Foreign direct investment is acquisition of foreign assets for the purpose of controlling them.

Foreign direct investment (FDI) is the prevalent mode of corporate governance to gain control over productive assets abroad. Control is achieved through the transfer of property rights to the foreign firm. Through FDI, companies can exploit their internal (so-called ownership-specific) advantages through combining them with location-specific advantages abroad, for example, market opportunities, resources, and local value chains. Another aim of FDI is to improve ownership-specific advantages by anchoring in foreign technological hot spots. The choice for the mode of governance depends on so-called internalization advantages, that is, the advantages of an in-house (acquisition) solution versus that of a market or contractual (network) solution. Over time, institutional improvements, including more advanced global regulatory frameworks for trading and transacting, have not only enabled more FDI but also the proliferation of other forms of cross-border business governance (networking, joint ventures, etc.). In addition to innovation in business organization, a key role is played here by global institutional players such as the Organization for Economic Cooperation and Development (OECD), World Trade Organization (WTO), and United Nations Conference on Trade and Development (UNCTAD), and by the formation of macro-regions such as the European Union (EU). Economic geographical work has traditionally focused on the impact of FDI on host regions, on employment, linkages, and increasingly, on knowledge spillover, and (collaborative) innovation. From a more global perspective, the link between FDI and core-periphery patterns has been critically scrutinized. A core question is the role of FDI in the currently emerging ‘archipelago’ structure of the global economy. Another critical contribution focuses on the pervasive role of neoliberal regulation in promoting the interest of dominant firms and their home countries.

FDI Growth and Distribution

Although with significant fluctuations, FDI has grown enormously during the last 35 years, and especially, since 1985. More specifically, during the period 1970–2003 the average rate of change of FDI inflows was 14.7%, growing significantly faster than exports (11.2%), and even faster than output (9.3%).

Until 1982 world output and trade grew at about the same rate (Figure 3). Since then, trade started growing significantly faster than GDP. In 2003 trade was 29 times its 1970 level, while output had only grown 18 times.

More importantly, since 1993 (almost a decade after trade started growing faster than output), trade growth was in its turn superseded by FDI growth (Figure 3). FDI growth was in fact so spectacular, that after three decades of growth, in 2000 (its peak year) it was more than 100 times higher than its 1970 level, with more than 80% of that growth occurring during the last decade.

TNCs and accordingly FDI (outward, Figure 4) as well as inward) are still concentrated in Developed countries. Low labor costs alone are not sufficient for a country to attract FDI. There are other more important factors, including for example physical and non-material infrastructure, socio-economic stability and human capital. In 2004, the inward FDI stock of Developed countries amounted to $6 766 per capita, while the respective figure for Developing countries was only $438. Furthermore, the stock of outward FDI of Developed countries was $9 005 per capita, while the equivalent figure for Developing countries was only $223.

Another important aspect regarding FDI is its distribution between developing countries. Table 2 provides a number of quite interesting hints about the distribution of FDI within developing countries:

Table 2. The 20 most significant developing FDI recipients

Source: UNCTAD FDI Database (http://stats.unctad.org).

The 20 most important FDI recipients absorb an extremely large share of the total inward FDI (84.1% in 2004).

although the concentration is very significant, it nevertheless is gradually being reduced. However, this does not imply that more countries are becoming significant players (in 1990 the countries receiving more than 1% of the total inward FDI stock were 20, while in 2004 they were 21). It rather appears as a consolidation of the place of established countries.

East and South-east Asian countries along with a small number of Latin American countries appear to have benefited the most. On the contrary, African countries are clearly underrepresented.

Data

International information on foreign direct investment in the geothermal industry in different countries tends to be hard to find. In conventional business activities, affiliate sales abroad are often used to proxy FDI (Markusen, 2002). However, we use geothermal generating capacity in various countries as to proxy for investment in geothermal activities. More specifically, we use data on geothermal installed power capacity (MW), since it is believed to well present the geothermal capacity in these countries. The world's greatest future potential in geothermal is probably in Indonesia, which has considerable operations today. Chile also has a great potential, but there are no operations in Chile yet.

