Fdi And Growth Vol-1, Un-escap, By Tarun Das

PROMOTING INDUSTRIAL INVESTMENT-TECHNOLOGY TRANSFERGROWTH NEXUS TOWARDS GREATER REGIONALISATION AND COMPLEMENTATION OF MANUFACTURING PRODUCTION AND TECHNOLOGY UPGRADING VOLUME - I _________________________________________________________________

DR. TARUN DAS ECONOMIC ADVISER MINISTRY OF FINANCE GOVERNMENT OF INDIA

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* Prepared for the Industry and Technology Division, ESCAP, United Nations, Bangkok as a part of their Project on Regional Dialogue on Promoting Industrial and Technological Development and Complementarities: Challenges and Opportunities for Co-operation in Light of Emerging Regional and Global Developments. August, 1997.

PROMOTING INDUSTRIAL INVESTMENT-TECHNOLOGY TRANSFERGROWTH NEXUS TOWARDS GREATER REGIONALISATION AND COMPLEMENTATION OF MANUFACTURING PRODUCTION AND TECHNOLOGY UPGRADING VOLUME - I _________________________________________________________________

DR. TARUN DAS ECONOMIC ADVISER MINISTRY OF FINANCE GOVERNMENT OF INDIA

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_________________________________________________________________ * The paper expresses personal views of the author and should not be attributed to the views of the Government of India. Author would like to express his gratitude to the ESCAP, United Nations for providing an opportunity to conduct this study as a part of their Project on Regional Dialogue on Promoting Industrial and Technological Development and Complementarities: Challenges and Opportunities for Co-operation in Light of Emerging Regional and Global Developments. August, 1997. CONTENTS VOLUME - I 1

Introduction and Overview

1.1 Objectives and Scope of the Study 1.2 An Overview of the Study 1.3 Profile of Regions and Sample Countries - South Asia and SAARC - East and South East Asia 2 Foreign Investment-Technological TransferGrowth Nexus 2.1 Long term capital flows to developing countries 2.2 Foreign direct investment and global integration 2.3 Foreign direct investment - growth nexus - The top 100 TNCs in the world - The top 50 TNCs from developing countries - Contribution of FDI in ASEAN economic progress 2.4 Foreign Investment - Trade nexus - Intra-firm trade - The impact of FDI on composition of Asian exports 2.5 FDI - Trade - Technology Nexus 2.6 Macro-economic impact of FDI in Asian economies 3 Geographical and Sectoral Distribution of FDI - Global and Country Experiences

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3.1 Regional distribution of FDI - Asia and Pacific 3.2 Sectoral distribution of FDI 3.3 Foreign Portfolio Investment (FPI) - East Asia and the Pacific - South Asia 3.4 FDI in selected countries in Asia (a) China (b) India (c) Japan (d) Republic of Korea (e) Taiwan, China (f) Philippines (g) Myanmer (h) Indo-China (Cambodia, Lao PDR, Vietnam) (i) USA’s direct investment in Asia 4 Different Modes of Foreign Investment and Technology Transfer 4.1 Alternative modes of capital transfer (a) Bond lending (b) Financing through new instruments (c) Foreign direct investment (d) Foreign portfolio investment (e) Foreign quasi-equity investments 4.2 Cross border mergers and acquisitions (M & A) 4.3 Modes of foreign portfolio investment 4.4 Modes and sources of technology transfer 4.5 Technology transfer and adaption: East Asian experience 4.6 Linkages, spillovers and market access by transnational companies (TNCs) 4.7 Acquisition of technologies by SMIs 5 Foreign Investment and Technology Transfer and Advances in New Technologies 5.1 Indicators of technological capability 5.2 Pattern of industrialisation in selected Asian economies 5.3 Industrial technology development in selected Asian economies 5.4 New Technology and its Applications

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(a) Micro-electronics and information technologies (b) Biotechnologies (c) Advanced materials technology (d) Software industry (e) Food processing industry (f) Textile industry 5.5 Issues relating to new technology 5.6 International R & D collaborations in new technologies 6 Foreign Investment and Development in Infrasructure and Services 6.1 6.2 6.3 6.4

Foreign investment and services Infrastructure financing in East Asia Project finance for infrastructure Foreign direct investment and infrastructure

7 Policies and Strategies for Promoting Foreign Investment- Technology Transfer- Growth Nexus 7.2 Macro-economic policies (a) Host country policies for FDI (b) Host country policies for portfolio investment (c) Sectoral policies and regulation (d) Miscallaneous factors - Fiscal incentives and investment environment - Low wages and low production costs - Higher rates of return - Huge domestic market - Labour mobility 7.2 The Export-Push Strategy and Role of Export Processing Zones 7.3 Role of Small and Medium-Sized Industries (SMIs) 7.4 Role of Natural and Human Resources 7.5 Role Research and Development Expenditures 7.6 Role of legal and institutional set up 8 Policies and Strategies for Foreign Investment: Selected Country Experiences from Asia 8.1 8.2 8.3 8.4 8.5

India Bangladesh Myanmar Nepal Pakistan

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8.6 Sri Lanka 8.7 Korea, Republic of 8.8 Singapore 8.9 Indonesia 8.10 Malaysia 8.11 Philippines 8.12 Thailand 8.13 Vietnam 8.14 China 8.15 Hong Kong 8.16 Taiwan, China 8.17 Japan 9 Regional Cooperation in Promoting Foreign InvestmentTechnology Transfer- Growth Nexus 9.1 Regional economic zones in Asia and Pacific 9.2 Informal sub-regional economic zones 9.3 ASEAN Experience - Industrial Co-operation - Improvement of the Investment Climate - Infrastructural and Resource-Based Co-operation - Intra-ASEAN trade - Intra-ASEAN investments - ASEAN regional integration in automobiles 9.4 SAARC Experience - Intra-SAARC trade and investment - SAARC preferential trading arrangement (SAPTA) 9.5 ESCAP experience 9.6 Intra-regional flows of FDI - Indian joint ventures in Asia 9.7 Regional co-operation by manufacturing TNCs - Integrated international production in automobiles 9.8 Regional cooperation in technology transfer 9.9 Multilateral agreement on investment (MAI) Selected Bibliography VOLUME -II 1 Executive Summary and Recommendations A. Major Conclusions 1.1 Basic Characteristics of Asian Economies

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1.2 FDI-Technology-Growth Nexus 1.3 Geographical and Sectoral Distribution of FDI 1.4 Different Modes of FDI and Technology Transfer 1.5 FDI-Technology Nexus and Advances in New Technologies 1.6 Foreign Investment and Development of Infrastructure and Services 1.7 Policies and Strategies for Promoting FDI-Technology-Growth Nexus 1.8 Foreign Investment Policy in Selected Asian Economies 1.9 Regionalisation, Globalisation and Foreign Investment Complementaries B. Recommendations 1.10 General 1.11 Policies for promoting FDI-Technology-Growth Nexus - Host country policies for FDI - Host country policies for portfolio investment - Economic reforms - Home country policies - The export-push strategy and role of export processing zones - The role of small and medium sized industries - Role of R&D expenditure - Human resource development - Legal and institutional set-up - Fiscal incentives 1.12 Different Modes of FDI and Technology Transfer 1.13 Technology development and advances in New Technologies 1.14 FDI and development of Infrastructure and Services 1.15 Regionalisation, Globalisation and Foreign Investment Complementaries - Technical cooperation - Regional cooperation in foreign investment - Regional cooperation in technology development List of Tables 1.1 Basic indicators of selected Asian countries: 1995 1.2 Indicators of infrastructure development in selected Asian countries: 1992 A Electricity generation and consumption B Telecommunications

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C D E F

Road transport Railways and water accessibility Forest aera and irrigation Fresh water resources

1.3 Economic structure of selected Asian countries in 1995 1.4 GDI, GDP Growth and ICOR in Asia: 1980-1996 1.5 Average growth rates of GDP and value added in industry in selected Asian countries: 1965-1996 1.6 Growth rates of valued added in agriculture and services in selected Asian countries: 1965-1996 1.7 Sectoral shares of GDP in selected Asian countries during 1965-1996 1.8 Share and structure of manufacturing in Asian countries 1995 1.9 Gross domestic savings, gross domestic investment, exports and current account balance: 1980-1996 1.10 External trade in selected Asian countries: 1991-1996 2.1 Aggregate net long-term capital flows to developing countries during 1990-1996 2.2 Net private capital flows to developing countries by country groups and countries: 1990-1996 2.3A FDI inflows by host region and countries: 1984-1995 2.3B FDI inward stock by host region and countries: 1980-1995 2.4A FDI outflows by home region and countries: 1984-1995 2.4B FDI outward stock by home region and countries: 1980-1995 2.5A Share of FDI inflows in gross fixed capital formation by region and country in 1984-1994 2.5B Share of FDI outflows in gross fixed capital formation by region and country in 1984-1994 2.6A Share of inward FDI stock in gross domestic product (GDP) by region and country in 1984-1994 2.6B Share of outward FDI stock in gross domestic product (GDP) by region and country in 1984-1994 2.7 Net foreign direct investment as a share of GNP by region and income group in 1990-1996 2.8 FDI in Asian developing countries: 1990-1995 2.9 Sales and gross product of foreign affiliates by region in 1982, 1990 and 1993 3.1A Gross portfolio flows to developing countries by region during 1990-1996 3.1B Composition of portfolio equity flows to developing countries by region: 1990-1996 3.2 Top 10 home countries for FDI flows to selected Asian economies in different period

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A B C D E

Bangladesh, Myanmer, Cambodia, China Hong Kong, India, Indonesia, Japan Laos, Malaysia, Mongolia, Pakistan Philippines, Singapore, South Korea, Sri Lanka Taiwan, Thailand, Vietnam, New Zealand

3.3 The importance of FDI in China: 1991-1995 3.4 Percentage share of international transactions of foreign affiliates and non-equity ventures in China in 1994 3.5A Major sources of utilised FDI in China: 1979-1994 3.5B Main destinations of utilised FDI in China: 1979-1994 3.6 Inflows of foreign investment to India: 1991-1997 3.7 Sectoral distribution of FDI in 1990 and 1997 3.8 Distribution of firms by foreign equity: 1988-1993 3.9 Geographical distribution of FDI in India: share of home countriesin 1981-1990 and 1991-1997 3.10 Proportion of foreign collaborations in India with packaging in 1988-1990 and 1991-1993 3.11 Trends of FDI by industry in Japan: 1986-1995 3.12 FDI by industry in Japan: 1993, 1994 and 1950-1994 3.13 FDI in Japan by key countries: 1993, 1994 and 1950-1994 3.14 Trends in FDI of Japan by sector & region: 1990-1995 3.15A Sectoral distribution of inward FDI flows to South Korea: 1962-1995 and 1994-1995 3.15B Geographical distribution of inward ad outward FDI of South Korea: 1962-1995 and 1994-1995 3.16 FDI inflows into Korea in terms of equity ratios in 1962-1992 and 1993-1995 3.17 Korea’s overseas direct investment by host country and region: 1968-1995 3.18 Sectoral distribution of inward FDI in Taiwan: 1952-1994 3.19 Geographical distribution of inward FDI of Taiwan during 1952-1994. 3.20 Sectoral distribution of outward FDI of Taiwan: 1952-1994 3.21 Geographical distribution of outward FDI of Taiwan during 1952-1994. 3.22 Sectoral distribution of FDI in Philippines: 1980-1992 3.23 Sources of FDI inflows in Philippines: 1980-1992 3.24 Sources of FDI stock in Philippines: 1980-1992 3.25 FDI in Myanmer by sector as of December 31, 1995 3.26 FDI in Myanmer by country of origin at the end of 1995 3.27 US FDI and related indicators in selected developing Asian countries in 1992 3.28 Performance of US FDI in the manufacturing sector

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6.1 Infrastructure financing raised by developing countries by type of borrower and instrument: 1986-1995 6.2 Infrastructure financing raised by developing countries by region and type of instrument: 1986-1995 6.3 Privatisation revenues in 1988-1995 A East Asia and the Pacific B Latin America and the caribbean C Middle East and North America D South Asia 6.4 Privatisation revenues by sector: 1988-1995 6.5A Foreign exchange raised through privatisation in developing countries: 1988-1995 6.5B Portfolio investment and foreign direct investment in privatisation: 1988-1995 6.6 Selected Direct Investment Funds for infrastructure 6.7 Measures for the liberalisation of FDI in infrastructure in Asian economies: 1991-1995 6.8 Outward FDI in infrastructure-related industries in Asia 6.9 Inward FDI in infrastructure-related industries in Asia 6.10 Infrastructure FDI flows relative to total investment in infrastructure in selected countries in 1992 6.11 Infrastructure privatisation in developing countries during 1988-1995 9.1 Intraregional FDI stock among selected economies in South, East and South-East Asia: 1980 and 1993 ACRONYMS ADB Asian Development Bank ADR American Depository Receipts AFTA ASEAN Free Trade Area APEC Asia Pacific Economic Cooperation (presently comprises 18 countries including Australia, Brunei, Darussalam, Canada, Indonesia, Japan, Malaysia, New Zealand, the Philippines, the Republic of Korea, Singapore, Thailand and the United States. ASEAN Association of South-East Asian Nations (comprises Brunei, Indonesia, Lao PDR, Malaysia, Philippines, Singapore, Thailand, Myanmer, Vietnam) BOL Build, Operate and Lease BOLT Build, Operate, Lease and Transfer BOO Build, Operate and Own BOOT Build, Operate, Own and Transfer

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BOT Build, Operate and Transfer CIS Commonwealth of Independent States ECB External Commercial Borrowing EEC European Economic Community EHTP Electronic Hardware Technology Park EOU Export Oriented Unit EPZ Export Processing Zone ESCAP Economic and Social Commission for Asia and the Pacific ESTP Electronics Software Technology Park FCCB Foreign Currency Convertible Bond FDI Foreign Direct Investment FERA Foreign Exchange Regulation Act FIs Foreign Investors FIIs Foreign Institutional Investors FTZ Free Trade Zone GATT General Agreement on Tariffs and Trade GDP Gross Domestic Product GDRM Global Depository Receipt Mechanism GNP Gross National Product GSP Generalised System of Preferences ICOR Incremental Capital-Output Ratio ILO International Labour Office IMF International Monetary Fund IPR Intellectual Property Rights M&As Mergers and acquisitions MFN Most Favoured Nation MIGA Multilateral Investment Guarantee Agency NIEs Newly Industrializing Economies NRI Non Resident Indian OCBs Overseas Corporate Bodies OECD Organisation for Economic Co-operation and Development comprises Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary,Iceland, Ireland, Italy, Japan, Republic of Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States of America. ODM Own - Design - Manufacture OEM Original Equipment Manufacture OPEC Organisation of Petroleum Exporting Countries PIO Persons of Indian origin PPP Purchasing Power Parity R&D Research and Development SAARC South Asian Association for Regional Cooperation comprises Bangladesh, Bhutan, India, Maldives, Nepal,

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Pakistan and Sri Lanka. SMIs Small and Medium-Sized Industries SOEs State Owned Enterprises STP Software Technology Park TNCs Transnational Corporations UN United Nations UNCTAD United Nations Conference on Trade and Development UNDP United Nations Development Programme UNIDO United Nations Industrial Developmemt Organisation WB World Bank WTO World Trade Organisation Notes on Units Million = 1000 thousand Billion = 1000 million Trillion = 1000 billion Tons = 1000 kilograms Dollar $ = US dollars, unless otherwise specified 1 INTRODUCTION AND OVERVIEW 1.1 Objectives and Scope of the Study The present study is a part of a larger Project on Regional Dialogue on Promoting Industrial and Technological Development and Complementarities: Challenges and Opportunities for Co-operation in Light of Emerging Regional and Global Developments. The basic objective of the present study is to critically analyse various modes of overseas direct investments (ODI) and to identify for promotion those forms which lead to depening of industrial and technological capability, forge greater linkages with domestic economy, and contribute to sustained growth in environment characterised by free flow of goods and services. The study focuses the following key areas : (a) Identification and analysis of specific forms of inter-industry and intra-industry overseas direct investments which promote technology transfer, employment genaration, exports and overall growth. This analysis also focuses on specific industrial activities which countries can promote for ODI. (b) Analysis of present trends and future directions in the changing geographical spread and sectoral composition of ODI, particularly in response to policy changes and technological advances in informatics and micro-electronics. Possibilities and potential for ODI in infrastructure projects with backward linkages are also analysed.

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(c) Identification and promotion of pre-conditions to foster the industrial investmenttechnology-growth nexus. This involves indepth analysis of successful policies and programmes which led to ODI in deepening industrial and technological base, forged greater linkages between such investments and the domestic economy, and helped sustain long-term growth. (d) Suggest sub-regional industrial complementation measures to overcome the constraint imposed by limited domestic market and how ODI can be both an effective means and as well as an end in achieving such complementations. Technological advances, allowing segmentation of a complete production process is analysed to see how sub-regional cooperation can be enhanced to exploit production complementarities through ODI participation. As the study is concerned with the impact and future issues, the time frame of the study is confined mainly to 1980s and 1990s. For analytical purpose, Asian economies considered in the study have been grouped into several regions, defined as follows: South Asia comprising Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. The Newly Industrializing Eeconomies (NIEs) comprising Hong Kong, the Republic of Korea, Singapore, and Taiwan, China. Developing Economies in the South-East Asia comprising Cambodia, Indonesia, Lao PDR, Malaysia, Myanmer, the Philippines, Thailand and Vietnam. Two other major Economies in East Asia comprising Japan and People’s Republic of China. 1.2 An Overview of the Study This report is divided into ten chapters including this introduction which describes objectives and scope of the study, and provides economic profiles and the extent of industrialisa-tion of sample countries selected for the study. Chapter 2 provides an overview of the foreign investment - technological transfer growth nexus in Asian economies. It also analyses the role of foreign investment for global and regional integration and the macro-economic impact of foreign investment. Chapter 3 deals with global and country experiences as regards geographical and sectoral distribution of foreign direct investment and portfolio investment. Chapter 4 makes a critical evaluation of various modes and sources of foreign investment and technology transfer in Asian economies. It also alalyses the linkages, spillovers and market access by the transnational companies (TNCs). Chapter 5 deals with pattern of industrialisation and industrial technology development in selected Asian economies. It also discusses the role of new technology, particularly micro

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electronics, information technology, biotechnology and new materials for promoting foreign investment and their applications in selected industries. Chapter 6 focuses on the inter-relation-ship between foreign investment and the development of infra-structure and service sectors. Chapter 7 deals with broad policies, reforms and strategies for promoting foreign investment - technology transfer - growth nexus in the South, East and South-East Asia. It examines particularly the role of macro-economic and sectoral policies, fiscal and other incentives, export-push strategy and the export processing zones, small and medium sized enterprises (SMEs), human resource development (HRD), Research and Development (R&D) expenditure, and legal and institutional set up for promoting industrial and technology development, and their linkages with foreign investment. Chapter 8 describes some country experiences with respect to deregulation, liberalisation and other reforms in the spheres of trade, industry, investment, financial and public sectors to encourage foreign investment. Chapter 9 reviews existing regional cooperation for promoting foreign investment technology transfer - growth nexus under regional groups like ASEAN, SAARC and APEC and their efficiencies and constraints. It also discusses the role of international organisations like ADB and ESCAP to encourage technology transfer to exploit production complementarities through foreign investment participation. Chapter 10 summarises the basic issues and problems for promoting industrial investment-technology transfer-growth nexus in Asian economies and recommends a set of measures which may be taken for greater regionalisation and complementation of manufacturing production and upgradation of technology. The report ends with a list of selected bibliography on the subject. 1.3 Profile of Sample Countries Selected countries for this study covering 55 per cent of the world population and 15 per cent of areas display a number of contrasts (see Tables 1.1 to 1.10 for economic and social profiles of the countries). The sample includes two most populous countries of the world viz. China and India, and also a small economy like Maldives with population less than a million and a city state like Singapore. The sample includes the world’s second richest country Japan with per capita GNP of $39640 in 1995 on the one hand, and some of the poorest countries of the world - Vietnam, Nepal and Bangladesh (Table 1.1). Levels of infrastructure development and social indicators also differ widely among the regions. While East Asia generally have higher degree of adult literacy and life expectation, South Asian countries except Sri Lanka, Maldives and Myanmar lagged behind. In recent years Asian developing economies have shown remarkable economic vigor and dynamism by outperforming by a wide margin other developing regions and industrial countries as a group. As regards industrial growth, performance by the developing

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countries of Asia continued to outpace that in every other developing region and even the industrialised countries by about 5 percentage points. The continued robust growth in Asia is attributable to a number of factors such as widespread and sustained policy reforms in many countries and continued surge of foreign capital flows to these countries. The mechanism that contributed the high growth of the Asian economies in these years can be summarised as export/investment-led growth supported by extremely low production costs. As judged by ratios to GDP, investments and exports made a much higher contribution to growth in Asia than in the other regions. Asian economies achieved high economic growth by introducing capital and technology from advanced countries, while enjoying the benefits of the huge markets that these advanced countries offer. In other words, the Asian economies are typical examples of “catch-up” type economic growth. Rapid growth in intra-Asian trade has been accompanied by rising foreign direct investment. The traditional focus of overseas investment by Asian companies in financial and real estate markets of industrial countries has been augmented by rapid growth in investment in manufacturing, primarily in South-east Asia. The changing pattern of capital flows is, to some extent, a reflection of the changing cost structure in the Asian economies as wages and other costs have risen rapidly in Japan and the NIEs. It is also indicative of the movement towards higher value added and more technologically intensive activities in these economies. The process of rapid growth in output and intraregional trade and investment in Asia is sometimes referrerd to as a “virtuous circle” of economic development. Foreign capital inflows have combined with a favourable policy environment, industrialisation and trade expansion to achieve a sustained acceleration in economic growth. The efficient use of resources, increased trade and rapid growth have, in turn, stimulated an increase in the flow of intraregional foreign investment. This process is gradually helping to internalise Asian growth and to reduce Asia’s vulnerability to external shocks. During the past four or five years, the “virtuous circle” has evolved rapidly primarily due to the structural adjustment process in Japan subsequent to the sharp appreciation of the yen following the Plaza Accord. Japan’s growth has become increasingly “domestic demand led” and it has been sustaining rapid export growth of other Asian countries, to some extent, offsetting the impact of rising protection. More recently, such a process has ocurrerd in the NIEs as well, fueling further intraregional trade and investment. Rapid structural adjustment and shifting comparative advantage from Japan to the NIEs and to the Southeast Asian countries as wages and factor prices rise have contributed significantly to Asia’s dynamism. South Asia, which depends more on the agriculture sector, was by and large left out of this process. But the situation is changing, albeit slowly, as these countries liberalise gradually and cautiously.

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South Asia South Asia is a region full of contrasts. On the one hand, it has vast economic potential. During 1980s it achieved an average growth rate of 5.2 per cent a year compared with 3.9 per cent by all low-income countries. Its growth was exceeded only by that in East Asia and Pacific. Progress in reducing fertility led to annual growth in per capital income by nearly 3 per cent during 1980s which was regarded as a “lost decade” for many other regions of the world. On the other hand, South Asia is characterised by widespread poverty and low levels of living. While accounting for a fifth of the world’s population, South Asia is also home to nearly half the world’s poor. It has lower life expentancy than in any other region except Africa, high infant mortality rates, high rates of malnutrition and low levels of literacy (except Maldives and Sri Lanka). While rates of growth in the 1980s were high, they were not sustainable. Growth in South Asia slowed in 1990’s due to poor industrial growth in 1991-1993 caused by Gulf crisis and breakdown of the former Soviet Union. The countries in the region, however, recovered quickly and showed improvements in the external sector with increased exports during 1992-1996. A recent development underlining the confidence of international investors in South Asia’s growth potential is the surge in capital flows, particularly to India and Pakistan. Two themes have characterised until recently the development approach of most South Asian economies: a strong economic role for the state and relatively inward-looking development policy. The broad lessons of development during the past decades are that countries with more market-friently policies and outward-looking strategies do better both in generating growth and reducing poverty. While there is general agreement in South Asia about the need of reforms, the pace has been uneven due to mainly political economy issues. Recent progress is most visible in reforms in taxation, industrial, external, public and financial sectors. Income and corporate taxes and capital gains taxes were reduced in many coutries to encourage private investment and savings. Progress continued in India, Nepal, Pakistan, and Sri Lanka towards moving to a full-fledged value-added tax, and Pakistan made important progress in broadening the tax base by introducing an agricultural income and wealth tax. SAARC has completed more than a decade of its existence, but the process of economic cooperation in the region has been slow. Nevertheless, SAARC has established itself as an important regional grouping due to its large market space measured by the size of its population and its potential purchasing power. The ongoing economic reforms and globalisation by the SAARC economies have also made the region an attractive destination for foreign direct investment and other capital flows. The SAARC is rich in natural resources which are not fully utilised. Its bio-diversity is an immense wealth, and mineral and water resources are plenty. The region is endowed with a large reservoir of skilled and semi-skilled manpower. Despite all these advantages, the

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region is faced with the common problems of poverty and unemployment. Economic cooperation in the region is an effective instrument for improving the welfare of the people. As compared to the world and other developing countries, the contribution of the industrial sector to GDP in South Asia is rather small. During last decade, the service sector grew at a faster rate than the industrial sector in South Asia. Within the service sector, major contribution has come from the financial and trade sectors, and contribution of the transport sector has improved rapidly in recent years. The share of South Asia in world trade is negligible being less than one per cent. The intra-regional trade of South Asian countries is also insignificant, being 3.5 per cent of total trade, compared to the intra-regional trade of all developing countries at around 40 percent of their total trade. This implies that there is significant potential for increasing intra-regional trade among the SAARC economies. About 35 per cent of South Asia’s exports is destined towards other developing countries, while dependence of South Asia on other developing countries for imports is to the extent of 46 percent. The composition of South Asian trade reveals concentration of exports in labour-intensive products like textiles, clothing, jems and jewellery, while imports consist of mostly crude oil, petroleum and capital goods. Most of the exports in intra-regional trade originates from India, followed by Pakistan, while Bangladesh and Sri Lanka are major impoerters in intra-regional market. The combined share of imports of Bangladesh and Sri Lanka was 70 percent in total intraregional trade, while the share of India’s exports in intra-South Asian trade was 60 per cent in 1993. The challenge facing South Asia in the 1990s is how to continue the high economic growth of the 1980s with rapid reductions in poverty and improvement in social indicators. A sustainable growth path for the 1990s must be based on continued economic reforms, lower fiscal deficits, dynamic capital market, sustainable balance-of-payments, and improvement in environment. East Asia and South-East Asia East Asia has a remarkable record of high and sustained economic growth and grew faster than all other regions of the world during 1965-1996. They all relied heavily on exportpush strategy and were generally open to foreign investment and technology although they adopted different strategies regarding industrial promotion and foreign technology. Some depended on FDI by TNCs, others on licensing and import of capital goods. All the countries were successful in expanding industrial base and exports, but they adopted different industrial structures, export specialisation and technological capabilities. China, the world’s largest developing economy, remained the fastest growing economy in the region and the world with average growth rate of 10.4 per cent during 1980’s and further acceleration during 1991-1996. The Chinese government continued to implement

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fiscal, monetary and basic market reforms and transnational corporations continued to commit record amounts of investment. As the economy was over-heated, it undertook measures since 1993 to slow the pace of growth and to ease inflationary pressures. East Asian countries provide very good examples of high growth rates alongwith effective poverty alleviation. These countries are economically more egalitarian in terms of the distribution of income, wealth, and assets, such as land. In 1960s the successful economies of East and South East Asia were already ahead of other developing countries with respect to human capital formation and other social development indicators. A major study namely “The East Asian Miracle : Economic Growth and Public Policy’’ made by the World Bank (1994) concluded that “exports push” and a combination of fundamentally sound development policy and selective interventions had been crucial to East Asia’s success. Developing countries which want to follow the footsteps of East Asia must limit policy interventions and focus on fundamentals. The study further concluded that “Of the many interventions tried in East Asia, those associated with export push hold the most promise for other developing countries”. The fundamentals focused by the East Asian economies included the following : * Managing monetary and fiscal policy to ensure low inflation and competitive exchange rate. * Concentrating public investment on education in primary and secondary levels of schooling, * Fostering effective and secure financial systems to encourage savings and investment. * Limiting protection so that domestic prices are close to international prices. * Supporting agriculture by assisting the adoption of green revolution, technologies, investment in rural infrastructure and limiting taxation on agricultural goods. In both the NIEs and the fast-growing economies of Southeast Asia, exports had grown fast, and export intensity had a strong positive correlation with income growth. The share of imports in total domestic demand was also highly correlated with the growth rate. Openness of trade and emphasis on competitiveness of the manufacturing sector were important factors contributing growth. Economic policies did not penalise the traded goods sector, and market forces were allowed to determine the real exchange rate. This facilitated an efficient allocation of resources. Initially endowed with abundant labour resources, they expanded their exports of low value-added and labor-intensive manufactured goods. Subsequently, as labor costs increased, they shifted the structure of manufacturing production and exports towards more sophisticated and higher valued-added products. A comparatively “level playing field” allowed both the traded and non-traded goods sectors to grow vigorously, complementing and supplementing each other in investment, production and trade. Economic growth in Asia correlates strongly not only with exports growth but also with high savings and investment rates. A trinity of openness to trade, high investment and

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high savings rates coexist in the fast-growing economies of Asia, and it is important to stress the presence of all these three factors to achieve higher growth. Trade has been pivotal to the economic success of the NIEs and the fast-growing economies of Southeast Asia. The benefits of a more liberal trading environment reached beyond the narrow efficiency gains highlighted by the theory of comparative advantage. Other benefits include more competitive goods and factor markets,increased investment including foreign investment, and the associated transfer of knowledge and technology. The prospect for an improved world trading environment has been enhanced by the conclusion of the Urguary Round of tariff negotiations under the aegis of the General Agreement on Tariffs and Trade (GATT) and the subsequent formation of the World Trade Organisation (WTO). But there are still legitimate concerns in a number of areas. There is a view that the gradual nature of some of the reforms undermines their credibility; the Uruguary Round agreement did not adequately cover investment; and much remains to be done to reduce barriers to trade in both services and agriculture. Some countries also fear that new obstacles to trade in the name of “social conditionalities” and “environmental protection” will take the place of old ones. There is also evidence that some industralised countries have bound themselves to maximum tariffs on agricultural commodities that exceed the existing rates. “Dirty tariffication”, as this practice is called, opens the way to reducing the potential gains from the WTO agreement. While overall the region performed impressively, there remain serious obstacles to sustained development for many countries of the region. Despite recent gains, the countries of the region have an average income of about $600 a year, which is low among developing countries. Serious environmental damange associated with rapid urbanisation, inadequate regulation and planning, and incorrect pricing of resources, continues to impose major costs. Another serious problem is the historical inadequacy of infrastructure investment relative to rapidly growing demand. As the region’s infrastructure needs are large, the private sector themselves and through foreign direct investment (FDI) will have to play an increasingly critical role in developing and modernising East Asia’s infrastructure base. In turn, governments of the region will need to estblish the appropriate regulatory and legal frameworks to attract and secure such investment. The need for expanding competent management across most areas of development is emerging as a major issue in East Asia. Whether in pollution monitoring and control, design and implementation of monetary and fiscal policies, or traffic-management planning and deregulation, effective institutions are essential. 2 FOREIGN INVESTMENT - TECHNOLOGICAL TRANSFER - GROWTH NEXUS

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2.1 Long Term Capital Flows to Developing Countries During 1990s there was a significant change in the composition of external financal flows to the developing countries with an increasing share of private capital from 44 percent in 1990 to 86 per cent in 1996 and a corresponding declining share of official development finance from 56 percent to only 14 percent over the period (Table 2,1). Within private capital, flows of foreign investment comprising foreign direct investment (FDI) and portfolio investment increased five-and-half times surpassing other types of capital flows and constituting 54 percent of total capital flows to developing countries in 1996. In fact, FDI was often the only source of international private capital to most least developed countries which failed to receive the investment-grade ratings required for borrowing from abroad or tapping international capital markets. The private capital flows are likely to be more beneficial since they are generally accompanied by technology transfer and market access in the case of FDI; diversified investor base in the case of bonds; and a reduction in the domestic cost of capital in the case of equity portfolio flows. Asian region received the major share (50 percent) of private finance in 1996 among the developing economies (Table 2.2). An analysis of trends of private capital flows in 1990s by the World Bank (1997) draws the following key conclusions : (a) Countries with sound macro-economic management and well organised money and capital markets received large private capital inflows. (b) Private capital flows to developing countries continued their strong growth and reached $244 billion in 1996, a fivefold rise since 1990. The two largest low-income countries, China and India, experienced substantial inflows, and virtually the rest had gone to middle-income countries. (c) Capital market finance for infrastructure projects is an important component of international flows. (d) Foreign direct investment continued to grow and reached a broader range of countries. Like trade, it is an important channel of global integration and technology transfer. Many developing countries liberalilsed their trade and investment regimes by adopting mostfavoured nation treatment, and level playing field for the foreign investors. (e) All categories of private flows (i.e.bonds, portfolio investment, foreign direct investment, commercial bank lending, and export credits) increased significantly during 1990-1996. Unlike other capital flows, FDI is a “package” which contains not only capital but also management, technology and skill. Experience in developing countries suggests that “unbundling” the FDI package by borrowing capital from the international banks, purchasing technology through licenses and negotiating management agreements, is less

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efficient in terms of productivity than the FDI package which brings capital, technology and management together. Mining operations are a notable large scale example. In Zambia, for example, copper mines became bankrupt as a result of nationalisation which involved replacement of equity by debt capital and use of management contracts instead of direct transnational corporation management (Hughes 1995). 2.2 Foreign Direct Investment and Global Integration Foreign direct investment (FDI) provides one of the most important economic links between developing and industrial countries and among developing countries. FDI like trade, provides an important channel for global integration and technology transfer. It also plays an important role in privatisation and in the provision of infrastructure. There is growing evidence of economic spillovers from FDI, such as transfers of managerial and technological expertise to the host country. FDI not only is linked to growth in trade, it also can promote an export orientation in host countries. Global foreign-direct-investment (FDI) inflows increased by 40 percent in 1995 to reach an unprecedented level of $315 billion (Table-2.3A). FDI inflows to developing countries also reached a record level of $100 billion in 1995, although their share in globl FDI declined from 39 percent in 1994 to 32 percent in 1995 (UN, UNCTAD 1996). As per the World Bank estimate, net FDI flows to developing countries reached more than $110 billion in 1996 (World Bank 1997). In 1991-1995, FDI growth (12.1 percent) was substantially higher than that of exports of goods and non-factor services (3.8 per cent), world output (4.3 per cent) and gross domestic capital formation (4 per cent). The average real GDP growth in the Group of Seven countries (G-7), the principal sources of FDI, increased from 1.4 per cent in 1991-93 to to 2.9 per cent in 1994 and 2.3 per cent in 1995. Inflows of FDI are influenced not only by the growth rates of the home countries but also by a number of factors viz. to exploit natural resource available in the host country, to get access to the host country’s protected market, to gain access to advanced foreign technology or to maintain international competitiveness in the face of exchange rate fluctuations and rising cost of labour and other non-tradeables in the home country. These different types of investments are defined as natural-resource seeking, market-seeking, technology seeking, cost-reducing, risk avoiding and defensive competitive FDI. Host countries can also be classified according to four stages of development viz. factordriven (attracting FDI in processing, textiles and minerals exploitation), investment driven (heavy and chemical industries, power, construction, transport and communications), innovation-driven (electronics, information technology, biotechnology) and wealth-driven (attracting FDI to meet domestic demand and also encouraging outward FDI flows). Natural resource-seeking FDI, which consists of investment in areas such as mining, processing, textiles, oil and gas extraction is the earliest type of foreign investment. Market-seeking FDI changed significantly in recent years. Until 1980s it was largely

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confined to the manufacturing sector motivated by “tariff jumping” to take advantage of the regulated and sheltered market, but due to the recent trends of greater openness of the economy and privatisation of infrastructure in developing countries, sectors such as power, telecommunications and financial services are attracting increasing amounts of foreign investment. Export-oriented FDI is of relatively recent origin, and is guided by the “product life cycle” theory of FDI, which postulates that as real wages increase due to economic growth in a country, labour-intensive industries will relocate to countries at a lower level of economic development. In response to technological and competitive pressures, companies from developed and developing economies, are becoming more active globally and seek to exploit new markets or take advantage of factors of production to build international production networks. Mergers and acquisitions (M&As) are their favourite route to production abroad. This is helped by the acceptance of privatisation with foreign-investor participation, particularly in developing countries. Regional groups (European Union, NAFTA, APEC, ASEAN and SAARC) also facilitate regionally integrated production networks. Geographical distribution of FDI also favours neighbouring and ethinically related countries. As regards sectoral fistribution, FDI tends to concentrate in industries using mature or standardised technology and management skills. The recent boom in flows has expanded the world’s total FDI stock, valued at $2.7 trillion in 1995 (Table-2.3B ), held by some 39,000 parent firms and their 270,000 affiliates abroad. About 90% of parent firms in the world are based in developed countries, while two-fifths of foreign affiliates are located in developing countries. The global sales of foreign affiliates reached $6.0 trillion in 1993 and continued to exceed the value of goods and non-factor services delivered through exports ($4.7 trillion) - of which about 25% are intra-firm exports. Sales by foreign affiliates in developing countries were $1.3 trillion equivalent to 130% of imports from these countries. In 1993, $1 of FDI stock produced $3 in goods and services abroad. 2.3

Foreign Direct Investment - Growth Nexus

Foreign direct investment has brought substantial gains to recipient economies, contributing to physical capital formation, human capital development, transfer of technology and know-how (managerial skills), and expansion of markets and foreign trade. Partly because of these benefits and partly because fast-growing countries attract a lot of foreign investment, there is a positive correlation between FDI and growth (World Bank 1997a). FDI promotes technological changes in developing countries in a number of ways.It has a direct impact through its contribution to higher factor productivity, changes in product and export composition, research and development practices, and employtment and training. It has an indirect impact through collaboration with local R&D institutions,

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technology transfer to local downstream and upstream products, and enhancement of efficiency through competition with local producers (World Bank 1997a). In 1980-1994, the ratio of global inward FDI stock to world GDP and the ratio of FDI inflows to gross domestic investment doubled from 4.6% to 9.4% and from 2% to 3.9%, respectively. The (Tables 2.5A to 2.6B) gross product of foreign affiliates accounted for 6 per cent of world GDP in 1991, compared with 2 percent in 1982. The share was considerably higher for Indonesia and Malaysia at 16 per cent and 11 per cent respectively in 1991. The ratio of global FDI outward stock to world GDP and the ratio of FDI outflows to gross domestic capital formation in developed countries also doubled in 1980-1994, from 4.9% to 9.7% and from 2.1% to 4%, respectively (Tables 2.5A to 2.6B). The share of foreign sales of Japanese TNCs in their total sales in manufacturing increased from 2.9% in 1980 to 8.6% in 1994. The top 100 TNCs in the World As reported in the World Investment Report 1996 (United Nations), the world’s 100 largest transnational companies (TNCs), ranked in terms of total assets, accounting for just 0.3 percent of the TNC universe had $1.4 trillion worth of assets abroad and accounted for a third of global FDI stock and a quarter of the estimated $6 trillion global sales by all TNCs in 1995. They employed some 12 million people or a sixth of 73 million by all TNCs, and their affiliates employed another 5 million- also a sixth of all workers employed by all foreign affiliates. The share of top 100 TNCS and their affiliates remained unchanged at one sixth of global employment throughout 1990s despite significant corporate restructuring. On contrast, labour productivity (sales per employee) increased by 30% in 1990-1995. Among the top 100 TNCs in the world, United States TNCs with 32 entries, constituted the largest group in 1994. These firms are involved in a wide range of industries, including oil and gas, chemicals, pharmaceuticals, metals, electric and electronics equipment, motor vehicles, food and beverages and diversified services. European TNCs in the list of the top 100 are prominent in research-and-development intensive industries, such as chemicals and pharmaceuticals where industry consolidation has triggered a wave of Mergers and Acquisitions (M&As). Japanese TNCs constituted the fastest growing group among the top 100 TNCs, doubling the number from 11 in 1990 to 19 in 1994. Japanese TNCs in electronics were amongst the most important new entrants, expanding through large acquisitions in the United States and new production facilities in East and South-East Asia, having the largest value of foreign sales among the top 100 TNCs from other countries. The top 50 TNCs from Developing Countries

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The 50 biggest TNCs based in developing countries, ranked in terms of foreign assets, accounted for about 10% of the combined outward FDI stock of their countries of origin. These firms’ ratio of foreign to total sales is high (30%), compared with the ratio of foreign to total assets (9%). In 1994, more than half of the top TNCs from developing countries were based in Asia; the rest were based in Latin America. In 1994, Daewoo (Republic of Korea) ranked first among the 50 largest TNCs from developing countries on the basis of ratio of foreign total assets. Contribution of FDI in ASEAN Economic Progress Foreign direct investment (FDI) inflows into ASEAN, have made important contributions to the economic development of the region. In fact the ASEAN experience shows that FDI can promote both industrial growth and export capabilities of the host countries through the creation of intra-regional and extra-regional linkages. During the early sixities to the mid-eighties, investment into ASEAN countries was motivated first by the need to secure access to petroleum and other raw materials and later by their lower wages and lower cost locations for labour-intensive production. The import-substitution type of industria-lisation pursued by the ASEAN countries also led the US, Europe, and later, Japan TNCs to locate some of production centres in ASEAN countries to serve their local markets. The eighties saw a rapid increase in FDI flows into the East and Southeast Asian region, particularly into the rapidly industrialising economies of Korea, Taiwan, Singapore and Hong Kong. The single most important event which led to a sudden surge of FDI into ASEAN was the appreciation of the Japanese yen and Asian NIEs’ currencies in 1985-86. This, combined with rising labour costs, led many Japanese, Korean and Taiwanese export manufacturers to seek cheaper locations in the ASEAN developing economies in order to maintain their export competitiveness. Low transportation costs, reliable communications network and the lower labour costs in Southeast Asia made it an attractive location for these firms, even though their final markets were located in North America and Europe. The investment boom has promoted economic growth in Asian developing countries by contributing to physical capital formation and human resource development, particularly in ASEAN, and more recently, in China. Japanese overseas direct investment has aimed at exploiting the comparative advantage in the region: investment in the Asian NIEs, shifted from labour-intensive industries towards technology and service industries. In South Korea and Taiwan, over 80 per cent of such investments were in manufacturing, mainly in chemicals, textiles, electronics and electrical products, while in Hong Kong and Singapore, the investments have been directed towards finance and commerce. However, even in the ASEAN-4 and China investments shifted in line with industrial growth in these countries (Chia, 1994). For example, the share of textiles in total Japanese FDI in ASEAN declined from 20.4% in 1985 to 11.8% in 1990; meanwhile, the share of electrical machinery rose from 4.9% in 1985 to 20.6% in 1990 (Urata, 1993).

