well as the EU export destination presenting the highest growth rate. Turning to the international mobility of tertiary students, the EU was the main destination for foreign tertiary students, though BRIC students still prefer more often to enrol in American universities. In particular, the USA hosted the bulk of the Indian, Chinese and Brazilian students in the Triad. However, this pattern might change in the future since the EU has succeeded in attracting an increasing proportion of BRIC s enrolments. BRIC students demand for tertiary education in the Triad has increased at the impressive annual average rate of 20%. Among BRIC countries, China registered the highest number of enrolments, the highest growth rate, and the highest mobility ratio in the Triad. Among European countries, the UK hosted the largest number of BRIC students, especially from India and China. With respect to the international mobility of professionals, the USA is undoubtedly the preferred country of residence of highly qualified foreign workers in the Triad; this fact especially applies to the BRIC migration. The USA was, except for Russia, the preferred location of highly educated BRIC workers, attracting 83% of the highly qualified Chinese workers, 82% of the Indians, and 50% of the Brazilian in the Triad. Among the BRIC countries, India was the major country of origin of the highly qualified workers both in the Triad and in the EU (mainly in the UK for the latter). The lack of regular and comparable data on the international mobility of professionals impedes us to glean sound conclusions on the trend of this type of migration, however, using EUROSTAT labour surveys we observed that BRIC skilled migration employed in the EU grew at an annual average rate of 10%. Mainly due to the increase in skilled migration employed in Spain and originated from Brazil. Given the importance of professional mobility in explaining tacit knowledge transfer, it would be advisable for statisticians and policymakers to address the need of developing an international comparable data on this area. 105

116 Finally, we analyse the overseas innovation activities of MNEs. We measure these flows by patents where the country of the owner (applicant) differs from the country of the inventor. The data reveal that the majority of patents owned by EU27 organizations are also invented in the EU27; knowledge creation is still much less internationalized than the production of goods. EU patents invented outside the European Union mostly originate from the US, Switzerland, Canada, and Japan. The share of the BRICs on all patent inventions of the EU27 is one per cent, but rises fast. This increase is mainly due to activities in China. The share of the other BRIC countries on EU patent inventions, in contrast, remained constant over the last years. Patents owned by BRIC countries invented in the EU27 are still rare and conclusions are based on small numbers; will all due care, we conclude that Brazil and the Russian Federation are more oriented towards the EU, while India and China tend to apply more inventions made in the US. References Blind, K., J. Edler, R. Frietsch, and U. Schmoch (2006). Motives to patent: Empirical evidence from Germany. Research Policy, 35(5): Breschi, S., and F. Lissoni (2001). Knowledge Spillovers and Local Innovation Systems: A Critical Survey. Industrial and Corporate Change, 10(4): Cohen, W. M., and D. Levinthal (1989). Innovation and Learning: the Two Faces of R&D. Economic Journal, 99(September): Cohen, W. M., and D. Levinthal (1990). Absorptive Capacity: A New Perspective on Learning and Innovation. Administrative Science Quarterly, 35: Cohen, W. M., R. R. Nelson, and J. Walsh (2000). Protecting Their Intellectual Assets: Appropriability Conditions and Why U.S. Manufacturing Firms Patent (or Not). NBER Working Paper, Cowan, R., P. A. David, and D. Foray (2000). The Explicit Economics of Knowledge Codification and Tacitness. Industrial and Corporate Change, 9(2): Criscuolo, C., R. Narula, and B. Verspagen (2005). Role of home and host country innovation systems in R&D internationalisation: a patent citation analysis. Economics of Innovation and New Technology, 14(5): Foray, D. (2004). The Economics of Knowledge. Cambridge [Mass], London: MIT Press. Gertler, M. S. (2003). Tacit knowledge and the economic geography of context, or The undefinable tacitness of being (there). Journal of Economic Geography, 3(1): Hinze, S., and U. Schmoch (2004). Opening the Black Box. In H. F. Moed, W. Glänzel, & U. Schmoch (eds.), Handbook of Quantitative Science and Technology Research: Dordrecht: Kluwer Academic Publishers. Keller, W. (2004). International Technology Diffusion. Journal of Economic Literature, 42(3): Kuemmerle, W. (1999). Foreign Direct Investment in Industrial Research in the Pharmaceutical and Electronics Industries - Results from a Survey of Multinational Firms. Research Policy, 28(2-3):