Table 3 presents geothermal-installed power capacity, and number of units by country. Table 3 presents the years 1990, 1995, 2000, and 2005, to give an indication of the increased capacity development. We apply this database since it runs over many countries over time, although knowing that capacity has been increasing substantially since 2005. For example, in the United States the installed capacity was up to 2830.65 MW by the end of year 2006 (ABS Energy Research, 2007).

Table 3. Geothermal-installed power capacity and number of units by country

Source: Reproduced from ABS Energy Research (2007).

We obtained data on installed MW from the ABS Energy Research (2007), for the dependent variable MW. However, for the independent variables we choose to apply World Bank (2009) data, since it is an excellent source for developing countries like Ethiopia and Nicaragua (Ethiopia and Nicaragua are classified as developing countries by the International Monetary Fund, 2009), see Table 4.

Table 4. Summary statistics for the basic sample

Reproduced from author's calculations.

The database runs over 24 countries, and 4 years, providing us with a dataset of 96 observations. The years included in this research are 1990, 1995, 2000, and 2005. We obtain data on these independent variables from the ABS Energy Research (2007).

In this research, we find data on the following countries: United States, Philippines, Italy, Mexico, Indonesia, Japan, New Zealand, Iceland, Costa Rica, El Salvador, Nicaragua, Kenya, Guatemala, China, Russia (Kamchatka), Turkey, Portugal (The Azores), Ethiopia, France (Guadeloupe), Australia, Thailand, Argentina, Austria, and Germany.

Foreign aid

Foreign aid is one of the key mechanisms, along with foreign direct investment, through which the Global North transfers funds, knowledge, and expertise to the Global South. While such transfers may have underlying geopolitical motives, clearly seen in Walt Rostow’s influential text on foreign aid The Stages of Economic Growth being subtitled A Non-Communist Manifesto, they are ostensibly designed to lessen North–South economic and social divisions. Some common concerns, however, include that the Global North is not providing enough foreign aid, that the aid is not going to the right places, and that has become tied to particular undesirable conditions. The criticism that the Global North is not providing enough aid derives from a UN General Assembly agreement from 1970 when Northern nations agreed to commit 0.7% of gross national income (GNI) to overseas development assistance (ODA). With a few notable exceptions – Denmark, Luxembourg, Netherlands, Norway, and Sweden (see Figure 2) – the vast majority of Northern countries have consistently reneged on this agreement with a country average, in 2004, of only 0.42% of GNI being committed to ODA. The direction of foreign aid is criticized for reflecting geopolitical interests rather than economic or social needs; strategically important Israel, for example, regularly receives more foreign aid from the USA than more impoverished Southern nations such as Sierra Leone. ‘Tied aid’ refers to the leverage Northern donors exert when allocating aid, requiring Southern partners to agree to certain conditions, such as undergoing particular institutional reforms or purchasing certain Northern products and/or services with the aid money, before the aid program will go ahead.

Dependency Reasserted

The development model of the NICs retains many aspects of dependency. The NICs usually rely on foreign direct investment in their early stages. They import technology continuously from existing centers of accumulated knowledge, for which licensing fees have to be paid. In addition, they serve markets in the First World where competition is severe from countries like China, where labor costs are even lower. The period of 1980–2006 saw recurrent debt and other kinds of financial crises exactly in countries like Mexico, Brazil, Argentina, South Korea, and Thailand that supposedly provided the ‘exceptions’ to dependency. In such times of crisis, the NICs applied to the IMF for short-term loans to see them through, and to the World Bank for longer-term restructuring loans. The international financial institutions (IFIs) are dominated by the biggest economies in the world, as with the US, Japan, Germany, and the UK. The IFIs placed ‘conditionalities’ on the loans, by which countries undergoing crisis had to restructure their economies in the direction of neoliberal models of development. By this means dependency is deepened to include control over the economic structure and the trajectory of development. Thus, in counterargument, the rumors of the death of dependency have been exaggerated. Dependency is not dead. It has just changed its institutional form, and widened its application.