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The pattern of investment and production in ASEAN had thus followed the “flying geese” pattern of evolving comparative advantage. There was a noticeable increase in FDI in manufacturing, hotels, commerce and other services. While there were substantial differences between the various ASEAN countries, electrical and chemical manufacturers attracted the most FDI for exports either back to the Japanese markets or to the US and Europe. Automobiles and automobile parts also attracted increased FDI partly due to increased demand for automobiles within the rapidly growing ASEAN countries. Production sharing refers to the practice of carrying out different stages of manufacturing a product in several countries (Drucker 1992). Such production sharing became quite common in industries involving high technology and sophisticated products. The technical development and designing may be done in one country, the various components may be manufactured in other countries, assembling may be done in some country(ies) and the product may be marketed globally. For example, the parts and components of a motor car finally assembled in the US or an European country are obtained from a large number of suppliers in different countries. In short, what is marketed as an American car or German car is not purely American or German but really transnational. Most of the parts and components of the IBM personal computer sold in the US are manufactured abroad. Nearly three-fourths of the total manufacturing costs of the IBM PC were accounted for by parts and components manufactured overseas. USowned overseas plants supplied more than one-third of these foreign parts and components. Drucker points out that the only thing really made in Japan of an electronic calculator carrying the label ‘Made in Japan’ is the label. FDI had not merely effected once-and-for-all change in industrial activities but also ongoing upgrading resulting in the increasing value-added content of manufactures. This in turn has promoted the export competitiveness of these countries by bringing in new technologies. The success of the ASEAN countries in continuing to attract FDI and multinationals is due largely to their economic and financial liberalisation measures. Fiscal incentives include exemptions from import duties on intermediate goods used in export production, accelerated depreciation allowance, and tax holidays. In addition, export processing zones and industrial estates offer appropriate infrastructural provisions. The creation of AFTA is intended to provide a further incentive in terms of a large single market to foreign investors (discussed in detail in chapter-9). FDI also helped to promote regional integration through the setting up of multiplant production in different countries of the region. Technological advances lowered transportation costs and improved telecommunications networks which markes location of production more sensitive to cost differentials such as lower wages. ASEAN countries benefited from these developments particularly in attracting foreign automobile manufacturers through the Brand-to-Brand Complementation scheme, which provides for a diverse production base (discussed in detail in chapter-9). 2.4 Foreign Investment - Trade Nexus

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Trade and foreign investment go hand in hand. Even very large markets such as that of the United States and the European Union are not large enough to enable firms to take advantage of economies of scale, product differentiation and competitiveness. Foreign investment has grown fastest among the countries which participated fully in the multilateral trade negotiations. In 1950s, foreign investment followed suppliers’ credits as the first commercial capital flow to developing countries mainly into highly protected manufacturing industries and associated services. Despite export performance carrorts (such as tax holidays) and sticks (such as mandatory export quotas), the transationals could not export out of inward oriented countries. In the 1960s foreign investment for labour intensive exports began in a few outward oriented developing countries. With the expansion of trade and associated fall in freight and other transaction costs, the transnationals focused on breaking down production processes according to labour, skill, technology and capital to take advantage of differences in resource endowments. Hong Kong, Taiwan and Singapore were able to take advantage of the inflows of foreign investment. In the 1970s more developing countries followed this trend. Mauritius was among the most successful. In the 1980s globalisation widened, with Thailand, Malaysia, Indonesia and China joining the stream. The importance of FDI in generating exports varies from country to country. In Taiwan and Hong Kong transnationals played a significant role at the margin, but the bulk of exports came from local firms. Hong Kong was initially an outward oriented entrepot for exporting manufactures from and importing raw materials to China. In the 1950s many mainland Chinese manufacturers emigrated to Hong Kong and Taiwan, and began to manufacture for exports. Singapore, in contrast, was an inward oriented entrepot, importing manufactaures for its hinterland and exporting raw materials to the world. With its separation from the Malaysian Federation in 1965 leading to disruption in raw material supplies for processing and transhipment, and very high unemployment, Singapore welcomed transnationals as the only way to start exporting quickly. By 1970 unemployment was wiped out and Singapore started recruiting immigrants for its export industries. More than 75 per cent of exports of manufactures still come from wholly owned transnationals. Foreign investment is also important but less dominant in tourism and financial service exports. The Republic of Korea, in contrast, had almost no foreign investment in its exports until it began to export motor vehicles. Local entrepreneurs developed labour-intensive exports in Thailand and Indonesia. Hong Kong, Singapore, Taiwan and Republic of Korea are moving rapidly up the skill and productivity escalator. The phasing out of the Multifibre Arrangement as a result of the Uruguay Round negotiations over the next decade will accelerate this movement. Thailand, Malaysia and Indonesia are following the path towards rising skill and remuneration, although Indonesia still has a large reserve of low productivity and low cost labour. India’s ample resources of low cost and skilled labour could make it a major export platform for labour intensive goods for the world.

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The rapid build up of exports from China began in the late 1970s. Small entrepreneurs from Macau and Hong Kong, being squeezed by rising wages, moved into the Pearl river delta in search of low cost supplies to meet their export markets. They took over factories and suplied second hand machines appropriate for low skilled labour. Productivity was raised by introducing commercial hiring and firing, piece work, shift work and quality controls. The enterprises were profitable, the workers learned skills and earned steadily rising incomes. After 1979 Taiwan and other East and Southeast Asian entrepreneurs joined those from Hong Kong, with many going to Fujien province just across the straits from Taiwan. At least seven million workers were employed in Hong Kong and Taiwan informally owned enterprises, which began to produce for the domestic market. Some Chinese cadres followed the export lead in township, village and co-operative enterprises which employ four million workers in exports, making a total of 11 million export workers. Investment in export production spread elsewhere within the region, driven by rising wages in the rapidly growing countries. High productivity management and marketing expertise found profitable export sites. Singapore firms moved into Malaysia, and the Singapore Economic Development Board is developing satellite export zones in Indonesia and China. Hong Kong, Taiwan and Korean investment spread throughout the region, ranging from Thailand to the small islands of the Pacific. Indian entrepreneurs also operate in the region. Mauritius exports were developed by Hong Kong, Taiwan, Indian and Pakistan entrepreneurs. Intra-Firm Trade Intra-firm trade across national boundaries is an essential feature of all international production through FDI and has reached considerable proportions relative to countries’ trade. The share of intra-firm exports by parent firms and affiliates of foreign firms located in the country in total exports of the country ranges from 18% in Swedan to 24% in Japan. The corresponding share of intra-firm imports in total country imports ranges from 14% in Japan to 43% in the United States. The geographical extension of a firm through FDI involves flows of intermediate goods and services from one or more members of a corporate system to others. Within the traditional structures of manufacturing TNCs generating FDI-trade linkages, intra-firm sales tend to comprise mainly flows of equipment and services from parent firms to their affiliates. If foreign affiliates are located downstream, intra-firm trade consists mainly of parent firms’ exports to affiliates; if they are upstream suppliers, they generate intra-firm imports for parent companies. Data on trade by United States parent firms and their affiliates abroad illustrate the high and growing importance of intra-firm trade for TNCs. During 1983-1993, the share of intra-firm exports in total exports of United States parent firms rose from 34 per cent to 44 per cent; and the share of intra-firm imports in total imports rose from 38 percent to almost one half. At the same time, the shares of intra-firm exports in total exports, and that of intra-firm imports from parent firms in total imports from the United States, of United States affiliates rose from 55 per cent to 64 per cent and 83 per cent to 86 per cent,

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respectively. Data for TNCs based in Japan confirm the importance of intra-firm trade in many manufacturing industries, especially those characterised by high research-anddevelopment intensities and firm-level economies of scale. Data on the patterns of intra-firm trade show that the share of affiliate-to-affiliate exports in total intra-firm trade within the same corporate systems have increased in importance from 30 percent in 1977 to 44 percent in 1993. Trade with other foreign affiliates was particularly striking for developed country affiliates (accounting for half of total intrafirm exports in 1993), reflecting greater integration within the parts of TNC systems. It was also noticeable for developing-country affiliates, although with geographical variations. The Impact of FDI on Composition of Asian Exports Manufacturing exporters in Asia today export a completely different range of products than they did 30 years ago. Initially, East Asian exporters concentrated on primary products, which accounted for more than 90 per cent of exports in 9 of 15 Asian economies for which data are available for 1970. Labour-intensive goods, specially textiles and clothing, accounted for 25 percent or more of exports in only five economies (Bangladesh, Hong Kong, India, Korea and Pakistan). Capital-and technology-intensive products (including electronics and machinery) were uncommon and accounted for more than 10 per cent of exports in only Hong Kong, India, Korea and Singapore. By the 1990s the composition of exports changed dramatically. Primary products accounted for more than 70 per cent of exports in only 3 of the 16 Asian countries. Several countries, including Bangladesh, Fiji, Indonesia, Pakistan, and Sri Lanka had shifted their export base toward labour-intensive products. In the most advanced Asian countries, exports moved towards skill-intensive and technology-intensive products, including more sophisticated electronics. In Malaysia and Singapore, for example, capital-and technology-intensive products accounted for more than 50 per cent of exports (although labour-intensive assembly operations remained important in these high-tech sectors). China, India and Philippines are moving in that direction, with capital-and technology-intensive products accounting for 20 to 25 percent of exports by the 1990s. Two manufactured product sectors - textiles and electronics, have dominated Asia’s exports in recent decades. South Asia, of course, has been exporting textiles to the world for centuries. In fact, textile exports have their origins in Japan. In the 19th century Japan exported raw and spun silk, and then moved into cotton textiles. In the early years of the 20th century Japanese entrepreneurs helped to organise the textile industry in Shanghai. Following the 1949 Chinese revolution, much of Shanaghai’s textile industry moved to Hong Kong, and Taiwan, China. In the 1960s, direct foreign investment from Japan helped the Taiwan’s textile industry. Since the 1970s the textile industry, mainly the ready-made garments moved progressively to East Asia, to Southeast Asia, and in more recent years to China and Viet Nam. The search for cheaper labour drove these movements initially, but they received a substantial boost as a device to overcome quota restrictions imposed under the Multi-Fibre Arrangement.

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More recently, an export common to the fastest growing Asian countries has been electronics products. Electrical machinery accounted for more than 15 percent of total exports in Hong Kong, Philippines and Thailand, and more than 20 percent of total exports in Korea, Malaysia, and Singapore between 1990 and 1995. Electronics exports also grew rapidly in the PRC and Indonesia. In the Philippines, electronics exports expanded from near zero in the late 1980s to 40 percent of all exports in 1995. In the late 1950s, the US semiconductor and electronics firms looking for low-wage locations for product assembly established themselves in Hong Kong. This initial success encouraged other Asian economies to copy Hong Kong’s approach. Korea, Malaysia, Singapore, and Taipei, China all tried to establish more open trading regimes in order to attract electronics firms. In 1971, 17 of the world’s 21 offshore electronics operations were located in East and Southeast Asia, and in 1974 the figure increased to 51 of 53 firms. 2.5

FDI - Trade - Technology Nexus

FDI has made significant contribution to economic growth in developing countries by promoting exports and providing access to export markets. The export propensities (measured by the ratio of exports to output) of U.S. foreign affiliates nearly tripled in the past two decades. This ratio more than doubled and reached 39 percent in Latin America, while the ratio remained high in Asia, ranging from 30 percent in the Republic of Korea to more than 80 percent in Malaysia. The export propensities of Japanese affiliates also have been increasing, most notably in East Asia, where their exports accounted for 34 percent of total sales in 1993. Japanese affiliates in China exported 53 percent of their sales in 1992, up from less than 10 percent in 1986, directing 43 percent of their sales to home markets in Japan. In 1977 foreign affiliates as a whole in developed countries exported about a third of output and the developing countries exported 18 percent of their output, while Asian affiliates were exporting 57 per cent of their output, led by those in Hong Kong, Singapore, Republic of Korea and Taiwan, China, which as a group, exported 81 per cent of their production. Export propensities maintained an upward trend since 1977. In Asia, some countries that were not part of the earlier export boom began to move towards higher exports, with United States affiliates in the Philippines and Thailand approaching the export ratios of the four newly industrialising economies in Asia and Malaysia. In contrast, affiliates in the four NIEs in Asia shifted their focus to local markets leading to a large decline in export propensity. It is estimated that foreign affiliates in Malaysia accounted for 46 percent of exports and 32 percent of employment in all industries, and 60 percent of exports and 49 percent of employment in manufacturing in the late 1980s. In China foreign affiliates’ share in total exports increased from 6 percent in 1989 to 28 percent in 1993.

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Export propensities of the U.S. affiliates in Asia were high in selected industries, notably electronics in which U.S. TNCs established affiliates in Asia as part of their integrated networks of production and trade. Developing countries were able to participate in global production and distribution systems because of their comparative advantage in labourintensive operations. For example, Malaysia was able to build up an electronics sector in the early 1970s, because US manufacturers moved the labour-intensive parts of their production process there. Malaysia could not design or produce computer chips, but it was able to assemble and test the operations that are labour-intensive. When Intel invested in Malaysia in 1972, the country was quickly brought into a world-class production system. Rapid growth in manufacturing exports requires close links with multinational firms that provide inputs, technology, capital goods and export markets. From an early stage, East and Southeast Asian firms brought most of their machinery and equipments from abroad. For example, in 1970, capital goods imports accounted for 50 percent of total investment in East and Southeast Asia, compared to 17 percent in South Asia and 35 per cent in Latin America and sub-Saharan Africa. Imported capital goods were a primary channel through which Asian countries gained access to leading technologies. Although several East Asian countries went through a phase of import substitution for consumer goods, they did not attempt to provide protection for domestic producers of capital goods. Even today, Korea - which produces more capital-intensive exports than any other Asian country - exports chemicals, ships, and automobiles, not machinery. Between 1991 and 1994, imported capital goods accounted for 73 percent of all equipment investment in Korea. This indicates the country’s continued reliance on imported foreign technology. FDI provided an important link to global markets for Hong Kong and Singapore, but played a more limited role in Korea and Taiwain, China. They preferred to import technology under licensing agreements and original equipment manufacturing arrangements. Asian exporters started to produce goods under the brand names of US and Japanese firms. The successful Asian firms learned quickly and developed the acumen to manufacture a variety of designs. Some firms gained specialised knowledge of particular markets, while others acquired skills for producing “knocks-off” copies of samples, or higher quality niche products. These activities allowed exporting firms to enhance their skills, adapt new technologies, and expand their production. 2.6 Macro-economic Impact of FDI in Asian Economies Several studies have been made to estimate the emperical relationship between FDI and savings and investment in the Asian developing countries. On the basis of time series data from four countries (Bangladesh, Republic of Korea, Nepal and Thailand) in 1960-1980, Fry (1984) found that foreign capital had a negative effect on domestic saving, implying that foreign capital tended to be a substitute for domestic saving.

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In another study coverinmg 16 developing countries for 1966-1988, Fry(1992) concluded that (a) FDI neither increases domestic investment nor provides additional balance of payments financing implying that FDI is used largely as a substitute for other types of capital flows; (b) an increase in FDI flows reduces national savings; (c) FDI does not have a significantly different effect from that of domestic financial resources on growth; (d) FDI exerts both direct aand indirect effects on the current account, the latter apperas to be a substantial negative effect. A study by Gupta and Islam (1983) on the basis of cross-section data from 18 Asian countries found that while foreign private capital had a favourable impact on the Asian saving rate, official aid had a highly negative or a substitutive effect. When a saving function was estimated with total financial flows (e.g., private and official flows) as the explanatory variable, no substitutive effect was found. Using similar methodology and pooled data from 13 Asian developing countries for 1968-1982, Go (1985) examined the inter-relationship between foreign capital and domestic investment. It was found that foreign financial flows tended to augment domestic investment, and that a 1 per cent increase in foreign capital inflows increases the investment rate by two-tenths of 1 percent. Regarding the relationship between FDI and growth, economists have also expressed doubts about the direction of causal relationship. Singh (1988) and Hein (1992) found insignificant relationship between FDI and growth and suggested that causality runs in the opposite direction i.e. from growth to FDI flows. The study of Chen et al (1995) analysing the FDI flows and their impact on the growth in the chinese economy in the post-1978 period finds that the ralationship between FDI and growth is much weaker than that between domestic savings and growth. FDI activity seems to have increased industry-concentration as reported by Dunning (1993), but the correlation between global industry concentration and participation by MNCs is significantly different from unity. However, Graham (1996) has argued that the correlation between the degree of industry concentration and the degree of monopoly power or competion may be spurious because of various economic policies. However, emperical studies generally support the view that FDI promotes economic growth in host developing countries by stimulating domestic investment. But the macroeconomic impact of FDI varies by country and region, depending on their policy regime and the extent of trade and investment liberalisation. Generally, benefits of FDI tend to be greater where policy distortions are fewer. Study by Lee, Rana and Iwasaki (1986) draws the conclusion that foreign capital has contributed favourably to investment efficiency in the Asian developing countries. Dowling and Rana (1990) also indicates that except for the effect of official flows on savings the impact of foreign capital and exports on growth and saving rates had been

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both positive and favourable. Furthermore, the negative relation-ship between official flows and the saving rate may not necessarily indicate that the latter is reduced by an increase in official flows. They concluded that inflows of FDI are determined by a complex set of economic, political and social factors and foreign investors look beyond the array of investment incentives. Performance requirements and various restrictions and regulations act as disincentives to FDI and often offset the positive effects of fiscal incentives. In a more recent quantitative study, Fry (1993) found that FDI has a positive effect on growth in eight Pacific Basin economies where distortions were low, whereas the effect was negative in a control group of developing countries. A study by Borenzstein, Gregorio and Lee (1995) on the basis of data from sixty-nine developing countries draws the following major conclusions: (a) FDI contributes to economic growth and has a larger impact on growth than does domestic investment. This finding is also supported by a study by Blomstrom, Lipsey and Zejan (1992). (b) Beyond a minimum threshold, higher FDI inflows are associated with higher productivity of human capital for the economy as a whole, indicating that FDI has positive spillover effects through the training of workers. (c) FDI does not crowd out domestic investment, but instead seems to supplement it through vertical spillovers leading to increased capital investment by suppliers and distributors. These findings are consistent with another recent study by Coe, Helpman and Hoffmaister (1995) showing that productivity tends to be higher in developing countries that have strong links with OECD countries than in those that do not. The difference is attributed to technology embodied in imports from OECD countries by the highproductivity developing countries. But because FDI flows from OECD to developing countries are highly correlated with trade flows, the productivity could be associated with technology transfer through FDI rather than trade. Another study by Shang-jin Wei (1997) provides evidence that FDI has produced technology spillovers in China. Using data covering 434 urban areas in China during 1988-90, the study showed that of the three types of firms in China (state-owned, township-and-village, and foreign-invested), the foreign-invested firms grew at the fastest rate; and that the share of foreign-invested firms and the depreciated stock of FDI were important factors in explaining differences in growth among urban areas. There is a broad agreement that FDI can make an effective contribution to the development efforts of developing countries. Its actual contribution, however, varies from country to country depending on the importance given to it in the overall economic strategy. FDI has traditionally been sought to supplement domestic savings in order to finance investment and other capital requirements. The significance of FDI in domestic capital formation can be judged from the ratio of inward FDI flows in the gross fixed capital formation which reached the peak level of 24.5 percent in China in 1994, 26 percent in Malaysia in 1992, 47.1 percent in Singapore in 1990, 37 percent in Fiji in

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1990, 61.3 percent in Vanuatu in 1994 and 96 percent in the Pacific least developed countries in 1994 (Table 2.5A). Share of FDI stock in gross domestic product was as high as 86.6 percent in Singapore in 1990, 46.2 percent in Malaysia in 1994, 36.6 percent in Indonesia in 1990, 18 percent in China, 21 percent in Hong Kong and 36 percent in Maldives in 1994 (Table 2.6A)). FDI flows as a share of GNP given in Table 2.7 also indicates the importance of FDI in overall economic development. For developing countries as a whole, it reached 2 percent in 1996. Among the largest recipients of FDI on this basis are Malaysia and Vietnam, with inflows equivalent to 6.5 percent of GNP in 1996. East Asia has sustained inflows equivalent to more than 4 percent of GNP. These figures, however, do not capture the full role of FDI as an agent for growth and structural transformation. In many countries FDI was instrumental in shaping their structure of industry, technological base and trade orientation. In general, FDI played a central role in Latin America’s industrialisation. It was also instrumental in the industrial transformation to a more diversified or broader-based structure in some of the more dynamic economies of Asia. The growing disillusionment with import substitution policies adopted by most developing countries in the 1950s and 1960s led to a shift in orientation aimed at promoting exports of manufactured goods. FDI was viewed as a mechanism to gain access to internatioinal markets and to boost exports. For the dynamic Asian economies, FDI was a driving force in their export-led growth as their take-off occurred when foreign investment was already outward-oriented. Perhaps the most significant contribution of FDI is qualitative in nature. FDI embodies a package of growth and efficiency-enhancing attributes. TNCs are important sources of capital, technology, and managerial, marketing and technical skills. Their presence promotes greater efficiency and dynamism in the domestic economy. The training gained by workers and local managers and their exposure to modern organisational system and methods are valuable assets. The full potential of FDI for fostering economic development in host countries can best be reached by strengthening domestic linkages and upgrading flows through encouragement of investment in technology and skillintensive industries with higher local value-added. 3 GEOGRAPHICAL AND SECTORAL DISTRIBUTION OF FOREIGN INVESTMENT - GLOBAL AND COUNTRY EXPERIENCES

3.1 Regional Distribution of FDI Two developments underlie the trend of the record FDI flows into developing countries in the 1990s : the growing importance of developing countries as sources of FDI for other developing countries; and increase in the value and share of total outflows from the developed countries going to developing economies. The FDI flows to developing

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countries have grown rapidly in 1990s and reached $100 billion in 1995 and $110 billion in 1996. The share of developing countries in global FDI flows increased from 19 percent in 1980 to 32 percent in 1995. In recent years developing countries also have generated substantial outflows, with the largest shares coming from Brazil, Chile, China, and Thailand. Motivating these flows has been the search for a supply of key raw materials (such as minerals and logs) and for lower labour costs in less developed economies as industries in the home countries become technology intensive. The most dynamic foreign investors from developing countries in recent years have been the South East Asians NIEs and ASEAN, India and Brazil. Surveys of FDI from developing countries high-light the following general features (UNCTAD 1993a): (a) The geographic distribution favours neighbouring and ethnically related countries. (b) FDI tends to concentrate in industries using standardised technology and management skills or industries based on natural resources (processing, textiles and minerals) or export-oriented industries (food processing, automobiles, and electronics). (c) Most TNCs from developing countries are involved in joint ventures, both to limit their capital commitments and to obtain know-how, local managerial and organisational skills or access to markets of their partners. Outflows from the developing countries rose from $39 billion in 1994 to $47 billion in 1995, with an increasing share going to other developing countries. Intraregional FDI flows accounted for 37 percent of inward FDI stock of nine Asian economies in 1993, compared to 25 percent in 1980. The share of newly industrialised economies in the FDI flows to the ASEAN countries increased from 25 percent in 1990-1992 to 40 percent in 1993-1994. More generally, about 57% of the FDI flows from developing countries were invested within the same region in 1994. The share of developing countries in the combined outflows of the world’s five largest outward investors rose from 18 percent in 1990-1992 to 28 percent in 1993-1994. The concen-tration of FDI in the largest 10 developing countries has increased from 69 percent of annual average FDI flows into developing countries in 1990-1992 to 76 per cent in 1993-1995. Asia and Pacific The Asia and the Pacific region is the new growth centre of the global economy with China, ASEAN and NIEs as important players in the region. It is the most important focus of FDI by transnational corporations (TNCs) in the developing world, with more than half of the developing country FDI inward stock being located there (Table 2.3B). FDI flows to Asia and the Pacific reached $65 billion in 1995 accounting for 21 percent of global FDI flows and 65 percent of FDI flows to the developing countries, compared

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with $20 billion in 1990 accounting for only 10 percent of global FDI flows (Table 2.3A). East and South-East Asia alone received an estimated $62 billion in 1995, while South Asia saw a doubling of inflows to $2.7 billion in that year, mainly as a result of a tripling of inflows into India. Inflows of FDI to four ASEAN member States (Indonesia, Malaysia, Philippines and Thailand) increased from $8.6 billion in 1994 to $14 billion in 1995. During 1990-1996 China and ASEAN had a share of more than 80 percent in FDI inflows to Asian countries, with Chinese share exceeding 50 percent. FDI contributed significantly for enhancement of domestic investment and accounted for almost one fourth of gross domestic investment in Singapore and China (Table 2.5A). The Asia-Pacific’s sustained economic growth, in fact, led to a doubling of its share in world FDI flows from 10 per cent in the first half of the 1980s to 20 per cent in the 1990s, although some countries (Afghanistan, Mongolia, Myanmer and and Nepal) continued to attract a very small volume of flows. China has been the principal driver behind the current investment boom in Asia and to the developing world as a whole. With an inflow of $38 billion in 1995 China became the second largest recipient of FDI after the U.S.A. in the world and the number one in the developing world in 1995, and became the home for 38 percent of FDI flows to developing countries and 55 percent of FDI flows to Asian developing countries. FDI inflows to China increased further to $42 billion in 1996 (World Bank 1997). About 80 per cent of FDI inflows to China come from countries with predominantly Chinese populations, such as Hong Kong, Macao, Singapore and Taiwan, China. Firms from those economies have certain advantages in investing in China, e.g., better knowledge of market conditions and reduced transaction costs owing to language advantages and family networks. China, as a result, has a special edge in attracting FDI from these economies compared to others. Asian developing economies themselves are increasingly becoming outward investors, reflected in the liberalisation of their outward FDI regimes and, in some cases, the provision of incentives for such investments. In 1995, the region with $43 billion FDI outflows accounted for 90 per cent of all developing-country outflows. Hong Kong was the single largest outward investor among the developing countries. Most outward FDI is going to other countries in the region to take advantage of cost differentials and liberal trade regimes and to allow export-oriented FDI to flourish, facilitated by ethnic and cultural links. Malaysian and Thai TNCs, for example, directed more than 60 per cent of their FDI outflows to Asia in 1995; some four-fifths of Hong Kong’s outward FDI went to China in 1995; a good part of Singapore’s outward FDI is distributed to other Asian countries (mainly ASEAN countries and China); and about 60 percent of China’s outward FDI remained within the Asian region (United Nations, 1996). Tables 3.2A to 3.2E present the top 10 home countries for FDI flows to selected host countries in the Asia and Pacific (Bangladesh, Cambodia, China, Hong Kong, India, Indonesia, Japan, Laos, Malaysia, Mongolia, Myanmer, Pakistan, Philippines, Singapore,

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South Korea, Sri Lanka, Taiwan, Thailand, Vietnam, and New Zealand). It is observed from the tables that intra-Asian FDI flows constitute major shares in FDI inflows to most of these host countries (only exceptions being Japan, India and Pakistan). The share of Asian countries among the top 10 host countries ranged from 45 percent in South Korea to around 90 percent in China, Mongolia and Cambodia. 3.2

Sectoral Distribution of FDI

The sectoral distribution of foreign direct investment in developing countries is not well documented, but it seems that in recent years services have increased their share to more than one third, while manufacturing has declined to less than one-half, with the remainder accounted for by agriculture and mining. Within services financial services are a major component, with trade, construction, and tourism also important. Within manufacturing the trend has been to move from lower-technology or labour-intensive industries (food, textiles, paper and printing, rubber, pastics) to higher-technology industries (electronics, chemicals, pharmaceuticals). The size of dynamism of developing Asia have made it increasingly important for TNCs to be established there, to service rapidly expanding markets or to tap the tangible and intangible resources of that region for their global production networks. In addition, the region’s infrastructure-financing requirements for the next decade will play a role in sustaining FDI flows to Asia. Countries are dismantling barriers to FDI in this sector, giving rise to new and large investment opportunities for TNCs, and privatisation, still lagging behind other regions, is showing signs of taking off, particularly in manufacturing industries, telecommunications, petroleum and financial sectors. European union TNCs which neglected Asia in the 1980s are making large-scale investment in Asian developing economies to take advantage of new opportunities in power, petrochemicals and automobiles. A significant portion of FDI in South, East and South-east Asia is of the market-seeking type that is unlikely to shift as long as there are profitable opportunities for production for a host country’ market. In particular, large-scale infrastructure-related FDI has been picking up in response to liberalisation in power and telecommunications. Similarly, Malaysia and Thailand have reached income levels at which it has become profitable to establish automobile manufacturing facilities for the domestic (and foreign) markets. Furthermore, the services sector is attracting more and more FDI flows, especially in the newly industrialising economies. In Korea, the share of the services sector in total inward FDI stock was 40 per cent in 1995, compared with about one quarter in 1981; in Taiwan Province of China, the share of services in FDI stock went up from 21 per cent in 1980 to 35 per cent in 1995. In addition to resource-seeking FDI in established resourceabundant host countries such as Indonesia, Malaysia, Papua New Guinea and the Philippines, new entrants such as Viet Nam and Myanmar have begun to attract FDI in the primary sector.

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A number of Asian countries are increasingly attracting FDI in capital-intensive industries. For example, average annual flows to the chemical industry in the Republic of Korea increased from $91 million during 1980-1986 to $189 million during 1987-1991 and further to $230 million during 1992-1993. FDI policies of countries in the region also reflect a recognition of this shift in locational advantages. Countries such as Malaysia and Singapore are becoming more selective with respect to the kind of FDI and putting an increased focus on its technological content. In Indonesia, the new regulations allow 100 per cent foreign ownership of local enterprises for 15 years and require only a 1 per cent divestment afterwards. In joint ventures, local firms are now required to hold only 5 per cent of ownership, a substantial drop from 20 per cent in the past. Previously restricted industries such as transportation, telecommunications and power are now open to foreign firms. Thailand has opening to FDI some of the previously restricted industries such as advertising, garments, construction and engineering works. The experiences of several East and South-East Asian countries indicate that contributions to international competi-tiveness and export performance have been particularly high in developing economies that are open to both trade and FDI. For example, since mid-1980s the share of foreign affiliates in exports were as high as 57% in Malaysia (all industries), 91% in Singapore (non-oil manufacturing), 24% in Hong Kong (manufac-turing and 17% in Taiwan Province of China (manufacturing). Taiwan, China where FDI was allowed with some restrictions, purchases from local subcontractors by foreign affiliates played an important factor in the building up of an export- oriented electrical and electronics industry in the 1960s and 1970s. On the other hand, in Malaysia, which had fewer restriction on FDI, export-oriented production by foreign affiliates played a greater role in building up the industry. In general, some ASEAN countries like Malaysia, Singapore, and Thailand relied more on FDI for securing access to international markets and access to resources, while such East Asian countries as South Korea and Taiwan, China relied more on non-equity arrangements; but in both cases, a key factor for building up long-run competitiveness involved the acquisition of technological and managerial capabilities as well as access to international marketing networks and capabilities from TNC systems. Transnational corporations in retailing, and other trading firms also played an important role in the building up of export capabilities of several Asian economies. In addition to linking local producers to foreign customers, they have deepened the ties of those economies to the internatioinal market-place. 3.3 Foreign Portfolio Investment (FPI) One important factor contributing to the private foreign investment in Asian developing countries in recent years has been the surge of foreign portfolio investment which includes both equity and bond investment. Portfolio flows to developing countries increased to $81 billion in 1995 from $78 billion in 1994 but remained below the peak of $95 billion recorded in 1993. Strong growth in equities and debt raised portfolio flows to a record $134 billion in 1996, accounting for 30 percent of net resource flows in 1996

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compared with only 5 percent in 1990 (Table 3.1). Equity flows at $46 billion accounted for 34 percent of these investments. An increasing share of foreign funds was invested in local equity markets directly rather than through depository receipts or other cross-border private equity placements. Debt instruments - mainly international bonds - have always accounted for most portfolio flows to emerging markets. Portfolio debt flows to developing countries - essentially bond issues in the international capital markets registered a record increase by 80 percent and reached a record level of $89 billion in 1996 on top of $49 billion in 1995. Portfolio equity flows, which include international equity issues and investment by foreigners in local equity markets, are estimated to have rebounded from $32-33 billion in 1994 and 1995 to a record $46 billion in 1996. Several factors which boosted investor interest in developing country equity markets in 1996 include the following : continuing low international interest rates; the availability of securities at low prices; relatively high economic growth prospects in developing countries; increased liquidity as investments in US mutual funds surged in early 1996, nearly doubling their share of funds invested abroad; the general trend among European asset managers to diversify investments from domestic to foreign markets; and depository receipts and direct investment in local equity markets. Depository receipts - American (ADRs) and global (GDRs) - and privately placed cross-border equity issues accounted for 25% of portfolio equity flows to developing countries in 1994-96, while 75% of PFI was channeled through direct investment in local stock markets. Depository receipts offer some advantages over FDI. To the issuer they provide the opportunity to tap the widest possible pool of investors and to attract the capital of new investors and retail investors who are unwilling to go directly to the markets or are prevented from doing so by legal restrictions. To the investor these receipts offer convenience, liquidity, elimination of settlement risks, and safer regulatory environment. Although ADRs have been more popular than GDRs, GDRs are becoming more popular with developing country issuers because of their ability to reach a broader investor base and the less stringent regulatory criteria that govern their use. Regional Distribution of FPI East Asia and the Pacific Flows to East Asia and the Pacific continued their upward trend, rising to $27 billion in 1995 and $36 billion in 1996. Equity flows accounted for more than half the total in 1995, and the bond issuance increased strongly in 1996. The level of depository receipts and private issues declined in 1996 because of smaller volumes from Indonesia, Malaysia, and the Philippines. Portfolio equity flows to East Asia and the Pacific reached a record $15 billion in 1995. The region, the largest recipient of portfolio equity flows to developing countries, increased its share of total portfolio equity flows from 32 percent in 1989-94 to 46 percent in 1995. About 38% of the region’s portfolio equity flows were raised through

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international equity issues; the rest was raised through direct investment in local exchanges. In 1996 funds flowing into the region reached $10 billion, about 25% of which was generated intraregionally. With bond issues of more than $10 billion in 1995, East Asia and the Pacific was second only to Latin America in volume of international bond issues. Strong issues by China, Indonesia, the Philippines, and Thailand doubled the volume of the region’s bond issues to $20 billion in 1996. Favourable international capital market conditions, a positive investor outlook toward regional issuers, and a scarcity of long-term funds in the Asian domestic markets helped increase volume. South Asia Portfolio flows to South Asia declined from a peak of $7.3 billion in 1994 to $3.1 billion in 1995 due to primarily lower foreign investment in local markets in India and Pakistan and a decline in international offerings. Flows of FPI recovered to $6.9 billion in 1996 due to record level of debt at $1.5 billion and substantial rise in equity to $5.4 billion. Bond issues from the subcontinent increased to more than $1 billion in 1996. The volume of international equity issues to South Asia fell sharply in 1995 as depository receipt placement by Indian issuers declined. Activity resumed in the euro-issue market in 1996, and foreign investment in 1996 increased over 1995 levels. However, only 3 percent of market capitalisation is accounted for by foreigners. The success of the $200 million GDR by India’s industrial Credit and Investment Corporation (ICICI) highlighted investor demand for quality borrowers from the region. A sharp pickup in activity by Indian issuers brought the volume for the region to $1.5 billion in 1996. Investments in Pakistan’s stock market are estimated to have declined in 1996 because of uncertainty over the course of economic policy. Bangladesh, which accounted for less than 2% of foreign funds flowing into regional stock markets in 1995, is seeking to attract greater volumes through a broad economic reform programme that includes specific measures to encourage foreign investment. Foreigners are now permitted to invest independently in all sectors except defence-related industries; previously, foreign investment was limited to joint ventures with local investors. The government also has lifted the one-year holding period imposed on foreign investors in the stock market. India continued its presence in the global bond markets in 1995, raising $770 million. The market response to a handful of bonds issued toward the end of the year was limited, as the outstanding international bonds from the country performed poorly in the secondary market. In Sri Lanka the Bank of Ceylon issued a $12 million three-year bond (with a put option) in a privately placed deal in the euro-market. Pakistan raised $100 million with its first floating-rate note issue. The note carried a maturity of four and a half years and had put and call options attached. 3.4 Direct Foreign Investment in Selected Countries in Asia

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(a) China, People’s Republic of Since the opening up of its economy in 1979, and the subsequent creation of the five Special Economic Zones (SEZs) and 14 open coastal cities, China has attracted substantial foreign investment, especially foreign direct investment (FDI). The country’s high growth, abundant supply of cheap labour, its huge domestic market,and the preferential treatment given to foreign investors, have served as strong magnets for foreign investment. Under the new guideliines, foreign investments are “encouraged” in projects that can raise the technological and economic efficiency of Chinese enterprises, exploit new markets, and increase exports. Moreover, foreign investments are encouraged in industries with insufficient domestic production capacity. The guidelines also open new frontiers for foreign investors. For the first time, foreign investors are encouraged in the construction and operation of projects such as nuclear power stations, civil airports and mass transit railways. However, to protect national interests, the state will take the majority share-holding in these projects. On the other hand, projects that exploit the country’s rare and precious raw mineral resources are “restricted”. The guidelines also reaffirm that foreign investments are prohibited in specific sectors such as air traffic control, telecommunications, broadcasting and post. The guidelines also have a geographical stress, encouraging foreign investors to invest in the central and western parts of the country where development lags behind the coastal provinces. Table-3.3 : The importance of FDI in China, 1991-1995 _________________________________________________________________ Item 1991 1992 1993 1994 1995 _________________________________________________________________ No.of contracts (‘000)

13.0

48.8

83.4

47.5

45.0

Contracted value of FDI 12.0 58.1 111.4 81.4 112.5 (billion dollars) Actual FDI inflows 4.4 11.2 27.5 33.8 37.5 (billion dollars) Average amount per project 0.9 1.2 1.3 1.8 2.5 (million dollars) FDI as a ratio to GDI 4.5 8.0 13.6 18.3 .. (per cent) Exports by foriegn 12.1 17.4 25.2 34.7 .. affiliates (bn US$) Exports shares by foreign 17.1 20.4 27.5 28.7 31.3 affiliates in total exports (per cent) Share of industrial output 5.1 6.0 9.0 11.0 13.0 by foreign affiliates

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in total industrial output (per cent) Number of employees in FDI 4.8 6.0 10.0 14.0 16.0 projects (millions) Share of tax contribution .. 4.1 .. .. 10.0 in total revenues (per cent) ________________________________________________________________ Source : World Investment Report 1996, UNCTAD, UN. During 1979-1996, under the government’s open door policy, foreign direct investment in China reached 260,000 enterprises, overall FDI commitments were worth $400 billion, while the inflow of FDI reached $135 billion. In 1995, China received about $38 billion in FDI, which made China number one in the developing world. In fact, FDI already plays a very important role in China’s economic and social development. About 50 percent of the country’s industrial turnover is due to FDI and enterprises with foreign investment earned one-third of the country’s foreign exchange, employing 17 million workers. Of foreign-invested enterprises (FIEs) approved since 1979, 64% are equity joint ventures, 15% are co-operative joint ventures, and 21% are wholly foreign-owned enterprises. As regards sectoral distribution of FDI, 50% was concentrated in processing industries, 24% in other industries, 14 percent in real estate, 9% in transport and communications, and 3% for agriculture and fisheries in 1979-1994. Although China received FDI from about 150 countries, the major proportion of athis FDI came from Hong Kong, Macao and Chinese Taipei. Only 30 percent of FDI came from other countries of the world. The United States accounted for 8 percent and Japan 8 percent. European countries account for less than 10 percent. The United Kingdom, Germany, France and Italy, together only accounted for 4 percent of total FDI flows to China, only half of the US level. China’s opening policy has been one of gradualism. For example, China opened the railway sector in 1992, the electric power sector very progressively in 1993 and the aviation sector in 1994. It harmonised the two-tier foreign exchange system that often created confusion for foreign private investors in 1994. In 1996, the Chinese government opened insurance, retailing, accounting and consulting to FDI. Other priority sectors are agriculture, electric power generation, main roads and highways, important raw materials, petrochemicals, chemical industry, iron and steel industry, high-tech industry and the export sector. In the future, more and more sectors will be opened to FDI such as civil aviation, foreign trade, and the banking system. China provides national treatment to FDI and is committed to make the currency fully convertible under the current account by 2000. Although there are already new types of private foreign investment in developing countries, such as BOT or project financing. China have only recently adopted such procedures. The pilot BOT project was opened for bidding in May 1996 and the second

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BOT package whose scope will be enlarged to include thermal power plants, bridges, expressways and water treatment plants will be opened very soon. The Chinese government is trying to accelerate its reform effort and opening further. In 1996, the Chinese government and the People’s Congress approved the next five-year development strategy, to the year 2000. According to the strategy, annual GDP growth target is 8 to 9 percent and exports target is 10 percent. The plan attaches priority to the development of private and foreign investment and to optimise the sectoral distribution of FDI by attracting more FDI into infrastructure sectors. In principle, the Chinese government does not limit the rate of return for FDI. Some enterprises with foreign investment already obtain very high rates of return, such as Motorola of the United States and Volkswagen from Germany, while other companies earned rates of return above 20%. Some processing-indstry projects earn rates of return even higher than 100%, but in certain sectors, such as the power sector, anti-monopoly, inflation, consumer-rights concerns require the government to negotiate tariffs with investors. In the commercial market, the Government of China cannot guarantee the rate of return. China’s record of sustained reform attracted a massive increase in foreign direct investment (FDI), which grew from a trickle in the early 1980s to $38 billion in 1995 and to more than $42 billion in 1996. Investment was initially concentrated in tourism, commercial and real estate, and petroleum. Close to half the FDI was in Fujian, Guangdong, the Jiangsu, where it accounted for between 50 and 60 percent of gross capital formation. This concentration of investment in the coastal zone was stimulated by local governments that had taken advantage of their administrative and policy freedom to build the infrastructure needed to attract foreign investment, to provide attractive tax deals to foreign investors, and to refrain from intruding in businesses or overburdening firms with regulation. In recent years, nearly 80 percent of FDI has been in small and medium-scale exportoriented manufacturing industries, with the average investment increasing from $0.5 million in the late 1980s to $2.5 million in 1995 (Table 3.3). Most of the investment was by overseas Chinese who had already established strong links to the main export markets in Europe, Japan, and the United States. As a result of this boom in export-oriented FDI, exports became the main engine of growth for the Chinese economy, and the country significantly increased its share of world trade. Foreign affiliates have become major vehicles for China’s trade. On the export side, TNCs have played a lead role in the expansion of export-oriented processing activities, in particular in the special economic zones. Processing trade (trade under the special customs regimefor imports for and exports after processing) has been the most dynamic component of China’s foreign trade: exports (after processing) reached 47 per cent of total exports in 1994. Foreign affiliates and other TNC-related firms handled more than 54% of these transactions. The massive investment by TNCs in trade-oriented production

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in China is particularly visible from the high share of foreign affiliates and other TNCrelated enterprises in China’s exports and imports as given in (BTable 3.4 ). The leading export items under processing trade are consumer electronics, textiles and garments and footwear. Typically, processing exports comprise goods in which the activities in China relate to labour-intensive production, whereas product development and international marketing is done elsewhere by TNCs. Net exports (exports minus imports) were 16 per cent of the export contract value under processing trade; for TNCs, the corresponding value was lower at only 9 percent. Foreign affiliates have also become a major vehicle for imports into China. In 1994, over a third of China’s total imports for the domestic market (imports excluding processing trade) were channelled through foreign affiliates and non-equity joint ventures. The bulk of these imports consisted of investment goods: Imports of machinery represented more than two-thirds of all TNC imports for the domestic market. In fact, TNCs were responsible for 55% of China’s machinery imports in 1994. Table 3.4 Percentage share of internationsl transactions of foreign affiliates and non-equity ventures in China in 1994 _________________________________________________________________ Type of firm Exports Imports Exports Imports Total Total except except after after exports imports proce- proce- proce- processing ssing ssing ssing _________________________________________________________________ Fully foreign 1 7 19 19 9 12 owned Equity joint 5 23 26 30 15 26 venture Non-equity 1 6 9 10 5 8 joint venture Total,above 7 37 54 59 29 46 Total,all firms 100 100 100 100 100 100 _________________________________________________________________ Source: World Investment Report 1995, Unitted Nations. Hong Kong is, by far, the largest supplier of FDI to China (Table-3.5A). Hong Kong’s investment in China has come not only from Hong Kong-based businessmen but also from many Taiwanese investors who have been using Hong Kong’s registration to sidestep the regulatory constraints on investments in China. Since late 1980s, Taiwan’s direct investment in China has grown rapidly too. In 1994, Taiwan accounted for 10% of China’s utilised FDI. In recent years, Singapore and South Korea have also expanded their investment in China to reduce their production costs, amidst rising labour costs in the domestic market.