117 le Bas, C., and C. Sierra (2002). 'Location versus Home Country Advantages' in R&D Activities: Some Further Results on Multinationals' Locational Strategies. Research Policy, 31(4): Narula, R., and A. Zanfei (2005). Globalisation of Innovation: The Role of Multinational Enterprises. In J. Fagerberg, D. C. Movery, & R. R. Nelson (eds.), The Oxford Handbook of Innovation: Oxford: Oxford University Press. OECD (2007). OECD Science, Technology and Industry Scoreboard. Innovation and Performance in the Global Economy. Paris: Organisation for Economic Co-operation and Development. OECD (2008a). OECD Science, Technology and Industry Outlook Paris: Organisation for Economic Co-operation and Development. OECD (2008b). Statistics on International Trade in Services 2008, Volume II, Detailed Tables by Partner Country. Paris: Organisation for Economic Co-operation and Development. OECD (2009). OECD Patent Statistics Manual. Paris: Organisation for Economic Co-operation and Development. Patel, P., and K. Pavitt (1991). Large Firms in the Production of the World's Technology: An Important Case of "Non-Globalisation". Journal of International Business Studies, 22(1): Patel, P., and M. Vega (1999). Patterns of Internationalisation of Corporate Technology: Location vs. Home Country Advantages. Research Policy, 28(2-3): Pavitt, K. (2005). Innovation Processes. In J. Fagerberg, D. C. Movery, & R. R. Nelson (eds.), The Oxford Handbook of Innovation: Oxford: Oxford University Press. Keller, W. (2004). International Technology Diffusion. Journal of Economic Literature, 42(3): OECD (2008). Statistics on International Trade in Services 2008, Volume II, Detailed Tables by Partner Country. Paris: Organisation for Economic Co-operation and Development. 107

118 2 Different models of BRICs economic development, implications for EU policies 2.1 Introduction The BRICs show many similarities in their interactions with the EU, but significant differences as well. The major reason behind the latter is that they are following different models of economic development. In brief, Brazil is a domestically oriented service economy; Russian economic development is heavily dependent on energy and raw material resources; the Indian economy is essentially service-led, supported by exports; and China s economic development is driven by manufacturing exports and investment. Nevertheless, looking at the more recent policies of the BRICs and their development plans for the future, a certain convergence of strategies across all of them can be observed. The different characteristics of the models of economic development in the individual BRICs lead to different challenges and opportunities for EU competitiveness and respective policy implications. In this section, we analyse the economic characteristics and major determinants of economic development for each individual BRIC country, with a focus on parameters relevant to external relations, in particular with the EU. These include, for instance, market size, income levels and distribution, age structure, the role of the government, the institutional framework, exports and imports, the foreign direct investment regime, the exchange rate system, the relative importance of private consumption and investment and of different sectors in the economy, labour markets, the education and research system and the quality of infrastructure. Special emphasis is put on future developments, and the impacts of the current global financial and economic crisis are taken into account as well. A special subsection points out the major future challenges and opportunities for EU competitiveness. After summarizing the results, some implications for EU policies are discussed. Annex 2 provides an extensive list of indicators for the individual BRICs, allowing for cross-country comparisons at a glance. 108

119 2.2 Brazil Marcos P. Ribeiro, CEPII Political, economic and social structure Macro level Brazil is a key emerging world economic power, being the fifth largest country in the world, both in terms of territory (8.5 million km²) and of population (with an estimated 189 million inhabitants in 2006). Its population is predominantly young 56 and mostly concentrated on or near the Atlantic coast of the Southeastern and Northeastern States (see Figure 2.2.1). 57 Since about 1970 there has been intense migration from the Northeast to the Southeast, as well as from rural to urban areas. 58 Figure North Region Population and economic geographical concentration GDP - Regional Distribution in 2005 Northeast Region North 5% Center-West 9% Northeast 13% South 17% Southeast 56% Central-West Region Population - Regional Distribution in 2005 Southeast Region North 8% Center-West 7% Northeast 28% South 15% Southeast 42% South Region Source: IPEA and authors calculations. Political structure Brazil is a Federal Republic made up of 26 States, one Federal District (Brasília), and 5560 municipalities. It is a stable and representative democracy with developed political bodies In % of Brazilians were less than 29 years of age. Brazil s Amazon rainforest is located in the North of the country and makes up 30% of the world s remaining tropical forests, providing shelter to at least one-tenth of the world s plant and animal species, and being a vast source of freshwater (Brazil holds 12% of the world s available freshwater). In 1940, 31% of the Brazilian population lived in towns. Today more than 80% of the population live in urban areas. 109