Conclusions

The investment promotion community broadly defined includes a diversity of practices and actors that have intermediated or facilitated international economic integration via FDI. The boundaries of this community are hard to define and tend to cut across some quite important professional distinctions. To date, the community’s quantitative significance in stimulating FDI flows may be rather minor. However, the qualitative role played by the constituents of this community in transmitting myriad signals regarding FDI may be much more significant. It is this qualitative role which positions the community as part of cadres concerned with articulating national and international economies with processes of international economic integration.

While private and public sector organizations with an international reach are part of the investment promotion community and while there are some reasonably common aspects to investment promotion, the intermediation of FDI flows is geographically uneven. The comparative youth of this industry and its implication with recent rapid rises in the level of international economic integration via FDI flows means that the role of investment promotion remains opaque. Even in those developed countries where the investment promotion community is most developed there is a genuine lack of knowledge regarding the role it plays and the attendant ramifications for policy regarding incentives and rules-based competition for FDI. In addition, it seems clear that such intermediaries will play an important though as yet unstudied role in the integration of the major emerging developing country markets of China and India into the international economy.

Transnational Corporations and Greenfield Development

Up to the 1960s, regional development policy was largely focused on inducing interregional industrial movement within national economies. With the rapid growth in foreign direct investment (FDI) by transnational corporations (TNCs) from that decade on, regional policy became increasingly focused on attracting the branch plants being set up by these corporations in various parts of the world. Such investments are attractive for a number of reasons. Driven by the forces of globalization, the absolute volume of mobile FDI has expanded enormously over the last 30 years. Being inherently footloose, such investment is amenable to being attracted to locations which can provide an appropriate package of attractions. TNCs tend to be to the forefront of technological innovation, so their production plants are in little danger of suffering obsolescence and might, indeed, function as sources of technology transfer to local businesses. Also, some TNC branch plants are very substantial operations which can bring substantial employment benefits to host locations. In addition, new production and communications technologies and new organizational structures have enhanced the ability of TNC branch plants to perform effectively in noncore locations, and have widened the range of possible functions which can be moved to such locations.

An important consequence of the latter point is the growing tendency on the part of TNCs to include service activities in the portfolio of projects potentially available for location in lagging regions. These include data processing, telephone call centers, and back-office administrative functions. In the aftermath of the creation of the Single European Market in 1993, many TNCs have been restructuring their European operations, one of the results of which is the rationalization of back-office functions into fewer ‘pan-European’ centers which, thanks to the proliferation of new information and communications technologies, have in many cases been set up in peripheral regions where cheap labor and investment incentives are available.

3.4.2 Industrial Sector Potential

The market opening during the 1990s has forced many industries in Latin America to modernize their production processes in order to compete with foreign companies in domestic and international markets. Foreign direct investment has taken place in many industrial sectors and substantial technology transfer has been achieved. The modernization of industrial processes often involves higher energy efficiency and fuel switching. An example is the large-scale substitution of pyrometallurgical processes in the Chilean copper industry by modern, more efficient electrochemical processes. Whereas large industries are successfully adapting to more efficient processes, small- and medium-scale industries in Latin America often face many problems adapting to the more competitive environment.

The energy-intensive sectors cement, iron and steel, chemicals, and food and beverages consume approximately 60% of industrial energy in Latin America. Several studies carried out during the 1990s estimate that the energy conservation potential in these activities is 10–30%. The same range of savings potential also applies for the textile, other nonmetallic minerals, and machine building industries, with the majority of measures having favorable payback periods. Electrical motors and drives, process heat, and refrigeration are important areas of industrial energy end use. The energy savings potential in the field of electrical motors and drives is up to 30%, depending on the kind of measures taken. Losses in industrial thermal processes are as high as 70%, and energy conservation potentials in industrial steam systems are as high as 40%. There is also a significant potential for industrial cogeneration in Latin America, which is largely untapped because of unfavorable legal frameworks.