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FDI brought into China not only the much needed capital and foreign exchange, but also new knowledge, including industrial technology, marketing know-how, managerial expertise and entrepreneurial skills. Such transfer of funds and knowledge has contributed significantly to the overall growth and export performance of China. Between 1979 and 1996, China’s gross domestic product (GDP) grew by an average annual rate of 10.7% in real terms. The role of FDI in China’s economic development can best be illustrated by the experience of Guangdong, the province that has received the largest amount of FDI, and is the host to these SEZs and two open coastal cities. Between 1989 and 1994, Guangdong attracted US$24.9 billion utilised FDI, or 30% of the country’s total, most of which were in export-oriented industries (Table-3.5B). Over the same period, Guangdong’s exports expanded by 34.7% annually, while the country’s exports grew by only 18.2% per year. In 1994, foreign invested enterprises (FIEs) accounted for 39.5% of Guangdong’s exports, compared with 28.7% in the country. As a result of the faster growth of the privince’s exports due to bigger contribution of FIEs, Guangdong recorded an average real GDP growth rate of nearly 18% per year since 1989, much faster than the national average of 10.7%. In recent years, as a result of increased economic activities and over-heating, China has run into infrastructure bottlenecks in ports, airports, roads, railways, telephone lines and power plants. It is estimated that by the end of the century, China will need up to US$250 billion to develop its transporta-tion, telecommunications, power-generating capacities. The classification of infrastructure developments as encouraged projects highlights the government’s desire to use foreign funds to help ease the capacity constraints of the country. China’s attractiveness to foreign investors, however, remains bright. China’s growth performance is outstanding. With an average annual GDP growth of 11.5 per cent in 1991-1996 China is one of the fastest growing economies in the world. The liberalisation of FDI policies is still underway. Some industries that had been restricted to foreign investors (such as air transport, general aviation, retail trade, foreign trade, banking, insurance, accounting, auditing, legal service, mining and smelting of precious metals, and the extraction and processing of diamonds and other precious non-metal minerals) are being opened gradually. There is a significant potential for FDI participation in infrastructure, and several build-operate-transfer projects have already been concluded. Foreign investors are now allowed to acquire state-owned firms. Furthermore, investments from other major source countries, such as Japan and the Republic of Korea, are increasing. The European Union and the United States are also pursing new initiatives to increase the presence in the Chinese market. As a result, the existing importance of FDI for China’s economy is likely to grow. (b) Foreign Investment in India Since July 1991 India had undertaken credible reforms in industry, trade, financial and public sectors to enhance globali-sation and competitiveness of Indian industries and to

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encourage inflows of foreign investment in industrial and technology development. The major reforms and fiscal incentives are discussed in detail in chapter-8. As the initial reforms take root and further reforms unfold, India is emerging as a land of immence opportunity for all. Transnational corporations and foreign firms have shown keen interest in investing in India. The total number of foreign collaborations approved during the post-liberalisation period (August 1991 to March 1997) amounted to 10729 of which 6092 proposals involved direct foreign investment amounting to $34 billion. More than 86 percent of these foreign investments are in priority sectors such as power and oil (24%), telecommunications (23%), financial services and hotels (10%), chemicals (7%), automobiles (6%), electrical equipments (6%), mettallurgical industries (5%) and food processing industries (5%). Considering the immence market potential for automobiles in the country, almost all the major automobile manufacturers from all over the world are setting up manufacturing plants in India, to meet the growing domestic demand and to develop production base for meeting global demand. The number of new vehicles based on contempory designs and lattest technology which have been introduced in the domestic market include Suzuki, Fiat, Ford Escort, Opel Astra, Cielo, Peugeot, Toyota, Uno, Mercedes etc. These joint ventures have already commenced their production and the cars are available in the Indian maeket. The average annual inflow of foreign investment to India increased from only $120 million in 1980s to $4.7 billion in 1993-1996. Total portfolio investments at $12.2 billion in 1993-1996 (Table 3.6) comprised $7 billion in equity shares purchased by FIIs attracted to India by the prospects of higher return, $4.5 billion by GDR/Euro equities and $0.7 billion by offshore and other funds raised by Indian firms interested in raising capital abroad at a lower cost than from domestic sources. Table-3.6 Inflows of Foreign investment to India in 1991-1997 (US$ million) _________________________________________________________________ Type of investment 1990 1991 1992 1993 1994 1995 1996-91 -92 -93 -94 -95 -96 -97 _________________________________________________________________ FDI

165 150 341 586 1314 2163 2609

RBI Automatic route 0 0 42 89 171 169 135 SIA/FIPB route 165 87 238 280 701 1249 1858 NRI (40% and 100%) 0 63 61 217 442 745 616 Portfolio Investment FIIs 0 GDR/Euro-issues Offshore Funds

0

8

92 3649 3581 2214 2775

0

1 1665 1503 2009 1855 0 86 1602 1839 140 900 0 8 5 382 239 56 20 0

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_________________________________________________________________ TOTAL 165 158 433 4235 4895 4377 5384 _________________________________________________________________ The sectoral distributions of FDI according to the FDI-stock before liberalisation policy and approvals in the post-liberalisation period (1991-1997) as given in (Table 3.7 reveal striking differences. In particular, the relative importance of manufacturing sector has declined with the opening up of infrastructure and service sectors to foreign direct investment under the liberalisation policy, and, within the manufacturing itself the preference pattern of FDI is shifting away from heavy capital goods industries to light industries. Table 3.7 Sectoral Distribution of FDI (percent) _________________________________________________________________ Sectors FDI outstanding FDI approvls end March 1990 Aug.1991-March 1997 _________________________________________________________________ 1. Plantation & agriculture 9.5 0.4 2. Mining 0.3 0.5 3. Petroleum and power 0.1 23.7 4. Manufacturing 84.9 42.2 Food processing 7.0 5.1 Textiles 4.0 1.9 Transport equipment 12.3 6.2 Machinery & mach.tool 15.4 3.2 Metals and its products 6.1 5.7 Electrical goods 12.8 6.0 Chemicals and allied 33.4 10.8 Others 8.8 3.3 5. Services 5.2 33.2 _________________________________________________________________ Total 100.0 100.0 _________________________________________________________________ As a consequence of the amendment of the Foreign Exchange Regulation Act (FERA) and automatic approval of foreign equity upto 51% in 48 priority industries and upto 74% in 9 high priority industries, many of the existing firms have raised their foreign equity above 50%. These constitute around 50 per cent of approvals since August 1991. The countrywise break-up suggests the increasing quest of the firms based in the United States (accounting for 27% of companies having majority foreign owner-ship), the United Kingdom (21%), Germany (18%) and Switzerland (6%) for acquiring foreign ownership control in their existing associates in India. More than 80% wholly-owned subsidiaries of foreign companies operating in India originated from United States (43%), Singapore (17%), United Kingdom (7%), Switzerland (7%) and Hong Kong (7%).

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The data on foreign equity range in the firms under foreign collaboration (Table 3.8) give some insights into the pattern of foreign ownership during the post-liberalisation period as compared with the pre-liberalisation period. The proportion of firms with foreign ownership range of 50 per cent and above (35 percenr) in the three years of the postliberalisation period is seven times higher than the corresponding figure (5 percent) in the three years in the pre-liberalisation period. Table 3.9 presents percentage share of major country-sources in the total foreign investment approvals during the 1981-90 (pre-liberalisation) and 1991-97 (postliberalisation) periods. In both the periods, the U.S.A., U.K., Japan, Germany and Nonresident Indians (NRIs) constituted the major sources of foreign investment. In 1990s, however, a change in the pattern of sources is observed in the sense that the relative shares of Germany and Japan declined and Maurious and Caymon Island emerged as a major home country due to establishment of various off-shore funds in these countries to take advantages of tax haven. The increasing share of NICs like Singapore, Hong Kong and Malaysia is also an interesting feature of the new pattern. Table 3.8 Distribution of firms by foreign equity _________________________________________________________________ Range of foreign Pre-liberalisation Post-liberalisation equity (percent of period period total equity) 1988-1990 1991-1993 ___________________ __________________ Number Percent Number Percent _________________________________________________________________ Up to 25 170 27,2 445 26.4 26 - 39 100 16.0 223 13.3 40 - 49 324 51.8 421 25.0 50 - 59 12 1.9 417 24.8 60 - 74 9 1.4 50 3.0 75 - 99 3 0.5 9 5.8 100 7 1.1 30 1.8 ______________________________________________________________ Total 625 100.0 1683 100.0 _________________________________________________________________ Liberalisations of foreign investment policy facilitated technology transfer through the provision of automatic approval of technology transfers in priority areas with specified parameters (e.g. maximum limits for royalty and lump-sum payments) and the freedom given for hiring of foreign technicians. Enterprises are now free to negotiate terms and conditions of technology transfer according to their commercial judgements. This is distinctly different from the earlier regime when the terms and conditions of technologytransfer were determined by the Government using ad hoc rules and discretion, which

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allegedly led to the transfer of outdated technologies and technological stagnation of Indian industry. TNCs generally prefer “packaging” of technology transfer with equity stake and the prevalence of this practice raises the cost of technology transfer to the host country. Therefore, the exploration of transfer of technology in less packaged forms like the simple licensing agreement or outright purchase is often taken as a better option. An analysis of foreign collaborations approved in the pre liberalisation period (1988-1990) and post-liberalisation period indicates a relatively higher proportion of collaborations in the latter in all industries except energy and textiles (Table 3.10). Further, the proportion of agreements with provisions for lump-sum payment, which is partly the reflection of outright purchase of technology, is also lower in 1991-1997. Table-3.9 Geographical distribution of FDI in India : Share of home countries (per cent) _________________________________________________________________ Host country 1981-1990 1991-1997 1991-1997 Approvals Approvals Actual Flows _________________________________________________________________ United States 25.5 26.0 13.5 United Kingdom 7.1 6.7 8.2 Mauritious 0.0 5.0 13.6 Korea, Rep.of 1.2 4.7 1.3 NRIs 9.7 4.4 33.2 Japan 8.4 4.2 5.3 Israel 0.0 3.6 0.1 Germany 18.0 3.4 4.6 Cayman Island 0.0 3.0 0.1 Netherlands 1.5 2.6 3.6 Australia 0.5 2.5 0.5 France 3.5 2.3 1.9 Thailand 0.0 2.1 0.5 Canada 0.9 1.7 0.1 Italy 4.7 1.7 0.9 Singapore 0.8 1.6 2.3 Switzerland 3.2 1.5 1.7 Malaysia 0.1 1.4 0.2 Hong Kong 0.4 1.1 0.8 Saudi Arabia 0.0 1.1 0.1 Sweden 1.3 1.0 0.4 Others 13.2 20.1 7.1 ________________________________________________________________ Total 100.0 100.0 100.0 _________________________________________________________________ Table 3.10 Proportion of Foreign Collaborations in India with ‘Packaging’ (percent)

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________________________________________________________________ Industry With foreign With lump-sum equity payment _________________ _________________ 1988-90 1991-93 1988-90 1991-93 ________________________________________________________________ Energy 71.4 57.9 85.7 52.7 Chemicals 27.1 32.7 83.2 69.0 Electricals & electronics 27.5 36.1 75.2 68.0 Industrial machinery 13.9 22.6 77.7 67.9 Mechanical engineering 21.9 34.8 82.0 62.3 Machine tools 18.6 40.5 81.4 64.9 Metallurgical 12.4 38.1 85.1 72.2 Textiles 40.9 36.1 65.9 80.2 Transport 18.8 24.1 66.7 60.5 Consultancy & services 40.9 68.6 52.8 31.2 Miscellaneous 42.8 54.1 63.2 48.2 ________________________________________________________________ Total 27.2 42.2 74.0 57.6 ________________________________________________________________ It is also observed that the share of agreements with 100% export commitment is less in 1991-1997 compared with the earlier period. The commitments of buy-back arrangement and export-orientation also indicate similar pattern. On the other hand, technology agreements approved in the post-liberalisation regime have relatively larger proportion of export-restraining clauses. Inflows of foreign investment to India are likely to increase further over the next few years due to several favourable factors. First, more than 85 per cent of FDI approvals are in the core sectors like power, oil refining, food processing, chemicals and electritical equipment and the pipeline of FDI is more than US$5 billion a year. Second, India is at present under-represented in the portfolio of FIIs. With a market capitalization of US$110 billion, India’s capital market is among the largest in the world, and FIIs could own up to 30 per cent of this market. Third, Indian firms will continue to have incentives to mobilize resources abroad so long as the domestic lending rates remain above international rates. (c) Japan Japan, the United States and the European Union have been the three most important sources (referred as Triad) of FDI stocks and flows worldwide. Inward FDI flows to Japan increased from $940 million in 1986 to $4155 million in 1994. Share of manufacturing in total FDI inflows showed a declining trend, while that of non-manufacturing had an increasing trend over the period (Table 3.11). Chemicals, machinery, commerce and trade, banking and insurance, and service sectors accounted for almost 80% of cumulative FDI inflows to Japan in 1950-1994 (Table 3.12). USA and Canada are the main sources of FDI accounting for 45 percent of cumulative FDI to Japan in 1950-1994,

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followed by Europe (30 percent) and affiliates of foreign businesses in Japan (11 percent) (Table 3.13). Japanese outward FDI flows reached $57 billion in 1990 followed by some decline in 1990s (Table 3.14). Major receipients of Japanese FDI flows are USA, Asian NIEs and Asean. As regards sectoral distribution, Japanese FDI outflows are determined mainly by comparative advantages of the host countries and tend to be concentrated in non-manufacturing and export-oriented sectors. (d) Korea, Republic of Republic of Korea provides an excellent example of how a capital importing country can turn into a capital exporting country over time by sound economic management and judicious combination of both inward and outward looking policies. The sectoral distribution of inward FDI flows is also illuminating. In 1962-1995, out of total FDI inflows of $14.5 billion, manufacturing accounted for 60 percent and services the rest, but the sectoral distribution was completely reversed in 1994-95 with services accounting for 61 percent of FDI flows (Table 3.15A). Within services, emerging sectors are trade, real estate, finance and insurance as contrast to hotels and construction in eralier years. Chemicals, automobiles and electronics are the dominant areas attracting FDI in manufacturing. Distribution of FDI inflows in terms of equity ratios ( Table 3.16) indicate that 70% of FDI was on a joint venture basis and 30% was on 100 percent foreign equity. Table 3.15A Sectoral distribution of inward FDI flows to South Korea (in per cent) _______________________________________________________ Sectors 1962-1995 1994-1995 _______________________________________________________ Manufacturing 60.0 39.4 Services 39.7 60.6 Mining 0.1 0.0 Agriculture and allied 0.2 0.0 Total 100.0 100.0 _______________________________________________________ Cumulative FDI ($ billion) 14.5 3.3 _______________________________________________________ Asian economies supplied 44 percent of inward FDI flows to South Korea in 1962-1995, while they received 46 percent of outward FDI from Korea in 1991-1995 (Table 3.15B). Within Asia, China and Indonesia had been major destinations for Korean outward FDI (Table 3.17). Korea has been seeking locations for its manufacturing investment in Asia. Although much of outward FDI was linked to trade prospects, a significant share of North America in the South Korea’s outward FDI reflects its desire to gain access to advanced technology from developed countries.

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Table 3.15B Geographical distribution of inward and outward FDI of South Korea (percent) ________________________________________________________ Area Inward FDI Outward FDI ____________________ ____________________ 1994-1995 1962-1995 1968-1995 1991-1995 ________________________________________________________ America 30.5 31.1 Europe 27.2 24.6 Asia 41.9 43.9 Africa 0.0 0.1 Middle East 0.4 0.4 Oceania 0.0 0.0

35.0 30.0 14.0 16.3 40.0 46.4 3.0 2.6 5.0 3.2 3.0 1.5

Total 100.0 100.0 100.0 100.0 _________________________________________________________ Cumulative FDI 3.3 14.5 11.9 9.0 (US$ billion) ________________________________________________________ (e) Taiwan, China During 1952-1994 Taiwan attracted $19.4 billion of FDI, around 86% of which was private foreign investment from the developed industrial countries. The balance of FDI came from oversees Chinese from different locations (Table 3.18). Electronic and electrical products and chemicals were the dominant industries accounting for 38 percent of the cumulative FDI inflows. In recent years, Taiwan has liberalised its service sectors (including banking anf insurance) which attracted 30 per cent of FDI in 1952-1994. Taiwan became a major foreign investor with cumulative outward FDI flows of $8.9 billion during 1952-1994. USA and Malaysia were major destinations accounting for 28 percent and 13 percent, respectively, of cumulative outward FDI. Taiwan’s overseas investment provides an emperical evidence of the investment life cycle theory, in which an investing country initially generates the capacity to export and then turns host to foreign investment aimed at jumping the protectionist barriers. Chemicals, electronics and electric products, and banking and insurance were the major sectors accounting for 43 percent of cumulative outward FDI in 1952-1994. (f) The Philippines Manufacturing, services and financial institutions are the major sectors attracting FDI inflows to philippines (Table 3.22), while USA, Japan and Hong Kong have been the major sources of FDI (Tables 3.24 and 3.25). Asian countries accounted for 64 percent of FDI flows to Philippines in 1994. Foreign equity contribution to total equity ranged from

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41% to 53% between 1986 and 1991, but the foreign equity share dropped to 26% in 1992. There is a high degree of correlaiton between foreign equity investments and technology transfer in the Philippines. Of the top 10 countries ranked according to size of foreign direct investments in the Philippines, seven are also the leading sources of technology imports: the United States, Japan, the Republic of Korea, the United Kingdom, the Netherlands, Australia and Singapore. The energy sector received the biggest comulative foreign investments until 1995 due to the Government’s efforts to promote energy development. Of the many types of technology transfer available, those which involved the actual transfer of know-how, trademarks, and patents constituted two-thirds of collaboration contracts in 1986-1996. Majority of such technology are manufacturingrelated. (g) Myanmer Up to the end of 1995, Uk was the largest investor in Myanmer followed by Singapore and France (Table 3.26). The same trends continued in 1996. Up to August 1996, UK continued to be the largest investor in Myanmer with cumulative investments of $1 billion, closely followed by Singapore ($896 million), France ($465 million) and Thailand and Malaysia with around $450 million each. The bulk of the funds have gone to oil and gas, hotel and tourism (Table 3.25), while other manufacturing sectors failed to attract much FDI, despite the SLORC’s move in recent years to open up the economy. (h) Indo-China (Cambodia, Lao PDR, Vietnam) Vietnam, Cambodia and Lao PDR, the three South East Asian countries generally known as Indo-China, are on the road to economic transition at different paces and on different scale. All of them are reshaping their policies to attract private investment including foreign investment. Vietnam and Lao PDR have already become members of ASEAN, and Cambodia may be admitted to ASEAN very soon. Cambodia’s corporate tax rate of 9%, the lowest in the Asia-Pacific, is a very attractive feature for investment, and the rise in manufacturing output has been boosted by FDI, particularly from Asia. In Vietnam, FDI has increased from $1.8 billion in 1995 to $2.3 billion in 1996. Taiwan is the largest investor in Vietnam followed by Japan, Singapore and Hong Kong, these four countries accounting for 60% of total FDI. Laos is expected to attract more FDI as costs rise in Vietnam. The key attractions are low labour costs, relative political stability, and continued commitment to economic reform. In addition, Laos’s strategic location to the larger markets of Thailand, Vietnam, China and Myanmer is an advantage for foreign affiliates looking for a new base for manufacturing. However, Lao DPR will need to improve its infrastructure to realise its full potential as a regional hub. (i) United States Direct Investment in Asia

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US FDI outflows and related indicators in 1992 in selected Asian countries are given in Table 3.27 and certain performance parameters of the US FDI in the manufacturing sector in Asia are indicated in Table 3.28. At the end of 1992, Asia and Pacific accounted for 16 percent of the US outward FDI stock and 18 percent of the US FDI outflows. Major destinations in Asia for US outward FDI are Indonesia, Thailand, Korea and Malaysia. These countries generally generated high returns for US FDI which was also mostly trade related. 4 DIFFERENT MODES OF FOREIGN INVESTMENT AND TECHNOLOGY TRANSFER

4.1 Alternative modes of capital transfer Empirical evidence indicates that private capital contributed more to economic growth of the Asian developing countries than official aid, the relative importance of which in total resource inflows declined since 1980s. There was also a change in the structure of private flows. Until 1983, bank lending was the major mode of foreign private flow to the Asian developing countries. Subsequently, the relative significance of bank lending has declined and that of other modalities has increased. The share of foreign direct investment has increased the most followed by bond lending and foreign portfolio investment. The major alternatives to syndicated bank lending are discussed below; (a) Bond Lending This type of lending has flourished in recent years. International bond markets have two components: Eurobond and foreign bond markets. Eurobonds are underwritten by an international group of banks and are issued in several different national markets simultaneously. They are not subject to formal controls. Foreign bond markets are simply domestic bond markets to which foreign borrowers are permitted access. (b) Financing through New Instruments In recent years a plethora of new instruments and modalities has emerged in the international financial system. Most of these are hybrid instruments between bonds and bank lending. Some seek to achieve continued access to bank lending (such as noteissuance facilities and transferable loan instruments), and others seek to expand the use of international capital markets (such as floating rate notes). New modalities for conducting international financial intermediation (such as interest and exchange rate swaps and options and networks such as CHIPS and GLOBEX) have also emerged. (c) Foreign Direct Investment

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This is the traditional alternative to sovereign borrowing and entitles the investor to a share of the distributed profits of the firm. The parent firm is typically motivated by the return it expects to earn by making use of its existing know-how in a local operation and/or by incorporating the local operation in its global production and marketing network. (d) Foreign Portfolio Investment in Equities Like FDI, foreign portfolio investment in equity entitles the investor to a share in the profits of a private enterprise. Unlike the direct investor, however, the equity investor typically seeks only a share of profits and not the responsibilities of control. Indeed, many equity investors deliberately restrict their holdings to a small percentage of the total stock in order to maintain liquidity and avoid being forced to take responsibility. Portfolio equity investment involves varying degrees of penetration of the domestic economy. The least penetrating mode, popular in many developing countries, is the offshore investment trust that is invested in a broadly diversified portfolio of domestic shares. Other more penetrating modes involve investments in individual shares, either through offshore listings of developing country firms or purchases of locally listed shares. (e) Foreign Quasi-Equity Investments A foreign quasi-equity investment opens the package of a risk-sharing and managerial control. These new forms of inter-national investment include joint ventures, licensing agreements, franchising, management contracts, turnkey contracts, production sharing and international subcontracting. While bond lending and lending through new instruments together with syndicated bank lending are forms of general obligation finance in the sense that the lender provides money to be repaid on terms independent of the success of investment made with the funds, financing by other alternatives (i.e., FDI, foreign portfolio investment and foreign quasi-equity investment) involves risk-sharing and responsibility sharing. For example, under FDI an investor is entitled to a share of the distributed profits of a firm and an investor also shares in the responsibility of managing the firm. Portfolio investment is similar, except that it does not encompass sharing management responsibility. Using criteria developed by Lessard (1989), the five alternatives to bank lending can be assessed in terms of expected cost, degree of risk-sharing or lending, and degree of managerial participation in the project financed (Table 4.1). The major advantages of foreign direct investment, foreign portfolio investment and foreign quasi-equity investment are that they involve risk-sharing, sharing of managerial responsibilities and the promotion of a more efficient use of resources. Foreign portfolio investment, in addition, has a favourable impact on local capital markets. The disadvantages are that there might be misuse of control and that foreign direct investment might introduce inappropriate technology. Table-4.1 : Alternatives to Bank Lending _________________________________________________________________ Modes of

Expected

Risk-

Managerial

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capital transfer Cost Sharing Participation _________________________________________________________________ Bond Lending

Low

Lending through New Instruments Foreign Direct Investment Foreign Portfolio Investment

Low

High Medium

Low

Low

Low

Low

Medium High

High Medium

Foreign Quasi-Equity Medium High Medium Investment _________________________________________________________________ 4.2 Cross Border Mergers and Acquisitions (M & A) The recent surge in global FDI has been fueled by the cross-border Mergers and Acquisitions (M&As) in industrial economies. Mergers and acquisitions are a popular mode of investment for firms wishing to protect, consolidate and improve their global competitive positions, by selling off divisions that fall outside the scope of their core competence and acquiring strategic assets that enhance their competitiveness. The main cross-border M&A trends are: (a) The total value of cross-border M&As (including both minority and majority crossborder M&As and related joint ventures) doubled in 1988-1995 and reached $229 billion in 1995. (b) Western Europe had the highest level of cross-border M&As ofall regions. Japanese cross-border M&As increased three-fond in 1995, reflecting a shift from a traditional preference for greenfield investment. (c) Most large-scale cross-border M&As have taken place in the energy distribution, telecommunications, pharmaceuticals and financial services industries. As a result of ongoing liberalisation, the value of service-related M&As increased by 146% between 1993 and 1995. The value of cross border M&As in banking and finance tripled in 1995 to reach $100 billion. (d) Small and medium-sized firms played a significant role in the growth of acrossborder M&As in electronics, business services, personal services,healthcare,distribution, construction and engineering industries.

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(e) About one tenth of world-wide M&A sales took place in developing countries due to growing availability and attrativeness of firms in Asia and privatisation programmes in Central and Eastern Europe. 4.3 Modes of Foreign Portfolio Investment Foreign portfolio investment in the emerging markets can be channelled through three main mechanisms: direct purchases on local stock markets, country or regional funds; and issues of depository receipts on foreign stock exchanges by the domestic companies. The size of direct purchases in local markets depends on market developments that facilitate and encourage such trading. In recent years, the opening of the local brokerage and investment banking business to foreigners has facilitated such purchases. Developing countries have also enhanced the limits of foreign equity which can be held by the foreign institutional invetors (FIIs). In India FIIs and non-resident Indians are permitted to hold up to 30 percent of total paid up capital of any listed or unlisted companies. Country or regional funds, which can be open - or closed-end, provide foreign investors with the advantages related to mutual funds. They can mobilise large resources for effective portfolio diversification and offer specialised knowledge regarding firms, markets and economies. Whereas open-end funds are brought and sold from the fund managers at the same value as in originating markets, the closed-end funds have priced on the exchange where they are traded. Typically, closed-end funds are traded with a premium or a discount over their net asset values. The premiums and discounts also fluctuate over time for a given fund. The investors thus face two sources of risk and return; the first is associated with net-asset value movements and the second is related to shifts in the discsount or premium. At the end of 1992, there were about 589 open- and closed-end country funds in operation in the emerging markets, with over $35.5 billion in net assets under management. In recent years, the public offerings and listing of the emerging markets equity on foreign markets through global depository receipts (GDRs) and American depository receipts (ADRs) increased due to relaxations in regulatory requirements and reduced costs. Since 1991, issues of depository receipts on international capital markets dominated other forms of FPEI. For foreign investors, ADRs and GDRs present the advantage of conformity to standards of developed stock markets. Moreover, ADRs allow United States institutional investors to purchase non-US securities. For companies from developing countries, depository receipts facilitate access to international capital markets, at lower cost of capital and heightened visibility. This alternataive also involves lower monitoring costs and smaller concern over foreign control as compared to direct purchases by foreigners on local stock markets. 4.4 Modes and Sources of Technology Transfer There are various channels of technology transfer and adaption. These include foreign direct investment, joint ventures, licensing, Original Equipment Manufacture (OEM), Own-design and manufacture (ODM), sub-contracting, imports of capital goods,

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franchising, management contracts, marketing contract, technical service contract, turnkey contracts, international sub contracting, informal means (overseas training, hiring of experts, returnees), overseas acquisitions or equity investments, strategic partnership or alliances for technology. Other modes of technology acquisition include minority interest in firms with R & D programmes, contracts for R&D to other companies and research institutes, grants consortia, bilateral cooperative technology agreements, buying technology embedded in products, material sub-asembly or processes. Out of the several modes of technology transfer, the three most popular among the developing countries are: licensing, joint ventures and foreign direct investment. A review of the last three decades of transfer of technology flows to the developing countries reveals that till 1970s licensing and joint equity ventures were the most preferred modes. There are quite a few reasons for this preference, namely (i) following the import substituting industrialisation pattern and having limited foreign exchange availability, these countries preferred licensing arrangements where they could negotitate know-how and/or patent i.e. one or two technology elements rather than all elements of technology in a packaged form; (ii) joint equity participation was preferred to participate in management and to ensure domestic benefits in terms of employment and profit sharing; (iii) 100 percent foreign direct investment was not considered as channel of technology transfer since it was an intrafirm transfer and the host country cannot retransfer it to any other firm, and lastly (iv) foreign direct investment was invariably by the multinational corporations, who were discouraged in developing countries for a variety of social and economic reasons until the middle of 1980s. These points of view had undergone drastic changes since the middle of 1980s when the Asian NIC’s became export oriented. It was realised that it is not sufficient to acquire process know-how or product design. One also needs to transfer the experience of costefficient production organisation, management and marketing capabilities to ensure survival in international competitive markets. Large multinationals and transnationals companies possess a number of technological and synergistic advantages viz. (a) ownership of industrial property rights, such as patents, trade marks and brandnames; (b) accumulated experience in organisation and management (unpatented know-how); (c) product differentiation, promotion and distribution; (d) vertical and horizontal integration of production; (e) large size and economies of scale in both host country and global operation; (f) diversification of product and activity lines and (g) opportunities to internationlise capital markets. FDI or joint ventures ought to be preferred as these bring all these technological and international advantages in production. The second reason for preference to FDI or joint venturewith MNCs/TNCs is the need to obtain efficient technology,. Here again, South Korea provides a good example, where initially Japan was the prime investor in the low technology and labour intensive areas like textiles, hotels and tourism. These were supplemented by high technology sectors like electronic, fertilizers, oil and petrochemicals from the USA. This strategy helped Korea to increase its exports earnings.

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The third reason favouring FDI or joint venture with TNCs/MNCs is the trend for regionalisation and globalisation with the view to improve upon economies of scale and take advantage of specialised skills across countries. There is a growing trend to network and form joint ventures such that different stages of production are carried out in different countries. There is also the need to merge and become competitive vis-a-vis larger MNCs position. Pooling of R&D resources being another reason for a group of large companies joining hands. Another reason for shift in FDI through MNCs is the emergence of new technologies like computer software, CNC machinery and new materials. All of these technologies are easily available with the firms in advanced countries and cannot be obtained through convensional licensing. A survey of companies operating in India carried out by the Indian Council for Research in International Economic Relations (ICRIER 1994) comes out clearly in support of joint ventures as a preferred mode of technololgy transfer with large foreign companies. The current Indian Industry’s tendency for joining hands with the well known MNCs and also turning to the top 500 companies appearing in the Fortune List is a confirmatory revealed preference. Another Survey on foreign investors in Korea carried out by the ICRIER (1994) revealed four key benefits, viz., increased capital formation, increased employment, increased value added (6 percent of GNP and 20 per cent of total value added in manufacturing) and net increase in exports. The successful modes of technology transfer depend upon each country’s technological needs,capabilities and market conditions. For example, in the early years of industrialisation, Japan acquired technological capabilities mainly through licensing, turnkey projects and reverse engineering of imported goods supported by overseas onthe-job training and study of foreign technical literature. In the case of South Korea, turkey plants and machinery imports were the most important modes of technology transfer, while licensing agreements and foreign direct investment played a minor role. For countries such as Singapore and Thailand, FDI appears to have played a more important role than other modes of technology transfer. India and Indonesia have relied more on licensing and technical agreements than other countries. Only recently they have started encouraging FDI flows and automatic transfer of associated technology. Embodied technology transfer through capital goods imports will be the most important source of technology and the cheapest way of technology acquisition for any Asian developing country. Japan initially acquired foreign technologies by reversing the engineering process, that is, disassembling and reassembling imported machinery. This mode of technology acquisition, of course, requires established engineering capabilities. Licensing agreements are the most effective way to suit local needs and conditions. However, this mode of technology transfer is costly and involves a process that is more complex and time consuming than other modes. Turnkey projects are the easiest way to establish new factories, but rarely transfer needed technologies unless the recipient makes conscious efforts to acquire them. FDI, however, plays a more important role than directly transferring needed technology and capital. This is the role to stimulate local firms in technology acquisition and

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improvement through competition. The Republic of Korea’s experience indicates that the technological level of joint ventures are initially higher than that of local firms but the rate of technological improvement oflocal firms is generally higher than the joint ventures,due mainly to the aggressive management strategy of the former to catch up with and compete with the latter in the domestic as well as international markets. Source of technology acquisition is as important as the mode of technology transfer. Japanese technologies are more suitable to the needs and conditions of Southest Asian countries because they are less capital intensive, smaller in scale and easier to assimilate than technologies from the United States and European countries. It is still controversial whether FDI from the United States is more capital intensive than that of Japan, but it is true that many Asian developing countries have been adopting the Japanese style of management which definitely influences the sources of technology acquisition. It should also be noted that the modification of technology is a costly and risky venture. Thus, many Asian developing countries tend to adopt advanced foreign technologies without any effort to modify them to fit in with the local needs. At the same time, technology suppliers have no interest in modifying their technologies to match local conditions. Instead, these suppliers quite often impose restrictive clauses. 4.5 Technology Transfer and Adaption : East Asian Experience At the beginning the East Asians specialised in simple assembly skills and developed production capabilities for churning out standardised products. Over time, they moved to improve upon quality and the speed of operation. An interesting feature of technology absorption at this stage was what is known as “reverse engineering of products”. The engineers and technicians began with the end-product and worked back to find the components, their inter-relationships, and the technologies. This way they upgraded their own technological awareness and capabilities without much risk. Ultimately, research and development (R&D) came to ococupy an increasing share of their investment, R & D became increasingly linked with the assessment of long term marketing needs, capabilities for innovation and product design developed and new products were launched. This full process took a considerable time to be completed, with inter-country variations in experiences. This evolution of technological competence and capability was associated with various successive stages of market development. In the early stages, cheapter labour was deployed for assembling and then selling to buyers for distribution. With reverse engineering, there was a move towards higher quality production in response to foreign buyers’ demand. As production skills and design capacities developed, companies tried to popularise their own brands by undertaking a vigorous sales campaign. In the last stage, emphasis was on direct marketing through their own independent channels and wide advertising and in-house market research.

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Out of the several modes of technology transfer as discussed in section 5.4, Original Equipment Manufacture (OEM) and Own - Design and Manufacture (ODM) played a major role in East Asian economies in technology adaption and upgradation, eventually leading to independent designing and development. OEM, a specific form of subcontracting, evolved out of the joint operations of foreign buyers and East Asian suppliers and become the most important channel for export marketing in the 1980s. Under OEM, the local enterprises produced largely under the technical guidance of foreign partners who were involved in the selection of capital equipments and in the training of managers and technicians. ODM was a stage forward, under which the local supplier did everything according to a general design layout supplied by the buyer, and the goods were sold under the latter’s brand name. South Korea’s electronic industry provides an interesting example of technological development under different stages. It began with the production of transistor radios in 1958, under the domination of multinational corporations. In the 1960s the major players included Motorola, Signatics and Fairchild. Even in 1972, eight foreign firms accounted for 54% of electronic exports from South Korea. The foreign firms were not interested in transferring technology and imported most of their inputs. In the next phase, joint ventures with Japanese firms, e.g., Samsung-sanyo, Toshiba-Goldstar, became more common and accounted for 15% of foreign participation in the 1970s. OEM supplemented joint ventures and opened up new areas of production, particularly in computers, consumer electronics and microwave ovens. Under this arrangement the foreign buyers supplied key components, material design and capital goods, and captured most of the post-manufacture value added, and sold those under their own brand names. OEM accounted for 60 to 70% of electronic exports. In the 1980s the chaebols took off and sought more independence from their patrons. First, there was a switch from OEM to ODM. In the next stage, their marketing strategy was to rely more on their own brand names. This strategy worked well and by the early 1990s several of them established themselves as leading firms in the global market, occupying fifth (Samsung), 12th (Goldstar-Electron) and 13th position (Hyundai) in DRAM (dynamic random access memories) production, with aggregate exports amounting to $106 billion in 1992. 4.6 Linkages, Spillovers and Market Access by Transnational Companies (TNCs) Transnational corporations, while securing and strengthening their access to markets through international production, can exert a powerful influence on market opportunities for other firms in host or home economies. These effects take place through the backward and forward linkages of TNC systems in production and distribution, through spillovers and externalities related to market access, and through the provision of distribution and marketing services by transnational trading corporations to domestic firms in home or host countries.

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Besides their linkages with customers, sourcing from suppliers is the most important linkage established by TNCs with enterprises outside their own organisational structures. One common mode of such relationships is subcontracting, which affords suppliers the benefits of state-of-the-art logistics, marketing and distribution, and often, of specifications, designs and training provided by TNCs which they supply. Established suppliers of TNCs may in turn become managers of a second and third tier of subcontractors, while retaining responsibility in terms of price, quality and delivery schedule vis-a-vis a client. These networks open up markets and export opportunities for large numbers of small and medium-sized firms. Much of this sourcing is from producers in the domestic economies of home and host countries. Local suppliers account for the majority of purchased inputs of both parent firms and foreign affiliates in United States TNC systems. In the case of Japanese TNCs, parent firms rely much more on local sourcing than do foreign affiliates. Furthermore, during 1989 and 1992, while Japanese parent firms reliance on imports slightly decreased, their imports from Asia increased. Component supply through subcontracting relations with foreign affiliates has created a major niche for domestic component producers in several host developing countries to enter the vertically integrated production chains of TNCs geared to export markets. In Mexico, for example, 59 per cent of a sample of 63 manufacturing affiliates surveyed in 1990 subcontracted nationally. Subcontracting in this sample of firms was concentrated mainly among foreign affiliates in technology-intensive and export-oriented industries, notably the automotive, computer, electrical and electronic and chemical (excluding pharmaceuticals) industries. Assistance provided by foreign affiliates to subcontractors, included technical, administrative and financial assistance, as well as training in quality control, the last by 87 per cent of affiliates surveyed. Similarly, in South-East and East Asia, networks of local producers (mainly joint ventures with TNCs) have been established for component-supply to automobile and electronics TNCs, with specialisation among plants in different countries to supply the regional market. In the automobile industry, these networks mainly belong to Japanese TNCs; all major Japanese automobile TNCs source automobile parts through their foreign affiliates and their local subcontractors, taking advantage of ASEAN regioinal cooperation provisions. In the electronics industry, such networks have been established by United States as well as Japanese TNCs, beginning with labour-intensive operations and moving towards increasingly sophisticated networks of operations with much cross-hauling of products across national boundaries (Graham and Anzai, 1994). Subcontracting arrangements are common for consumer goods such as consumer electronics, footwear, furniture, garments, houseware and toys. They carry the same advantages for the subcontractors as those mentioned earlier for component suppliers: production is generally carried out by locally-owned producers, while the specifications are supplied by brand name TNCs or large retailers that design the products, provide technical assistance and manage marketing and distribution. Subcontracting relationships are also often structured in tiers, with established primary suppliers retaining the

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responsibility for price, qyality and delivery, while managing lower tiers of supply. These networks open up market and export opportunities for many small and mediumsized firms. Linkages of suppliers with TNCs may take forms other than subcontracting and sales through transnational trading companies. One popular form is original equipment manufacturing , in which producers manufactaure finished products that are sold under another company’s brand name, but not, as in subcontracting, under contract with a commitment by the client to buy, or with the assistance and support of the client in production. These arrangements, like subcontracting, strengthen the competitiveness of manufactaurers by providing them access to markets, but only when the manufacturers already possess the capabilities to meet buyers’ quality, price and delivery conditions. For example, Japanese TNCs in the electronics industry rely heavily on original equipment manufacturers. In some developing countries, original equipment manufacturing has provided a useful export niche for small and medium-sized firms. Firms in East and South-East Asia in particular have made wide use of it. Non-equity arrangements under which producers outside a TNC system acquire from a TNC the right to produce and market a product in return for a royalty or a fee are a acommon mode of internationalisation of production by TNCs. Licensing arrangements are frequently used for transferring technology to firms outside the system, but they are also widely used for the marketing or distribution of the licensor’s products or the use of its proprietary assets, including trade marks or brand names. Licensing and other nonequity modes of participation (including franchising, which is especially common in services) carry advantages as a means of market access when FDI is not permitted, involves high risks, or is not sufficiently profitable and cross-border trade less attractive due to transport cost, perishability of products or other factors. 4.7 Acquisition of Technologies by SMIs The SMIs in the Asian region have been found weak in technology acquisition and adaptation. They have been also found to rely on their own experience or the assistance of machinery producers for their technology. Even in the labour-intensive industries, access to the most efficient technologies is an esential element. An important conduit of technology transfer in Japan has been sub-contracting route. Large firms that subcontracted the production of parts and components of SMIs saw to it that standards were maintained. The New Delhi Declaration on Strengthening Regional Economic Cooperation adopted by the Economic and Social Commission for Asia and the Pacific (ESCAP) at its fiftieth session held in April 1994 identified technology transfer as an effective means to achieve the specific purpose of raising the standars of living of the people in Asia-Pacific developing countries and sustaining the dynamism of the region. As firms, both local and external have emerged as the central actors in technology transactions, their technological capabilities have a considerable influence on the whole spectrum of technologies used

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over time. Equally, technology transfers can contribute to the enhancement of the technological development of local firms and SMIs. Technology transfer arrangements may include two broad flows of technology. The first is a combination of the flows of capital goods, operation know-how, maintenance and repair, etc. which are usually incorporated into a new unit. The second constitutes the broad type of flows, which contribute to the technological capability of the importing firm. This type consists of system-related knowledge, various kinds of skills, experience, technical and managerial knowledge that are required for controlling, modifying and improving the system over time. The existing technology climate of a country can be further improved through technology transfer and, in particular, foreign direct investment (FDI) consisting of a package combining capital, technology and access to international markets and their contributions to economic growth and, more especially, the enhancement of endogenous technological capabilities. Ultimately, an effective way to achieve sustainable industrial development in developing countries is to allow them to improve the technologies they imported and in the long run to create their own technologies relevant to their problems. Therefore, there is a need for technological infrastructure development including R&D institutions with links to the production sector, standardisation and quality control and industrial engineering design and consultancy service organisations, technology information patent office,intellectual property rights regime mechanisms, technological education and training institutions, and an appropriate policy-mix, etc. In order to provide the countries of the region, and particulary their SMIs, with quality information on environmentally sound technology opportunities, the ESCAP secretariat through the Asian and Pacific Centre for Transfer of Technology (APCTT) has been implementing a project entitled Mechanism for Exchange of Technology Information (METI). 5 FOREIGN INVESTMENT AND TECHNOLOGICAL TRANSFER, AND ADVANCES IN NEW TECHNOLOGY 5.1 Indicators of Technological Capability Determinants of a country’s economic growth can be decomposed into three components, viz., diffusion of technology from abroad (imitation effect), creation of new technology within the country (innovation) and developing the country’s own capacity for exploiting the benefits offered by available technology. Countries which are at or near the technological frontier grow mostly by generating innovations, while the technology followers benefit by imitation or through the diffusion of technology.

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Manufactured goods reflect greater technological content compared to nonmanufactured goods. The share of manufactured value added in GDP shows the extent to which a country has moved away from agriculture and allied activities and has moved up on the ladder of industrialisation. As the technological capability grows, a country is able to produce more capital goods, the share of machinery increases in the capital goods sector, and the value of consumer goods imports decreases relative to the imports of capital goods. As countries move from technologically under-developed to becoming technologically developed, some of them start exporting consumer goods. Some others even export the standard-modern type of technology. Mostly, countries which have encourgaged exports have been able to stay in the race of technology. Exception to this is (a) Japan, whose strategic protectionist policies did not come in the way of its immense technological capabilities; and (b) India, where the opposite is claimed. The inward looking policies have made India develop its technical base, but at an enormous cost due to wasteful and duplicative R&D in India. The share of exports in GDP is highly correlated with the technological capabilities of a country. A large share of exports in GDP in countries like Hong Kong, Singapore, South Korea, Taiwan and more recently in Malaysia, Indonesia and Thailand goes hand in hand with the presence of a technologically oriented industrial structure. But, these countries have not scaled similar heights on the ladder of technological capability. South Korea and Taiwan have achieved a higher level of technological abilities than the other countries. The volume of expenditure on research and development is another determinant of the creation of technological capability. The fast growing technologies have high research and development expenditures. In fields such as computers, micro electronics and robotics, the ratio of research and development expenditures to sales surpasses that in mature industries like metal extraction. 5.2 Pattern of Industrialisation and Technology Development in Selected Asian Economies In 1990s the small enterprises accounted for 90 percent of enterprises and 60 percent of export value in Taiwan. While most of the large firms were state-owned, the government relied on the small private sector units for the growth of the electronics industry which was the most modern and dynamic among them. In 1990, Taiwan was the seventh largest computer goods manufacturer in the world and worked with 700 hardwdare manufacturers and 300 software manufacturers, accounting for 83% of the “motherboards” and the largest number of mouses, monitors, image scanners and keyboards produced in the world. Taiwan’s success in electronics relied on the speed, skill and agility of hundreds of local entrepreneurs, rather than the scale and financial power of the chaebol. Local firms overtook TNCs in domestic production in the 1980s, but foreign firms provided technologhy through joint ventures in electronics, as also in bicycles and footwear.

