Regional Integration and Foreign Direct Investment in Developing Countries

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1 Regional Integration and Foreign Direct Investment in Developing Countries Dirk Willem te Velde and Dirk Bezemer Overseas Development Institute Seminar 3 September 24 EC-PREP project on Regional Integration And Poverty funded by DFID

2 Introduction Regional Integration and Poverty: Attraction of FDI through formation of region is one possible route to development when appropriate policies and economic conditions are in place. Examine relationship between Regional Integration and Foreign Direct Investment relevant for negotiators of RTAs, moving beyond most econometric studies that measure regions as a black box

3 Regional Integration and FDI: theory Regional trade rules (tariffs, rules of origin, non-tariff barriers, services provisions) Regional investment rules (national treatment and market access pre/post establishment, dispute settlement procedures) Other regional links (regional public goods, investment funds, joint promotion)

4 Econometric studies on Regional Integration and FDI Study Research question; Region, countries and years; Methodology Explanatory variables Findings Levy, Stein and Daude (22) How do RTAs affect the location of FDI? FDI from 2 OECD countries to 6 OECD/non-OECD countries, : FTA membership, Extended market host, Extended. market source, capital/worker distance, market size, bilateral trade, inflation trade/gdp, privatization capital/worker, investment. environment, common border, common language FTA membership doubles FDI stocks on average FDI increases upon joining a FTA with: more trade/gdp (openness) more similar capital/worker better investment environment larger market UNCTAD (1993) How does the EC Single Program (SEM) affect the location of FDI? OECD countries, Level and change in income, domestic.invest, exchange rate(t), exch rate volatility FDI flows increases with less exchange rate volatility This may affect way in which a currency union would affect FDI. Srinivasan and Mody (1997) Which factors determine US and Japanese FDI? 35 OECD and non-oecd countries, , split out in groups of low-middle, high income countries; and EEC, Latin America, East Asia Market size, labour costs capital costs. previous FDI infrastructure (telephone, electricity), country risk openness When split by periods (77-81; 82-86; 87-92), no evidence that SEM increased US & Jap. FDI (But we should bear in mind that SEM was complete only in 1993) Brenton et al (1998) Does European integration increase FDI? Does it divert FDI? Are trade and FDI substitutes or complements? FDI in and outflows, imports, exports for Eu and CEEC countries, Population, distance, trade/fdi agreement dummies, host country economic freedom dummies, CEE dummies, host country Eu membership dummy, FDI residual (in trade regression) Single European Act (1992) and Iberian enlargement : more FDI but no observed FDI diversion Pain and Lansbury (1996) How has intra- and extra EC FDI by UK and German forms in different sectors changed with the introduction of the Internal Market Programme (SEM)? UK and German outward FDI for seven sectors, 198/ Sector output, factor costs, currency volatility, corporate finance conditions, non-tariff barriers (1-3 scale), SEM dummy, sector dummies FDI determinants differ over sectors IMP introduction boosted FDI IMP redirected UKFDI from US to EC

5 Econometric studies on Regional Integration and FDI Positive correlation between intra/ extra FDI and Regional Integration BUT, Regions often seen as black box and static, and often identified by /1 dummies (Dee & Gali, 23, offer recent exception, but include few developing countries) Even recent studies that account for regional market size do not fully account for factors that can be influenced by negotiators: e.g. tariffs

6 Market size and initial MFN tariffs Market size (bn$, 21) Unweighted average applied MFN tariffs (latest year available) Approximate market size gained by regional tariff preferences NAFTA MERCOSUR ANDEAN ASEAN SAARC COMESA SADC CARICOM Source: WTO, WDI The higher the initial MFN tariffs, the larger the regional market size that can be gained through intra-regional tariff reductions

7 Thinking outside the black box Regional investment provisions differ in two fundamental respects: Over time when regions change or add investment related provisions Across regions when investment related provisions differ at one single point in time Differences can be categorised as Extent of regional tariff preferences Restrictiveness of Rules of Origin Investment rules, including national treatment for pre and post establishment and presence of effective dispute settlement mechanisms Regional co-ordination on investment.