4.3 Is Trade Good for the Environment?

Although there is no hard evidence on the magnitude of the net benefits (or costs) of trade in polluting goods, and there is no strong evidence regarding major effects of environmental regulation on trade and foreign direct investment, there are detailed analyses of the effects that an increase in world trade has on pollution in different countries. Trade has significant effects on pollution, but often more trade implies a cleaner environment.

World trade has increased enormously during the past few decades. Between 1973 and 1998, world merchandise exports and global foreign direct investment increased at annual rates of 9 and 14%, respectively. This expansion of trade is not responsible for increases in world pollution. The share of dirty products in world trade has declined. Comparing open economies (countries with high shares of exports and imports in GDP) to closed economies (countries with little foreign trade), statistical analysis shows that open economies have less pollution per unit of GDP (other things being equal). Open economies tend to adopt clean technologies more rapidly.

Trade often has a beneficial impact on the environment because of the interaction between comparative advantages and adjustment of environmental regulation. High-income countries tend to have higher environmental standards. However, high-income countries can also produce pollution-intensive (which are often skilled-labor or capital-intensive) products at a relatively low cost due to access to advanced technology and large endowments of skilled labor and capital. This implies that high-income countries have a comparative advantage in producing pollution-intensive goods. When they liberalize trade, they tend to export more of these goods. Thus, world trade becomes greener since trade shifts production of polluting goods to countries in which environmental standards are higher. Moreover, international trade increases income, which leads to a policy response since richer countries tend to impose more stringent environmental regulation. Thus, countries with lower incomes tighten their environmental regulation. Multinational firms adopt environmental practices overseas that are (partly) determined by environmental regulations in their home countries under pressure of consumer actions and for fear of loss of reputation.

Although evidence on an aggregate level suggests that international trade is benign to the environment, in certain areas trade has a serious adverse impact on the environment. Certain types of pollution or natural resource use remain unregulated, and it is in these areas that there are concerns. One example is transport. The growth in world trade has been accompanied by increases in transport movements, which are heavily energy intensive. The pollution costs (externalities) associated with transport are not fully reflected in regulation so that welfare losses and excessive pollution may stem from the increase in transport. Since the costs of transport cross borders, appropriate policies require international coordination, which is often difficult to establish. Second, transport involves the problem of invasive species: The accidental or intentional introduction of harmful nonindigenous species of plants and animals can damage environmental resources. The cost of screening and quarantines is often prohibitive. Third, the concentration of agriculture in certain locations without appropriate regulation puts stress on biological diversity with potential loss of soil quality in larger regions in the long term. It destroys the habitat of species and may lead to extinction of species and loss of biodiversity.

The Future of EPZs

EPZs are created under specific circumstances – developing countries have abundant labor resources, while capital becomes mobile in the global economy. The combination of labor and capital in EPZs provides a chance for developing countries to absorb foreign direct investment (FDI) and be linked to the global economy with the minimum impact on the domestic economy, as the goods produced in EPZs are exported. The consequence is that this policy indirectly protects domestic firms that do not have international competitive capacity.

For developing countries that are in the earlier stages of opening up their economies, the EPZ policy is a useful experiment. The demonstration effect can help the reform of the whole economy toward more export-oriented growth. China seems to suggest this route of growth, with EPZs being part of the overall reform package, which will eventually spread over the coastal region and to inner and Western regions. But such a spreading out effect may not easily be achieved. According to United Nations Conference on Trade and Development (UNCTAD), the production of EPZs focuses on low skills and low technology. The sectors are concentrated in garments, toys, footwear, electronic assembly, and light machinery goods. The material processing industries are low-value-added sectors, and the FDI absorbed in these sectors is ‘low quality’ in terms of the potential for technological advancement. Even when productive capacities are developed, with separation from the local economy, low technology transfer, and weak backward linkage, EPZs may not be able to overcome this growth trap and fully develop into engines for future growth.

Because WTO rules are against subsidies for export, direct exemption from taxes in EPZs in countries that exceed US$1000 annual per capita income for 3 years is seen as a subsidy for exports. This requires the phasing out of EPZs’ tax incentives. Some EPZs are taking this chance to evolve into industrial and science parks and beginning to integrate with their local economies.