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In contrast, in South Korea, large corporate giants, chaebols, emerged and took over control with state support. The combined sales of the top ten chaebols increased from one-third of GNP in 1980 to two-thirds of GNP in 1994. Chaebols were the major vertically integrated business houses of South Korea, each with 15-20 affiliated units, competed with each other, but colluded to keep foreign investors at bay. They borrowed at home and abroad, brought high technology, diversified the industries and gave South Korean industrialisation a certain continuity. Hyundai, Samsung and Daewoo are the leading Chaebol groups that have spread their network throughout the world. East Asian countries started with textiles, household appliances and other labourintensive light industries. In the second stage, they moved to capital and knowledge intensive industries such as steel, shipbuilding, petrochemicals and synthetic rubber, to provide basis for further industrialisation by way of forward linkages. Another pattern, known as the “flying geese model” first developed by A.Kaname in the 1930s and then by K.Akamatsu in 1956, postulates that Japan, the leader in industrialisation and technological development in Asia, relocated its production facilities to East Asia as its wages and other costs increased. Later, as the Plaza Accord of 1985 and the Louvre Accord of 1986 were signed by the G7 countries to rectify US trade imbalances, and the exchange rate of Yen further appreciated vis-a-vis dollar, Japan further relocated production to low wage economies in order to retain its market share. Thailand benefited from this and became a production base for Japan, receiving raw materials and equipment and then producing finished goods for export to Japan and other countries. Further, as US consumers turned to imports from NICs such as Taiwan and Korea, the US pressure came on the latter to adjust and strengthen their currencies, which forced them too to invest more in low wage foreign countries, including Thailand. This progression from Japan to East Asia and then to Southeast Asia, took on the form of an inverted “V”, as the economies of Pacific Asia began to fly together led by Japan. During 1986-88 the overall Japanese investment exceeded the cumulative value of FDI in previous three and half decades, and while most of it went to North America and other developed countries a significant share went to East Asia. Because of its closest geographical, cultural and educational proximity to Japan, the Republic of Korea imported most of its technologies from Japan. Japan took the lion’s share (51.7 per cent) of technology transfer to the Republic of Korea followed by the United States (24.9 per cent), Federal Republic of Germany (5.6 per cent) and France (4.5 per cent) in 1982-1987. As in Japan, the case of the Korean automobile industry is a classical example of the infant industry development which was well-staged, financed and promoted until the industry attained international competitiveness. All technology acquisitions and adaptation by Korea were also carefully selected and sequenced. As regards technology, Thailand pursued laiseez faire policy until recently. Firms were free to import almost any kind of technology, although technology importers had to take the approval of the Bank of Thailand for foreign exchange remittances. The liberal technology policy contributed to the rapid industrialisation of Thailand through the exploitation of its comparative advantage. Foreign investment through joint ventures had

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been a major type of Thailand’s technology acquisition and Japan had been the most important technology supplier to Thailand followed by the United States. Since its Fifth National Social and Economic Development Plan (1982-1986), Thailand shifted from laissez faire imported technology policies to the development of indigenous technologies. 5.3 Industrial technology development in selected Asian economies There are basically two sources of industrial technology -indigenous or local technology and imported or transferred technology. The Asian developing countries, particularly the newly industrialising economies (NIEs), have heavily depended upon the latter because imported technologies are not only cheap and easy to acquire but also risk-free, tested and standardised. India’s industrial technology level is relatively much higher than the level indicated by its per capita income because of its technology accumulation in capital goods and chemical industries, its strategy of promoting heavy industries since 1955 and adopting import substituting industrialisation until 1980s. The share of machinery, transport equipment and chemical industries in the value added of the manufacturing sector is quite high in India (lower than that in only three cointries viz. Taiwan, Malaysia and Japan). The Asian NIEs adopted a strategy of export-oriented industrialisation which made use of relatively cheap labor to compete in the international market. Consequently, the NIEs started importing relatively labor-intensive and simple technologies. The Republic of Korea used to produce and export low technology products such as radios and black and white television sets in the 1960s. As these labor-intensive technologies matured and the capital-labor ratio rose, the country shifted to more advanced technology products such as colored televisions, tape recorders and amplifiers in the 1970s and VCRs and computers in the 1980s. On the other hand, Indonesia and India initially adopted import-substituting industrialisation through various protective and incentive measures for domestic industries. Machines, equipment, parts and components, required by import-substituting industries, which were basically labor-saving or capital intensive, were imported from the developed countries under a system of licences and fiscal and monetary incentives. However, since 1980s, technology imports were liberalised to some extent by many developing countries including India. An important factor in East Asia’s successful productivity-based catching up was openness to foreign ideas and technology. Governments encouraged improvements in technological performance by keeping several channels of international technology transfer open at all times. In contrast to most economies with import-substituting industrialisaiton strategies, even when protection was practiced with respect to the domestic market, the search for and absorption of foreign technology was encouraged. While Japan and Korea set obstacles to FDI, they were hospitable to licensing. Singapore

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always welcomed FDI and a major task of the economic planning agency was to locate appropriate foreign investors. Malaysia has aggressively sought export-oriented FDI, particularly from Japan. In contrast, many other developing economies were suspicious of open policies with respect to knowledge acquisition. Suspicion of external trade was often reflected in a mistrust of FDI and licensing. Even where FDI was permitted in inward-oriented economies, it was not viewed as providing access to modern technology but rather as a source of additional domestic producion. The basic difference between these economies and Singapore, which was more heavily dependent on FDI, is that the multinational corporations locating in the latter could only do so to export, given the small internal market. Korea and Taiwan with larger domestic markets created a similar situation by encouraging FDI for export and other sectors which required substantial technology transfer. A study made by Lall (1993) concludes that the promotion of technological capabilities (TC) is a vital part of the strategy of industrial development. Technological capabilities include the skills - technical, managerial and institutional - which are necessary for productive enterprises to utilize equipment and technical knowledge more efficiently. It also suggests that, in the presence of market failures, active government involvement is required to ensure capability development. This involvement must be based first on the removal of irrational and inefficient interventions. It then has to address several determinants of TC activity: the incentive framework, the supply of human capital, the supporting infrastructure, finance for ITD, and access to foreign technologies. The best incentive framework for ITD is to provide constant competition to enterprises in a stable macroeconomic environment. Full exposure to world competition may, however, have to be tempered by the fact that a new entrant has to incur the costs and risks of gaining technological knowledge and experience, when its competitors in more advanced countries have already gone through the learning process. This may be a case for temporaty and limited infant industry protection. But, it has to be carefully designed, sparingly granted, strictly monitored, and offset by measures to force firms to aim for world standards. The supply of human capital, technical support services, foreign technology, S&T infrastructure and finance can suffer from market failures. They therefore require government intervention and policy support, and their most effective use calls for selectivity and coherence. Much of ITD support work must focus on market friendly or functional interventions to strengthen the infrastructure, improve its relations with enterprises, help small and medium-sized firms with their special information and support needs, augment the supply of finance for technology investments, and build up requisite skill needs for efficient industrial operations and growth. However, there does not exist any universal strategy for ITD, and an optimal mix of policies for a country depends on its stage of development, factor endowments, product-mix and relevant supporting institutions.

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The Repoublic of Korea has been transferring self-developed technologies in the areas of pulp, paper manufacturing, electricity, electronics and machinery as Korean technologies are considered to be more fitted to less-developed countries than those of developed countries in terms of cost and factor intensity. Labour-intensive standardised technologies, which became an engine of the Korean export drive, have already reached maturity. These technologies could be easily imported, adapted, disseminated and marketed. The country is now entering a higher technology stage which requires more costly R&D activities with higher risk than before for the development of better products. As far as technology acquisition and assimilation are concerned, developing countries can learn much from the Korean experiences. The Korean lessons indicate that technology can be upgraded only through conscious and steady efforts to improve available technologies, and that the most effective way to achieve such constant progress is through interaction with a competitive market. The Korean experience also indicates that technologies are best learnt by workers in the workplace. 5.4 New Technology and Applications A set of technology collectively referred to as New technology is a single most profound source of technological progress of both of advanced and developing economies, rapid globalisation and shifts in global trade. The term refers to innovative development in electronics relating to informatics, computer hardware, software, telecommunication, bio-technology and new materials. To this can be added emerging technologies namely renewable energy technologies like photovoltaic, remote sensing, super conductivity and photonics. New technologies are knowledge intensive in contrast to conventional capital intensive technologies. Moreover, new technologies are process technologies rather than product technology. Therefore, they are not only scale free but also have a very wide range of applications. Countries like Korea, China and India stand to gain substantially by revitalising their economies to become internationally competitive not only in new technologies but also in many other industries with the use of time and material saving production processes like CNC/CAD/CAM integrated manufacturing, flexible manufacturing systems, just in time production systems etc. Likewise, the bio-technology has a wide range of application ranging from food processing, pharmaceuticals, chemicals, agriculture and allied sectors, mining, soil fertility etc. As for new materials, the sectoral range is even wider and includes material industry, energy, automobile, semi-conductor, communications, precision machinery, air-craft/ space, medical equipment/ instruments and life technology product like heart valvle and other synthetic human body parts. New technologies help to develop new manufacturing location. The conventional need to look for resource base or cheap labour is no longer required. A. Micro-Electronics and Information Technologies:

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With the incorporation of micro-electronics, which permits programming of user’s instructions, monitoring usage-variables, controlling the process and projecting the status of operation - the products have become highly sophisticated and user-friendly without much additional cost. It is not surprising, therefore, that micro-electronics has entered practically every sphere of daily life. Micro-electronics has entered domestic and personal use appliances. It is being used extensively in health care and education. It has already transformed the entertainment scenario. Transportation, Banking and Publishing sectors see ever increasing use of micro-electronics in their operations. Even agriculture and retain services are beginning to use micro-electronics in a substantial way. Perhaps, the most dramatic and immediate application of micro-electronics has been in the field of manufacturing industry where the application of automted programmable tools: numerically controlled machines, robotics, flexible manufacturing systems and computer integrated manufacturing have revolutionised the very basis of production. B. Biotechnologies: Except for a few of the more dynamic economies which have made impressive industrial development gains, several economies in the Asia-Pacific Region continue to remain technologically backward with 650-700 million people suffering from diseases, malnutrition and poverty. Biotechnology assumes significance in terms of the opportunities it offers for improved utilisation of microbes, animals and plants for improving the food, energy and health care needs in the region. Biotechnology is a multi-disciplinary subject combining micro biology, biochemistry, chemical engineering and chemical technology. It can also be clasified as microbial biotechnology, plant biotechnology and animal biotechnology etc. based on the kind of biological agent involved. Biotechnology includes the recombinant DNA technology, protoplastfusion, hybridoma, cell culture, tssue culture, germplasm development, embryo transfer technology, and immobilisation of cell and cellular products. It has immense potential for use in agricultuire, forestry, horticulture, medicine, nuclear medicine, bonegrowth, artificial limbs transplant and replacement, health, chemical industry, food industry, pollution control and environment. Industrial applications of biotechnology are in the area of production of fine chemicals from agricultural wastes through microbial processes, plant cells, animal cells, production of antibiotics, vitamins, aminoacids, steriods, biofuels and preservation of industrial products. Another important area of application of biotechnology is in protection of environment. Bio-degradation of man-made chemicals, plastics, polymers and synthetic materials, management of hazardous wastes, promotion of sewage and industrial effluents, cleaning of oil spills through bacteria, enhancement of oil recovery, biogas generation from wastes, control of air pollution, biomass production and use of biosensors for environmental monitoring are some of the more prominent applications. As far as the status of biotechnology industry in the region is concerned, the Republic of Korea, Singapore, Taiwan Province of China and Thailand show a comparatively stronger

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market driven orientation and considerable efforts behind biotechnology development. Their industrial policies are more specifically focussed on biotechnologies including supply of credit, risk capital and support for training and process/product development. In India, major effort has been in the creation of an R&D base and manpower training and the development and application of new technologies. China has given actrive support of biotechnology development and has developed a substantial biotechnology industry which grew from almost scrach to $22 million by 1988. In Sri Lanka, traditional biotechnology applications include the production of fermented foods, beer and alcohol but recent activities are growing in the areas of tissue culture, bio-fertilizers and biological waste treatment. C. Advanced Materials Technology Materials figure extensively as an enabling parameter for modern technologies in almost all sectors like heavy engineering, transportation, aerospace, power generation, micro-electronics and bio-engineering. In all these sectors, technological progress is aided by the continuous development of critical materials with improved performance capabilities. The shaping of these materials in the form of components or devices under production conditions calls for development of new, expensive and complicated processing methods. A variety of basic materials, like metals, inter-metallics, polymers, ceramics and glasses, and their combinations in the form of alloys, blends and composites and the related processing and manufacturing techniques are being developed at a rapid speed. Diverse new materials are emerging as substitutes for and enabling conservation of fast depleting materials e.g. plastics in place of wood packaging, composites in place of conventional structural materials and optical fibres in place of copper cables in telecommunication. D. Software Industry Software industry has been growing by 20 to 30 percent annually. Estimates about the size of the industry vary quite considerably. The present size of the software industry could be anywhere between US$ 350 and 400 billion. It is expected to expand to US$450 billion by 1998. Given that the software industry remains highly knowledge-intensive as well as labour-intensive and the demand for software professionals is growing much faster than the economies of the Asia-Pacific region - particularly those which have reasonably extensive infrastructaure for education and training. Many countries of the Asia-Pacific region enjoy a comparative advantage in terms of the low cost of skilleld and educated labour. Software programmes in India, Malaysia, the Philippines and Singapore, for example, cost less than their counter parts in the UK or USA by a factor ranging anywhere from 1/10th to 1/4th. The favourable labour factor coupled with the fact that the software industry presents relataively low barriers to entry in terms of capital requirements and infrastructure requirements, means that software industry can be of great value to the economies of this region. E. Food Processing Industry:

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The food processing industry is quite important in the economies of most Asia-Pacific countries, notably China, India, Japan, South Korea, Singapore, Thailand, Malaysia and Hong Kong. It is a growth industry generating exports and employment, providing food to the millions and expanding domestic market for agriculture and marine products. The economies of the Asia-Pacific region will need skills in the technologies in order to realise the potential of the food processing industry. Manpower would be required at various levels which is capable of understanding and utilising these technologies; adopting technology to the local crops and scale of production; developing, establishing and maintaining food processing equipment; and finally undertaking technology transfer, technology adaptation and technology development functions in relation to the food processing industry’s requirements. F. Textile Industry: Textile industry is an important part of the industrial structure of many economies in the region. Apart from its contribution to economic develolpment, a major contribution of the textile industry has been in terms of the employment it provides both directly and indirectly to relatively unskilled and semi-skilled persons in the developing economies of the region. In recent years, major innovations in weaving have been related to the introduction of so-called “shuttleless looms” from the rapier loom. Shuttleless looms are faster, quieter, cleaner and considerably more labour-saving than shuttle looms. In case of knitting technology, there have been tremendous advances in speed, quality and flexibility; advanced machines are completely programmable and flexible. There are growing computer applications in dyeing, finishing, fibre measurement, colour measurement and matching, automataic control and adjustments, computer-aided design, quality monitoring and change of style. Computers also have a great impact on management functions, including planning, informations processing and communication, manufacturing and maintenance records. In general, one can identify three groups of countries in the region with different pattern of structural adjustments in the textile industry. The first group consists of highly industrialised countries where the adjustment led to greater reorientation to high-value added and small batch production, increased flexibility of production, decreasing labour intensity and improved skills of management and technical staff. The second group consists of high-income developing countries where the textile industries are dominated by mass production and export-orientation, growing interest in high value added products and intensification of technological change at all stages of production. The third group comprises a number of developing countries where the industry is geared mainly to internal market and mass production, with high proportion of low productivity, small scale undertakings and high labour intensity. 5.5 Issues Relating to New Technology

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International technology markets are complex, imperfect and rapidly evolving. However, some trends are significant. First, the pace of technological innovation is quickening. This has been caused by both demand factors such as growing global competition and supply factors such as breakthroughs in genetic engineering and solid state physics. Second, life cycles of technological processes and products are shortening. These have been caused by new electronics-based technologies and increased participation in technology-intensive industries. Third, rapid automation is transforming factor intensities of certain industrial processes. As a result, certain industries may be losing their labour-intensive character. Technological change, currency appreciation and wage increases, in addition, will lead to the shift of industries from Japan and the newly industralising economies (NIEs) to the Asian developing countries as the former move up the market. Japanese foreign direct investment had, in fact, played a key role in fostering the horizontal division of labour with the NIEs. Because of the special characteristics, the new technologies throw-up a number of issues for developing countries like India. Some of the issues particularly relating to information technology and bio-technology are discussed here briefly: (a) Most of the developing countries except South Korea, India and Malaysia are not in a position to manufacture semi-conductors, digital tele-com switches and are at a comparative disadvantageous position. Even in India the technological gap in these specific areas continues to exist which adversely affects the competitiveness of the informatics industry. (b) Another problem which is about to manifest itself in a big way is the patents issue in the computer software. The advocates of it ask for patent right to some of the basic software development packages that act as engineering tools. This will create a great hardship to the software firms. (c) Although softwares have high export potentials for India because of its comparative advantage in terms of cheap skilled professionals, it is not in a position to exploit fully the potentials as it is unable to enter high value added software. A similar set of issues cloud the future potential of bio-technology. Despite considerable advances made in bio-technology in developed countries and selected developing countries like Cuba, Brazil and India, serious doubts have been raised about the success in commercialisation in the developing countries. (a) First, as bio-technology is a science based industry, it is difficult to orient the research scientists in the university departments and National Research Laboratories to switch over from a pure research pursuit to a profit oriented application research. This is true of India where emphasis is still on supply-push innovation rather than demand-pull incentives.

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(b) Second, bio-technology is even said to be capital intensive and not knowledge intensive as generally believed, particularly when scaling up is involved. (c) Third, in the areas of animal and plant genetics, there are still unresolved environmental and ethical issues (such as patenting of seeds and animals). (d) The real economies of scale in the bio-tech comes through the combination of biotechnology with information technology. For instance, the use of micro processors and computers in automatic controls for bio-reaction and DNA synthesizers or in sequencing. Likewise in the field of bio-sensors and bio-chips, integrated circuits are being fused with protein engineering. Bio-tech is still a factor technology for India and it lags behind in these new technologies. 5.6 International R&D collaboration in new technologies The high technologies are R&D intensive and their development requires large risky investments, and it is non-viable for developing countries to make an effort to become technologically self-reliant in all high technology sectors. A developing country like India which is not in a position to undertake organised R&D on a high scale through its own efforts has two options: either to license international R&D collaborations for upgrading its technological design capability or to allow foreign direct investment and joint ventures for state of art technology. In the Indian context the second option has been largely accepted. India identified high technology sectors like electronics, pharmaceutical and engineering in 1970s. However, due to inefficient management by the public sector, it made poor progress in electronics and engineering as compared to South Korea, and other Asian NICs. Pharmaceutical industry is an exception, where Indian exports have gone up substantially but credit goes to joint ventures with multinationals. Being knowledge intensive, it appears logical to have great scope for internatiional collaborations. But, it is unlikely that advanced countries will be willing to collaborate to transfer new technologies. An alternative option is to allow university departments and research institutes to take up sub-contracted work for the multinationals/ transnational corporations who have not only resources but also the marketing network. Alongwith the existing high technology sectors like chemicals and allied, engineering and industrial machinery, new technology sectors hold the key for the future technological development in developing countries like India. The latter include micro electronics, telecommunications, informatics, bio-technology, new materials, photonics, polymers, energy environment, liquid crystal design, super conductivity etc. 6 FOREIGN INVESTMENT AND DEVELOPMENT OF INFRASTRUCTURE AND SERVICES

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6.1 Foreign Investment and Services In general, services include transport and communications, wholesale and retail trade, finance, real estate, insurance, public administration, defence and others. It is generally observed that the share of primary sectors (e.g. agriculture, forestry and fisheries) in gross domestic product (GDP) decreases and that of services increases with economic growth. Table 1.7 indicates the expanding role of the service sector in most Asian developing economies during 1980s and 1990s. The share of the service sector in the GDP increased substantially during 1965 to 1996 for most of the Asian economies. The countries which are exceptions to this trend are the People’s Republic of China, Malaysia, Myanmar, Singapore and Sri Lanka. The decline in Singapore is due to a faster growth of industry vis-a-vis services, although this trend is likely to be reversed in the future. The same trend has occurred in Malaysia and Sri Lanka; in both countries, industry has grown somewhat faster than services, leading to a slight decline in the importance of the latter in the economy. In Myanmar the role of the service sector has declined due to faster growth of agriculture during the period. In the People’s Republic of China, the share of the service sector has been virtually constant. Although industry has grown, its growth has been at the expense of agriculture. Rapid technological developments in telecommunications and computers in the 1980s have made some services, especially information-intensive ones, more tradable. The affected service industries include financial services, consulting, engineering, professional services, international reservation services in their transportation and hotel industries, research and development, education and data services and informationintensive operations in other industries. The “long-distance” type of service does not necessarily require physical proximity, though physical proximity between the provider and the user may be useful. Live broadcasts, transborder data transmissions, and traditional bank and insurance services fall under this category. The scope of long-distance service transactions has greatly increased with the advance of technology. In “long-distance” services, there is no need for any direct foreign investment or movement of labour. With technological innovations, the traditional boundaries between telecommunications and informatics seemed to have vanished, leading to the emergence of the so-called telematics, which greatly increased transborder data transmission, both commercial and corporate. 6.2 Infrastructure Financing in East Asia Efficient infrastructure is essential for rapid industrial growth. Huge public investments have been made in infrastructure stocks, but in many developing countries these assets are not generating the quantity or the quality of services demanded. It is estimated that, in the 1980s, infrastructure investment in East Asia may have lagged necessary levels by 2 to 3 per cent of GDP, and the region will need an estimated $1.5 trillion in infrastrucure investment during the 1990s. World Bank lending emphasises effective infrastructure development across the region, with lending for transportation, power, and irrigation as the largest component of the overall programme. Fifty-eight per cent of World Bank

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lending to East Asia in fiscal 1994 was for infrastructure viz. transportation, power generation, irrigation, urban development and telecommunications. The Bank is working with its member countries to upgrade and liberalise financial markets and institutions, to create a competitive environment for business growth and to take steps to expose state enterprises to the discipline of the market. The Bank is assisting countries in a range of fields to establish or strengthen regulatory authorities and legal institutions. In a recent study the World Bank (1994b) has explained some stylised facts and lessons from the early experience of private provision of infrastructure services in East Asia and Pacific. In the last few years there has been an increasing interest on the part of both governments and private sector to enhace the role of the private sector in infrastructure development in East Asia and Pacific, and the Latin American countries. While the specific motivations and circumstances vary by countries, basic factors leading to enhanced private sector investment in infrastructure include the massive investment needs which cannot be met by the state without crowding out investments for other priority and social sectors, managerial and capacity constraints within public sector, and the need to raise the efficiency and quality of basic infrastructure services. However, there is a basic difference of experiences between Latin America and East Asia. Most countries in Latin America have started privatising public enterprises through outright sale or tranfer of management/ majority share to private companies, while East Asian countries have encouraged private investment for creating new capacities. Three factors appear to explain this difference. First, unlike in East Asia, performance of utilities was widely considered to be poor and privatisation was an important ideological element of reforms in Latin America because of the widespread economic distress and general dissatisfaction with the performance of public sector. Second, Latin America needed proceeds from privatisation for reduction of foreign debt and fiscal deficit. Third, while in Latin America the basic objective was to utilise better the existing capacity, East Asia needed private investment to enhance capacity in order to meet the growing demand for the sustained and faster growth of the economy. There were major differences between sectors in terms of the extent of private sector and the instruments used for its participation. Alongwith telecommunications, the power sector was an early candidate for infusion of private capital and management. Private investment was also encouraged in highways, container ports, tunnels and bridges, and water supply and treatment projects. The methods used were generally BOT arrangements without providing significant sovereign guarantees. In the case of highways and water supply, other instruments like long term leases and state support (e.g.free land, assignment of revenues from state-owned assets, land development rights etc.) were also considered. Equity appears to be the main source of finance, and commercial bank lending is not yet the major source of funding. Initial experience of private power projects in East Asia and Latin America confirms that the sponsors are able to implement them at a lower cost and on a shorter schedule

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than public projects. Recent experience suggests that the East Asian countries are competing with each other to attract quality investors into infrastructure. Another striking feature is that the initial efforts of the East Asian countries have been to attract private capital rather than to increase efficiency. The lessons of experience in East Asia indicate that countries in South Asia are required to have priority attention in the following five areas while formulating country strategies to enhance private participation in the provision of infrastructure: * Overall country objectives, strategy and priorities; * Reform of policy, legal and regulatory framework; * Facilitation and increased transparency of government decisions * Unbundling and mitigation of risks; and * Mobilisation of private term lending. In fact, South Asian countries have already started to liberalise their policies and to adopt competitive entry, sector unbulding and incentives regulations to encourage private investment. 6.3 Project Finance for Infrastructure Developing countries are increasingly financing their infra-structure projects through external commercial borrowing and increased use of bond and equity markets. Finance for infrastruc-ture typically comes in a package with equity, debt, commercial bank loans, export credit guarantees, and contingent liabilities of the host government ranging from “full faith and credit gurantees” to “comfort letters”. Capital market finance for infrastructure has increased more than eightfold since 1990 and reached $22.3 billion in 1995 (Table 6.1). But the growth has been uneven across the regions, countries and sectors. East Asia raised the most finance (led by China, Indonesia, South Korea, Malaysia, Philippines and Thailand) followed by Latin America (Table 6.2). The sectoral distribution of external financing of infrastruc-ture is dominated by power generation, telecommunications and transport, while power transmission and distribution and water supply lagged. In 1990s telecom became very prominent with large investments by the Philippine Long Distance Telephone Company, PT Telekomunikasi Indonesia, Thai Telephone and Telecommunications, Telex Chile and Indonesian- and Chinese sponsored satellite companies. In the power sector, major investment was made by the Indonesian Paiton. In a reversal since the 1980s the private sector outplaced the public sector in borrowing infrastructure funds, although with the help of substantial public gurantees. Compared with the public sector, the private sector relied more on loans than on bonds or equity (Table 6.1). Guarantees from host governments, multilateral institutions and export credit agencies play an important and legal role to mitigate the policy uncertainties and

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commercial and foreign exchange risks inherent in large-scale infrastructure financing. But, these should not be taken as substitutes for correcting sectoral distortions. 6.4 Role of Privatisation for Infrastructure Development Narrowly defined, privatisation is the sale or transfer of state-owned enterprises to private investors through auction, stock flotation or distribution, management-employee buyout, or voucher or coupon privatisation. Broadly defined, privatisation also includes leasing, partial disinvestment, management contract or concession-type arrangements like BOT, BOO and BOOT. In 1988-1995 developing countries raised $130 billion through privatisation led by Latin America and the Carribbean ($68 billion), Europe and Central Asia ($25 billion), East Asia and the Pacific ($25 billion), South Asia ($6 billion), Sub-Saharan Africa ($3 billion) and Middle East and North Africa ($2 billion). Infrastructure related sales accounted for 44 percent in both 1994 and 1995 (Table 6.4). Privatisation continued to be an important channel for foreign investment (direct and portfolio equity) in 1990s. Total foreign investment raised from privatisation in 19881995 amounted to $58 billion, nearly two-thirds of which were in the form of foreign direct investment, with portfolio investment accounting for the remainder (Table 6.5). 6.5 Foreign direct investment and infrastructure Transnational corporations are becoming increasingly involved in infrastructure development. Investment flows from developed countries in the early 1990s into the main infrastructure industries (construction, communications and transport and storage) were around $7 billion annually. Throughout the 1990s, FDI inflows and inward stocks in infrastructure in selected major developed and developing countries increased steadily, both in value and as a share of total investments. Infrastructure FDI outflows accounted for 8 percent of total outflows in 1994 in the United States, and 7 per cent in 1992-1994 in Japan. Even so, FDI in infrastructure is still low compared to investments in other industries, except for a few countries (e.g., Denmark, South Africa, Kenya and Nepal). The financial requirements for infrastructure are vast. India needs about $400 billion during 1997-2006 for its infrastructure development. Present growth rates in East Asia suggest that such investment requirements will be $1.4 trillion during the next decade; for China alone, the figure is over $700 billion. In Latin America, requirements are about $600-800 billion (World Bank, 1995b). Another projection made by the Asian Development Bank indicates that investment demand for infrastructure in Asia (excluding Japan and the NIEs) will amount to about $1 trillion in 1994-2000. This includes $300$350 billion of investment for the power sector alone to the year 2000, $300-$350 billion for transportation, $150 billion for telecommunications, and $80-$100 billion for water supply and sanitation. The investment for infrastructure is projected to increase from 5 per cent of GNP per annum to 7 percent of GNP.

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Because of the huge financial requirements of the infrastructure projects, the risks involved and the bugetary constraints in the developing countries, external resources play a prominent role in overcoming these bottlenecks. Transnational corporations invest in infrastructure projects in the form of FDI (greenfield investments or acquisitions through privatisation), BOT, BOO, BOOT, BOLT, BTO or variants of these schemes. There are various forms of BOO and BOT schemes in the region such as those for toll roads in China, India, Malaysia, and Thailand; telephone facilities in Indonesia, Sri Lanka and Thailand; power generation in China and Indonesia; and energy, transportation and water resources in the Philippines. BOT projects are estimated to account for about 53 per cent of total committed infrastructure investments in the Philippines for the 1994-98 period. A key element in financing infrastructure is risk, both commercial and sovereign. Risk sharing is an important aspect of investment negotiations between governments and private investors. Large foreign investors may have an advantage in risk pooling due to a diversified portfolio in multiple countries, access to export credits, and access to nonrecourse loans in countries, but the limited availabililty of debt instruments with a term structure sufficiently long to match the extended payback period of most infrastructure projects, is one of the main constraints to infrastructure development in Asia. Opportunities for public-private and foreign-domestic partner-ships are increasing in Asia. While the public sector will remain responsible for a large share of infrastructure investment, in water development, rural roads and mass transit, private investment in infrastructure is already occurring in countries such as China, Indonesia, India, Malaysia, and Philippines. In particular, Singapore is developing industrial estates with partners in China, India, Indonesia, Myanmar, and Vietnam. Private companies from Singapore, Japan, and Korea have joined the Economic Development Board of Singapore, other state agencies, and the Government of China to establish the China-Singapore Suzhou Industrial Park in Jiangsu Province to penetrate the Chinese market and to transfer Singaporean technology in areas of public administration and construction. The Government of Singapore is involved in a partnership with India to set up a technology park in Bangalore. Manufacturing firms from Hong Kong, Japan, Korea and Taiwan are located in technology parks and investment areas near Manila and the Subic Bay in Philippines. In recent years, a number of Asian investment funds have been created to mobilise international capital to finance Asia’s infrastructure needs. These funds provide investment in medium and long-term projects (5-10 years) for infrastructure development through equity (usually 10% or more) or convertible debt. Funds are raised from a diverse group such as institutional and private investors, TNCs, other private companies, regional banks and multilateral organisations. The Asian Infrastructure Fund (AIF), in which the Asian Development Bank was an initial investor, was the first infrastructure investment fund in the region. The AIF is expected to invest in utility, transportation and communications projects in the People’s Republic of China, Indonesia, Malaysia, POhilippines, Chinese Taipei and Thailand,

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mobilising up to $15 billion of additional resources for the region’s infrastructure. Since then, several infrastructure investment funds, similar to international mutual funds, or unit trusts, have been set up. Various constraints such as high fixed or sunk costs, long gestation periods, price ceilings and other regulations on the operations of an infrastructure facility in host countries, and political risk (expropriation or nationalisation) have induced foreign investors to minimise equity commitments to such projects and relying on debt (commercial loans and bonds) and non-equity financing (technical know-how, expertise, R&D cost sharing, trade credits and supply of capital goods). There are also constraints that arise out of the very nature of some of the ways (e.g., BOT) in which infrastructure projects are financed through foreign capital. Given the perceived risk, investors require high rates of return (which need to be backed up by legally binding assurances). This necessarily requires user fees commensurate with the rate of return, which, in many developing countries, are too high to be sustainable. There are also various environmental issues associated with infrastructure projects. Consequently, negotiations of BOT and similar schemes - in developing and developed countries - are typically very complex and long drawn out. Table-6.6 Selected Direct Investment Funds for infrastructure projects _________________________________________________________________ Fund Core investors Capital raised of 1994 _________________________________________________________________ AIG Asian American International Group $1-1.2 billion Infrastructure Government of Singapore Fund Bechtel Enterprises Alliance Scan Equitable Life Assurance East Fund,L.P. Society of American International Group, International Finance Corporation, European Bank for Reconstruction & Development Asea Brown Boveri Asea Brown Boveri Funding The Asian Infrastructure Fund (AIF)

$ 22 million

$ 500 million

Pergine Investment Holdings Soros Fund Management Frank Russell Company

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$ 500 million

as

International Finance Corporation, Asian Development Bank. Central European Creditanstalt Bankverein Telec Investments, International Finance L.P. Corporaation. Global Power Investments Company, L.P. Corporation.

GE Capital Corporation Soros Fund Management International Finance

$42 million

$ 0.5 - 2 billion

Scudder Latin NRG Energy Inc. $ 100-300 America Trust for CMS Energy Inc. million Independent Power. NRG Energy,Inc. Corporation Andida de Fomento,International Finance Corporation. _________________________________________________________________ Despite various constraints, there is considerable potential for TNC participation in infrastructure development, given the recognition that the size of the investment requirements is too big to be met from public sources alone. By pooling financial resources, through new instruments, TNCs can share the cost and spread the risk associated with infrastructure development. Insurance against political risks is provided increasingly by bilateral or multilateral institutions such as MIGA and export credit agencies. There is also considerable scope for TNC participation in science and technology parks, export-processing zones and facilities for human resource development. Table-6.7 : Measures for the liberalisation of FDI in infrastructure in Asian economies , 1991-1995 _________________________________________________________________ Economy Year Measures _________________________________________________________________ China 1993 aircrafts to FDI

Opens construction of airports and

India 1997 Allows FDI in all infrastructure on BOT basis or otherwise, FDI permitted in mining,

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telecommunications services, television broadcasting, and domestic air transport. Indonesia 1994 Opens ports,shipping, airlines, railways, production, transmission and distribution of energy, mass media, water distribution,sanitation to FDI. Pakistan 1994 Incentive package and guidelines for private sector participation in the power generation sector. Philippines 1994 Authorises the financing,construction,operation and maintenance of infrastructure projects by the private sector. Taiwan Province of China Viet Nam

1994 Allows FDI in major transportation infrastructure projects. 1993

Promulgates BOT regulations

1994 Streamlines the approval process for infrastructure projects, including BOT. _________________________________________________________________ 7 POLICIES AND STRATEGIES FOR PROMOTING FOREIGN INVESTMENT- TECHNOLOGY- GROWTH NEXUS

7.1 Macro-economic Policies (a) Host country policies for FDI The substantial increase in FDI flows to Asian developing countries in recent years is attributable to a large number of factors, including: * A change of attitude in the host countries, which had welcomed FDI as an engine of growth and a factor contributing to the transfer of technology, upgradation of skills and overall efficiency and competitiveness.

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* Ongoing economic reforms in almost all the countries in Asia. Favourable policies ranged from general economic policies leading to a stable macroeconomic framework and liberalization of industrial, trade, financial and public sector to specific FDI-related measures such as transparent and non-discriminatory legal and regulatory systems. * A change of attitude by multinational companies to work more closely with host countries on a partnership basis; and an increase in global competition reinforced by the close linkage between FDI and trade, increased intra-firm trade and trade within regional groupings. * Among the traditional factors influencing FDI, most important factors are domestic market potentials and low cost of labour. * Governments of home and host countries have adopted various measures to encourage FDI. Widely used instruments were bilateral investment protection agreements containing rules on fair and equitable treatment, repatriation of equity and dividends, and international arbitration in the case of disputes. Impediments to FDI include sectoral protection, ceilings on foreign ownership, licensing and approval procedures, performance requirements and restrictions on employment of foreign staff. The formation of regional trading groupings (such as NAFTA, ASEAN, SAARC etc.) would have an important impact on the FDI pattern. In the foreseeable future, countries outside the regional groupings might be at a disadvantage in attracting FDI. The diversity of experiences in Asia with respect of FDI requires different policy approaches on the part of host countries. Those countries that have only recently been open to FDI need to ensure that the “open door policy” is maintained and remains stable. They should examine the possibility of a further liberalisation of FDI regimes; the harmonisation of FDI and related policies on industry, trade and technology; and improving the efficiency of their administrative set-up for investment approvals. In doing so, all countries in the region should pay particular attention to the firms from neighbouring countries, so as to capitalise the growing intra-regional investment. Special attention needs to be given to small and medium-sized enterprises whose special needs dictated by their limited financial and managerial resources and insufficient information may call for incentives for the joint ventures. The Asian market has high potentials for small and medium-sized TNCs. (b) Host Country Policies for Portfolio Investment The upsurge in the flows of FPEI to emerging markets has been driven by liberalisation of these markets and the global factors such as low interest rates. International investors, aiming to maximise returns and minimise risk, have found that emerging markets offer attractive risk-adjusted returns and opportunities for diversifying portfolios. Host country factors which have attracted portfolio investments fall into three groups: (a) the degree of political and macroeconomic stability; (b) the commitment to the process of economic

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and financial liberalisation and reforms; and (c) the state of development of the stock markets and the institutional and regulatory frameork. The size of the local stock market, number of listed companies, liquidity, number of participants, investor protection (such as insider trading regulations), enforcement of regulations and volatility etc. are particularly important to influence the inflow of foreign portfolio investment. In order to sustain the inflow of FPEI, many of the Asian developing countries have taken a number of steps including transparent economic policies and commitment to a longer-term package of regulatory and market reforms; taxation policies which are nondiscriminatory for foreign investors;appropriate investors protection; improvement of the settlement system; encouraging periodic disclosure of financial information; and improvement of accounting and auditing practices. Most of the South Asian and East Asian countries are liberalising foreign exchange regimes, and domestic financial sector and capital markets. Consequently, the stocks markets in the emerging markets are expanding rapidly with increasing number and volumes of stocks traded and higher market capitalisation. In many countries of Asia, massive infrastructure investment requirements, coupled with government fiscal constraints, have led to a strong interest in private financing of infrastructure projects with special emphasis on build-operate-transfter (BOT) financing schemes. The BOT schemes have generally been applied in the transport, telecommunications, energy, water-treatment and waste-management sectors. Among the main issues to be tackled are the need to restructure some utility sectors, the need for an improved regulatory environment, and problems associated with demand risks and foreign exchange risks. (c) Sectoral Policies and Regulation Locational, safety and environmental regulations are necessary for the efficient functioning of industry, but these are a relatively small component of sectoral regulation. India’s complicated regulations, as in most countries, have their origins to offset market failures. The financial sector, transport and telecommunications, professional services and media all have special regulatory requirements, but most of these regulations are excessively detailed and outdated. The reduction, simplification and greater transparency to reduce the need for bureaucratic intervention is needed to ensure that a country can obtain benefits from foreign investment quickly. Mineral industries, including petroleum and gas, create particular problems for investment because resource rents have to be divided between local landowners, the States and the central governments. Private firms also seek a share of such rents to compensate them for the riskiness of mineral exploration and subsequent mine development. The efficient and equitable apportioning of mineral rents is thus an important aspect of the economic policy framework.

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Indonesia and Malaysia have been among world leaders in dealing with foreign investment in petroleum, gas and other minerals. Papua New Guinea developed mineral resource taxes to tax mineral rents. With such policies in place, project by project negotiation can be avoided or minimised. Forestry, fisheries and hydroelectricity also generate rents that require special consideration. All these industries have environmental aspects that should be taken into account on a nationwide basis rather than project by project. Agriculture and real estate present difficulties for foreign investment because of complexities of landownership, and rules and taxes regarding tenancy, sale, purchase, trasfer, lease or mortgage. Because of these problems, many countries like India donot allow foreign investment in agriculture and real estate. In the case of plantation, foreign investment in nucleus estates and processing facilities can provide a market for farmers and at the same time enable them to improve their productivity. Investment in minerals, including petroleum, has retained its share of total foreign investment. Indonesia led the way in devising agreements that gave an equitable share in mineral “rents” to the host country while satisfying investors. Forestry has attracted investors, mainly within the region, but with growing policy difficulties as the socioeconomic costs of forestry become evident and had to be funded. The mainstream of investment has been in manufacturing, ( in protected markets and for export), and in service industries such as tourism, financial sectors and, on a smaller scale, in professional services. Investment in infrastructure is now beginning to take place. (d) Miscellaneous factors affecting foreign investment Fiscal incentives and investment environment In 1960s the International Chambers of Commercve argued strongly that developoing countries should attract foreign investment with tax ‘holidays’ and other incentives such as subsidised credit and privileged access to preotected domestic markets. The International Monetary Fund (IMF) favoured the suggestions, but advised that incentives should be extended to all investors. Many developing countries began to compete for foreign investment with various incentives. But, a considerable body of evidence showed that these incentives failed to attract foreign investment. Only those ‘fly-by-night’ firms that move from country to country, exploiting tax holidays, are attracted by these incentives, but they exit as soon as fiscal incentives expire or are withdrawn. An efficient and equitable tax system with internationally competitive taxes and duties is far more conducive to long run investment inflows than incentives. Inflows of foreign direct investment are determined by a complex set of economic, political and social factors and that investors look beyond the array of investment incentives (in particular fiscal incentives) offered. Performance requirements and various restrictions and regulations act as disincentives to foreign direct investment and often serve to offset the positive effects of investment incentives. What should be determined in evaluating the policy impact of foreign direct investment is the net incentive effect,

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taking into account all policies which directly indirectly affect business risk, profitability and ability to repatriate capital and investment income. Foreign investors are also attracted by market opportunities (domestic and international), a clear legal and institutional set up, administrative speed and efficiency, efficient infrastruc-tural services and above all by liberal economic policies and stable economic situation.. Although some transnational firms prefer wholly or majority owned branches or subsidiaries in their foreign operations, it is widely held that some form of joint venture with a host country partner is advisable because of the experience and insights local partners bring. Local partners are particularly effective in managing labour and dealing with regulatory issues. Some form of joint venture investment is becoming increasingly prevalent. Foreign investors are also moving into joint ventures with public enterprises, preferring corporatised ones. Foreign investment with its capital, technology and management package can make a considerable contribution to the vast investment required in infrastructure in developing countries like India. Existing plants can be made more productive and new facilities can be provided, often on the BOT/ BOO principles, but governments and investors are still at the process of learning and experimenting. Low wage rates and low production costs From the view point of the advanced countries, Asia is still an extremely attractive place for estabilishing production bases because of its extremely low production costs. China, India and countries of ASEAN have large, low-income farming populations, implying the existence of a potentially huge supply of labour for the manufacturing sector. This reserve should enable manufacturers to secure an adequate labour force. Moreover, since younger people make up a larger proportion of the population of Asia, they can be expected to play a major role in ensuring a smooth supply of labour in the future. Besides low labour costs, various other production costs such as real estate rents, transport, communications and electricity charges are all substantially lower in Asia than in the advanced countries. Higher Rates of Return An important factor that determines the influx of direct investment into Asia is the ongoing globalisation of companies from the advanced countries to take advantage of low costs in the developing countries. Another factor that encourages Japanese companies to continue shifting their production bases into Asia is the generally high profitability of their overseas affiliates in the region. Compard with production bases in North America and Europe, production bases in Asia are far more profitable. Huge domestic market

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Furthermore, in addition to their original role in producing goods for export, these production bases are now expected to play a growing role in producing goods for rapdily expanding consumer markets within the region. In a recent survey conducted by the Export-Import Bank of Japan in 1995, Japanese manufacturers were asked their reasons for investing overseas. In the case of China, the NIEs and ASEAN, a great deal of importance was attached to investments designed to ‘maintain and expand local markets”. In fact, overseas Japanese affiliates substantially increased their sales within the Asian region. Expanding regional consumer markets are expected to provide an impetus for further economic growth. Consumption of Asia continues to expand at a healthy rate. Compared with the developed countries in the world, the relative share of labour in GDP is still low in Asia. Even in more advanced economies in Asia such as South Korea and Hongkong, labour relative share is almost 10 percentage points lower than in Japan, the United States and Germany. This suggests that there is ample scope for an expansion in consumption as labor relative share rises. Labour mobility Labour reform is another area of concern, particularly in large organised sectors. Though detailed information on labour markets is not available formany low-income countries, government regulation generally reduces labour mobility. Large firms bear the brunt of rigid labour laws that constrain them from restructuring atheir operations, force smallercapacity expansions than othjerwise, and reduce employment creation by encouraging capital-intensive modes of production. ‘ Rigid labour laws have slowed the pace of economic reforms, privatisation, and state enterprise reforms. In India, where the organised industrial sector accounts for 80 percent of industrial value added, constraints on rationalising the labour force act as the heavy drag on industrial growth. In China, the competitiveness of a the state-owned sector has been adversely affected by the need to maintain high employment and provide workers with housing, medical care, schools, transport, and other social services not usually provided by other firms. Their labour costs are more than twice those of collectivelyowned enterprises. The challenge is to unbundle these services and transfer them to municipalities or commercial entities so that firms can operate on a commercial basis and labour is free to seek opportunities elsewhere. 7.2 The Export-Push Strategy and Role of Export Processing Zones Of the many policies tried by the East Asian countries for accelerating growth, those associated with their export push hold the most promise for other developing economies. The export-push approach provided a mechanism by which industry moved rapidly toward international best practice and technology. Export-push strategies were, however, implemented in different ways by the High Performing East Asian countries (World Bank 1994).