8 RTAs: classifying regions 1. Without investment related provisions except trade rules (most RTAs); 2. Towards a more restrictive common policy toward investment (ANDEAN in the early 7s); 3. Developing a common approach gradually over time introducing provisions that stimulate regional investment co-operation and regional investment promotion and national and MFN treatment to foreign firms (e.g. ASEAN); 4. With comprehensive investment provisions from the beginning, including pre-establishment national treatment and effective investor-state dispute mechanisms (e.g. NAFTA).

9 USFDI (% of GDP) in ANDEAN.15 Categena Decision 24 Agreement Decisions 291and 292 Andean free trade area

10 USFDI (% of GDP) in MERCOSUR Treaty Investment of Protocols Asuncion

11 USFDI (% of GDP) in ASEAN Inv protection agreement Signing AFTA Improved protection AIA

12 FDI and ASEAN FTA: Effect? (Inward FDI stock as per cent of GDP) 8 Signing AFTA Improved invcestor rules Signing AIA 6 ASEAN Vietnam (1995) Cambodia (1998) ASEAN- 5 (exc l. S'pore) Myanmar (1997)

13 Formal statistical evidence Need to account for other factors affecting FDI Policy (e.g. bilateral investment treaties) Economic (human capital, infrastructure, market size) Need to derive a regression equation with policy induced regional provisions as one of the measurable explanatory variables: FDI = f (GDP,OTHER, RTA) Similar equation has been used before

14 Measuring provisions in RTAs Investment Trade 197s 198s 199s 197s 198s 199s NAFTA 3 (1994) 2 MERCOSUR 2 (1994) 3 (1991) CARICOM 1 (1982) 2 (1997) 1 (1973) 2 3 ANDEAN -1(197) 1 2 (1991) (1993) ASEAN 1 (1987) 2 (1996), 3 (1998) SADC 1 (1992) 1 (1992) COMESA 1 (1994) 1 (1994) Index = if not member of group Index = if not member of group = 1 if some investment provisions, = 1 some trade provisions, = 2 if advanced inv prov = 2 low MFN, zero intra-reg tariffs = 3 if complete inv prov + dispute settl =3 high MFN, zero intra-reg tariffs = -1 if more restrictive provisions

15 Set up of empirical model Extra regional FDI: UK and US real stock of FDI in developing countries (extra-regional FDI accounts for majority of FDI in developing country regions such as ASEAN, SADC, SAARC) As many developing countries as possible; in practice many gaps; 75 countries for UKFDI and 99 for USFDI (of total 142) Max period: , in practice many gaps, availability differ by host/home country Also gaps in explanatory variables In principle interested in LR model, but present static model only

16 FDI = f (GDP,OTHER, RTA) US and UK FDI in developing countries I II III IV V VI VII VII Region.12 Region7.68* SADC -.37* COMESA.35 CARICOM 1.31** ASEAN 1.42** ANDEAN 1.7** NAFTA 1.48** MERCOSUR Regional Investment Provisions.41**.17**.39*.63** Regional Trade Provisions.43** INVPROV*G DPRATIO.8** INVPROV*G DPpcRATIO.8 INVPROV*D ISTANCE -.1**

17 Implications of regressions Moving away from region measured by a /1 dummy and a black box, to an RTA indicator that includes measurable and negotiable regional provisions Approach successful: Only advanced regions attract more extra regional FDI as a result of forming a region But effect depends on introduction of trade and investment provisions And: the closer to the main market in region (in economic size or in distance) the more FDI

18 Conclusions The attraction of FDI is potentially one way how regions can affect poverty; important, because number and scope of RTAs is growing. Two camps: a) statistical evidence using /1 region dummies; and b) descriptions of provisions in RTAs. We argued that research should focus on what type of regions (and what provisions) are likely to affect FDI and suggested a few tools how this might be done. The results indicate that the type of (provisions in) RTA matters and the location of a country within it: smaller countries far away from the main market tend to benefit less.

19 Thank you