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(a) Hong Kong and Singapore estblished free trade regimes, linking their domestic prices to international prices; the export push was an outcome of the limited size of their domestic markets alongwith neutral incentives for domestic and external markets. Both economies made export credits available, although they did not subsidise it, and Singapore focussed its efforts on attracting foriegn investment in exporting firms. (b) In Japan, Korea, and Taiwan, China, incentives were essentially neutral between import sustitutes and exports. Export incentives, however, were not neutral among industries or firms. There was an effort in Japan, Korea, Singapore, and Taiwan China, to promote specific exporting industries. In Korea, firm-specific exports targets were employed; in Japan and Taiwan, China access to subsidised export credit and undervaluation of the currency acted as an offset to the protection of the local market. One of the major factors for success of the export push in some countries like Japan and Korea, was the government’s ability to combine cooperation with competition. Export targets provided a consistent yardstock to measure the success of market interventions. The more recent export-push efforts of the Southeast Asian newly industrialising economies (NIEs) relied less on specific incentives and more on gradual reductions in import protection, coupled with institutional support to exporters and a duty-free regime for inputs into exports. Recent strategies to attract direct foreign investment in Indonesia, Malaysia, and Thailand have also been explicitly export-oriented. The rapid expansion of export processing zones (EPZs) in developing countries during the last two decades represents a significant development in the world economy. Ireland is credited with establishing the first modern EPZ in the world with the establishment of the Shannon Export Free Zone in 1955. The success of the Shannon experiment led to the rapid growth of EPZs in developing countries. The first developing country to set up an EPZ was India with the creation of the Kandla Free Trade Zone in 1965. Today there are more than 200 EPZs in 60 developing countries compared with just eight EPZs in 1970 and 55 EPZs in 1980. Nearly half of EPZs is located in Asia. The emergence of EPZs reflects a shift in the industrialisation strategy of developing countries, which in the 1950s and 1960s favoured import substitution policies to reduce dependence on the outside world. The inward-looking policies were supported with high tariff rates, generous subsidies and foreign exchange restrictions. Since the late 1960s, there has been a gradual shift in emphasis towards an outward-looking industrialisation strategy through the promotion of non-traditional exports. This was accompanied by a more liberal attitude towards FDI in an effort to attract it not only to acquire much needed capital but also to promote the transfer of new technologies, upgrade skills and acquire access to markets and distribution channels. EPZs were a means of fostering exportoriented industrialisaion, and in some countries, they assumed a prominent role in the strategy. There is undeniable evidence that the EPZ sector, although still small, has been among the most dynamic sctors in attracting FDI. EPZs accounted for more than 85 percent of

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FDI in Mauritous and over 70 percent in Mexico. FDI inflows to the oldest four special economic zones in China amounted to more than 30 percent of FDI inflows in 1989. Foreign investors account for a major portion of investment and employment in EPZs, which are characterised by the dominance of the textiles, garments or the electronics industry. There is also evidence that EPZs were successful in promoting exports of manufactures and in generating foreign exchange earnings. One of the striking features of EPZs is the tendency to breed a distinct type of industrial monoculture, either in textiles and garments or in the electronics industry. An analysis of the structure of employment by product group in EPZs of selected countries indicate that there is one dominant industry in each country: textiles and garments industry in Bangladesh, China, Dominican Republic, Egypt, Jamaica, Mauritius and Sri Lanka; and the electronics industry in Barbados, Brazil, Republic of Korea, Malaysia, Mexico and Taiwan, China. Concentration rates vary among countries and zones. In Jamaica, Mauritius and Sri Lanka, the leading industry, textiles and garments, accounts for almost 90 percent of total employment, whereas for the electronics industry, EPZs in Malaysia have the highest concentration rate of over 74 percent. EPZ’s effectiveness as an instrument for the long-term development of industries depends on the degree of linkages created with the domestic industries and on the extent to which they provide avenues for the transfer of technology and the upgrading of skills. In this regard, EPZs seem to have fallen short of expectations. A major limiting factor to the transfer of technology and skills is the nature of the production processes typically undertaken in EPZs, which involve low technology and/or simple skills (UNCTAD 1993). Success of EPZs depends on a favourable investment climate, skilled labour force and an active local business community and government’s support for the EPZs, while failures may be attributable to poor locations, inadequate infrastructure, insufficient promotion, excessive costs and mismanagement. The long-term viability of EPZs also requires that their operations should be properly integrated with the overall economic and industrial development strategy of the country. Results of a cost-benefit analyses of a few Asian EPZs have shown that incentives, subsidies and infrastructure expenditures entail considerable costs for the host countries. These costs are sometimes difficult to justify, from both the financial and economic viewpoints. However, stiff competition among EPZs of developing countries to attract investors has exerted pressure to offer increasingly generous incentives, thus eroding their net benefits (UNCTAD 1993). 7.3 Role of Small and Medium Sized Industries (SMIs) Small and medium industries predominate output in a number of industrial sectors in many Asian countries such as Bangladesh, India, Pakistan, China, Korea, Indonesia and Philippines. Even they played a significant role in the economic development in Japan and Singapore (Chowdhury 1990). They are mainly in the textiles, garments, wood and

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furniture, food processing, leather products, fabricated metals, machinery and equipments, rubber and plastic products, pottery, printing and publishing. In 1990 they accounted for 95 per cent of establishments in Bangladesh, 70 per cent in Indonesia and 80 per cent in the Philippines. The importance of these industries in India may be gauged from the fact that the SSI sector accounts for 40 per cent of the total turnover in manufacturing and 35 per cent of total exports. It is the second largest employer after agriculture, providing employment opportunities to 15 million persons. Many East Asian economies supported small and medium enterprises (SMEs) with preferential credits and specific support services. Rapid growth of labour-intensive manufacturing in these firms absorbed large numbers of workers reducing unemployment and attracting rural labour. As firms shifted to more sophisticated production, efficiency rose and workers’ real incomes increased. Support for SMEs has been most explicit and successful in Taiwan, China. SMEs comprise at least 90 percent of enterprises in each sector and also dominate the export sector, producing about 60 percent of the total value of exports. Japan directed enormous financial resources towards developing SMEs. Public financial institutions have allocated an average of 10 percent of lending towards SMEs. During the rapid growth period of the 1950s, about 30 percent of their total lending for fixed investments went to SMEs. The SME sector has become a cornerstone of Japan’s economy. In 1989, SMEs accounted for about 52 percent of both manufacturing value added and sales, and their share of employment in various manufacturing subsectors ranged from 41 percent in transport machinery to 100 percent in silverware. Korean development has been largely driven by the expansion of conglomerates. But in the 1980s, the SME sector began to grow rapidly. SMEs share in total manufacturing employment rose fom 37.6 percent in 1976 to 51.2 percent in 1988, while that in manufacturing value added rose from 23.7 percent to 34.9 percent. Like Japan, Korea established an exensive support system for SMEs such as export financing system and credit guarantee programmes. In China, rural industries dominated production in cement, iron and steel, fertiliser, hydro-power and agri-machinery and contributed about 25 per cent of total industrial output in China and 20 per cent of rural employment in 1990. Initial focus of rural industry in China was on primary processing of farm produce, handicrafts, manufacturing and repairing of simple farm tools, developing and processing local industrial resources. The industries were small and used primitive techniques. Reforms in China have encouraged rural industrialisation alongwith entry of multinationals in export-oriented sectors. The SPARK programme on rural industrialisation approved by the Chinese Government in 1986 aims at vitalising and modernising the rural economy of China through Science and Technology. The SPARK programme works at three levels - county, province and

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central government. In general, units under SPARK include (i) village and township enterprises having R&D units in cooperation, (ii) R&D units which have village or township units for cooperation and (iii) scientific and production consortium. SPARK has adopted a mechanism of setting up technology development and extension network that interlinks local sectors and central departments and institutions for continuous flow of technology. China’s experience in providing 100 million jobs in rural enterprises under non-farm sector during 1986-1993 and plan to provide similar number of employment opportunities by the end of this century, reveals that its rural non-agricultural enterprises owe their success to a market-orientation, availability of infrastructure, stress on higher technology, incentive-linked wages, competitiveness, diversity in products and community cooperation. Sub-contracting and ancillarisation have helped the dispersal of industry and growth of the small and medium industries and rural non-farm sector in many countries. The most successful example of sub-contracting from large urban areas to small rural entrepreneurs is Japan. The division of responsibility and resources, in keeping with its economic popensity, has given Japan an unparalleled global edge. Its success is attributed to expanding demand, limited capital of large companies, low basic skills required by small units and paternalistic relationships. Big business houses shares the production process, technology and innovation with small/medium industries. Thailand, Malaysia and Indonesia have adopted Japanese model with variations to suit each nation’s cultural and social environment. In Thailand large companies are allowed to develop ancillaries which can operate within the same factory premises and yet entitled to have independent recruitment, wage structure and service conditions. In Pakistan, sub-contracting has been in practice over a long period in traditional products such as carpets, garments and footwear. Sub-contracting is also strong in the labour intensive activities of rattan in Indonesia and for garments in Philippines. “Bapakangkat” (parent Unit) and “Anakangkat” (related units) of Indonesia are good examples of networking. Under the scheme, in addition to contractual networking, the Bapakangkat provides technical and financial assistacne, leases plant and equipment and trains people which leads to higher employment and lowering of cost of production. In India, Indonesia and Philippines, about 50 per cent of the small enterprises now in existence were established within the past decade. Most of these began as household industries, but subsequently grew into the small and medium categories, and into larger enterprises in a number of cases. The experiences of Japan, Republic of Korea and Singapore suggest that given appropriate program and policy assistance, small and medium industries can make substantial contributions not only to output and employment but also to exports. In all these countries, small and medium units received a number of fiscal and monetary benefits such as tax holidays, concessional excise duty and lending rate, priority lending, purchase and price preference by the public sector and reservation of items for exclusive production by them.

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In brief, a dynamic small and medium industries sector serves not only to generate employment but also to earn foreign exchange, upgrade the quality of the labour force, expand the base for indigenous entrepreneurs, help in dispersal of industries, and diffuse technological know-how throughout the economy. The location of small and medium enterprises in rural areas helps to utilise rural savings, surplus labour and local raw materials that may otherwise remain idle and unutilised. It helps to reduce the migration to urban areas by providing livelihood opportunities to rural labour. Small enterprises also provide a source and training ground for the development of entrepreneurship and business management skills for medium and large undertakings. Against these positive aspects, there have been criticisms regarding the ability of small industries to realise economies of scale in production, procurement and marketing. Consequently, they may experience larger unit costs despite low labour costs and other advantages due to their proximity to the local markets. In many branches of manufacturing, small units exist on the strength of the costly government support programmes in terms of reservation, price and purchase preference, priority lending and fiscal concessions. A wide range of opportunities can be seized by small-scale, labor-intensive industries in the Asian region where horizontal division of labor through trade and joint-venture projects has been increasing sharply in recent years. The following issues need to be given due consideration while formulating policies for the SSI sector : * Adequate backward and forward linkages need to be established between small and large units in terms of sub-contracting, manufacture of components etc. * Suitable measures may be taken to enhance the access of the SSI sector to information particularly relating to external markets, foreign investment and better technology. * Vertical expansion of the small scale industries may be limited due to reservation of items for the small scale. A review of the reservation policy is necessary. 7.4 Role of Natural and Human Resources Many studies have found an inverse relationship between natural resource endowment and the level of industrial technology (Kakazu 1990) for the following reasons : (a) The first is the “Dutch Disease” hypothesis which maintains that overconcentration on resource-based production and exports may create an adverse environment for the introduction and diffusion of advanced technology. For example, rich mineral and forest resources for exports in Indonesia seem to have adversely affected its technological assimilation and improvement. (b) Second, India and Indonesia, relatively resource-rich countries in terms of the size of land and population, have been tempted to adopt more inward or domestic marketoriented policies compared with the Republic of Korea and Thailand. Import-substituting

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industrialisation has discouraged the adoption and dissemination of industrial technologies appropriate for labor surplus economies such as India and Indonesia. (c) The third explanation is that a resource-rich economy can sustain its growing populatin by exploiting extensively its natural resources and may not feel the pressure or need to adopt advanced technology to utilise given resources more efficiently. The availability of well-educated human resources is more important than the availability of natural resources in industrial technology development. Various case studies made recently by the Asian Productivity Organisation (APO) also found that a shortage of skilled and technical manpower is the major constraint to the digestion of new technologies in Asian developing countries. Indonesia’s institutional capability for technology development is limited due to several cultural and policy factors. The diversified geography with more than 6,000 inhabited islands and 2,000 ethno-cultural groups creates problems for institutional development in education, communications and administration. Recently Indonesia is attaching special importance for the development of basic infrastructure including human resources. In the Republic of Korea, scientists, engineers and skilled workers are the main actors who made it possible for the country to achieve such a remarkable progress. Korea broadened its educational base to increase technical manpower and thereby trained the required manpower within a relatively short span of time. Even the poorest of the Korean families do not spare any efforts to provide the kind of education which the economy would consider necessary. Formal education is important to all Koreans. The government’s investment in education has expanded several times. But, the government expenditure on education represents only 30 percent of the total expenditure on education; the remaining being borne by the private sector. 7.5 Role of Research and Development (R&D) Expenditures There is a high correlation between R&D expenditure and technological capability because a new technology, which depends upon R&D activities, must be developed domestically as a country attains technological maturity. The NIEs spent more and more on their own technology development as imported technologies became more costly and increasingly difficult to obtain from developed countries due to growing technology protectionalism. The R & D expediture in India at 0.9 percent of GNP and in Thailand at 0.5 percent of GNP in 1992 were considerably lower than that in U.S.A. (2.7%), Japan (3%), Germany (2.9%), and South Korea (2.8%). In USA the Federal government provided 43% of total R & D funds in 1992 and the remaining 57% was provided by the industry, state governments, Universities and other non-profit institu-tions. In Japan, while the government provided only 16% of R & D expenditure, the rest was provided by industry. In Germany, 35% came from government sources and the remaining 65% was borne by the industry. In South Korea, the ratio of govwernment and private investment in R & D changed significantly from 97:3 in 1963 to 15:85 in 1992. In contrast R&D expenditures are mostly funded by the public sector in Thailand, Indonesia and India.

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India has built a wide array of institutions to support the development and diffusion of industrial technologies since the inception of planning in 1951. It has virtually all basic, applied, hardware and software and R&D institutions, some of which have world-class standards. But, these institutions have failed to commercialise R&D activities as these are virtually financed and controlled by the public sector without any linkage with the private sector. Since 1993 Government had encouraged private sector funding of research institutions by providing tax reliefs on R&D expenditure. The Indian government adopted a progressively more restrictive policy of technology imports from the mid-1960s due mainly to foreign exchange constraints. Imports of capital goods were liberalised to some extent during 1980s, but the import duties were high and irrational. Since July 1991 as a part of structural reforms in industry and trade, India has liberalised completely the import of capital goods and technology transfer with significant reduction of import duties on capital goods. 7.6 Role of Legal and Institutional Set up Many of the difficulties faced by governments in handling foreign investment, and by the foreign investors setting up in a host country, derive from the absence of a clear civil, commercial and criminal legal system. Given a set of laws, it is esential that foreign investors are treated equally with domestic investors. Not only is this a moral issue, but there are strong practical arguments against giving foreign investors privileges that domestic firms do not enjoy (and vice versa). Domestic firms will launder money to become foreign investors if this will give them subsidies that they cannot otherwise receive. Chinese publicly owned enterprises use transfer pricing at other than arms’ length to become foreign investors in China, or they form joint ventures within foreign firms to benefit from subsidies to foreign investors. Giving entrepreneurs of Indian origin special privileges by India are also inequitable and inefficient. Continued reforms will attract the worthwhile investors among them without incentives. In open economies, such as Singapore, Hong Kong or Mauritius, only minimal special foreign investment laws and regulations are necessary and administrative costs are negligible. Most developing countries like India are faced with a transition period. The experience of countries such as Indonesia, Malaysia, Taiwan and Thailand suggests that the transition can be managed well. The faster an economy is reformed, the easier the management of foreign investment. Regulations can be simple and their administration transparent. 8 POLICIES AND STRATEGIES FOR FOREIGN INVESTMENT : SELECTED COUNTRY EXPERIENCES FROM ASIA 8.1 India Since July 1991 India had undertaken credible reforms in trade, industry, financial and public sectors to enhance competitiveness of Indian industries and to strengthen the role of the private sector including foreign investment in industrial and technology

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development. The major reforms included wide-scale reduction in the scope of industrial licensing, simplification of procedural rules and regulations, reduction of areas reserved for the public sector, disinvestment of equity in selected public enterprises, enhancing the limits of foreign equity in domestic companies, liberalisation of trade and exchange rate policies, reduction and rationalisation of customs and excise duties, and personal and corporate income tax. Specific policy packages were taken for the small and cottage industries, 100% Export Oriented Units (EOUs) and Units located in the Export Processing Zones (EPZs), Electronics, Software and Hardware Technology Parks. Industrial licensing has been abolished except for 9 industries (accounting for less than 10 percent of value added in manufacturing) which are strategic on considerations of defence, health, safety and environment. Scope of the public sector is reduced to only six industries viz. defence products, coal and lignite, petroleum products, railways, atomic enery and minerals used for it. Entry of foreign investment and technology has been liberalised with automatic approval of foreign investment up to 51% of equity in 48 priority industries, upto 74% in 8 high priority industries in metallurgical and infrastructure industries and upto 100% in power, EPZs, 100% EOUs, export/ trading/ star trading houses, and electronics, software and hardware technology development parks. Even in sectors still reserved for the public sector (petroleum, coal, railways and postal services) government has taken a more liberal stance towards private investment including foreign investment. Permissible levels of foreign equity for different sectors are indicated in Table-8.1. Indian firms are allowed to raise funds abroad through Global Depository Receipts (GDRs), Foreign Currency Convertible Bonds and off-shore fund. Foreign Institutional Investors (FIIs) and Non-resident Indians (NRIs) are allowed to operate in India’s capital markets subject to an individual holding of 10% (1% for NRIs) and collective holding upto 30% (5% for NRIs) of total paid up capital of a company. Foreign investors are permitted to pick up disinvested shares of public enterprises. The Foreign Exchange Regulation Act was amended, and FERA companies (having foreign equity exceeding 40% of total equity) can operate like any other Indian Company, can own real estate, use their trade marks and brand names for domestic sale. India has become a member of the Multilateral Investment Guarantee Agency (MIGA) and signed treaties for avoidance of double taxation with 45 countries. Table 8.1 Extent of permissible foreign equity by NRIs/OCBs/FIs _________________________________________________________________ Areas of Investment NRIs/OCBs/PIOs Foreign Investors _________________________________________________________________ 1a)48 priority 100%, repatriable, 51%, repatriable, industries automatic approval automatic approval b) 9 high priority 74%, repatriable, 74%, repatriable, industries automatic approval automatic approval c)Export/Trading/ 100%, repatriable, 51%, repatriable, StarTrading Houses automatic approval automatic approval 2.100% EOUs & Units

100%, repatriable,

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100%, repatriable,

in FTZ,EPZ, automaticapproval automatic approval Technology Parks 3.Sick industries 100% private placement 100% private placement prior approval by RBI prior approval by RBI 4. Mining 50%,automatic approval 50%,automatic approval 5.Tele49% in basic,cellular 49% in basic,cellular communications mobile,paging,wireless; mobile,paging,wireless 51% in other services. 51% in other services. 6.Entertainment 51%,automatic approval 51%,automatic approval electronics 7.Power 100% with approval 100% with approval 8.Medical clinics, 100% with approval 100% with approval Hospitals,Shipping, Oil exploration, Deep-sea fishing 9.Industries 24%,with approval, 24% with approval, reserved for SSI 100% for 50% exports 100% for 50% exports 10.Housing, real 100%, repatriable, Not allowed except estate,business automatic approval for company property. 11.Domestic air 100% with approval 40% with approval taxi operations 12.Banking services 40% with approvaal 20% with approval 13.Non-banking fin. 100% with conditions 100% with conditions companies(NBFCs) 51% otherwise. 51% otherwise. 14.Portfolio individual ceiling 1% individual ceiling 10% Investment collective ceiling 5% collective ceiling 30% (Inv.in shares relaxable to 24% by Allowed to invest in & debentures) General Body Resolu. dated govt.securities. 15a)Disinvested Allowed,repatriable, Allowed, repatriable govt.shares through both primary/ through both primary/ b)Units in UTI secondary markets. secondary markets. c)Public/Private sector mutual funds _________________________________________________________________ NRIs= Non-resident Indians, PIOs= Persons of Indian origin OCBs= Overseas Corporate Bodies, FIs = Foreign Investors FIIs= Foreign Institutional Investors. The rupee is fully convertible on the current account, and almost fully convertible on the capital account for the non-residents. India permits free repatriation of profits and equity capital. Import controls are virtually abolished except for some consumer goods.

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Almost all items of capital goods, raw materials and intermediates are on open general license (OGL). Export trading houses are provided special import licenses which permit them to import certain consumer goods and other restricted items. Most recently, the export-import policy for 1992-1997 has widened the list of such items. Government intends to liberalise fully the imports of consumer goods and to introduce full convertibility of rupee in near future. Personal income tax rates have been reduced to 10 - 30 percent with various exemptions. Corporate tax rates have been reduced to 35% for domestic companies and 48% for foreign companies. A comparative picture of personal income tax and corporate income tax rates in India and selected Asian countries is presented in (Table 8.2). India has comprehensive agreements on avoidance of double taxation with 45 countries. India provides various tax exemptions for the development of industry, infrastructure and technology (Table-8.3) and these fiscal and other incentives are equally applicable to both domestic and foreign companies. It allows tax exemption for exports income, exemption or refund of customs duties on imported inputs and duty drawback on domestically procured inputs for the manufactured exports. Producers are allowed duty free imports of capital goods subject to export obligations. Exporters are granted Special Import Licenses for restricted consumer goods. EOUs/EPZ units are allowed to sell upto 25% of general goods and 50% of agro-based output in the Domestic Tariff Area (DTA). Supplies from DTA to the EPZ/EOUs are regarded as deemed exports. In keeping with India’s federal structure, a number of investment incentives such as capital investment subsidy, tax breaks, exemption of state duties, concessional power and utility tariffs etc. are provided by the state governments. Infrastructure Development Major improvements in India’s infrastructure are necessary to achieve its medium-and longer-term objectives of higher and sustained rates of growth and export expansion. Inadequate power supply is a major constraint to industrial growth. Not only generation capacity is in short supply, there is also under-investment in transmission and distibution which exacerbates imbalances in the sector. At 50 per cent, the share of India’s paved roads is lower than it was in 1971 in Malaysia (85 per cent) and Thailand (67 per cent). At present, teledensity in India (1 per 100 persons) is lower than what was in Korea (4) and Malaysia (2.5) in 1975 and well below its needs. Table 8.2A Personal income tax rates in 1996 : Comparison for selected Asian countries ________________________________________________________________ Country Corporate Personal Personal deduction income income as percent of tax rate tax rate per capita 1994 GDP (per cent) (per cent) ___________________________ Single member Family of household 3 children

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________________________________________________________________ India 35 - 48 10 - 30 200 275 China 15 - 33 5 - 45 260 260 Indonesia 10 - 30 10 - 30 87 261 Malaysia 0 - 30 0 - 32 52 108 Philippines 10 - 40 0 - 35 35 128 South Korea 30 - 45 5 - 45 15 75 Thailand 30 5 - 35 147 245 _________________________________________________________________ Table 8.2B Comparative fiscal indicators: 1994-1996 Revenue collections as per cent of GDP ________________________________________________________________ Country Personal income tax Corporate income tax ________________________________________________________________ India 1.4 1.5 Indonesia 2.5 5.4 Malaysia 3.8 2.5 Philippines 2.6 6.5 South Korea 2.0 2.9 Thailand 2.1 3.9 _________________________________________________________________ Table 8.2C Comparative fiscal indicators: 1994-1996 Revenue collections as % of total tax revenues ________________________________________________________________ Country Personal income tax Corporate income tax ________________________________________________________________ India 13.8 14.7 Indonesia 18.7 40.0 Malaysia 21.8 14.1 Philippines 13.0 32.5 South Korea 12.3 17.8 Thailand 11.8 22.9 ________________________________________________________________ Source : Information based on country embassies in India. Table 8.3 Fiscal Incentives for Industrial, Infrastructural and Technological Development in India

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_________________________________________________________________ Category % of profit exempt from tax Period _________________________________________________________________ New power projects set up 100% anywhere in India 30% New industrial undertakings set up in any underdeveloped states or areas identified by the government

100% 30%

Companies created exclusivey for research and development Enterprises carrying on business of developing, maintaining and operating infrastructural facilities*

5 years Next 5 years 5 years Next 5 years

100% 30%

100% 30%

5 years Next 5 years 5 years Next 5 years

Newly established industrial 100% undertakings in 100% EOUs,FTZs, electronics, hardware and software technology parks

Consecutive 5 years of first 8 yrs

Profits from exports of merchandised goods and computer softwares

100%

Unlimited no.of years

Profits on projects outside India

50%

Foreign exchange earnings of hotels/tour operators

Unlimited no.of years 50%

Unlimited no.of years

Royalties, commissions or 50% Unlimited fees from foreign enterprise no.of years _________________________________________________________________ * Infrastructural facilities which are eligible for five year tax holiday include power, roads, highways, bridges, sea ports, new airports, rail systems, rapid mass transit system (RMTS), telecommunications, water supply, irrigation, sanitation, and sewarage systems. India needs massive financing requirements to meet the growing demand for infrastructure in the future. For instance, power requires $60 billion in the next decade and national highways and expessways need $50 billion. The total demand for telephone

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services is estimated at 40 to 50 million by the end of the decade and the investment needed is $40 billion. While such funding needs may not be affordable, experience worldwide shows that the private sector would respond once the investment climate is favourable and the requisite legal, regulatory, institutional, and macroeconomic conditions are fulfilled. First, a stable macro-economic environment conducive to faster growth, low inflation and sustainable fiscal deficit is a pre-requisite for balanced expansion of capital markets and their capability to provide finances for the infrastructure. Secondly, sectoral reforms and appropriate institutional and regulatory framework are necessary to encourage efficient private sector investment. Thirdly, the task requires evolving appropriate legal mechanisms and market instruments for risk sharing. 8.2 Bangladesh During 1980s the Government initiated steps for industrial deregulation, trade liberalisation, promotion of the private sector, and the divesting of state-owned enterprises. The notable reform measures included privatisation of 33 jute mills and 37 textile mills, agricultural reforms, replacement of positive import list with negative list, a significant reduction of quantitative restrictions on imports and liberalisation of interest rates. In 1991 Bangladesh, building on the experiences of the 1980s and with the financial support of multilateral and bilateral donors, launched a more comprehensive reforms programme to establish a market- and private sector-driven economy. The Industry Policy of 1991 and its subsequent amendments relaxed the regulations for both domestic and foreign investment, reduced the scope of the public sector and opened telecommuni-cations, power generation and domestic air transport to the private sector. Except 5 sectors viz. defence products, security printing, mining, forest plantation and atomic energy, all other industries are now open for private investment. Foreign equity participation is encouraged in export-oriented industries and for projects involving advanced technical know-how or where the investment outlay is large. However, the legal/ regulatory framework and appropriate pricing policies still need to be worked out for active participation of private and foreign investment into the infrastructural sectors. The 1980 Foreign Private Investment Act provides foreign private investment an equal treatment and protection against nationalisation and expropriation. Since April 1994, Bangladesh rupee is fully convertibile on current account. Foreign investors can undertake projects in all but 5 reserved areas with 100% ownership and are permitted to reptriate equity and dividends. Imports are liberalised by reducing the coverage of QRs from 315 tariff headings (25 percent of the total tariff headings) in 1990 to 104 commodity categories in 1995. Of these, only 26 categories (mainly textiles) are now kept in the Control List for traderelated reasons. There has been also a considerable reduction of import tariffs from the maximum tariff rate of 509 per cent in 1991 to 40 per cent in 1997 for general goods.

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Several fiscal incentives as indicated below are granted to investment including foreign investment in Bangladesh since 1989. (a) A tax holiday for 5 years for developed areas, 7 years for less developed areas, 9 years for least developed areas and 12 years for the Special Economic Zones. (b) A 20 per cent import duty on capital goods for industries in developed areas, 7.5 per cent for less developed areas and 2.5 per cent for least developed areas. A 2.5 per cent import duty on capital machinery for export oriented industries and for selected industries using 70 per cent or more of indigenous raw materials. (c) Tax exemptions on interest on foreign loans, royalty, technical know-how and technical assistance fees. 8.3 Myanmar The Union of Myanmar is in a transition from a centrally planned economy to a marketoriented economic system.It undertook several reforms in trade and industry since 1988 to encourage foreign and local investment. Major measures include decentra-lising economic control, abolishing price control and subsidies, allowing foreign direct investment, restructuring of banking system, rationalising taxes and duties, restructuring wages, prices, regularising the border trade, streamlining exports and imports procedures, improving infrastructure support and allowing farmers to cultivate crops at their own choice. In the process of drawing up the Foreign Investment Law in 1988 particular care was taken to make it as conducive to foreign investment as possible. A key element of the Foreign Investment Law is the establishment of the Foreign Investment Commission (FIC) which has broad authority to approve foreign investment. Approval of the FIC is also required for termination of any investment before the expiry of terms and contracts. The Law provides for two types of foreign investment - wholly owned foreign enterprises and joint ventures with a Myanmar partner. The Law guarantees that foreign investments under taken shall not be nationalised. It also guarantees the repatriation in foreign capital after the termination of the business. Foreign investors may hire Myanmar labour or foreign technical staff without any restriction. The Foreign Investment Law also provides special tax incentives for foreign investors and allows Foreign companies to lease land and immovable property at reasonable rates from the Government. 8.4 Nepal The savings and investment rates are relatively low in Nepal. However, it has gradually started picking up with increase in private sector activities in the country. In 1991-1996, the average Gross Domestic Investment as percentage of GDP was 22.6 percent per annum while the average Gross Domestic Saving was only 12 percent. Almost two third of the total fixed capital formation was contributed by the private sector while the remaining by the public sector. The Eighth Five Year Plan (1992-1997) set a policy of sustainable economic growth through market-oriented policies. A comprehensive programme of public enterprise

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reform was initiated by the government. The role of private sector was encouraged in all economic activities for the enhancement of output growth and emloyment generation, while the government sector is mainly concerned in providing infrastructure, basic health and social services. The public policy aims to encouraging private and foreign capital in core economic sectors such as hydro-electric power where positive developments have been observed. The industrial policy greatly simplified industrial licensing procedures. The Industrial Enterprises Act 1992 graded the industries into 4 categories according to the investment pattern: cottage industry, small scale industry, medium-sized industry and large scale industry. Cottage, small and medium-sized industries with fixed assets up to Rs.2 million are open to technology transfer, and foreign investors have ample scope for investing in large-scale industries with fixed capital of Rs.5 million or US$1 million. The Foreign Investment and Technology Transfer Act 1992 provides for legal support to parties entering into joint ventures and technical collaborations. In order to promote rapid private sector response to the on going reforms, regulations on opening new commercial banks and financial institutions have been liberalised and interest rate controls have been eliminated. Since 1993 major changes in the trade and exchange system moved Nepal from a highly distorted, inward-looking economy to one of full de facto convertibility on current account. In 1993 the import license auction system was abolished; all quantitative trade restrictions, except for security and environmental reasons, were eliminated and the tariff structure was rationalised with significant reduction in the basic rates, abolition of additional duties and reduction of the peak tariff rate from 200% to 110%. The benefits of more open trade links with the rest of the world are being reflected in strong export growth and a strengthening of the balance of payments. Foreign investment approvals increased significantly in 1990s. Recently introduced one-window system has favourable impact on industralisaion of the country. Liberalisaiton of trade and unification of the exchange rate contributed to a major rationalisation of a highly distorted set of incentives. Capital goods are now imported virtually duty free. Foreign investment policy issued in 1992 helped to establish a more outward orientation for the manufacturing sector. Over the medium term, Nepal envisages to pursue the policy of low and non-discriminatory import tariffs and qualification of WTO membership. The Government’s aim is to reduce further the number of tariff bands, and to cut the level and dispersion of tariff rates. 8.5 Pakistan Pakistan allows foreign investment in many infrastructural industries including power, natural gas, pipelines, port facilities, expressways, mass transit system etc. Pakistan offers various incentives to foreign investors in infrastructure, power generation, railways, highways, airport construction etc. and in export processing zone or 12 special industrial zones.

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Fiscal incentives for exports and high levels of protection for domestic industry featured prominently in the trade policies of the past. The new trade policy announced on July 25, 1994 liberalised imports with a shorter negative list and reduced import duties. Pakistan declared its currency fully convertible w.e.f. July 1, 1994. Export promotion was encouraged by sales tax exemptions, continuance of concessional tariffs for imports of capital goods by export-oriented industries, and freight subsidy of 25% to exporters of fruits, vegetables, cut flowers, ceramics confectionery, processed fish products, etc. A new industrial policy embodying extensive incentives and concessions aimed at accelerating industrialisaiton had been introduced. The whole country had been given tax holiday for three years, and still more tax concessions had been provided for the rural and backward areas. Substantial concessions had been given on customs duty, import surcharges, sales tax and import license fee. There is no ban on establishing any industry except security-oriented and those producing alcoholic beverages. During 1990s many new measures have been taken to attract foreign and domestic investment. Multiple government agencies, such as the National Investment Council, the Pakistan Investment Board and the investment Promotion Bureau, dealing with investment decisions were merged into a single institution viz. the Board of Investments (BOI). A number of investment funds have been set up abroad for either exclusive investments in Pakistan or investments in emerging markets including Pakistan. In March, 1994 a package of liberal incentives was announced to attract foreign investment in power generation. These incentives include guaranteed 25% return on the capital, tax holidays and exemption from import duties on generation machinery, and the sovereign guarantee by the Pakistan government. Further fiscal incentives for the promotion of engineering industry announced in 1995 include withdrawal of sales tax on new plants and for balancing, modernisation and replacement (BMR), use of zero-rated tariff for raw material and component, accelerated rate of depreciation and reduced withhold-ing tax for components and raw materials. With a view to attract foreign investment, the Board of Investment (BOI) announced in May 1995 a package of incentives for the pharmaceutical raw materials producing industry. The package includes 10 per cent reduction in import duty for the related equipment and machinery, exemption of duty on import of raw material, withdrawal of sales tax on the finished material, an increase of debt-equity ratio from 60:40 to 70:30 and tariff protection for locally produced material against the imported raw material and finished products. 8.6 Sri Lanka Since 1977 Sri Lanka adopted credible trade reforms which included a sharp reduction in quantitative restrictions (QRs). The 1977 tariff system consisted of 8 bands, ranging from zero duty on certain essential consumer goods to 500 per cent on luxury goods. Basic raw materials, machinery, and spare parts faced duties of 5 per cent, while intermediate goods faced duties ranging from 12.5 per cent to 25 per cent. Subsequently during 1980s and 1990s the tariff bands and the peak tariff rates were reduced significantly.

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During 1993-94 the Government removed export licensing restrictions on all but four items, most justified for reasons of environmental protection. A large number of import licensing restrictions were also removed, with the remaining restrictions justified for reasons of national security, public health, public morals, or environmental protection. Sri Lanka accepted the obligations of Article VIII of IMF for full convertibility on current account in March 1994. Sri Lanka is a member of the Bangkok Agreement, which is intended to promote regional economic development through trade expansion among members of the Economic and Social Commission for Asia and the Pacific (ESCAP). Under the Bangkok Agreement, Sri Lanka offers concessional tariff rates to Bangladesh, India, Lao P.D.R. the Republic of Korea, and Papua New Guinea. The product coverage is about 300 items. 8.7 Korea The performance of Korean economy over last 3 decades is a constant reminder to the developing world that industrialisation-export based development straegies can be implemented to achieve two objectives of development viz. growth and equity. The stabilisation and recovery were the Government’s top priorities in the early reform period. Stability was attained through exchange rate adjustments, which restored export competitiveness and reduced the import demands. To dampen inflationary pressures, officials tightened fiscal policy and initiated tax reform programmes. External trade was liberalised significantly except selected import restrictions. Foreign investment rules were liberalised to encourage inlow of foreign capital. Entry of foreign investment to the Korean economy has been significantly liberalised over the years. There is no specified limits on foreign equity participation except in the case of industries on the restricted list. There is no minimum cash requirement and Foreign Direct Investment may be entirely in the form of patents or technology transfer. In 1960’s when the foreign investment began to be introduced, investments centered in labour-intensive industries such as electricity, electronics, fibre and garments. As the economy began to make progress,foreign investment was gradually shifted to technology or capital-intensive industries such as chemicals and transportation means. In July 1984, Korea adopted the negative list system. Consequently, the foreign investment liberalisation ratio rose to 66% compared with 61% under the positive system. Since March 1993 the approval oriented system was changed to the notification oriented system, which covers 91% of the total businesses eligible for foreign investment regardless of foreign equity ratio(except for few industries such as retail business and hotels). Manufacturing sector has been opened to FDI more rapidly than other industries, as indicated by the higher liberalisaiton ratio at 97.8 percent for it in 1993. Though the service sector has a far lower liberalisaiton ratio than manufacturing, those services

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which are of interest to foreigners such as finance, wholesale trade, and marine transportation are at least open to FDI. Korea has 1148 distinct business sectors. Of this 64 sectors are currently either restricted or banned for FDI. Restricted sectors include agriculture, finance, telcom and broadcasting. The banned sectors include rice farming, cattle breeding etc. All foreign companies in Korea enjoy a National status and get the same incentives which are available to domestic companies. Mergers and Acquisitions of foreign enterprises are allowed subject to prior approval and the condition that thay do not violate the norms of the restricted and banned sectors. Since the early 1980s, Korea has implemented a comprehensive program of trade liberalisation, and has achieved a significant reduction of quantitative controls and tariffs. By 1992, the import liberalisation ratio for manufactured products had risen to 99.9 percent, and that for agricultural products has increased to 87.1 percent.Korea successively reduced import tariffs since 1980s. The Korean Stock Exchange gradually expanded market access for foreign portfolio investments through introduction of various instruments such as investment funds for foreigners, issuances of equity-related overseas securities, opertions of foreign securities companies through branch offices and joint-ventures, and direct investment in the Korean stock market by the foreigners. Ongoing refornms may enhance the current 10% ceiling on foreign holdings of a domestic firm’s stocks. Foreign investors are provided with many incentives such as repatriation of earnings, protection for intellectual property rights such as patents and trade marks, Investment Guarantee Agreement and Double Taxation Avoidance Agreement, tax exemptions and deductions, a favourable business environment for investors by constructing free export zones, facilitating the use of financial resources, and establishing a one-stop service center where government officials from relevant ministries worked together. The Korean tax system is composed of national taxes and local taxes. The national tax system includes corporate tax, income tax, value-added tax and special excise tax as its highest revenue sources, while local tax is dividend into provincial tax and city and country tax. In step with the current international economic trend of liberalisation and globalisation, the corporate tax rate has been reduced from 32% to 30% and the depreciation and tax accounting systems have been improved. In the case of large-sized utilised companies (including domestic companies having net worth of over 10 billion won), a 15% tax rate is levied on the excess accumulatedd earnings. However, the excess accumulated earnings used for reinvestment is exempted from the payment of the tax. There are six income tax rates depending on the income slabs (Table 8.4), and various exemptions relating to basic reduction, spouse, dependents, handicapped, female houiseholder and labour income are available for the taxpayers. Table 8.4 Income Tax Rates in Korea (in per cent) _________________________________________________________________

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Income tax Base Income Tax Rate _________________________________________________________________ Under 4 million won 5 4 million - 8 million won 9 8 million - 16 million won 18 16 million - 32 million won 27 32 million - 64 million won 36 64 million won and above 45 _________________________________________________________________ The Foreign Capital Inducement Act has stipulated a wide range of tax support systems that can facilitate the transfer of advanced technology and the introduction of foreign capital. The foreign companies receive various fiscal incentives such as exemption or reduction of income tax and corporate tax; exemption or reduction of acquisition tax, property tax and aggregate tax; and exemption or reduction or customs duty, special surtax and value added tax when introducing capital goods. Foreign investors receive exemption or reduction of income tax and corporate tax on dividends, royalties and other investment income. Foreign companies transferring advanced technology receive exemption or reduction of income tax and corporate tax for providing technology. Lenders of public loans get exemption or reduction of tax and public charges on loan interest. Foreign technical service providers related to public loans get exemption or reduction of income tax and corporate tax for providing services. Employment of foreigners in industry and trade is allowed. Taiwanese firms are importing labour from Bangladesh and Philippines to carry out low end jobs while upgrading Korean labour to higher skill levels. Companies are free to close down operations provided they are able to compensate the labour according to a formulaset by the government. The Government is currently planning to open up more and more sectors such as wholesale and retail trade of grains, mutual credit companies, air and land freight hndling services, inter-city bus transportation, hospitals, vocational schools, offset and commercial printing, employment agencies, manufacture of lubrication oil and gases, legal services, real estate, insurance brokerage, publication of newspapers etc. A New Foreign Direct Investment Act passed in January 1, 1997 announced that additional 28 sectors will be liberalised from June 1997, 11 sectors from Jan 1998, 6 sectors from Jan 1999 and another 6 sectors from Jan 2000. Investment related regulations are being brought in line with international standards. Conditions and procedures are being formulated for friendly Mergers and Acquisitions. Investor protection and establishment of an investment related dispute settlement procedure is an important part of this law. 8.8 Singapore Singapore is one of the most open economies in the region and allow foreign investments in almost all sectors of the economy. It is relatively open to foreign

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investment in banking and other related institutions, energy, services and trading firms. It has no limits on foreign investment except in public utilities, media, transport and telecommunications. The Singapore government initially introduced quotas for protection of infant industries like textiles, and used import licensing to regulate the trade of a limited range of goods (such as films, publications, live animals, food, ornamental fish, fresh or frozen meat, arms and explosives, medicines and drugs) for social or security reasons. Free trade zones which facilitate entrepot trade and promote the handling of transshipment cargo have been in operation since 1969. The country has presently six free trade zones. Tariff levels in Singapore are the lowest compared to its ASEAN neighbours with 70% of its tariff lines set between 0-10%. The government aims to reduce tariff bound rates for 2480 tariff lines under the Uruguay Round (UR) standard of 10% to 6.5% and bind additional 291 tariff lines at a maximum rate of 6.5% thus extending UR tariff binding coverage from 70% to 75% of all tariff lines. Legal system in Singapore is highly developed, fair and efficient. Singapore readily interacts with foreigners, encouraging multinationals to set up shops in the country. However, foreigners are required to obtain work permits, limited in duration, and restricted for certain categories. An important characteristic of foreign investment in Singapore, not shared by other ASEAN countries and Asian NIEs, is the overwhelming dominance of FDI over portfolio investments. More than 95% of net long-term capital inflows into Singapore is in the form of FDI which has been the driving force behind Singapore’s phenomenal growth over the last three decades. It brought capital, technology, management expertise and access to world markets. It transferred Singapore from a labour surplus economy to a labour tight economy. The foreign share of total investment in Singapore has been about 70 percent in manufacturing and more than 80% in services in recent years. Foreign investment is dominated by 100% foreign or majority foreign owned companies which account for more than 60 percent of the companies with foreign equity capital. The USA leads the foreign investors in both manufacturing and services, followed by Japan and Europe. While Japan’s share has increased over time and Europe’s share has declined. Foreign investment is highly export oriented, with 85% share in manufacturing exports. Singapore’s latest strategy has been to promote outward FDI aggressively to develop an external “wing” with strong linkages with the domestic economy. It has introduced various incentives schemes to encourage local companies to go abroad. The most popular destination for local companies has been Asia which had a share of about 65 percent of Singapore investment in 1994. 8.9 Indonesia Indonesia promotes foreign investments that increase non-oil exports, encourage procesing of raw materials into finished goods, use local products or components, transfer

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technology and skills and save foreign exchange. Most foreign investments are structured as joint ventures to foster the development of domestic industries. In May 1989 the minimum size of foreign investment was reduced from US$1 million to $0.25 million for certain sectors. In 1994 Government shortened the negative list for foreign investors to 34 industries and relaxed ownership of foriegn investors by allowing 95 percent of equity owned by foreigners in business ventures in Indonesia. The sectors opened for foreign capital in 1994 were seaports; the generation, transmission and distribution of commercial electricity, telecommunications, civil aviation, shipping, drinking water supply, railways, nuclear power generation and mass-media. The negative list for foreign investors now consists of 34 sectors, including domestic distribution and retailing and sectors reserved for small scale firms. Foreign ownership is limited to 80% for total investment of at least US$1M. 100% foreign ownership for a maximum period of 15 years is granted if the total paid-up capital is at least US$50M; the company is located outside Java or in a bonded area and it is a 100% export-oriented unit. Indonesia has 2 duty-free zones at Batam Island and Surabaya. Projects in free trade zones are allowed 95% foreign ownership. Foreign ownership for commercial production is reduced to 49% or less within 20 years. Foreign investors who issue more than 20% of their equity through the capital markets are allowed to maintain up to 55% of shareholdings to qualify as a domestic market enterprise: this allows them to distribute goods at retail level and obtain credits from the state banks. Negative list defines areas restricted to foreign investments and includes retailing and advertising. In 1989, a new list replaced the Investment Priority List and opened more than 300 sectors to foreign investors, and only nine sectors remained closed. Since 1988, foreign investors have been allowed to set up joint ventures in services like banks, finance, insurance and securities companies. Foreign investors are also allowed to enter shipping, civil aviation, telecommunications, media and energy sectors. The “strategic” commodities such as agriculture products, palm-oil based products, paper products, plastics, and automotive sectors and machinery are still subject to either non-tariff barriers or high import duties or export taxes. The imposition of export tax with escalated base and rates on crude/semiprocessed palm oil not only discourages exports but also creates economic rents for domestic producers of fatty alcohol at the expense of labour intensive, mainly state-owned, palm oil planters. Tariff levels have considerably fallen since 1985 when the government announced an across-the-board reduction in the range and level of import duties. At present, tariff levels range in between 0 to 100% with an average rate of 20% compared with an average rate of 37% before 1985. In an effort to promote an open economy, the reforms in the tariff structure have ensured that over 50% of the domestic output from import competing sectors have tariffs of 10% or less.

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Since 1986, the government has moved to dismantle the complex import licensing system. The share of imports subject to non-tariff barriers (NTBs) decreased from 43% in 1986 to 13% in June 1991, and the share of domestic production protected by NTBs declined from 41% to 22% over the same period. Nevertheless, some important subsectors in manufactruring such as engineering goods, tires, paper products, glass, man-made fibres, textiles, iron and steel, plastics and food processing and most of agricultural goods remain subject to NTBs. Imports of restricted goods, such as essential agricultural commodities like rice, sugar, soybeans, fresh fruits, milk products, batik goods, garlic, some steel items and strategic minerals like coal, are permitted only when there are shortfalls in domestic production. Indonesia allows foreign investors to appoint own management, but they must use Indonesian labour except in positions where suitable nationals are not available. There is no restriction on repatriation of profits. Indonesia has bilateral agreements with a number of countries and is a signatory of MIGA protecting investments against political risk. However, Indonesian judiciary system is very weak with unclear legal rights. The tax bills of 1994 to 1996 broadened value added tax and property tax, reduced the highest income tax rate from 35 percent to 30 percent, and improved tax administration bu giving greater authority to tax offocials to check tax returns. The list of objects of the value added tax now includes a wide range of services, including franchising. The income tax bills reintroduce various forms of incentives for investment in remote locations, particularly in the Eastern part of Indonesia, pollution abatement and development of human resources. The fiscal incentives include reduction of the highest marginal tax rate from 30 percent to 25 percent; accelerated depreciation and amortisation; a longer period for compensation of loss and a lower tax on dividends; exemption from import duty, import surcharge, excise and income tax for trade zones; drawback of import duty and VAT for export manufacturers; and general exemption from import duties on capital goods and raw materials for two years production. 8.10 Malaysia Malaysia prioritises investments in capital-intensive, value-added and high-technology industries, and encourages joint ventures for the development of domestic industry in almost all the manufacturing sectors with 60%-40% ownership in favour of local enterprises. Promotion of Investments Act of 1986 contains the principal incentives for investment in agriculture, manufacturing, tourism and other commercial undertakings. Foreign ownership is allowed if investment in fixed assets (excluding land) is at least RM50M or has at least 50% value added; products do not compete with existing domestic production; and for projects in extraction or mining or processing of mineral ores. No equity limit is imposed on manufacturing projects that export 80% or more of total production. 100% foreign ownership is allowed for high-technology projectrs and other

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priority products for the domestic market. Maximum foreign equity of 60% is prescribed for sales to the domestic market, Although investment is promoted in all areas, certain targeted sectors and activities such as agriculture & agro-processing, forestry, manufacturing, hotel & tourism projects and the film industry are promoted by the government. The Free Trade Zone Act of 1972 established FTZs designed for establishments producing or assembling goods for export. Lubuan island is being promoted as an international offshore financial centre. From 1994-95, Malaysia further liberalised foreign investment in its financial services and increased entry of foreign banks, enhanced equity participation in insurance, and liberalised the shipping, telecommunications, and transport sectors. It has also opened 64 service sectors including computers, audio-visual, transport and business services. The government enforces import controls through a system of import licensing to protect domestic producers from imports and to ensure adherence to sanitary, safety, security, environmental and copyright requirements.Import duties in Malaysia are relatively high ranging from 0% to 300% though most goods fall within the 15% to 25% tariff range. In implementating the Uruguay Round commitments for market access, Malaysia has unilaterally accelerated the tariff cuts on a number of items. Malaysia allows free repatriation of profits and capital, and provides bilateral protection against nationalisation and expropriation. Based on British model, legal system and company laws are generally well developed in Malaysia and provide investors protection and fair arbitration disputes. Malaysian society is not generally anti-foreign, but its New Economic Policy (NEP) extends preferential treatment to ethnic Malaysians and limits foreign control over the economy. The government allows the employment of technical and skilled foreign personnel in areas where there is shortage of local talent. But it requires a training programme to transfer skills to locals. Fiscal incentives include tax exemptions for 5 years for 85% of income for pioneer industries; lower income tax at the rate of only 30 percent of income for 5 years for the potential pioneer status industries; full exemption from import duty on raw materials or components used for export production or for production in a promoted zones for both domestic and export markets; partial import duty relief for goods produced for the domestic market; and full drawback of import duty and sales tax on parts, components or packaging materials used in the manufacture of goods exported. 8.11 Philippines Philippines encourages investments in sectors that provide significant employment opportunities, increase the productivity of resources, improve technical skills and strengthen inter-national competitiveness. Under the 1987 Omnibus Investments Code, a 60% - 40% equity rule prevails in favour of local enterprises. The Foreign Investment Act of 1991 allows 100% foreign equity in any business except those in the Negative List without any incentives. The Negative List restricts foreign participation to a maximum of

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40% and prohibits foreign equity in areas mandated by the Constitution such as mass media, engineering and accountancy. The Special Economic Zone act of 1995 created ecozones or selected areas which are found in highly developed regional growth centres with adequate infrastructure, industrial capacity and availability of labour. These zones have the potential to be developed into industrial, tourist/recreational, agro-processing, commercial, banking, investment and financial centres. This includes the Subic Bay Freeport, Clark Special Economic Zone and three major EPZs with plans for expansion. Philippines liberalised recently its financial sector to promote more innovation in terms of products, services as well as technology. Since 1994, foreign banks have been allowed entry and further liberalisation of the sector is planned. Foreign banks are also allowed to establish subsidiaries and enter into joint ventures. The insurance, financing and securities industry is generally open to foreign firms. Recent policies are also being adopted to liberalise and deregulate the telecommunications, shipping and energy sectors. However, the media and retail trade remains closed under the negative list. Generally, all merchandise imports are freely allowed. However, the government prohibits the imports of some products for reasons of health, morality, balance of payments and national security.The Philippines likewise sets technical standards and regulations. In 1990 import tariffs ranged between 10 to 30% with four-tiered bands. In 1991, a more gradual tariff reduction was adopted with 95% of the tariff lines set in the range of 3% to 30% with four layers: 3%, 10%, 20% and 30%. Beginning 1996, the fourtiered tariff system was narrowed furtheer to two tiers in preparation for a uniform tariff rate of 5% by 2004. The country is generally open. Its strong relationship with the US and the widespread use of English make Filipinos more open to foreigners. Philippines has a well-established judicial system, but enforcement is rather non-effective and lax. The constitution limits foreign ownership of property and so-called strategic industries. Foreigners need to obtain work permits and are required to train local counterparts. Foreigners may retain top management positions if the majority of capital stock is foreign-owned. But, the foreign nationals employed in supervisory, technical or advisory positions cannot comprise more than 5% of total workforce. The government also allows the full and immediate repatriation and remittance privileges for all types of investments. The foreign investment policies provide the basic rights and guarantees for the protection of foreign investments such as repatriation of equity and profits; the right to foreign loans and contracts; freedom from expropriation of property; and non-requisition of investment. Foreign investments are treated equally as domestic investments, except in the areas listed in the Foreign Investment Negative List. The package of incentives, which are competitive with those provided by other ASEAN countries, take the form of income tax holiday for four to eight years; duty free imports of capital goods and components, breeding stocks and genetic materials; provision of tax

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credits on capital goods bought locally and raw materials, supplies and semimanufactured products used in the manufacture of products and/or forming parts thereof for export; additional deduction for labour expense; exemption from the payment of contractor’s tax, wharfage dues and any export tax. Additional incentives such as tax holiday for 6 years and exemption of major infrastructural costs and wages from the taxable income etc. are provided for projects located in less-developed areas as categorised by the National Economic Development Authority (NEDA). During 1981-1992 foregone revenue through the grant of fiscal incentives represented 0.64 percent of GDP. 8.12 Thailand The Thai policy makers had always held the view that the government should play a limited role in the economy and the private sector should be the engine of growth. Thailand’s public enterprise sector is small and more profitable than in many developing countries. Over time, public sector activity shifted away from direct involvement in industrial production toward the provision of public infrastructure and services. This, together with the pro-business orientation in tax laws and industrial policy, has served to create a dynamic private sector. Thailand’s adjustment experience since 1980 has, in general, been impressive. Despite having been subject to adverse external shocks in the late 1970s and early 1980s, Thailand, unlike many developing countries, did not experience a major “investment pause”. Since 1986-87, Thailand experienced an unprecendented economic boom led by a surge in private investment and manufactured exports. Factors that contributed to this rapid growth include a sustained improvement in external competitiveness, a relatively high degree of labour mobility, lower labour costs relative to its trading partners, the elimination of export taxes and the introduction of other incentives aimed at export promotion and providing a favourable environment for private investors. The fiscal consolidation since the mid-1980s also resulted in substantial surpluses and made it possible to accommodate the surge in capital inflows and the investment boom without high inflation or a real appreciation of the baht. Thailand prefers foreign investments in activities that are labour-intensive, exportoriented, raw material-intensive, and import substituting. It also encourages investment for construction and infrastructure, R&D services, agro-industries, and telecommunications. The Alien Business Law of 1972 allows foreign participation in certain enterprises provided that Thai ownership is more than 50%. Presently the Law is under revision to further liberalise trade and industry. Currently, any firm that exports at least 80% of its production may be completely foreign owned, although full ownership may be negotiated on a case by case basis for lower levels of export obligations. For projects in agriculture, fishery, mining and services, foreign investors may hold majority or all shares if capaital investment is over 1M Baht. However, Thai nationals must acquire at least 51% control

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within 5 years of operation. Foreign equity participation cannot exceed 49% in manufacturing projects for the domestic market, although majority foreign ownership is allowed for enterprises that export at least 50% of its total sales. Thailand has a Negative List of areas closed to foreign investments. The Thai government has divided the country into 3 zones for the purpose of decentralisation. Zone 3 or the Investment Promotion Zone allows full foreign ownership for manufacturing. Thailand plans to transform its economy into a strong regional financial centre by 2000 and has recently allowed more foreign banks to set up branches in the country. The Thai Government uses import licensing mainly for protection of infant industries. There are local content rules on dairy products, tea and motor vehicles as a way of aiding local producers. The government also regulates imports to meet certain technical regulations and standards for health and safety reasons. Around 100 product categories are subjected to import licensing and about one-fourth of these are agricultural commodities such as rice and sugar. Industrial products covered by import licensing include certain textile products, machinery items, motor vehicles, motorcycles, paper products, chemicals, porcelain items and building stones. The Thai economy has traditionally been outward-oriented and at the same time there was a fair degree of government intervention in the trade system. The main instrument of intervention has been tariffs. The system of protection was biased against the agricultural sector, agro-based and labour intensive products and favourable towards capital-intensive and import substituting industries such as automobiles and pharmaceuticals. The labourintensive textile industry was also heavily protected. After a period of heavy protectionism in the late 1980s when relatively high tariff rates were adopted, Thailand has recently embarked on a tariff reduction programme in compliance with its commitment under AFTA. Tariffs on fast-track products will be reduced from 25% to 0- 5% by 2000. Normal-track traffis are subject to 30% taxation. In the case of 3908 items, which now attract rates up to 100%, tariffs will be reduced to 30% or less. Thailand is a relatively open society and does not vigorously oppose foreign influence. Although it has an independent judiciary system, enforcement is rather arbitrary and lax. Foreign employment is subject to the Alien Occupation Law which requires all aliens to obtain work permits. Thailand allows free repatriation of profits and capital. Fiscal incentives include tax holiday for 3-8 years depending upon zone; exemption or 50 percent reduction of import duties and business taxes on imported machinery; reduction of import duties and business taxes of up to 90 per cent on imported raw materials and components; and additional incentives for investments in outlying areas and export firms. 8.13 Vietnam

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The Vietname is in a transitional stage of moving to a market oriented economy and implementing the development policies with an accelerated pace. The expansion of foreign cooperation and mobilisation of FDI funds are among the most important objectives of the Vietnam’s present macro policies. Foreign direct investment has played a major role in developing the Vietnamese economy by utilising fully and raising the production capacity of vairous existing units and creating new production capcities in industry, transport, post, communication and hotels. International telecommunications and domestic telephone services have been greatly improved, creating favourable conditions for economic development. Through FDI, the Vietnamese have received some advanced techniques and technologies in various economic areas such as telecommunicaiton, oil and gas, electronics, motorcar assembling, hotels and agriculture. Beginning 1986, foreign investments are encouraged in high technology and labourintensive production and infrastructaure to strengthen the country’s industrial development. The Law on Foreign Investment provides for 3 forms of foreign investment: contractual business cooperation ventures, joint ventures and wholly owned foreign enterprises. In joint ventures foreign participation should be at least 30% of prescribed capital. In 1993, the government adopted the BOT scheme which allows 100% foreign capital for infrastructure and energy projects. Since 1991, foreign investors are prohibited from doing business in the following areas : exploitation of rare minerals, large-scale supply of power and water, communications, shipping and aviation, tourism and trade services. Foreign-owned or joint ventures are allowed in EPZs devoted to light manufacturing industries such as garments, textiles, leather, footwear, paper, packaging and printing products, food and beverage, home appliances, plastic products and electronics. Special areas for foreign investments include services such as banking, insurance, construction, auditing, fuel and gas supply and import/export related sectors. The government has allowed the entry of foreign banks to modernise its financial system. Until 1990, foreign investment was mainly concentrated in oil and gas (32.2%) and hotels (20.6%). At the end of 1993, foreign investment was concentrated in industry (36.8%), tourism and hotels (18.6%) and oil and gas exploitation (15.3%). An appraisal of FDI fund implementation in recent years shows that the realised funds of FDI accounted for about 30 per cent of the total committed value of FDI becaue of various factors such as delays in project implementation, legal procedures and complex rules and procedures. The government regulates external trade through the administration of quotas and the issuance of import and export licences. Import duties in Vietnam is relativiely high ranging from 3% to 100%. The lowest rates are levied on imports of raw materials and capital equipment, while the highest are levied on imports of luxury goods. Upon its entry into ASEAN, Viet Nam has agreed to join the Common Effective Preferential Tariff (CEPT) Scheme for AFTA beginning January 1996 and complete implementation of the CEPT Agreement by the year 2006.

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In its desire to catch up with the globalisation, local enterprises are allowed to enter foreign paratnerships to assimilate product, market, management and technological knowledge. Employment of expatriates is permitted, although there is a priority for local employment and foreign firms should provide training programmes for locals for trasfer of skill. The state guarantees ownership of invested capital and provides favourable conditions and simple procedures for foreign investments. However the legal system is not well developed and there is a lack of uniform commercial code to protect private sector against government seizure. 8.14 China Reforms in China started in 1979 when the Chinese government adopted an open-door policy which recognises the need for foreign capital and technology to accelerate the growth rate and to build up infrastructure. Areas promoted are agriculture, energy, electronics and manufactures. Generally, it promotes labour-intensive and high technology industries. Nearly $140 billion of FDI had came into China between 1979 and 1996. Most of this has been in high tech areas such as automobiles/ digital exchanges. China identifies four categories of foreign investment: Encouraged sectors, Allowed sectors, Limited sectors and Prohibited sectors. In the limited sectors, the foreign equity participation should be minimum of 25% and a maximum of 50% whereas in encouraged sectors the equity participation could be up to 100%. Limited foreign ownership is allowed in civil aviation industry including airport facilities. Joint ventures are allowed in energy and infrastructure projects. Restricted areas include public utilities, transport, real estate, trust and investment leasing. Foreign investment can take place in the form of equity joint ventures, contractual joint ventures and wholly owned foreign enterprise. In wholly owned foreign entprises, the following conditions apply: it must utilise advanced technology & equipment: develop new products or improve existing ones, and must export more than 50% of output. Several foreign banks, financial and insurance institutes are opening their branches and business in larger areas in China. In special economic zones and the coastal development areas, many foreign investors are investing substantial amounts of money on land exploitation, capital intensive and long-term cost-recovery infrastructure projects, such as railways, highways and harbours, or even the projects of airport construction and civil airlines. China’s open door policy began in isolated areas or special economic Zones (SEZ) with considerable autonomy for attracting foreign investments. The SEZs are designed to encourage foreign capital and technology by offering various incentives such as duty-free imports, lower taxes and administrative autonomy in order to boost the development of China. In the SEZs, foreign banks are generally allowed entry and this is also extended to insurance and securities firms.

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Special Economic Zones (SEZs) play an important role in the overall economic development of China by generating forward and backward linkage and generating employment. The first SEZ came up in 1980 and initially processing industries which were highly labour intensive set up their bases in SEZs (1980-85). During 1985-90, more hi-tech processing industries were set up. During 1990s emphasis was shifted on high tech areas. Most of the investment in these areas came from overseas Chinese natioinals who were attracted by market economy operating in these zones, efficient infrastructure and other support services, various tax exemptions and concessional credits applicable to these areas. Visas are not difficultto get for the expatriates working in SEZs. China plans to upgrade the SEZ’s to international standards, to accord national treatment to all foreign enterprises, to standardise the legal system, and to create SEZs in the interior. China’s tariff regime is characterised by a relatively high average tariff and a large number of tariff bands with wide dispersions. In 1993, the average unweighted tariff rate stood at approximately 40%. Rates tend to be lowest for raw materials and higher for finished consumer goods. The structure of tariffs provided very high rates of effective protection for some finished goods. Since the APEC Bogor Meeting in 1994, China has reduced the regulatory tariff on some products. In 1996, China promised to slash substantially the tariff on 4994 tariff lines. The average tariff rate will be cut from 35.9% to 23%. Several levers of state control over Chinese foreign trade activity have remained: such as export and import licensing, restrictions on foreign exchange retention and use; commodity inspection, customs regulation and protective duties; and state pricing of traded goods, especially imports. Beginning 30 June 1995, China removed quota, licensing and other non-tariff measures from 367 tariff lines. In 1996, China eliminated the quota, licensing and other import control measures on about 170 tariff lines, accounting for over 30% of the commodities subject to import quota and licensing requirements. Since the adoption of open-door policies, China has become more receptive to foreign business. The government is, however, opposed to certain foreign cultural influences and strictly regulates the flow of information. Mergers and Acquisitions are difficult as most enterprises are state owned. Land is also state owned and is only given on lease.Chinese legal system is not well established and enforcement is lax and arbitrary. In recent years there has been significant increase in commercial disputes due to an imperfect legal system and ineffective government supervision. Process of legal reform is currently being undertaken to make the system more professional and independent. Some 11 categories of tax apply to foreign companies in China. These are : Income Tax, Value Added Tax, Business Tax, Natural Resources Tax, Vehicle Tax, Land Tax, Real Estate Tax, Tax on slughter of Animals, Consumption Tax, Customs Duties, and Urban

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Property Tax. The basic corporate tax rate for foreign companies with offices in China is 33% (30% belongs to the centre and 3% to local governments). If the company has no office in China the rate is 20% of the basic rate. A 10% reduction is given to companies whose country of origin has a tax treaty with China. VAT is 17% and 13% for infrastructure and agriculture industries respectively and business tax ranges between 35%. There are various preferential tax rates depending on the location of a project as well as the sector it operates in. Basic policy is to encourage the setting up of EOU’s, stepping up the growth of exports, and to promote hi-tech industries in the SEZ’s as well as the backward regions. The country is divided up into various zones. These include : — — — — — — —

Coastal open Cities Economic and Technical Development Areas Sp[ecial Zones Coastal open Areas Hi-Tech open Development Areas Tax Havens Other special areas such as Hainan area in Shanghai.

The various fiscal incentives include a tax holiday for 2 years followed by 50% reduction of income tax for the next 3 years; a 5 year tax holiday followed by a rebate of 50% for the next five years for the construction of ports; a reduced tax rate of 24% in coastal cities for businesses over 10 years old; a reduced tax rate of 24 per cent for those engaged in energy, transportation, port and harbour or other state-encouraged projects in the economic and technological development zones, in the coastal areas or in other areas as approved by the State Council; a reduced income tax rate of 15 per cent in technological and special areas for enterprises over 10 years old and in coastal areas for technology-intensive companies; reduced local income tax rate of 10% for activities in SEZ; 50% reduction in income tax each year for export-oriented units exporting more than 70 per cent of output; 50% reduction in income tax for a three year period for technology enterprises; a tax rebate of 40% for reinvestment of profits in China; a tax rebate of 100% in the case of EOU units, Hi-tech units and Hainan SEZ; duty free imports of inputs for export industries; and duty free import of capital goods in technology development and special areas. These tax incentives will soon be done away with and a national treatment will be given to all FDI investors. China’s Patent Law and Trademark Law protect the patent rights and trademarks registered in the country by foreign businessmen. The retail sale business, which was long forbidden for FDI, has opened its door to foreigners. Supermarkets operated by Japanese have appeared in Beijing and Shanghai. However, there continues to be ban on foreign firms in information services. 8.15 Hong Kong

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Hong Kong has been a free port and has been open to FDI for several decades. Favourable impact of its liberalisation policy is evident from its economic progress. In spite of a lack of natural resources, it ranks third in Asia in terms of per capita GDP (US $ 21,700 in 1996) after Japan and Singapore, and seventh in the world in terms of total asets. FDI is allowed in all sectors. Japan, USA & UK are the major investors in Hong Kong. Restrictions on FDI exist only in banking where a license is required and in broadcasting where only a Hong Kong based company can operate. There is no discrimination amonng overseas and domestic investors and no special conditions are attached to overseas investment. Government follows a free enterprise and free trade policy based upon a philosophy of minimum interference with market forces and maximum support for business. Hong Kong Productivity Council provides a wide range of support, services and facilities to industry such as training, design, consultancy, strategic alliances for technology transfer, joint product development etc. Hong Kong Industrial Technology Centre Corporation facilitates technology development and application in Hong Kong’s industry by the technology based business incubation, technology transfer services and product design and development support services. A strong financial base exists in Hong Kong, and there is no exchange control or restriction on capital overseas. There is no restriction on employment of foreign labour provided there is a need to import labour from overseas. No local content or technology transfer requirements are imposed on the foreign companies. Comprehensive laws exist for protection of IPRs. Government supports industry with the provision of technical training facilities, consultancy, technology transfer, R & D etc. A low, simple, non-discriminatory and practicable taxation system exist in Hong Kong without any provision for tax holidays and other incentives for overseas investors. Corporate tax rate for unincorporated business is 15% and that for incorporated business is 16.5%. Property tax is charged on the owners of land and buildings in Hong Kong at a rate of 15%. There are no customs or excise duties except on cigarettes, alchohol, petroleum and automobiles. Cigarettes carry a tax of 100% while the rate on alchohol varies according to the type. This tax is imposed only to discourage consumption of these two products for health considerations. Automobiles face an initial registration tax of about 100% and petroleum attract tax of about 40-50%. This is done to discourage the use of private cars and ease the pressure on Hong Kong congested roads for environmental considerations. With labour costs in Hong Kong rising a huge chunk of Hong Kong’s manufacturing base has been shifted to Guangdong province of China. 75% of the total investment in Guangdong Province in China is from Hong Kong. Labour intensive industries are being shifted out and the hi-tech areas are being retained in Hong Kong. The aim is to convert Hong Kong into a Science & Technology island. By July 1997, sovereignty over Hong

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Kong have been transferred to China from the U.K. This will strengthen the existing linkages between China and Hong Kong. 4.16 Taiwan, China Taiwan has always followed a relatively liberal policy over the past 30 to 40 years. FDI up to 100% of total equity is welcome in most areas except for a restricted list and the prohibited list. Prohibited industries include those industries which violate good public morals, are highly polluting, and are legal monopolies or legally prohibited. Restricted industries include public utilities, banking and insurance, news media and publishing, and other industries for which investment is restricted by law. There are equity caps on the restricted industries which vary from sector to sector. All FDI applications must be submitted for approval to the Investment Commission (IC) which grants licenses for these comnpanies to operate. Foreign companies enjoy the same incentives as the domestic companies of the same type. There is no restriction on the repatriation of profits. Equity is also repatriable at any time after completion of the project. There is no restriction on mergers and acquisition by foreign companies so long it does not violate the norms prescribed in the restricted list. There is no restriction on importing labour from other countries subject to grant of Visa. Taiwan companies are free to exit provided they compensate the labour according to a formula set by the government. The duty structure in Taiwan by and large confirms to OECD regulations and the average tariff rate is around 6% in nominal terms and 4.6% in real terms. Automobiles attract the highest duty rate of 35%. Raw materials, machinery, oil seeds and grains etc. attract zero duty. There is a 5% VAT imposed in Taiwan. Foreign companies are subject to a withholding tax of 15% and corporate tax at the rate of 20%. Companies in high tech areas or those with a lower investment can choose between 5 year tax holiday or a 20% investment allowance against their income tax. R&D or production equipment not produced in Taiwan is exempted from import tariffs. A 2-year depreciation is allowed for instruments and equipments for R&D quality inspection and energy conservation. Investment tax credits are given for investment in backward areas, procurement of at least NT$0.6 million worth of automated production equipment and pollution control equipment within a single year, an expenditure of NT$ 3 million or more on R&D and of NT $0.6 million or more on personnels training within a single year and for the promotion of the “Made in Taiwan” label. Preferential loans are given at reduced interest rates and longer repayment periods for the following purposes: upgrading, procurement of domestically produced automated machines and equipment, procurement of imported automated machinery and equipment, economic revitalisation programme, encouraging private participation in infrastructural

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projects, and re-accommodation of foreign exchange funds. Subsidies at the rate of 5060% of investment upto certain limits are given for the development of a new product, turnkey automation, product upgradation, improvement of the process technology, and for strategic technology applications. Over time, labour has become expensive thus causing Taiwan to turn towards modern technology-intensive industries. Traditional industries have shifted their production base to China, and are now looking at other markets like the ASEAN countries and India. Till now the Taiwanese concentrated on Trade as an Engine of Growth. 75% of their GDP originate from trade. Resigned to the fact that the Taiwanese will have to restrictthemselves to that island and cannot return to the mainland, they are now investing in their infrastructure. Their aim is to convert the island into a science & technology island as well as a Asia Pacific regional operations centre for sea and air transport, manufacturing, financial services, telcom and media. 8.17 Japan Foreign Direct Investment contributed to structural reforms of the economy, such as enhancement of Japanes economy, reduction of the disparities between international and domestic prices, import expoansion, through introduction of new technology, managewment knowhow and various kinds of competition among domestic and foreign firms. Deregulation of the Japanese Economy carried out in phases since 1967 with the following major landmarks : In 1984 the Japan Development Bank began a programme of finance to promote FDI in Japan. In 1991 the Foreign Exchange and Trade Control Law revised various procedures including those relating to FDI in Japan. In 1992 the Law on Promotion of Imports and Facilitation of Inward Investment was passed to provide tax incentives, loan guarantees and other forms of support for foreign affiliates in Japan. In 1993 the Foreign Investment in Japan Development Corporation (FIND), a joint project of the govwernment and the private sector, is set up to provide comprehensive support services to the foreign affiliates planning operations in Japan. In 1994 the Japan Development Council was set up to promote FDI in Japan. FDI is welcome in most sectors except a few sectors related to defence and environment-protection. Japan now allows ex-post facto notification as against prior notification earlier. Mergers and acquisition have no restrictions so long as they are not anti competition and are not carried out in the restricted sectors. There is no restriction on repatriation of profits and capital by companies. There is no local content requirements by the foreign enterprises. Companies are free to bring in their own management as well as their workforce provided that they obtain visas. Companies are free to close down operations whenever they want. Unemployed labour are entitled to support from the government for 10 months, which is financed by a contributory fund created by the employers, employees and the government.

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Customs duties in Japan fall mainly in range of 0-5%, although some sectors like textiles and leather attract higher duties as they need protection. The corporation tax rate is around 52%. Japan provides various fiscal incentives for FDI which include the following : (a) Tax Incentives - carry forward of losses up to 10 years for Foreign Companies as against 5 years for other companies; (b) Loan Guarantees - Industrial Structure Improvement Fund guarantees loans taken by Foreign companies to help them set up operations in Japan; (c) Japanese SMEs doing business with foreign companies are given credit guarantees to expand ties between the foreign companies and SMEs; (d) Japan Development Bank and North East Finance of Japan give preferential loans to the Designated Inward Investors (DIIs) for start up of projects, R & D etc. in manufacturing production and wholesale and retail trade and services. (e) Local Governments offer tax incentives to DIIs to attract them to their areas. These include Prefectural and Municipal level tax at reduced or zero rate of tax, subsidies and loans. Impediments to FDI include very high cost of real estate, high wages and labour cost, fluctuating exchange rates for yen, and complex distribution channels and strong linkages between companies, distributors, retailers etc. As the Yen started to climb and Japan became a high cost economy, Japanese firms shifted their production base to China. This was so as the Chinese had embarked on an early reform process, had a large domestic market, was growing at a fast pace and was geographically and culturally close to Japan. However, as the political uncertainty in China rose, Japanes firms turned to ASEAN countries like Thailand, Malaysia and Indonesia. These countries had virtually no local industry but provided better incentives to foreign companies vis-a-vis domestic companies, allowed 100% equity by foreign companies, offered various fiscal incentives and, with the formation of AFTA, their customs duties were likely to fall. Now the Japanese firms have expanded their frontier to India and Myanmer. Japanese firms operate basically in 2 ways: (a) as a sourcing operation and (b) as a company looking at the domestic market. When they operate a sourcing affiliate, they prefer to have 100% equity, retain management control for maintaining the quality of goods and services, and import all machinery and raw materials. When they operate a company which caters to the domestic market, they prefer the joint venture route so that they have a local partner who knows the market. They hire local labour and import only the crucial machinery, components and raw materials. They try not to differentiate quality. However, if the domestic country is willing to accept lower technology, and afordability, this is permitted by the Japanese Company. Japanese outward FDI stock stood at US$ 306 billion amounting to 6.5 percent of GDP in 1995 as against its FDI inward stock at $17.8 billion amounting to only 0.4 percent of GDP in 1995. The average annual FDI inflows to Japan amounted to $720 million (having a share of only 0.1 percent in gross domestic investment) in 1984-1995 compared with the average annual outflow of FDI from Japan at $24.4 billion (having a share of 3.1 percent in GDI) in the same period.

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9 REGIONAL COOPERATION FOR INVESTMENTTECHNOLOGY TRANSFER- GROWTH NEXUS

PROMOTING

FOREIGN

9.1 Regional Economic Zones in Asia and Pacific Regional economic cooperation facilitates the free flow of goods, services, capital and labor across national boundaries and acts as an effective instrument for securing efficiency in the use of resources and thereby enhancing growth of all member countries. However, regional trading arrangements need to conform to the requirements of Article XXIV of the General Agreement on Tariffs and Trade (GATT). Asia is the least regionalised of the world’s regions in terms of the coverage of economic and trading arrangements. The only regional economic grouping in East Asia is ASEAN, and the only one in South Asia is SAARC, and the corresponding trading arrangements are AFTA and SAPTA. Like the second generation agreements in Europe (the EU), North America (NAFTA) and Australia/New Zealand (Closer Economic Relations (CER), ASEAN covering most of the economies of Southeast Asia, has now evolved into a comprehensive regional trading arrangement, the ASEAN Free Trade Area (AFTA), with an explicit time table for eliminating tariffs within the group by the year 2003 and for introducing its Common Effective Preferential Tariff (CEPT). Viet Nam has now joined ASEAN and there are plans to include the remaining Southeast Asian economies, i.e., Cambodia, Laos PDR, and Myanmar. Under the Framework Agreement on Enhancing ASEAN Economic Cooperation, members have agreed to eliminate quantitative restrictions and nontariff barriers on trade in products in the CEPT, to cooperate in some areas of service trade and to explore cooperation in some non-border issues such as harmonisation of standards, reciprocal recognition of tests and certification of products, and removal of bariers to foreign investments. Another unusual feature of this Agreement is the intent to free the movement of capital and to increase investment, industrial linkages, and complementarity among members. South Asia’s counterpart to ASEAN is SAARC (the South Asian Association for Regional Cooperation) comprising Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. It is more recent, having been formed only in 1985. SAARC countries are committed to step-by-step liberalisation of trade in a such a manner that all countries in the region share the benefits of trade expansion equitably. In 1992, member countries agreed to form a SAARC Preferential Trading Arrangement (SAPTA) and to complete all formalities for operationalising the SAPTA, including the finalisation of schedules of concessions, before 1995. The end-1994 deadline was not met. By middle of 1995, most countries forwarded their “request list” to all contracting states, which will form the basis for negotiations on national schedules of concessions.

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SAARC, too, has a broader mandate than the GATT-notified regional trading arrangements. It aims to promote active cooperation and mutual assistance in socioeconomic fields among its seven South Asian members. An action plan has been prepared which includes a strategy for social mobilisation, empowerment of the poor, promotion of agriculture and small-scale industry, and the development of human and financial resources. AFTA and SAPTA are the only two regional trading agreements in Asia. The other economies of the region, including those such as the People’s Republic of China; Korea; Japan and Taipei, China, which account for a very large share of total Asian trade, are not part of any formal trading arrangements. In addition to encouraging intra-regional trade, the facilitation of capital flows within the region is an important goal of regional cooperation in Asia. Such intraregional capital flows, particularly foreign direct investment (FDI), have grown very rapidly over the past decade. They have also entailed an increasing flow of technology associated with individual projects and embodied in the flow of capital equipment and intermediate inputs arising from projects. Japan and the NIEs are the source of much of this intraregional FDI. The share of intraregional FDI rose to about 36 percent in 1993. About two thirds of this now comes from the NIEs. The destination of most of this capital flow is China and Southeast Asia. South Asia began opening up to external capital flows from the early 1990s and is only now beginning to attract FDI. However, much of it is from sources outside the region. Another aspect of regional cooperation that is of growing importance is the sharing of information. Cooperation can reduce the transaction costs of gathering information, and through economies of scale, can reduce the research and development costs of generating information. The sharing of information may be embodied in the form of technology transfers within a region. It may also encourage capital flows into or within a region by lowering perceived risks. 9.2 Informal Sub-Regional Economic Zones While there are only two formal regional trading arrangements in Asia, there are economic cooperation of a more informal nature among countries in the region. These sub-regional economic zones (SREZs) are popularly referred to as “growth triangles”, “growth polygons”, or simply “growth areas”. The main focus of the SREZs is on the transnational movement of capital, labour, technology, and information and on the intercountry provision of infrastruc-ture rather than on trade in goods and services. SREZs generally constitute provinces or states of the nations involved. However, in the case of Singapore, as a member of the Indonesia-Malaysia-Singapore (IMS) growth triangle, the zone applies to the whole of the national territory. This growth triangle (also known as SIJORI) comprising Singapore, the south Malaysian state of Johor and the west Indonesian province of Riau, including the island of Batam, was recognised in 1989 as a trilateral agreement by the Governments of Singapore, Malaysia, and Indonesia. Labor-

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intensive industries are being shifted from Singapore to Johor and the Riau Islands because of rising real wages in Singapore. Since 1989, a number of other SREZs have been formed in Southeast Asia and Northeast Asia. Some of the zones, such as the Brunei Darussalam-Indonesia-MalaysiaPhilippines East ASEAN Growth Area (BIMP-EAGA) and the Tumen River Area Development project in China are intended to hasten economic growth in areas where are less developed than other parts of the pariticipating countries. The Indonesia-MalaysiaThailand Growth Trinagle (IMT-GT) and the Greater Mekong Subregional (GMS) Economnic Cooperation project are also intended, inter alia, to pay increased attention to lagging subnational areas. The experiences of these “growth areas” can lead to multiple and overlappling growth triangles in ASEAN and their eventual merger under the wider AFTA (Chia and Lee, 1994). Other forms of subregional cooperation that mix private sector ventures and multigovernment cooperation are emerging. For example, after an initiative by the Government of the Peoples’s Republic of China in 1992, the Governments of Singapore and China have cooperated in the establishment of the China-Singapore Suzhou Industrial Park Development in the town of Suzhou in Jiangsu Province. The Singapore-led consortium of investors includes the Economic Development Board of Singapore, other state agencies, private companies from Singapore and some participation from Japanese and Korean companies. This cooperative effort is developing a Singapore-style township. This is a flagship project to penetrate the large Chinese market and to transfer Singapore technology to China in areas of public administration and private activities. The Singapore Government, in partnership with India, is also setting up a technology park in Bangalore, and planning investments in infrastructurerelated projects in Myanmar and Viet Nam which combine government and private sector inputs. The most comprehensive form of multi-government cooperation in terms of both countries and the scope of issues addressed is the Asia Pacific Economic Cooperation (APEC). This organisation was established in 1989 and currently has 18 member countries in Asia and the Pacific including the Unites States. The APEC forum is of special significance, as it is not founded on a formal agreement in accordance with the GATT. The member countries have agreed by consensus on a program of action to achieve a state of “free and open trade and investment” by the year 2010 for industrial country members and 2020 for developing country members. Many of the members have already made significant unilateral tariff reductions before the target date. There is an agreement on a set of APEC Nonbinding Investment Principles for investment flows in the region. These are intended to reduce restrictions on the international flow of portfolio investments. APEC discussions have gone well beyond traditional border trade measures to the consideration of other measures of trade and investment facilitation, such as visa-free

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travel for business people, standards and harmonisation, and the possibility of implementing an open skies policy. There are also nongovernmental forms of linkage in the region as well. The sharp increase in intra-Asian FDI has led to the development of Japanese and “overseas Chinese” production networks throughout all the countries of East Asia. These are an important vehicle for spreading market information, new products, and new technologies of production. The most common form of subnational zones are export processing zones. A feature of these zones is the establishment of some subnational customs area that gives a preferred customs treatment to goods entering the area compared with goods entering non-zone parts of the country. These preferences are normally restricted to export activities. Export processing zones also give preferences or privileges relating to the establishment of foreign-owned enterprises and to nontrade-related instruments of government policies such as tax holidays, reduced rates in taxes and duties or preferences in government loans. A closely related form of subnational zone is the financial service zone, such as a financial offshore center. These zones essentially provide preferences for the finance service industries, analogous to those provided for manufactured goods in export processing zones. There are other subnational zones which are not international traderelated, such as science and technology parks. The number of these parks has increased rapidly in many Asian countries since 1980. Most science and technology parks in Asia have concentrated primarily on attracting foreign investors. Subnational zones are, therefore, an integral part of the wider pattern of intra-Asian trade development. Subnational and sub-regional zones have increased the intraregional share of total trade in goods and services and intraregional flows of FDI. 9.3 ASEAN Experience ASEAN encompasses the nations of Brunei, Malaysia, the Philippines, Singapore, Thailand, and Vietnam which joined the grouping in 1995. Launched in 1967, ASEAN, in addition to its political goals, was intended “to accelerate economic growth” through cooperation in trade, industry, technology, commodities, services and infrastructural development among themselves, and co-operation with its extra-regional “Dialogue Partners”. Industrial co-operation The ASEAN-sponsored industrial cooperation took place within the framework of three instruments viz. ASEAN Industrial Projects (AIPs), ASEAN Industrial Complementation (AICs) and ASEAN Industrial Joint Ventures (AIJVs). The AIPs are large-scale government to government projects, while AICs are designed to avoid duplicaiton in industrial capacities by assigning specific industrial processes to each ASEAN country on a time-bound basis and AIJVs are government-approved private sector ventures. Some

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specified investment incentives such as margin of tariff preferences (MOPs) as well as provisions on equity participation favourable to encourage intraregional joint ventures are also built into these ASEAN industrial cooperation programmes. Some positive results were achieved in the ASEAN Brand-to-Brand complementation (BBC) in the automotive industry. BBC schemes envisage manufacturing different components of a vehicle in different countries, as described latter in this section. Improvement of the investment climate To promote and protect intra-ASEAN investment, the ASEAN countries since 1976 have an Agreement providing (i)most-favoured nation treatment to intra-ASEAN investment; (ii) safeguards against nationalisation; (iii) adequate compensation against expropriation; (iv) generous repatriation of profits, dividends, interests, royalties, technical fees and other income; (v) repatriation of capital and proceeds from total or partial liquidation of any intra-ASEAN investment. Moreover, separate arrangements on avoidance of doubble taxation and involving regional financial institutions in supporting regional industrial and commercial endeavours were also included. Besides facilitating intra-ASEAN investment, all the ASEAN members adopted several incentive packages to attract more foreign investments from any available source. As a result, the largest country in the ASEAN region, namely, indonesia, attracted foreign investments of $22.5 Billion over 1967-1994 from diverse sources. The foremost among athem were Japan, Hong Kong, the former Federal Republic of Germany, United States of America, Netherlands, United Kingdom, Taiwan, Province of China, and Singapore. Investment incentives included provision for foreign ownership for exort-oriented investment, permission to export-oriented firms to distribute domestically, and allowing joint ventures to participate in government exports. Infrastructural and resource-based cooperation Other important ASEAN integration efforts related to their efforts towards joint resource mobilisation and intra-ASEAN infrastructures. For instance, the “ASEAN Minerals Cooperation Plan” was designed to develop downstream industries. Similarly, different ASEAN subsectoral programmes in energy cooperation, including those in petroleum security, promoted efficient use of coal in the subregion and the gas pipeline projects across the member States also proved useful for the subregion. The ASEAN initiatives in shipping and ports included those on bulk pool system, pointto-point shipping services, foreign booking and cargo consolidation centres. In posts and telecommunications, inter-country remittance services made possible an efficient money order service and telegraphic money order services. An ASEAN capital fibre submarine cable network was one of the projects in the telecommunicaiton field. Similarly, a multimodal project to strengthen the existing modes of transportation and the establishment of new road, rail, sea, ferry and air links was initiated with the assistance of the World Bank. One of the striking features within the ASEAN region is the high propensity to save which continued unabated since the mid-1960s. This enabled them to maintain high

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domestic investment rates and growing exports, thus expanding and diversifying industrial capacities with a shrinkage of the agriculture sector in their domestic outputs. Following the Japanese model, Singapore, Thailand and Indonesia, in evolving their Governments’ economic policies, laid emphasis on their private sectors and taken them into their confidence. As the situation permitted, private-sector Government mutual consultaiton was institutionalised, which favoured the adoption of realistic and pragmatic economic policies. Similarly, the more important ASEAN Governments adopted measures and policies surrendering their control and facilitating the emergence of a vibrant private entrepreneurship. Intra-ASEAN Trade: The share of intra-regioinal trade of ASEAN is quite small. Over the past two decades, intra-regional tradehas hovered around 15-20 percent of the region’s total trade (compared with the EC range of 55-60 per cent). Higher value-added manufacturers are gradually becoming a growing component in ASEAN countries exports. By 1991 the share of manufacturing in ASEAN exports had risen - to 71 per cent in the Philippines, 67 per cent in Thailand, 61 percent in Malaysia and 41 per cent in Indonesia. This rapid industralisation has increased intra-industry trade in manufacturing, making trade more complementary than competitive. Exports have shifted from primary products to textiles and clothing, chemicals, basic metals, machinery and electronics. The main markets for these goods have been North America and Western Europe, but the sources of capital and intermediate goods are largely from the East Asian region. Intra-ASEAN Investments Intra-regiional investments in ASEAN are also increasing. Singapore is the major investor from within the region. The development of “growth triangles” has promoted intra-regional investments and economic cooperation and complementation between geographically contiguous regions. An example is the SIJORI growth triangle, (described in section 9.2). Singapore provides the investment, entrepreneurial and managerial skills from both domestic sources and the large concentration of multinational companies based in SIJORI. It also provides ready access to financial services, and efficient entrepot facilities and air, sea and telecommunications links with the rest of the world. Johor and Riau have land, natural resources and relatiavely lower-wage labour supply. These complementary resources are directed towards promoting industry, resource development and tourism as well as skill formation. New investments have been directed at infrastructural projectrs and property development. ASEAN Regional Integratuin in Automobiles Auto makers from around the world are boosting their investments in ASEAN countries. Japanese car companies, which have a 90% share of the markets in the four

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ASEAN countries of Thailand, Malaysia, Indonesia, and the Philippines, are increasing their production capacity even further, primarily in Thailand. Three auto makers, Honda, Toyota, and Nissan, have already launched “Asiacars”, models developed specifically for Asian markets in preparation for market expansion. Though slower than the Japanese companies to get going, the American Big Three and such South Korean firms as Hyundai, Kia Motors, and Daewoo have also made ASEAN a priority investment region. GM stands out for its efforts to increase its ASEAN presence, and is investing $750 million to build a factory in Thailand with a capacity of about 100,000 cars a year. The remarkable growth of ASEAN, combined with the fact that the three big markets of North America, Europe, and Japan have very little growth potential, and with the high business risks associated with China (even though it has greater market size and higher growth rates than even ASEAN), has made the ASEAN a favourable destination for the world’s auto makers. ASEAN markets are generally in the range of 100,000-500,000 cars and, with more than 10 auto makers competing in each country, they are each only producing between 10,000 and 30,000 units a year. With parts companies also moving into these markets, basic parts will end up being produced locally. Although local content rates are currently not high, the influx of parts makers will continue and ASEAN countries will gradually gain the ability to produce higher value added parts. For example, Aisin Seiki Co. Ltd., an auto parts maker with ties to the Toyota group, has set up its first ASEAN operations in 1996 in Indonesia, where it will produce clutch covers, cluch disks, and other parts for transmission systems. Zexel, a Nissan-affiliated parts company, also plans to produce the air-conditioner compressors for its cars locally. From the US side, GM-affiliated Delphi plans to have a local factory for steering parts up and running by 1997. These companies and others like them will enable ASEAN countries to begin putting in place the parts industries that are at the core of the automotive sector. The use of the “brand to brand complementation” (BBC) scheme waives some duties for automotive parts produced within the ASEAN regioin and considers them as domestically produced. If each country tried to produce a full complement of auto parts, an unavoidable limit would be placed on lot sizes, even as production volumes increased. The basic idea behind the BBC scheme is therefore to secure economies of scale by allowing the production of specific parts to concentrate in specific countries and then sharing them with each other. This scheme took effect in 1994 and most Japanese manufacturers have qualified for it. 9.4 SAARC Experience The countries of SAARC (i.e. Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka) have formulated an agreement to establish and promote regional

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preferential trading arrangement for strengthening intra-regional economic cooperation and the development of national economies, generally known as SAARC Preferential Trading Arrangements (SAPTA). It consists, inter alia, of arrangements on tariffs, paratariffs, non-tariff measures and direct trade measures. The negotiations for liberalisation are conducted through (a) product by product basis, (b) across-the-board tariff reduction, (c) sectoral basis, and (d) direct trade measures. Primary products, agricultural and extracted raw materials, marine products, scrap metals, other manufactuers with more than 50 percent of domestic content are being considered in first phase. The negotiated concessions among contracting States are incorporated in the national schedule of concessions. A list of initial concessions agreed by contracting States is given in the SAPTA document adopted at Colombo. A number of other provisions like special treatment for least developed countries, balance of payments measures, safeguard rules, “rules of origin”, dispute settlement, etc. have also been formulated in the initial proposal. In order that SAPTA becomes an effective instrument for intra-SAARC trade and investment expansion, many supporting steps are required. These include steeper reduction in the trade barriers than that provided under the WTO agreement, increase in supply capabilities for additional exports, expansion of investment flows in the region, replacement of product by product approach by across the board concessions and bolder steps to move Intra-SAARC Trade and Investment Neither the political nor economic climate within the region has been conducive to promoting intra-regional trade and investment linkages. Intra-regional trade has been almost stagnant in the 1980s, averaging a little over $1 billion dollars. The share of intraregional trade to global trade declined from 3.2 percent in 1980 to 2.7 per cent in 1990. The share of SAARC countries intra-regioinal exports to their global exports declined from 4.9 per cent in 1980 to 3.2 per cent in 1990, while their share of intra-regional imports to global imports over the same period remained at around 2 per cent. These figures , however, do not reflect the high share of intra-regional trade for the smaller SAARC economies. For Bhutan, which trades almost exclusively with India, 90 per cent of imports and 96 per cent of exports are intra-regioinal. In 1990, the region accounted for about 20 per cent of Nepal’s total exports and about 36 per cent of its imports. At the other end of the scale, the intra-regional share of Pakistan’s exports and imports were about 4 per cent and less than 2 per cent respectively, while for India intraregiional exports and imports represented only 2.6 per cent and less than 1 per cent respectively of its global trade (IMF, Direction of Trade Statistics, 1991). The dominant constraint to intra-regional exports of various minerals and industrial raw materials is the limited absorptive capacity and lack of user industries. The ASEAN experience shows that trade liberalisation measures tend to favour the economically stronger members of the grouping. In South Asia the pattern is similar. India, and to a lesser extent, Pakistan are in a better position to take advantage of market opportunities

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created by the opening up of the region as they are relatively more advanced industrially and possess more advanced technological skills and know-how. The larger SAARC members have large domestic markets and a diversified economic base which makes them less dependent on trade for economic growth. On the other hand, the smaller economies like the Maldives, Sri Lanka and Bhutan have to rely on external markets to stimulate expansion of their industrial base. Several areas of cooperation which might have an marginal impact on India, the major SAARC partner, could have far-reaching effects on the smaller partners such as the Maldives, Nepal, Bhutan and Bangladesh - e.g. regional promotion of tourism, establishment of linkages in the service and infrastructural sectors, a regional clearing union arrangement and joint research and development schemes. Also, rather than their competing in certain commodities such as rubber, jute,tea, and textiles, the SAARC members may consider cooperation in the production, marketing and transportation of these commodities. Similarly, there would be an advantage in intra-regional transfer of technologies through the creation of regional joint ventures and joint or sub-regional training schemes. Compared with ASEAN’s share of 30 per cent and China’s share of 57 percent, SAARC received only 4.2 percent of all FDI flows to developing countries in Asia in 1995 (Table 9.3). SAARC Preferential Trading Arrangement (SAPTA) Like the ASEAN’s initial tariff reductions under PTA, SAPTA’s tariff reductions are also being implemented on a product-by-product basis, rather than on sectoral or acrossthe-board basis. This is a slow process implying that the small level of reductions achieved is not likely to have a noticeable impact on intra-regional trade. As with the ASEAN PTA, there is a tendency to restrict the offer list to items of little trade significance in order to avoid erosion of the market by liberalising trade in major products. Even if the scheme were to be widened, it is unlikely to improve intra-regional trade unless other schemes of regional cooperation are also introduced, aimed at creating greater complementation among the economies of the region, improving their supply capabilities (i.e.investment and production partnerships, such as regional/ bilateral joint ventures), and creating efficient infrastructural linkages, especially in terms of transport, communications and information exchange. Moreover, for SAPTA to be effective, members’ tariff reduction offers would neeed to be greater than those made under multilateral trade agreements including their WTO commitments. In order to accelerate the pace of regional trade liberalisation, it might be preferable to adopt two tracts - one being the region-wide slower track, and the other, a series of bilateral agreements between the more advanced countries within the group. There are already some bilateral initiatives between India and Pakistan, India and Sri Lanka, India and Bangladesh and India and Nepal. Sectoral cooperation such as a SAARC Textile Council can also boosot economic and trade relations within the region.Textile is a priority sector as developing countries will no longer benefit from preferential quotas

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when the Multi-Fibre Arrangement is disbanded in the year 2005, and it is an important component of SAARC country exports. In order to rise to the challenge of open competition, SAARC producers need to pool their design, marketing and technological resources. With rapid growth in the ASEAN economies, wages and labour costs have been rising considerably. SAARC countries need to adopt policies which would favour the relocation of some investments and labour-intensive production from ASEAN to SAARC countries particularly as the NIEs and Japan and even some ASEAN countries such as Malaysia and Thailand have become important sources of FDI. All these Southeast Asian countries have a common interest with SAARC countries in creating trade-generating joint ventures. India became an ASEAN ‘dialogue partner’ in 1992-93 and a ‘sectoral dialogue partner’ in 1996, the ASEAN countries view India as long-term potential market. India can exploit this opportunity by facilitating and encouraging private sector contacts with ASEAN entrepreneurs. With a much longer history, ASEAN has developed better intra-regional and extralinkages than has SAARC. Only recently SAARC has included activities trade and investment as a part of its regional cooperation. ASEAN economies are far more open than those of SAARC due to long-followed policies of export promotion and international competitiveness. Foreign investment inflows into ASEAN have been far more significant and instrumental in raising the productivity and competitiveness of the private sector through the introduction of newer technologies and marketing know-how. ASEAN is much more integrated into global economy than SAARC and its members, particularly Malaysia, Singapore and Thailand have contributed significantly to the process of globalisation by promoting export competitiveness. SAARC, on the other hand, has so far made little contribution to either regionalism or globalisation. There is, however, hope that as a first step SAARC members, having agreed on a free trade area, will promote regional trade cooperation as a building block towards globalisation. For its success, SAARC will need to agree on a clear policy towards foreign investment as a vehicle of technology upgradation and overall growth. 9.5 ESCAP Experience From its inception ESCAP has done much to promote economic co-operation in the Asian and Pacific region. ESCAP has conceived the integrated communications infrastructure for the Asian region and promoted regional cooperation in shipping, ports and technology tranfer. Several financial and developmental institutions like the the Asian Development Bank (ADB), The Asian and Pacific Centre for the Transfer of Technology, Asian Clearing House (ACU), the Asian Reinsurance Corporation (ARC) etc. were established at the initiative of ESCAP in order to promote economic co-operation within Asia. However, ADB has had a wider impact on the region through supply of finance and technical assistance.

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Although regional economic cooperation in Asia and Pacific is being worked out at various levels as indicated above, actual achievements had been limited due to a number of reasons (ESCAP 1992). First, all the subregional groupings, with the exception of ASEAN and the South Pacific Forum, are about a decade old and it takes much time to build up the confidence and trust among the members. Second, regional groupings in Asia and Pacific are merely intergovernmental institutions and unlike the EC, do not have any supranational authorities. Third, there is hardly any linkage or even dialouge among the subregional or regional groupings with the exception of ASEAN and APEC. In fact,inter-regional trade links are dominated by selected bilateral flows. For example, India accounts for most of SAARC trade with ASEAN, while Singapore accounts for most of ASEAN trade with SAARC. The major benefits will come from removing restrictions that impede flows of people, capital, and goods, and that segment geographically contiguous markets. In addition, there is considerable untapped potential for regional cooperation in power, transportation, and distribution ( particularly petroleum products), which would reduce the costs of doing business. There will be an important pull effect on growth throughout Asia if the remaining impediments to local and foreign investors removed. Such regioinal cooperation and integration should be seen not as a substitute for opening up to the global economy, but as a way of assisting firms to connect to global markets at lower cost. 9.6 Intra-regional Flows of FDI The on-going liberalisation of investment policies, including privatisation programmes, has created new opportunities for foreign investment in developing countries. The value of FDI and portfolio investment from privatisation at $10.5 billion accounted for nearly 8 per cent of total investment inflows to developing countries in 1995. Share of Asia and the Pacific region in total FDI and portfolio investment from privatisation in developing countries increased from almost nil in 1990 to 20 percent in 1995 (table 9.1). FDI from developing countries has become an important source of capital for other developing countries. Outward FDI stock from developing countries at $214 billion constituted 8% of the global outward stock; while inward FDI stock to developing countries at $693 billion constituted 26% of the global inward stock at the end of 1995. In 1993, the share of Asian countries in the inward FDI stock amounted to 32% in Thailand, 38% in Malaysia, 26% in Indonesia and 80% in China (Table 9.2). Asia and the Pacific, and particularly the East and South-east Asian subregion, have emerged as the most dynamic region worldwide in terms of economic performance, with large and growing markets and profitable investment opportunities in manufacturing and services. This led to an increase in the region’s FDI share: (inward) FDI stock in the Asia-Pacific region rose from 8% to 15% of worldwide stock during 1980-1995, and from 35% to 58% of developing country FDI during the same period. The Triad - Japan, United States and European Union - has played the most important role in this build-up of FDI, but the importance of the Triad as a whole declined, reflecting the increasing role of the developing-country TNCs in intra-regional FDI flows.

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More than 80 percent of FDI implemented in China in 1985-1995 originated in Hong Kong, Singapore, Macao and Taiwan, China. Also in Indonesia, Malaysia, Philippines and Thailand, more than one quarter of FDI inflows came from these economies in 19851995. Taiwan, China and Hong Kong were the largest two home countries for FDI in Vietnam in 1988-1995 and Singapore became the largest investor in Myanmer with 25% of the total FDI in 1988-1995. Like TNCs based in developed countries, developing country TNCs in manufacturing undertake international production to minimise costs, improve efficiency, access large markets, acquire natural resources, technology and expertise and improve their export performances. Firms from Taiwan Province of China invest in China, Thailand and Vietnam in labour-intensive, low-skill operations. Similar investments by the Republic of Korea in China’s northern provinces aim at reducing the cost of producing traditional exports, such as textiles and shoes, and improving efficiency. Geographical proximity and cultural affinity also play a role for FDI flows as examplified by the investments of ethnic Chinese in Asia. A number of TNCs from such developing countries as India, the Republic of Korea, Mexico and Taiwan Province of China have also developed significant technological and innovation capabilities and production experiences, comparable to those of firms from developed countries.

Indian Joint Ventures in Asia India, Thailand, Bangladesh and Sri Lanka, having a coastline on the Bay of Bengal, has formed a regional trade group on June 6, 1997, called the Bangladesh, India, Sri Lanka, Thailand Economic Cooperation (BIST-EC). Trade between these countries currently totals only $1 billion and is expected to improve substantially in the next decade due to predicted economic boom. Attemps are also being made to form a sub-regional economic group through the Bangladesh, Bhutan, Nepal and India “growth quadrangle” (BBNI-GQ). Under BBNIGQ each country has been allocated responsibility for specific sectors in Phase-I which is to last a year. Apart from overall coordination Nepal will chair the working groups in the sectors of multi-modal transport, communications and tourism. Bangladesh will coordinate project evolution in the areas of natural resource endowments and energy. Bhutan will coordinate projects relating to the environment, and India will be responsible for projects in the area of investment promotion. Both the World Bank and the ADB are vying with each other to get into act and fund a comprehensive programme of studies. The ADB has in fact been fomenting polygons of various description in the Asian region for several years (for example hexagon in the Greater Mckong sub-region) to take advantage of the “economies of neighbourhood” by building on incipient growth impulses in parts of the countries contiguous to each other.

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The number of overseas investment ventures by Indian companies, including joint ventures (JVs) and wholly owned subsidiaries (WOS) has shot up dramatically, crossing the 1000 mark by the end of 1995 with nearly $400 million worth investment. Out of this, about 55 percent were investments for setting up manufacturing units abroad. The regional break-up of the Indian joint ventures (JVs) and Wholly-owned subsidiaries (WOS) at the end of 1995 is indicated in Table 9.4. The preferred locations for JVs were Europe, East and South Asian countries, while those for WOSs are Europe and USA. Despite the trend of a steady growth in Indian direct investments abroad, the total quantum of such investment is quite small. Tablele 9.4 Regional Distribution of Indian Joint Ventures _________________________________________________________________ Home Country Number of Joint Number of Wholly Total Ventures Owned Companies _________________________________________________________________ East Asia 141 90 231 South Asia 82 16 98 Oceania 14 3 17 America 58 105 163 Europe 164 152 316 Africa 55 45 100 West Asia 78 10 88 _________________________________________________________________ Total 592 421 1013 _________________________________________________________________ 9.7 Regional Co-operation by Manufacturing TNCs Japanese affiliates, particularly in Asia, are establishing affiliates abroad. For example, 47 per cent of Japanese affiliates in Hong Kong, and 43 percent in Singapore, had already established foreign affiliate networks in the region by 1993. Although only 4 percent of the Japanese affiliates in Thailand and Malaysia have invested in other Asian countries to date, 35 per cent of the affiliates in Thailand and 28 per cent in Malaysia are planning to do so within the next five years. The recent increases in Japanese FDI have taken place in manufacturing and some services industries, unlike the late 1980s when most FDI went into financial services and real estate. Japanese FDI in such traditional industries as food, textiles and iron and nonferrous metals established many small and medium-enterprises in South, East and SouthEast Asia. By 1994, chemicals became the second largest destination of FDI after electrical machinery. Investment in transport equipment in developing countries (mainly in Latin America and South, East and South-East Asia) increased fourfold in 1994, reflecting a rising demand for automobiles. The following developments indicate that Japanese manufacturing TNCs, especially in electronic machinery and transport equipment, are leading in the establishment of

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regional or global integrated production systems and networks since the late 1980s to maximise efficiency: (a) Five percent of Japanese affiliates in the world was a regional headquarters by 1993, indicating the emergence of multi-layered networks. (b) One fifth of foreign affiliates specialising in research and development were conducting R&D for their entire TNC systems by 1993, implying that there is inter-industry transfer of R&D activities. (c) Intra-firm transactions among Japanese affiliates within the same TNC systems accounted for 48% of the exports of these affiliates in Asia, 23% in the European Union and 28% in the United States in 1992. (d) Japanese small and medium-sized enterprises account for about 15% of Japan’s outward FDI stock and about 50% of Japan’s equity investment, and these firms have established affiliates mainly in Asia. Integrated International Productionin Automobiles Exports of motor vehicles from Japan amounted to nearly four million vehicles in 1995. About 32% were by the Toyota Motor Company, which exported almost 38% of domestic production. Toyota’s overseas production increased to more than a third of its total automobile production in 1995 and exceeded, for the first time, its exports from Japan. At the end of 1995, Toyota had some 143,000 employees with more than 70,000 outside Japan. Toyota established integrated manufacturing systems in all of its main markets- North America, Europe and Asia.In January 1996, Toyota had 35 overseas manufacturing affiliates in 25 countries, more than a third of which were located in Asia. Plants in China, Indonesia, Malaysia, Philippines, Thailand and Taiwan accounted for a third of the company’s overseas production in 1995. Toyota produces specialised models in its Asian affiliates, both for local sales and exports. These include Toyota’s all purpose-vehicle (the Kijang) in Indonesia and a compact car in Thailand for possible exports in Asia, South America and the Middle East. Although Toyota’s vehicle production in the region partly results from Asian countries’ restrictions on imports of autombiles, the company responded to the regional industrial cooperation policies of the ASEAN countries by establishing a network of affiliates for parts supply to local and regional markets. Toyota’s intra-firm trade of parts and components in the region is coordinated by the Toyota Motor Management Company, Singapore. Toyota exports diesel engines from Thailand, transmissions from Philippines, steering gears from Malaysia and engines from Indonesia. In 1995, intra-firm exports among these affiliates accounted for 20 per cent of exports of parts and components of the company’s manufacturing affiliates worldwide. Exports of these affiliates to other destinations outside the ASEAN market accounted for another 5 per cent. 9.8 Regional Cooperation in Technology Transfer Increasing levels of intraregional trade and investment are gradually shaping a truly interdependent regional economy in the Asia-Pacific region, based on the linkages of production structure the region and through regional division of labour. They succeeded significantly in utilising the technological revolution to enhance their national

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comparative and competitive advantages. First, Japan and then the advanced countries of the region have become critical growth centres supplying FDI and technology to other economies of the region. Regional industrial and technological development has created a fertile ground for cooperation in technology transfer, which need to be supported by incentives and policy measures for strengthening technological capabilities by the recipient countries. The opportunities for regional cooperation in the endogenous technological capabilitybuilding of ESCAP member countries are enormous. While advanced developing countries such as the NIEs have adequate domestic resources to attract technology and capital and to expand their technological capacity, a number of developing countries in the region (LDCs, island developing countries and disadvantaged traditional economies) remain outside the mainstream of economic development primarily because of poor, inappropriate or unfavourable local conditions in terms of skills, market size, technological and physical infrastructure etc. These countries also suffer from a lack of information and knowledge and financial resources to attract adequate volumes of technology and foreign capital. Concerted regional cooperation is necessary to assist them to develop local industrial and technological capabilities. The ESCAP at its fiftieth session in April 1994 adopted an Action Programme for Regional Economic Cooperation in Investment-related Technology Transfer. The programme was inspired by the realisation that the growing interdependence of production structures, high growth and liberalisation of regional economies, coupled with the expansion of regional trade and investment, provide an impetus to greater regional cooperation in science and technology. It was also realised that as technology transfer remained the main avenue for developing countries in their quest for technology-led industralisation and product competitiveness in the world market, the ability of such countries to adopt foreign technologies and maximise the benefits greatly depended on their endogenous technological capabilities. The higher the level of such capabilities, the greater will be these countries’ ability to adopt foreign technologies. For technological partnerships, the presence of basic scientific and technological capacities and a cluster of small and medium-sized enterprises is essential for both backward and forward integration. Technology partnership initiatives at the regional level, and bilaterally and multilaterally need to be complimentary and supplementary to each other. The experiences of successful countries emphasise the need for promoting and providing incentives for direct firm-to-firm partnerships, training and the adoption of environmentally sound technologies. With regard to technology partnership, countries should formulate policies for strengthening human resource development and training capabilities, for creating an infrastructure and an environment conducive to entrepreneurs and for establishing mechanisms for mobilisation of financial resources. Foreign investors should be encouraged to engage in partnerships with local enterprises from developing countries to increase their scientific and technological capacity. Support institutions for technical

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information services and programmes sponsored by the international community are essential to strengthen entrepre-neurship in developing countries. 9.9 Multilateral Agreement on Investment (MAI) One of the arguments put forward in support of MAI is that trade and foreign investment are mutually complementary activities and hence a suitable liberalised foreign investment regime should be established to supplement the new liberalised trade regime. They contribute not only individually and directly to the development process, but also jointly and indirectly, through linkages with one another. Consequently, governments are increasingly establishing national policy frameworks within which FDI and trade can flourish (UNCTAD 1996). They reduce restrictive investment measures; strengthen standards of treatment; provide investment protection; and pay more attention to ensuring the proper functioning of the market. In 1995 alone, 106 of 112 regulatory changes in 64 countries that altered investment regimes were in the direction of greater liberalisation or the promotion of FDI. The vigorous growth of bilateral and regional investment agreements, the inclusion of certain FDI-related issues in the Uruguay Round agreements and the beginning of negotiations on a Multilateral Agreement on Investment in the OECD clearly indicate that both the developed and developing countries are moving towards liberalised trade and investment regime. As the bilateral level, key investment concepts, principles and standards have been developed through the conclusion of bilateral investment treaties (BITs) for the protection and promotion of FDI. Their distinctive feature is their exclusive concern with investment. They contain mostly general standards of treatment after entry and establishment and specific protection standards on particular key issues, and generally recognise the effect of national laws and policies on FDI. The network of BITs is expanding constantly. Some two-thirds of the nearly 1,160 treaties existing in June 1996 were concluded in the 1990s (172 in 1995 alone), involving 158 countries. Originally concluded between developed and developing countries, recently more BITs are between developed countries and economies in transition, between developing countries, and between developing countries and economies in transition. At the regional level, the mix of investment issues covered is broader than that found at the bilateral level, and the operational approaches to deal with them are less uniform. Most regional instruments are legally binding. Issues typically dealt with at the regional level include the liberalisation of investment measures; standards of treatment; protection of investments and disputes settlement; and issues related to the conduct of foreign investors, (e.g., illicit payments, restrictive business practices, disclosure of information, environmental protection, and labour relations).

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At the multilateral level, most agreements relate to sectoral or to specific issues. Particularly important among them are services, performance requirements, intellectual property rights, insurance, settlement of disputes, employment and labour relations, restrictive business practices, competition policy, incentives and consumer protection. It is at the multilateral level that concern for development is most apparent. This is particularly so in the case of the GATS, TRIPS and TRIMs agreements, as well as the (non-binding) Restrictive Business Practices Set, where special provisions are made that explicitly recognise the needs of developing countries. The Uruguay Round of Multilateral Trade Negotiations was the first time that some investment issues were directly introduced as part of the disciplines of the multilateral trading system. This occurred most markedly in the negotiatijons of GATS which defines trade in services as including the provision of services through commercial presence. The TRIMs Agreement, in fact, focuses on one aspect of the policy inter-relationship between trade and investment (performance requirements). Although multilateral rules on FDI could be established in an independent agreement, recent proposals aim at the negotiation of such rules in the framework of international organisations with global, or potentially global, membership. In particular, the WTO has been mentioned as an appropriate forum for such negotiations. An important consideration underlying this suggestion is that the interwining of investment and trade requires a more integrated approach to international rule-making. This has already manifested itself in the work of the GATT and of the WTO. Thus, the WTO already deals with certain aspects of investment isues in the context of the agreements on trade in services, trade-related investment measures and trade-related aspects of intellectual property rights, and an agenda exists for the expansion and deepening of these rules. Negotiations on liberalisation through the expansion of the GATS schedules of commitments are scheduled to take place before 1999, and the TRIMs Agreement provides for consideration of competition and investment isues by the same year. The question of a possible future multilateral framework on investment was addressed at the 1996 UNCTAD IX Conference at which it was agreed that UNCTAD should identify and analyse implications for development of issues relevant to a possible multilateral framework on investment, taking into account the interests of developing countries. The areas of policy analysis and consensus-building, with a particular focus on the development dimension, are, indeed, areas in which UNCTAD can make a valuable contribution. Investment issues are currently the subject of discussion or negotiation in a number of regional and interretional fora. One important recent initiative was the launching, in May 1995, of negotiations aimed at the conclusion of Multilateral Agreement on Investment among the members of the OECD in time for the Organisation’s ministerial meeting in 1997.

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Three lessons can be drawn from past developments on FDI policies. First is that progress in the development of international investment rules is linked to the convergence of rules adopted by individual countries. Second is that an approach to FDI issues that takes into account the common advantage, is more likely to gain widespread acceptance and to be more effective. Third is that in a rapidly globalising world economy, the list of substantive issues entering international FDI discussions is becoming increasingly broader and complex and include the entire range of questions concerning factor mobility. Selected Bibliography Agrawal, C. (1996). Human Resource Development for Assimilation of New Technologies, World Association for Small and Medium Enter-prises (WASME), New Delhi. Ali, Ifjal (1990). Strategies and policies for structural transfor-mation, Asian Development Review, Vol.8,No.2, pp.1-27, Asian Development Bank, Manila. Anayiotos, Andrea (1994). Infrastructure investment funds, Private Sector, December, pp.29-32. Asian Development Bank (ADB) (1995). Asia : Development Experience and Agenda, ADB Theme Paper 3, ADB, December 1995. ______(1996). Asian Development Outlook 1996 and 1997, Oxford University Press, Hong Kong. ______(1997a). Asian Development Outlook 1997 and 1998, Oxford University Press, Hong Kong. ______(1997b). Emerging Asia- Changes and Challenges, Asian Development Bank, Manila. ASSOCHAM (The Associated Chambers of Commerce and Industry in India) (1995). Foreign Direct Investment Status and Prospects, August 1995, New Delhi. Bhalla, A. and P. Bhalla. (1995). ASEAN and SAARC, RIS Digest, Vol.13, nos.2-4, December 1996, pp.55-90, Research and Information System (RIS) for the Non-Aligned and Other Developing Countries, New Delhi. Blomstorm, Magnus (1990) Transnational Corporations and Manufacturing Export from Developing Countries, Document no. ST/CTC/101, United Nations, New York. _______and Robert E. Lipsey (1993) Foreign firms and structural adjustment in Latin America: lessons from the debt crisis, Working paper no.1856, National Bureau of Economic Research.

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_______and Lipsey, Robert E., and Zejan, Mario (1992). What explains developing country growth ?, NBER Working Paper no. 4132, National Bureau of Economic Research, Cambridge, Mass. Borenzstein, E., Gregorio, J.de, and Lee, J. (1995). How does foreign direct investment affect growth ?, NBER Working Paper no. 5057, National Bureau of Economic Research, Cambridge, Mass. Brooks, D.H. and Leuterio, E.E. (1997). Natural resources, economic structure and Asian infrastructure, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD. Cantwell, J.A. (1995) The globalisation of technology : what remains of the product cycle model?, Cambridge Journal of Economics, Vol.19, no.1, pp.155-174. Chakwin, Naomi and Hamid, Naved (1997). Economic environment in Asia for investment, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD. Chia, Siow Yue (1994). Trade and Foreign Direct Investment in East Asia, in Pacific Trade and Investment: Options for the 90s, ed. Wendy Dobson and Frank Flatters, Proceedings of a Conference, 6-8 June 1994, Toronto. Chia, Siow Yue; and Tsao Yuan Lee (1994). Economic Zones in Southeast Asia, in Asia Pacific Regionalisation: Readings in International Economic Relations, ed. R. Garnaut and P. Drysdale, Pymble, Haeper Educational Publishers. Chung, Cheng., Chang, Laurence and Zhing, Yimin (1995). The Role of Foreign Direct Investment in China’s Post-1978 Economic Development, World Development,Vol.23, no.4, pp.691-703. Chowdhury, A. H. M. Nuruddin (1990) Small and medium industries in Asian developing countries, Asian Development Review, Vol.8, No.2, pp.28-45. Coe, David.,Helpman,Elhanan., and Hoffmaister, Alexzander (1995). North South R & D spillovers, Discussion Paper no.1133, Centre for Economic Policy Research, London. Confederation of Indian Industry (CII) (1996). Foreign Direct Investment: Policy and Procedures - Select Countries, New Delhi. Das, Tarun (1993a). Structural Reforms and Stabilisation Policies in India - Rationale and Medium Term Outlook, in Economic Liberalisation and its Impact, ed. S.P.Gupta, pp.20-56, MacMillan India Ltd, New Delhi. 1993. ______(1993b). Macro-economic Framework, Special Economic Zones and Foreign Investment in India, Ad-Hoc Workong Group on Investment and Financial Flows, UNCTAD,Geneva, pp.1-75,June 1993.

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______(1994). India’s Recent Economic Development and Policies and Prospects for 1995-1996, paper presented at the Seventh Workshop on Asian Economic Outlook, October 1994, Asian Development Bank, Manila. ______(1996). Policies and Strategies for Promoting Private Sector’s Role in Industrial and Technological Development, Including Privatisation in South-Asian Economies, paper presented at the Regional Dialogue on Privatisation, organised by the Industry and Trade Division, ESCAP, United Nations, Bangkok. Dasgupta, Biplab (1996). New Political Economy and the East Asian Development Experience, mimeo, December 1996, New Delhi. Dean, J.,S. Desai and J. Riedel (1994). Trade Policy Reform in Developing Countries since 1985, Discussion Paper No.267, World Bank, Washington, D.C. 1994. Drucker, P.F.(1992). Managing for the Future, Butterforth,Oxford. Dunning, John H. (1994). Re-evaluating the benefits of foreign direct investment, Transnational Corporation, Vol.3, no.1, February, pp.23-52. ______(1996). The changing geography of foreign direct investment, paper presented at international workshop on Foreign Direct Investment, Technology Transfers and Export Orientation in Developing Countries, Maastricht, the Netherlands, November 1996. ESCAP (1992). Economic and Social Survey of Asia and Pacific 1991, Part 2, Challenges of Macroeconomic Management in the Developing ESCAP Region, United Nations, New York. ______(1993). Economic and Social Survey of Asia and Pacific 1992, Part 2, Expansion of Investment and Intraregional Trade as a vehicle for Enhancing Regional Economic Co-operation and Development in Asia and Pacific, United Nations, New York. Estanislao, Jesus (1977). The institutional environment for investments in Chin and ASEAN: current situation and trends, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD. European Commission (1995) A level playing field for direct investment world-wide, COM (95), 42, Brussels, mimeo. Fry, Maxwell J. (1984). Domestic resource mobilisation through financial development, Asian Development Bank, manila, mimeo. ______(1992). Foreign Direct Investment in a Macro-Economic Framework,Finance,Efficiency, Incentives and Distortion, International Finance Group, Birmingham University, mimeo.

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______(1993). Foreign Direct Investment in a Macro-Economic Framework,Finance,Efficiency, Incentives and Distortion, Policy Research Working Paper, no.1141, International Economics Department, International Finance Division, World Bank. Go, E. (1985). The impact of foreign capital inflow on investment and economic growth in developing Asia, Economic Office Report Series, no.33, Asian Development Bank, Manila. Graham, Edward M. (1996a). Global Corporations and National Governments, Institute for International Economics, Washington. ______(1996b) Foreign Direct Investment in the World Economy, OECD Background Paper. ______(1996c) Investment and the new multilateral trade context, in OECD, Market Access after the Uruguay Round: Investment, Competition and Technology Perspectives, pp.35-62, OECD, Paris. Gupta, K.C. and Islam, M.A. (1993). Foreign Capital, Savings and Growth, D. Reidel Publishing Company, Dordrecht, Holland. Haley, Geoff; Payne, Helen and Falconer, Jeffrey (1994). Private Financing of Infrastructure Projects in Developing Countries, Build-Operate-Transfer (BOT) Arrangements, No.UNCTAD/GID/DF/5, UNCTAD, Geneva. Hein, Simeon (1992). Trade Strategy and Dependency Hypothesis: A Comparison of Policy, Foreign Investment and Economic Growth in Latin America, Economic Development and Cultural Change, Vol.40, No.3, pp.495-521. Hu, Zulia and Khan, M.S. (1997). Why is China growing so fast ?, International Monetary Fund, Economic Issues 8, April 1997. Huges, Helen (1995). Foreign investment experience in developing countries: costs and benefits, a paper presented in the Seminar on Structural Adjustment and Policy Reforms: Perspectives from International Experiences, organised by the International Council for Research on International Economic Relations, New Delhi. International Monetary Fund (IMF) (1995). Balance of Payments Statistics Year Book 1995, Part 1, Washington, D.C. ______(1996). Direction of Trade Statistics Yearbook, 1996, Washington, D.C. ______(1997). World Economic Outlook - Globalisation, Opportuni-ties and Challenges, May 1997, Washington, D.C.

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Joshi, B. (1993). Macro policy analysis of technology transfer issues, mimeo., Indian Council for Research on International Economic Relations, New Delhi. Julius, DeAnne (1994) International direct investment: strengthe-ning the policy regime, in Managing the World Economy: Fifty years after Bretton Woods, Institute for International Economics, pp.269-286, Washington, D.C. Kakazu, Hiroshi. (1990). Industrial Technology Capabilities and Policies in Asian Developing Countries, Asian Development Review, Vol.8, No.2, pp.46-76, Asian Development Bank, Manila. Kumar, Nagesh (1966) Foreign Direct Investment and Technology Transfer in Development: A Perspective on Recent Literature, UNU/ INTECH Discussion Paper no.9606, Maastricht, UNU/INTECH. Lall, Sanjaya (1993). Policies for Building Technological Capabilities : Lessons from Asian Experience, Asian Development Review, Vol.11, No.2, pp.72-103, Asian Development Bank, Manila. Lee, J.S., Rana, P.B. and Iwasaki, Y. (1986). Effects of foreign capital inflows on developing countries in Asia, Economic Staff Paper, no.30. Asian Development Bank, Manila. Lessard, D.R. (1989). Beyond the debt crisis: alternative forms of financing growth, Working Paper of the Alfred P.Sloane School of Management, Massachusetts Institute of Technology, Feb.1989. Lim, Chee Peng. (1993). Flows of Private International Capital in the Asian and Pacific Region, Asian Development Review, Vol.II No.2, pp.104-139, Asian Development Bank, Manila. Lipsey, Robert E. (1995) Outward direct investment and the U.S. economy,Working paper 2020,National Bureau of Economic Research. Naya, Seiji (1990). Direct foreign investment and trade in East and Southeast Asia, in the Political Economy of Intwernational Trade: Essays in honour of Robert E. Baldwin, edited by Ronald W. Jones and Anne O. Kruegger, Cambridge, Mass: Basil Blackwell. Oman, C.P., Brooks, D.H. and Foy, C. (1997). Investing in Asia, Development Centre, The Organisation for Economic Co-operation and Development (OECD). Panchmukhi, V.R. (1995). Economic Cooperation in South Asia: The Crisis of Perception, in Emerging South Asian Order: Hopes and Concerns,ed.S.Ghosh and S. Mukherjee, Media South Asia, Calcutta.

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______(1996). Multilateral Agreement on Investment - What should be the response of the developing countries?, RIS Digest, Vol.13, nos.2-4, Dec.1996, pp.7-54, Research and Information System (RIS) for the Non-Aligned and Other Developing Countries, New Delhi. Puri, Ashwani and Mathew, Jacob (1994). Investment promotion zone schemes - A regional context, Price Waterhouse, India, New Delhi. Rana, P.B. and Dowling, J.Malcolm (1990). Foreign capital and Asian economic growth, Asian Development Review, vol.8, No.2, pp.77-103, Asian Development Bank, Manila. Research and Information System (RIS) for the Non-Aligned and Other Developing Countries (1995). SAARC Survey of Development and Cooperation 1995, New Delhi. Reza, Sadel (1994). Policy reform for promoting trade in developing countries, Asian Development Review, Vol.12, No.12, pp.85-112, ADB, Manila. Shirazi, Javed K. (1995). Private Financing of Infrastructure: A Broad Perspective, Keynote Address at SCICI’s Seminar on The Role of Capital Markets in Financing Infrastructure Services, Bombay. Singh,I.J. and Jefferson,Gary (1993). State Enterprises in China: Down from the Commanding Heights, Transitions. Vol.4 No.8. Singh, Ram D. (1988). The multinationals’ economic penetration, growth and industrial output and domestic savings in developing countries: Another Look, Journal of Development Studies, Vol.25, No.1, pp.55-82. Subrahmanian, K.K., Sastry, D.V.S., Pattanaik, Sitikantha and Hajra, Sujan. (1996). Foreign Collaboration under Liberalisation Policy: Pattern of FDI and Technology Transfer in Indian Industry since 1991, Reserve Bank of India, August 1996, Mumbai. Tang, Min. (1996). Recent development on capital flows to the Asian and Pacific Developing Countries, Discussion Paper, ADB, Economics & Development Resource Center, Manila. United Nations (1996). World Investment Report - Investment, Trade and International Policy Arrangements, New York and Geneva. United Nations Centre on Transnational Corporations (UNCTC) (1992a). World Investment Report 1992: Transnational Corporations as Engines of Growth, United Nations, New York. ______(1992b). The determinants of Foreign Direct Investment: A Survey of Evidence, United Nations, New York.

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______and United Nations Conference on Trade and Development (UNCTAD) (1991) The Impact of Trade-related Investment Measures on Trade and Development, United Nations, New York. United Nations, Transnational Corporations and Managemant Division (UN-TCMD) (1993) Foreign Direct Investment and Trade Linkages in Developing Countries, United Nations, New York. United Nations Conference on Trade and Development (UNCTAD), (1992). Exchange of experiences among groupings of developing countries - An evaluation of the ASEAN experience, No.UNCTAD /ECDC/331, September 1992, United Nations, Geneva. ______(1992). World Investment Report 1992: Transnational Corporations as Engine of Growth, United Nations, Geneva. ______(1993a). Foreign Direct investment in developing countries: Recent trends and policy isues, Report by the UNCTAD secretariat, TD/B/WG.1/7, April 1993, United Nations, Geneva. ______(1993b). World Investment Report 1993: Transnational Corporations and Integrated International Production, United Nations, Geneva. ______(1993c). Export processing zones: Role of foreign direct investment and developmental impact, No.TD/B/WG.1/6, April 1993, United Nations, Geneva. ______(1993d). Ad Hoc Working Group on Investment and Financial Flows; NonDebt-creating Finance for Development; Country Reports on (a) The Republic of Korea, No.TD/B/WG.1/Misc.3/Add.2, (b)Philippines,No.TD/B/WG.1/Misc.3/Add.4, (c)China,No.TD/B/WG.1/ Misc.3/Add.5, and (d) Myanmar, No.TD/B/WG.1/Misc.3/Add.10, May-June 1993, United Nations, Geneva. ______(1993e). Report of the Ad Hoc Working Group on Investment and Financial Flows; Non-Debt-creating Finance for Development; No. TD/B/40(1)/12 and TD/B/WG.1/8, July 1993, U.N., Geneva. ______(1993f). Host country policies and measures to promote foreign direct investment : a synthesis of eight case studies - Report by the UNCTAD secretariat, No.TD/B/WG.1/10, October 1993, United Nations, Geneva. ______(1993g). Portfolio Equity Investment and New Financing Mechanisms - Foreign portfolio equity investment in developing countries: current issues and prospects,No.TD/B/WG.1/11,Oct.1993, United Nations, Geneva. ______(1994). World Investment Report 1994: Employment and Workplace, United Nations, Geneva.

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______(1995a). Country and Regional Experiences in Attracting Foreign Direct Investment for Development- Foreign Direct investment in developing countries, No.TD/B/INTC/3, February 1995, United Nations, Geneva. ______(1995b). Recent Developments in International Investment and Transnational Corporations - Trends in foreign direct investment, No.TD/B/ITNC/2, Feb.1995, United Nations, Geneva. ______(1995c). National Legislation and Regulations Relating to Transnational Corporations - Volume VIII, United Nations, Geneva. ______(1995d). Technological Capacity-Building and Technology Partnership: Field Findings, Country Experinces and Programmes, United Nations, Geneva. ______(1996). World Investment Report : Investment, Trade and International Policy Arrangements, United Nations, Geneva. UNCTAD, Division on Transnational Corporations and Investment (UNCTAD-DTCI) (1993). World Investment Report 1993: Transnational Corporations and Integrated International Production, United Nations, New York. ______(1995). World Investment Report 1995: Transnational Corporations and Competitiveness, United Nations, New York. ______(1996). International Investments Instruments: A Compendium, Vols.I, II and III, United Nations, Geneva. Urata, S. (1993). Changing pattern of direct investment and the implication for trade and development, in Pacific Dynamism and the Interntional Economic System, ed. C.F.Bergston and M. Noland, Institute for International Economics, Washington D.C. Wei, Shang-jin (1997). Foreign direct investment in China: sources and consequences, in Takatoshi Ito and Anne O. Kruger. ed., Financial Deregulation and Integration in East Asia, Chicago University Press, Chicago. World Bank (1993). The East Asian Miracle: Economic Growth and Public Policy, Oxford University Press. ______(1994a). World Development Report - Infrastructure for Development, Washington, D.C. ______, 1994b. Private provision of infrastructure services in East Asia and Pacific Some stylized facts and lessons from early experience, Staff Discussion Paper, Washington, D.C.

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______(1994c). Infrastructure Development in East Asia and Pacific: Towards a New Public-Private Partnership, Washington,DC. ______(1995a). Global Economic Prospects and Developing Countries, Wachington. D.C. ______(1995b). Private Sector Development in Low-Income Countries, Washington D.C. ______(1996). World Development Indicators, Washington, D.C. ______(1997a). Financial Flows and the Developing Countries - A World Bank Quarterly, May 1997, Washington, D.C. ______(1997b). Global Development Finance, Washington, D.C. ______(1997c). World Development Report 1997, June 1997, Washington, D.C. World Economic Forum (WEF) (1996). The Global Competitive Report 1996, Geneva, Switzerland. Xiaoqiang, Zhang (1997). Investment in China’s future, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD. Yam,T.K.,and L.Low (1992). ASEAN and Pacific Economic Cooperation, ASEAN Economic Bulletin, March 1992. Yamazama, Ippie (1997). APEC and investment, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD. Yifu, Lin Justin (1996). China’s economic reforms: implications for India and other economies, paper presented on Seminar on India’s Economic Reform and Structural Adjustment: Perspectives from International Experience, ICRIER, New Delhi.

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PROMOTING INDUSTRIAL INVESTMENT-TECHNOLOGY TRANSFERGROWTH NEXUS TOWARDS GREATER REGIONALISATION AND COMPLEMENTATION OF MANUFACTURING PRODUCTION AND TECHNOLOGY UPGRADING VOLUME - II EXECUTIVE SUMMARY AND RECOMMENDATIONS _________________________________________________________________

DR. TARUN DAS ECONOMIC ADVISER MINISTRY OF FINANCE GOVERNMENT OF INDIA

_________________________________________________________________ * Prepared for the Industry and Technology Division (ITD), ESCAP, United Nations, Bangkok as a part of their Project on Regional Dialogue on Promoting Industrial and Technological Development and Complementarities: Challenges & Opportunities for Cooperation in Light of Emerging Regional and Global Developments.

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* Author would like to express his gratitude to the ESCAP, and the Industry and Technology Division, United Nations, for providing an opportunity to write this Report, and the Government of India, Ministry of Finance for granting necessary permission. However, the paper expresses personal views of the author and should not be attributed to the views of the Government of India. Update: August 31, 1997. CONTENTS Contents 1

Paragraps

Executive Summary and Recommendations

A Major Conclusions

1-164

2-116

1.1 Basic characteristics of Asian economies (a) South Asia and SAARC 4-5 (b) East Asia and South East Asia 6-8

2-8

1.2 FDI - Technology - Growth Nexus

9-25

1.3 Geographical and Sectoral Distribution of FDI 26-56 (a) Regional distribution of FDI 26-31 (b) FDI in selected countries of Asia 32-51 1 China 32-34 2 India 35-39 3 Japan 40-41 4 Republic of Korea 42-43 5 Taiwan, China 44-45 6 Philippines 46-47 7 Myanmer 48 8 Indo-China (Cambodia, Lao PDR, Vietnam) 49-50 9 USA’s direct investment in Asia 51 (c) Sectoral distribution of FDI 52-55 (d) Foreign Portfolio Investment (FPI) 56 1.4 Different Modes of FDI and Technology Transfer (a) Modes of foreign capital 57-62 (b) Modes of foreign portfolio investment 63 (c) Modes of technology transfer 64-67 1.5 Advances in New Technologies

68-74

148

57-67

(a) Pattern of industrialisation in East Asia (b) New Technology and Applications

68-71 72-74

1.6 Development of Infrastructure and Services

75-84

1.7 Policies and Strategies for Promoting 85-102 FDI - Technology - Growth Nexus (a) Macro-economic policies 85-91 (b) Fiscal and financial policies 92-93 (c) Role of Special Economic Zones 94-95 (d) Role of Small and Medium-Sized Industries 96-98 (e) Role of Research & Development Expenditures 99-100 (f) Infrastructure and human resource development 101-102 Contents

Paragraps

1.8 Regionalisation and FDI Complementarities 103-116 (a) ASEAN Experience 104-106 (b) SAARC Experience 107-108 (c) APEC Experience 109 (d) ESCAP experience 110-113 (e) Multilateral agreement on investment (MAI) 114-116 B. Recommendations

117-164

1.9 General recommendations

117-118

1.10 Policies and strategies for promoting 119-140 FDI-Technology-Growth Nexus (a) Host country policies for FDI 119-126 (b) Host country policies for 127-128 foreign portfolio investment (c) Home country policies 129-131 (d) The role of special economic zones 132 (e) The role of small & medium sized industries 133-134 (f) Role of R&D expenditure 135 (g) Infrastructure & human resource development 136-137 (h) Legal and institutional set-up 138-139 (i) Fiscal and financial incentives 140 1.11 Different Modes of FDI & Technology Transfer 1.12 Advances in New Technologies (a) Industrial technology development

141-143

144-149 144-146

149

(b) New technology and applications

147-149

1.13 Development of Infrastructure and Services

150-152

1.14 Regionalisation and FDI Complementaries 153-164 (a) Technical assistance 155-157 (b) Regional cooperation 158 (c) Regional cooperation in SAARC 159-164 Selected Bibliography : List of Tables 1.1 Basic indicators of selected Asian countries: 1995 1.2 Average growth rates of GDP and value added in industry in selected Asian countries: 1965-1996 1.3 Share of FDI inflows in gross fixed capital formation by region and country in 1984-1994 1.4 Share of inward FDI stock in gross domestic product (GDP) by region and country in 1984-1994 1.5 Net foreign direct investment as a share of GNP by region and income group in 1990-1996 1.6 FDI inflows by host region and countries: 1984-1995 1.7 Top 10 home countries for FDI flows to selected Asian economies in recent years : A Bangladesh, Myanmer, Cambodia, China B Hong Kong, India, Indonesia, Japan C Laos, Malaysia, Mongolia, Pakistan D Philippines, Singapore, South Korea, Sri Lanka E Taiwan, Thailand, Vietnam, New Zealand 1.8A US FDI and related indicators in selected developing Asian countries in 1992 1.8B Performance of US FDI in the manufacturing sector 1.9 Gross portfolio flows to developing countries by region during 1990-1996 1.10 Infrastructure financing raised by developing countries by region and type of instrument: 1986-1995 1.11 Privatisation revenues by sector: 1988-1995 1.12A Foreign exchange raised through privatisation in

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developing countries: 1988-1995 1.12B Portfolio investment and foreign direct investment in privatisation: 1988-1995 1.13A Comparative statement on Foreign Investment Regime in selected countries in Asia. 1.13B Comparative statement on Foreign Investment Regime in selected countries in Asia. 1.14 Potentials of South-Asian Sectoral Cooperation. EXECUTIVE SUMMARY AND RECOMMENDATIONS 1. The basic objective of the present study is to critically analyse various modes of overseas direct investments (ODI) and to identify for promotion those forms which lead to deepening of industrial and technological capability, forge greater linkages with domestic economy, and contribute to sustained growth in environment characterised by free flow of goods and services. This chapter summarises the main conclusions drawn from other chapters and present a set of recommendations covering overall issues for promoting the nexus among foreign investment, technology transfer and overall economic growth. A. Major Conclusions 1.1 Basic Characteristics of Asian Economies 2. In recent years Asian economies exhibited remarkable economic vigor and dynamism (Tables 1.1 and 1.2) and outperformed by a wide margin other developing regions and industrial countries. As judged by ratios to GDP, investments, savings and exports made a much higher contribution to growth in Asia than in the other regions. A trinity of openness to trade, high investment and high savings rates coexisted in the fast-growing economies of Asia. They achieved high economic growth by introducing capital and technology from advanced countries, while enjoying the benefits of huge markets of these advanced countries. In other words, the Asian economies are typical examples of “catch-up” type economic growth. It is also indicative of the movement towards higher value added and more technology-intensive activities. 3. The process of rapid growth in output and intraregional trade and investment in Asia is sometimes called a “virtuous circle” of economic development. Foreign capital inflows combined with a favourable policy environment, industrialisation and trade expansion to achieve a sustained economic growth. The efficient use of resources, increased trade and rapid growth have, in turn, stimulated an increase in the flow of intraregional investment. This process gradually helped to internalise Asian growth and to reduce Asia’s vulnerability to external shocks.

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(a) South Asia and SAARC 4. Two themes characterised the past development approach in South Asia: a strong economic role for the state and relatively inward-looking development policy. The broad lessons of past development are that countries with more market-friently and outwardlooking policies do better in generating growth and reducing poverty. While there is general agreement in South Asia about the need of reforms, the pace has been uneven due to mainly political issues. Recent progress is most visible in reforms in taxation, industrial, external, public and financial sectors. 5. SAARC has completed more than a decade of its existence, but the process of economic cooperation in the region has been slow. Nevertheless, SAARC has established itself as an important regional grouping due to its large market space measured by the size of its population and its potential purchasing power. The ongoing economic reforms and globalisation by the SAARC economies have also made the region an attractive destination for foreign direct investment and other capital flows. (b) East Asia and South-East Asia 6. East Asia has a remarkable record of high and sustained economic growth and grew faster than all other regions of the world in 1965-1996. They are also economically more egalitarian in terms of the distribution of income, wealth and land. Although initially called “the East Asian Miracle”, various World Bank studies concluded that there was no “miracle” or “myth” for the outstanding performance of East Asia in the past three decades, which can be explained fundamentally by efficient macroeconomic management, investment in human capital and a judicious combination of sound development policies and selective interventions based on twin pillars of “outward orientation” and “market friendly environment”. There was no single or uniform “East Asian model” or “a distinct East Asian path”. Although the “basics” of their development policies were more or less uniform and they were quick to respond to macroeconomic disequilibria with success, they adopted “heterodox approaches” regarding the “specifics” of industrial, trade and technology development. 7. Openness of trade and emphasis on competitiveness of the manufacturing sector had been pivotal to the economic success of the NIEs and the fast-growing economies of Southeast Asia. Economic policies did not penalise the traded goods sector, and market forces were allowed to determine the real exchange rate. A comparatively “level playing field” allowed both the traded and non-traded goods sectors to grow vigorously, complementing and supplementing each other in investment, production and trade. This facilitated an efficient allocation of resources. The benefits of a more liberal trading environment reached beyond the narrow efficiency gains highlighted by the theory of comparative advantage. Other benefits include more competitive goods and factor markets,increased investment including foreign investment, and the associated transfer of knowledge and technology. 8. While overall the region performed impressively, there remain obstacles to sustained development. Serious environmental damage associated with rapid urbanisation,

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inadequate regulation and planning, inadequacy of infrastructure and incorrect pricing of resources, continue to pose threats to sustained growth and impose major costs for development in East and South East Asia. 1.2 FDI - Technology - Growth Nexus 9. In 1990s there was a significant change in the composition of external capital flows to the developing countries with an increasing share of private capital from 44% in 1990 to 86% in 1996 and a corresponding declining share of official development finance. Asian region received 50% of private finance in 1996 among the developing economies. Within private capital, flows of foreign investment increased five-and-half times surpassing other types of capital flows and constituting 54% of total capital flows to developing countries in 1996. 10. The private capital flows are likely to be more beneficial since they are generally accompanied by technology transfer and market access in the case of foreign direct investment (FDI); diversified investor base in the case of bonds; and a reduction in the cost of capital in the case of portfolio flows. Unlike other flows, FDI is a “package” which contains capital alongwith management, technology and skill. Experience in developing countries suggests that “unbundling” the FDI package by borrowing capital from the international banks, purchasing technology through licenses and negotiating management agreements, is less efficient in terms of productivity than the FDI package. 11. FDI, like trade, provides an important channel for global integration and technology transfer. FDI also promotes export orientation and plays an important role in privatisation and the provision of infrastructure. The ASEAN experience shows that FDI can promote both industrial growth, technology upgradation and export capabilities of the host countries through the creation of intra-regional and extra-regional linkages. As regards sectoral distribution, FDI tends to concentrate in industries using mature or standardised technology and management skills. 12. There are different types of FDI such as natural-resource seeking, market-seeking, technology seeking, cost-reducing, risk avoiding, export-oriented and defensive competitive FDI. Natural resource-seeking FDI, which consists of investment in mining, processing, textiles, oil and gas is the earliest type of foreign investment. Until 1980s market-seeking FDI was largely confined to the manufacturing sector motivated by “tariff jumping” to take advantage of the regulated market, but due to the recent trends of economic reforms and privatisation of infrastructure, sectors such as power, telecommunications and financial services are attracting increasing amounts of foreign investment. Industrial restructuring through mergers and acquisitions (M&As) have emerged as a favourite route to FDI. Export-oriented FDI is guided by the “product life cycle” theory of FDI, which postulates that as real wages increase due to economic growth in a country, labour-intensive industries will relocate to countries at a lower level of economic development. Regional groups (such as the European Union, NAFTA, MERCOSUR, APEC, ASEAN and SAARC) also facilitate regionally integrated production networks. Geographical distribution of direct foreign investment also favours neighbouring and ethinically related countries.

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13. Host countries can be classified according to four stages of development viz. factordriven (attracting FDI in processing, textiles and minerals exploitation), investment driven (heavy and chemical industries, power, construction, transport and telecommunications), innovation-driven (electronics, information technology, biotechnology) and wealth-driven (attracting FDI to meet domestic demand and also encouraging outward FDI flows). 14. Global FDI reached $315 billion in 1995, and the FDI growth (12.1%) in 1991-1995 was substantially higher than that of exports of goods and non-factor services (3.8%), world output (4.3%) and gross domestic investment (4%). The recent boom in flows has expanded the world’s total FDI stock, valued at $2.7 trillion in 1995 held by some 39,000 parent firms and their 270,000 affiliates abroad. About 90% of parent firms in the world are based in developed countries, while two-fifths of foreign affiliates are located in developing countries. The global sales of foreign affiliates reached $6.0 trillion in 1993 and continued to exceed the value of goods and non-factor services delivered through exports ($4.7 trillion) - of which about 25% are intra-firm exports. Sales by foreign affiliates in developing countries were $1.3 trillion equivalent to 130% of imports from these countries. In 1993, $1 of FDI stock produced $3 in goods and services abroad. 15. Between 1980 and 1994, the ratio of global inward FDI stock to world GDP and the ratio of FDI inflows to gross domestic investment doubled from 4.6% to 9.4% and from 2% to 3.9% respectively. The ratio of global FDI outward stock to world GDP and the ratio of FDI outflows to gross domestic capital formation in developed countries also doubled between 1980 and 1994, from 4.9% to 9.7% and from 2.1% to 4% respectively. 16. The pattern of investment and production in ASEAN followed the “flying geese” pattern of evolving comparative advantage, and promoted regional integration through “production sharing” which involved the setting up of multiplant production in different countries. Technological advances lowered transportation costs and improved telecommunications networks which made location of production more sensitive to cost differentials such as lower wages. ASEAN countries particularly attracted foreign automobile manufacturers through the Brand-to-Brand Complementation scheme, which provides for a diverse production base. 17. Trade and FDI go hand in hand. FDI has grown fastest among the countries which participated fully in the multilateral trade negotiations. Within the traditional structures of manufacturing TNCs generating FDI-trade linkages, intra-firm sales tend to comprise mainly flows of equipment and services from parent firms to their affiliates. If foreign affiliates are located downstream, intra-firm trade consists mainly of parent firms’ exports to affiliates; if they are upstream suppliers, they generate intra-firm imports for parent companies. 18. Data on trade by United States parent firms and their affiliates abroad illustrate the high and growing importance of intra-firm trade for TNCs. During 1983-1993, the share of intra-firm exports in total exports of United States parent firms rose from 34 per cent to 44 per cent; and the share of intra-firm imports in total imports rose from 38 percent to

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almost one half. Data for TNCs based in Japan confirm the importance of intra-firm trade in many manufacturing industries, especially those characterised by high researchand-development intensities and firm-level economies of scale. 19. FDI has made significant contribution to economic growth in developing countries by promoting exports and providing access to export markets. The export propensities (measured by the ratio of exports to output) of U.S. foreign affiliates nearly tripled in the past two decades. This ratio more than doubled and reached 39 percent in Latin America, while the ratio remained high in Asia, ranging from 30 percent in the Republic of Korea to more than 80 percent in Malaysia. The export propensities of Japanese affiliates also have been increasing, most notably in East Asia, where their exports accounted for 34 percent of total sales in 1993. Japanese affiliates in China exported 53 percent of their sales in 1992, up from less than 10 percent in 1986, directing 43 percent of their sales to home markets in Japan. 20. Several emperical studies generally support the view that FDI promotes economic growth in host countries by stimulating investment, and benefits of FDI tend to be greater where policy distortions are fewer. Studies also conclude that (a) FDI has a larger impact on growth than does domestic investment; (b) higher FDI inflows are associated with higher productivity of human capital for the economy as a whole, indicating that FDI has positive spillover effects through the training of workers; and (c) FDI does not crowd out domestic investment, but instead seems to supplement it through vertical spillovers leading to increased capital investment by suppliers and distributors. 21. FDI adds to the capital stock of the host country in many ways viz. green-field FDI (establishing a new business), or ownership switching (through mergers and acquisitios) or raising equity shares in joint ventures. In developed countries, most FDI is ownership switching whereas it is mostly greenfield FDI or joint ventures in the developing countries. However, privatisa-tion related FDI has recently become an important form of ownership-switching FDI for developing countries, although such FDI accounted for less than 10% of cumulative FDI inflows to the developing countries in 1988-1993. 22. The financial capital generated, mobilised, transmitted and invested by the TNCs is one of the FDI’s major contribution to a country’s growth and investment. For all the countries that report such data to the UNCTAD, total profits of foreign affiliates (reinvested and repatriated) amounted to $99 billion in 1993 or 8% of the global FDI stock (UN-UNCTAD 1995). Over 50% was reinvested by the foreign affiliates and the remainder was either repatriated or paid as dividends or circulated via equity flows and intra-company loans. The net equity capital of TNCs for 40 countries that report such data was $80 billion in 1993 amounting to 70% of the total FDI inflows in these countries. Inter-country loans for 41 countries were $51 billion in 1993 (amounting to 37% of total FDI inflows in these countries). Repatriated profits for 27 countries for which such data are available were $56 billion in 1993. 23. The significance of FDI in domestic capital formation can be judged from the ratio of inward FDI flows in the gross fixed capital formation which reached the peak level of

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24.5% in China in 1994, 26% in Malaysia in 1992, 47.1%% in Singapore in 1990, 37% in Fiji in 1990, 61.3% in Vanuatu in 1994 and 96% in the Pacific least developed countries in 1994 (Table 1.3). 24. Share of FDI stock in GDP was as high as 86.6% in Singapore in 1990, 46.2% in Malaysia in 1994, 36.6% in Indonesia in 1990, 18% in China, 21% in Hong Kong and 36% in Maldives in 1994 (Table 1.4). FDI flows as a share of GNP (Table 1.5) also indicates the importance of FDI in overall economic development. In 1996 it reached 2% for developing countries as a whole, and 6.5% for Malaysia and Vietnam. East Asia has sustained inflows equivalent to more than 4% of GNP in the 1990s. 25. These figures do not capture the full role of FDI as an agent for growth and structural transformation. In many countries FDI was instrumental in shaping industrial structure, technological base and trade orientation. Perhaps the most significant contribution of FDI is qualitative in nature. FDI embodies a package of growth and efficiency-enhancing attributes. TNCs are important sources of capital, technology, and managerial, marketing and technical skills. Their presence promotes greater efficiency and dynamism in the domestic economy. The training gained by workers and local managers and their exposure to modern organisational system and methods are valuable assets. 1.3 Geographical and Sectoral Distribution of FDI (a) Regional distribution of FDI 26. The FDI flows to developing countries have grown rapidly in 1990s and reached $100 billion in 1995 and $110 billion in 1996. The share of developing countries in global FDI flows increased from 19% in 1980 to 32% in 1995 (Table 1.6). As regards sources, more than 80 percent of global FDI inflows originate in OECD countries and the major home countries are the United States, United Kingdom, Germany, Japan and France which accounted for two-thirds of global FDI outflows in 1990s. The main suppliers of FDI to Latin America remain United States and Europe, while Japan has emerged as the predominant partner in Asia. The dominant role of FDI from the United States in Latin America and the Caribbean, from Japan in Asia and from Europe in Africa underline the tendency of the TNCs from the “Triad” in building up regionally integrated networks of affiliates. 27. The Asia and the Pacific is the new growth centre of the global economy with China, ASEAN and NIEs as important players. FDI flows to Asia and the Pacific reached $65 billion in 1995 accounting for 21% of global FDI flows and 65% of FDI flows to the developing countries, compared with $20 billion in 1990 accounting for only 10% of global FDI flows. East and South-East Asia alone received $62 billion in 1995, while South Asia saw a doubling of inflows to $2.7 billion in 1995, mainly due to tripling of inflows into India. Inflows of FDI to ASEAN-4 (Indonesia, Malaysia, Philippines and Thailand) increased from $8.6 billion in 1994 to $14 billion in 1995. In 1990-1996 China

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and ASEAN had a share of more than 80% in FDI inflows to Asian countries, with Chinese share exceeding 50%. 28. Asian developing economies themselves are increasingly becoming outward investors, reflected in the liberalisation of their outward FDI regimes and provision of incentives for such investments. In 1995, the region with $43 billion FDI outflows accounted for 90% of all developing country outflows with Hong Kong as the largest outward investor. Most outward FDI is going in the region to take advantage of cost differentials, liberal trade and FDI regimes and to allow export-oriented FDI to flourish. Malaysian and Thai TNCs directed 60% of their FDI outflows to Asia in 1995; some four-fifths of Hong Kong’s outward FDI went to China in 1995; a good part of Singapore’s outward FDI is distributed to other ASEAN countries and China; and 60% of China’s outward FDI remained in the region. 29. Surveys of FDI from developing countries high-light the following general features (UNCTAD 1993a): (a) The geographic distribution of FDI favours neighbouring and ethnically and culturally related countries. (b) FDI tends to concentrate in industries using standardised technology and management skills or industries based on natural resources (processing, textiles and minerals) or export-oriented industries (food processing, automobiles, and electronics). (c) Most TNCs are involved in joint ventures, both to limit their capital commitments and to obtain local managerial and organisational skills or access to markets of their partners. 30. An analysis of the FDI flows to selected host countries in the Asia and Pacific (Bangladesh, Cambodia, China, Hong Kong, India, Indonesia, Japan, Laos, Malaysia, Mongolia, Myanmer, Pakistan, Philippines, Singapore, South Korea, Sri Lanka, Taiwan, Thailand, Vietnam, and New Zealand) indicate that intra-Asian FDI flows constitute major shares in FDI inflows to most of these host countries (only exceptions being Japan, India and Pakistan). The share of Asian countries among the top 10 host countries ranged from 45 percent in South Korea to around 90 percent in China, Mongolia and Cambodia (Table 1.7A to 1.7E). The share of newly industrialised economies in the FDI flows to the ASEAN countries increased from 25% in 1990-1992 to 40% in 1993-1994. More generally, about 57% of the FDI flows from developing countries were invested within the same region in 1994. (b) FDI in selected countries in Asia 1 China, People’s Republic of 31. China is the principal driver behind the current investment boom in Asia. With an inflow of $38 billion in 1995 China became the second largest recipient of FDI after the U.S.A. in the world and the number one in the developing world, and became the home for 38% of FDI flows to developing countries and 55% of FDI flows to Asian developing countries. FDI inflows to China increased further to $42 billion in 1996. About 80% of FDI inflows to China come from countries with predominantly Chinese populations, such as Hong Kong, Macao, Singapore and Taiwan. Firms from those economies have certain

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advantages in investing in China, e.g., better knowledge of market conditions and reduced transaction costs owing to language advantages and family networks. 32. In 1979-1996, under the government’s open door policy, total FDI commitments in China reached $400 billion and FDI inflows $135 billion by 260,000 enterprises, of which 64% are equity joint ventures, 15% are co-operative joint ventures, and 21% are wholly foreign-owned enterprises. About 50% of the country’s industrial turnover is due to FDI and enterprises with foreign investment earned one-third of the country’s foreign exchange, employing 17 million workers. As regards sectoral distribution of FDI, 50% was concentrated in processing industries, 24% in other industries, 14% in real estate, 9% in telecommunications and transport, and 3% for agriculture and fisheries in 1979-1994. 33. In recent years, nearly 80 percent of FDI has been in small and medium-scale export-oriented manufacturing industries, with the average investment increasing from $0.5 million in the late 1980s to $2.5 million in 1995. Most of the investment was made by overseas Chinese who had already established strong links to the main export markets in Europe, Japan, and the United States. As a result of this boom in export-oriented FDI, exports became the main engine of growth for the Chinese economy, and the country significantly increased its share of world trade. 34. In 1989-1994, Guangdong attracted $25 billion utilised FDI, or 30% of the country’s total, most of which were in export-oriented industries. Over the same period, Guangdong’s exports expanded by 34.7% annually, while the country’s exports grew by only 18.2% per year. In 1994, foreign invested enterprises (FIEs) accounted for 39.5% of Guangdong’s exports, compared with 28.7% in the country. As a result, Guangdong recorded an average real GDP growth rate of nearly 18% per year since 1989, much faster than the national average of 10.7%. 2 India 35. The total number of foreign collaborations approved in post-liberalisation period (August 1991 to March 1997) amounted to 10729 of which 6092 proposals involved FDI amounting to $34 billion. More than 86% of these FDI are in priority sectors such as power and petroleum (24%), telecommunications (23%), financial services and hotels (10%), chemicals (7%), automobiles (6%), electrical equipments (6%), metallurgical industries (5%) and food processing industries (5%). 36. The average inflow of foreign investment to India increased from only $120 million per annum in 1980s to $4.7 billion per annum in 1993-1996. Total portfolio investments at $12.2 billion in 1993-1996 comprised $7 billion in equity shares purchased by FIIs attracted to India by the prospects of higher return, $4.5 billion by GDR/Euro equities and $0.7 billion by offshore and other funds raised by Indian firms interested in raising capital abroad at a lower cost than from domestic sources. 37. The U.S.A., U.K., Japan, Germany and Non-resident Indians (NRIs) constituted the major sources of foreign investment in India. In 1990s, however, Maurious and Caymon

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Island emerged as a major home country due to establishment of various off-shore funds in these countries to take advantages of tax haven. The increasing share of NICs like Singapore, Hong Kong and Malaysia is also an interesting feature of the new pattern. 38. As a consequence of the amendment of the Foreign Exchange Regulation Act (FERA) and automatic approval of foreign equity upto 51% in 48 priority industries and upto 74% in 9 high priority industries, many of the existing firms have raised their foreign equity above 50%. These constitute around 50 per cent of approvals since August 1991. An analysis of FDI approvals in 1990s also indicates a relatively higher proportion of joint ventures in all industries except energy and textiles. Further, the proportion of agreements with provisions for lump-sum payment, which is partly indicative of outright purchase of technology, is also lower in 1990s. 39. Inflows of foreign investment to India are likely to increase further due to several favourable factors. First, more than 85% of FDI inflows are in the core sectors, and the pipeline of FDI is more than $40 billion. Second, with a market capitalization of $150 billion, India’s capital market is among the largest in world, and FIIs could own up to 30% of this market. Third, Indian firms have incentives to mobilize resources abroad so long as the domestic lending rates remain above international levels. 3 Japan 40. Inward FDI flows to Japan increased from $940 million in 1986 to $4155 million in 1994. Share of manufacturing in total FDI inflows showed a declining trend, while that of non-manufacturing had an increasing trend over the period. Chemicals, machinery, commerce and trade, banking and insurance, and service sectors accounted for almost 80% of cumulative FDI inflows to Japan in 1950-1994. USA and Canada are the main sources of FDI accounting for 45% of cumulative FDI to Japan in 1950-1994, followed by Europe (30%) and affiliates of foreign businesses in Japan (11%). 41. Japanese outward FDI flows reached $57 billion in 1990 followed by some decline in 1990s. Major receipients of Japanese FDI flows are USA, Asian NIEs and ASEAN. Japanese overseas direct investment has aimed at exploiting the comparative advantage in the region: investment in the Asian NIEs, shifted from labour-intensive industries towards technology and service industries. In South Korea and Taiwan, over 80% of Japanese investments were in manufacturing, mainly in chemicals, textiles, electronics and electrical products, while in Hong Kong and Singapore, the investments have been directed towards finance and commerce. Even in the ASEAN-4 and China, Japanese investments have shifted in line with industrial growth in these countries (Chia, 1994). For example, the share of textiles in total Japanese FDI in ASEAN declined from 20.4% in 1985 to 11.8% in 1990; while that of electrical machinery rose from 4.9% to 20.6% over the period. 4 Korea, Republic of

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42. Republic of Korea provides an excellent example of how a capital importing country can turn into a capital exporting country over time by sound economic management and judicious combination of both inward and outward looking policies. The sectoral distribution of inward FDI flows is also illuminating. In 1962-1995, out of total FDI inflows of $14.5 billion, manufacturing accounted for 60% and services the rest, but the sectoral distribution was completely reversed in 1994-95 with services accounting for 61% of FDI flows. Within services, emerging sectors are trade, real estate, finance and insurance as contrast to hotels and construction in eralier years. Chemicals, automobiles and electronics are the dominant areas attracting FDI in manufacturing. Distribution of FDI inflows in terms of equity ratios indicate that 70% of FDI was on a joint venture basis and 30% was on 100 percent foreign equity. 43. Asian economies supplied 44% of inward FDI to South Korea in 1962-1995 and they received 46% of its outward FDI in 1991-1995. Within Asia, China and Indonesia are major destinations for Korean outward FDI. Korea has been seeking locations for its manufacturing investment in Asia. Although much of outward FDI was linked to trade prospects, a significant share of North America in the South Korea’s outward FDI reflects its desire to gain access to advanced technology from developed countries. 5 Taiwan, China 44. In 1952-1994 Taiwan attracted $19.4 billion of FDI, 86% of which was private foreign investment from the developed industrial countries. The balance of FDI came from oversees Chinese from different locations. Electronic and electrical products and chemicals were the dominant industries accounting for 38% of the cumulative FDI inflows. In recent years, Taiwan has liberalised its service sectors (including banking and insurance) which attracted 30% of FDI in 1952-1994. 45. Taiwan became a major foreign investor with cumulative outward FDI flows of $8.9 billion in 1952-1994. USA and Malaysia were major destinations accounting for 28% and 13%, respectively, of cumulative outward FDI. Taiwan’s overseas investment provides an emperical evidence of the investment life cycle theory, in which an investing country initially generates the capacity to export and then turns host to foreign investment aimed at jumping the protectionist barriers. Chemicals, electronics and electric products, and banking and insurance were the major sectors accounting for 43% of cumulative outward FDI in 1952-1994. 6 The Philippines 46. Manufacturing, services and financial institutions are the major sectors attracting FDI inflows to philippines, while USA, Japan and Hong Kong are the major sources of FDI. Asia accounted for 64% of FDI flows to Philippines in 1994. Foreign equity contribution to total equity ranged from 41% to 53% between 1986 and 1991, but the foreign equity share dropped to 26% in 1992.

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47. There is a high degree of correlaiton between FDI and technology transfer in the Philippines. Of the top 10 countries ranked according to size of FDI in the Philippines, seven are also the leading sources of technology imports: USA, Japan, South Korea, UK, Netherlands, Australia and Singapore. The energy sector received the biggest comulative foreign investments until 1995 due to the Government’s efforts to promote energy development. Of the many types of technology transfer available, those involving the actual transfer of know-how, trade marks, and patents constituted two-thirds of collaboration contracts in 1986-1996. Majority of such technology are manufacturingrelated. 7 Myanmer 48. Up to the end of 1995, Uk was the largest investor in Myanmer followed by Singapore and France. The same trends continued in 1996. Up to August 1996, UK continued to be the largest investor in Myanmer with cumulative investments of $1 billion, closely followed by Singapore ($896 million), France ($465 million) and Thailand and Malaysia with around $450 million each. The bulk of the funds have gone to oil and gas, hotel and tourism, while other manufacturing sectors failed to attract much FDI, despite Myanmer’s move in recent years to open up the economy. 8 Indo-China (Cambodia, Lao PDR, Vietnam) 49. Vietnam, Cambodia and Lao PDR, the three South East Asian countries generally known as Indo-China, are on the road to economic transition at different paces and on different scale. All of them are reshaping their policies to attract private investment including foreign investment. Vietnam and Lao PDR have already become members of ASEAN, and Cambodia may be admitted to ASEAN very soon. Cambodia’s corporate tax rate of 9%, the lowest in the Asia-Pacific, is a very attractive feature for investment, and the rise in manufacturing output has been boosted by FDI, particularly from Asia. In Vietnam, FDI has increased from $1.8 billion in 1995 to $2.3 billion in 1996. Taiwan is the largest investor in Vietnam followed by Japan, Singapore and Hong Kong, these four countries accounting for 60% of total FDI. 50. Laos is expected to attract more FDI as costs rise in Vietnam. The key attractions are low labour costs, relative political stability, and continued commitment to economic reform. In addition, Laos’s strategic location to the larger markets of Thailand, Vietnam, China and Myanmer is an advantage for foreign affiliates looking for a new base for manufacturing. However, Lao DPR will need to improve its infrastructure to realise its full potential as a regional hub. 9 United States Direct Investment in Asia 51. US FDI outflows and related indicators in 1992 in selected Asian countries are given in Table 1.8A and certain performance parameters of the US FDI in the manufacturing sector in Asia are indicated in Table 1.8B. At the end of 1992, Asia and Pacific accounted for 16 percent of the US outward FDI stock and 18 percent of the US

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FDI outflows. Major destinations in Asia for US outward FDI are Indonesia, Thailand, Korea and Malaysia. These countries generally generated high returns for US FDI which was also mostly trade related. (c) Sectoral Distribution of FDI 52. The sectoral distribution of FDI in developing countries is not well documented, but it seems that in recent years services have increased their share to more than one third, while manufacturing declined to one-half, with the remainder accounted for by agriculture and mining. Within services financial services are a major component, with trade, construction, and tourism also important. Within manufacturing the trend was to move from lower-technology or labour-intensive industries (food, textiles, paper and printing, rubber, pastics) to higher-technology industries (electronics, chemicals, pharmaceuticals). 53. Sectoral distribution differs among regions depending on their level of development. In most countries in Asia, FDI went primarily to the secondary sector (mainly manufacturing), although investment in the tertiary sectors was of major importance for some Asian countries. Some resource-rich countries like Indonesia, Papua New Guinea and Viet Nam also attracted FDI into the primary sector (mainly oil production). In Latin America, new investment flows to the natural resources and services sectors have now surpassed that in the manufacturing sector. In Africa, the bulk of FDI went to primary sector. 54. The size and dynamism of developing Asia made it a favourable base for TNCs to service rapidly expanding markets or to tap the tangible and intangible resources for their global production networks. In addition, the region’s infrastructure financing for the next decade will play a role in sustaining FDI flows to Asia. Countries are dismantling barriers to FDI in infrastructural sectors, giving rise to large investment opportunities for TNCs. Privatisation, although lagging behind other regions, is showing signs of taking off particularly in manufacturing, mining, power, telecommunications, petroleum and financial sectors. European union TNCs which neglected Asia in the 1980s are making large-scale investment in Asian developing economies to take advantage of new opportunities in power, petrochemicals and automobiles. 55. Transnational corporations in retailing, and other trading firms also played an important role in the building up of export capabilities of several Asian economies. In addition to linking local producers to foreign customers, they deepened the ties of those economies to the internatioinal market-place. Asian experiences also indicate that contributions to international competitiveness and export performance are particularly high in developing economies that are open to both trade and FDI. (d) Foreign Portfolio Investment (FPI) 56. Portfolio flows to developing countries increased to $81 billion in 1995 but remained below the peak level of $95 billion in 1993. Strong growth in equities and debt

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raised portfolio flows to a record $134 billion in 1996, accounting for 30% of net resource flows in 1996 compared with only 5% in 1990. Equity flows at $46 billion accounted for 34% of these investments. An increasing share of foreign funds was invested in local equity markets directly rather than through depository receipts or other cross-border private equity placements. Debt instruments - mainly international bonds have always accounted for most portfolio flows to emerging markets. Portfolio debt flows to developing countries - essentially bond issues in the international capital markets - registered a record increase by 80% and reached a record level of $89 billion in 1996 (Tabe 1.9). 1.4 Different Modes of Foreign Investment and Technology Transfer (a) Modes of Foreign Capital 57. Empirical evidence indicates that private capital contributed more to economic growth of the Asian developing countries than official aid, the relative importance of which in total resource inflows declined since 1980s. There was also a change in the structure of private flows. Until 1983, bank lending was the major mode of foreign private flow to the Asian developing countries. Subsequently, the relative significance of bank lending has declined and that of other modalities has increased. The share of foreign direct investment has increased the most followed by bond lending and foreign portfolio investment. 58. The major alternatives to syndicated bank lending are bonds, financing through new instruments, foreign direct investment, foreign portfolio equity investment, and foreign quasi-equity investments (such as joint ventures, licensing agreements, franchising, management contracts, turnkey contracts, production sharing and international subcontracting). Out of these the most popular modes are FDI, portfolio investment and foreign quasi-equity investment as they involve risk-sharing, sharing of managerial responsibilities and the promotion of a more efficient use of resources. Foreign portfolio investment, in addition, has a favourable impact on local capital markets. The disadvantages are that there might be misuse of control and that foreign direct investment might introduce inappropriate technology. 59. Country experiences indicate that the majority ownership was preferred mode of FDI in capital intensive industries like chemicals, equipments, electronics and automobiles, whereas joint ventures were preferred in traditional and primary industries like textiles, food processing, paper products and metals. 60. TNCs generate technology through innovation and disseminate it within their corporate system and business partners, and other firms in both home and host countries. TNCs supply a mutually reinforcing package of resources consisting of capital, R&D, technology skills, organisational and managerial practices and expansion of markets. TNCs play their role through equity and non-equity investments which range from wholly owned foreign affiliates through joint ventures to licensing, subcontracting and

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franchising agreements. Although TNCs retain control on key assets and key posts of production and distribution, they have a great deal of flexibility regarding the contents of the package. 61. TNCs help in industrial restructuring in both home and host countries. Japan, South Korea and Taiwan are the text book cases of successful industrial restructuring and development with the help of the country’s own TNCs. At the initial stage of industrialisation, they needed some FDI to build their automobiles, electronics, textiles and apparel industries, but at a latter stage, these economies gave rise to their own TNCs for further technological upgrading and industrial restructuring; and relocated production abroad to take advantage of new markets. 62. The recent surge in global FDI has been fueled by the cross-border Mergers and Acquisitions (M&As) in industrial economies. Mergers and acquisitions are a popular mode of investment for firms wishing to protect, consolidate and improve their global competitive positions, by selling off divisions that fall outside the scope of their core competence and acquiring strategic assets that enhance their competitiveness. About one tenth of world-wide M&A sales took place in developing countries due to growing availability and attrativeness of firms in Asia and privatisation programmes in Central and Eastern Europe. Most large-scale cross-border M&As have taken place in the energy distribution, telecommunications, pharmaceuticals and financial services industries. As a result of ongoing liberalisation, the value of service-related M&As increased by 146% between 1993 and 1995. The value of cross border M&As in banking and finance tripled in 1995 to reach $100 billion. (b) Modes of Foreign Portfolio Investment (FPI) 63. FPI in the emerging markets can be channelled through three main mechanisms: direct purchases on local stock markets, country or regional funds; and issues of depository receipts on foreign stock exchanges by the domestic companies. The size of direct purchases in local markets depends on market developments that facilitate and encourage such trading. In recent years, the opening of the local brokerage and investment banking business to foreigners has facilitated such purchases. Developing countries have also enhanced the limits of foreign equity which can be held by the foreign institutional invetors (FIIs). In India FIIs and non-resident Indians are permitted to hold up to 30 percent of total paid up capital of any listed or unlisted companies. (c) Modes of Technology Transfer 64. There are various channels of technology transfer and adaption. These include foreign direct investment, joint ventures, licensing, Original Equipment Manufacture (OEM), Own-design and manufacture (ODM), sub-contracting, imports of capital goods, franchising, management contracts, marketing contract, technical service contract, turnkey contracts, international sub contracting, informal means (overseas training, hiring of experts, returnees), overseas acquisitions or equity investments, strategic partnership or alliances for technology. Other modes of technology acquisition include minority interest

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in firms with R & D programmes, contracts for R&D to other companies and research institutes, grants consortia, bilateral cooperative technology agreements, buying technology embedded in products, material sub-assembly or processes. Out of these, the most popular modes are licensing, joint ventures and foreign direct investment. 65. Original Equipment Manufacture (OEM) and Own - Design and Manufacture (ODM) played a major role in East Asia in technology adaption and upgradation, eventually leading to independent designing and development. South Korea’s electronic industry provides an interesting example of technological development under different stages. In the 1980s the Chaebols took off and sought more independence from their patrons. First, there was a switch from OEM to ODM. In the second stage, their marketing strategy was to rely more on their own brand names. This strategy worked well and by the early 1990s several of them established themselves as leading firms in the global market, occupying fifth (Samsung), 12th (Goldstar-Electron) and 13th position (Hyundai) in DRAM (dynamic random access memories) production, with aggregate exports amounting to $106 billion in 1992. 66. Component supply through subcontracting with foreign affiliates helped domestic component producers in several host countries to enter the vertically integrated production chains of TNCs geared to export markets. Subcontracting arrangements are common for consumer goods such as electronics, footwear, furniture, garments, houseware and toys. In South-East and East Asia, networks of local producers (mainly joint ventures with TNCs) have been established for component-supply to automobile and electronics TNCs, with specialisation among plants in different countries to supply the regional market. 67. The networks in automobiles mainly belong to Japanese TNCs which source automobile parts through their foreign affiliates and their local subcontractors, taking advantage of ASEAN regioinal cooperation provisions. In the electronics industry, such networks have been established by United States as well as Japanese TNCs, beginning with labour-intensive operations and moving towards increasingly sophisticated networks of operations with cross-hauling of products across national boundaries. 1.5 Advances in New Technology (a) Pattern of industrialisation in East Asia 68. East Asian countries started industrialisation with textiles, household appliances and other labour-intensive light industries. Then they moved to capital and knowledge intensive industries such as steel, ship-building, petro-chemicals and synthetic rubber for further industrialisation by way of forward linkages. 69. Another pattern, known as the “flying geese model” first developed by A.Kaname in the 1930s and then by K.Akamatsu in 1956, postulates that Japan, the leader in industrialisation and technological development in Asia, relocated its production facilities to East Asia as its wages and other costs increased. This progression from Japan

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to East Asia and then to Southeast Asia took on the form of an inverted “V” as the economies of Pacific Asia began to fly together led by Japan. 70. Because of its closest geographical, cultural and educational proximity to Japan, South Korea imported most of its technologies from Japan. Japan took the lion’s share (52%) of technology transfer to Korea in 1980s followed by the USA (25%), Germany (6%) and France (5%). As in Japan, the case of the Korean automobile industry is a classical example of the infant industry development which was well-staged, financed and promoted until the industry attained international competitiveness. All technology acquisitions and adaptation by Korea were also carefully selected and sequenced. 71. The Asian NIEs adopted a strategy of export-oriented industrialisation which made use of relatively cheap labor to compete in the international market. In contrast, Indonesia and India initially adopted import-substituting industrialisation through various protective and incentive measures for domestic industries. An important factor in East Asia’s successful productivity-based catching up was openness to foreign ideas and technology. Governments encouraged improvements in technological performance by keeping several channels of international technology transfer open at all times. (b) New Technology and Applications 72. A set of technology collectively referred to as New technology is a single most profound source of technological progress of both of advanced and developing economies, rapid globalisation and shifts in global trade. The term refers to innovative development in electronics relating to informatics, computer hardware, software, telecommunication, bio-technology and new materials. To this can be added emerging technologies namely renewable energy technologies like photovoltaic, remote sensing, super conductivity and photonics. New technologies are knowledge intensive in contrast to conventional capital intensive technologies. Moreover, new technologies are process technologies rather than product technology. Therefore, they are not only scale free but also have a very wide range of applications. 73. As for new materials, the sectoral range is even wider and includes material industry, energy, automobile, semi-conductor, communications, precision machinery, aircraft/ space, medical equipment/ instruments and life technology product like heart valve and other synthetic human body parts. New technologies help to develop new manufacturing location. The conventional need to look for resource base or cheap labour is no longer required. 74. International technology markets are complex, imperfect and rapidly evolving. However, some trends are significant. First, the pace of technological innovation is quickening, led by both demand factors such as growing global competition and supply factors such as breakthroughs in genetic engineering and solid state physics. Second, life cycles of technological processes and products are shortening as a result of new electronics-based technologies and increased participation in technology-intensive industries. Third, rapid automation is transforming factor intensities of certain industries which are losing their labour-intensive character.

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1.6 Development of Infrastructureand Services 75. Rapid technological developments in telecommunications and computers in the 1980s have made some services, especially information-intensive ones, more tradable. The “long-distance” type of service does not necessarily require physical proximity between the provider and the user. Live broadcasts, transborder data transmissions, and traditional bank and insurance services fall under this category. The scope of longdistance service transactions has greatly increased with the advance of technology. In “long-distance” services, there is no need for any direct investment or movement of labour. 76. In the last few years there has been an increasing interest on the part of both governments and private sector to enhace the role of foreign investment in infrastructure development in East Asia and Pacific, and the Latin American countries. However, there is a basic difference of experiences between Latin America and East Asia. Most countries in Latin America encouraged outright sale or tranfer of management/ majority share of public enterprises, while East Asian countries encouraged private investment for creating new capacities (World Bank 1994). 77. Because of lumpiness of huge capital, risk involved and the budgetary constraints, developing countries are increasingly financing their infrastructure projects by external commercial borrowing and increased use of bond and equity markets. Finance for infrastructure typically comes in a package with equity, debt, commercial bank loans, export credit guarantees, and contingent liabilities of the host government ranging from “full faith and credit gurantees” to “comfort letters”. 78. Capital market finance for infrastructure increased more than eightfold since 1990 and reached $22.3 billion in 1995 (Table 1.10). The private sector outpacd the public sector in external infrastructure finance although with the help of substantial government guarantees. Compared to the public sector, the private sector relied more on loans than on bonds or equity. But the growth has been uneven across the regions, countries and sectors. East Asia raised the most finance (led by China, Indonesia, South Korea, Malaysia, Philippines, Thailand) followed by Latin America. Power generation, telecommunications and transport attracted the most external finance, while power transmission and distribution and water supply lagged behind. 79. In 1988-1995 developing countries raised $130 billion through privatisation led by Latin America and the Carribbean ($68 billion), Europe and Central Asia ($25 billion), East Asia and the Pacific ($25 billion), South Asia ($6 billion), Sub-Saharan Africa ($3 billion) and Middle East and North Africa ($2 billion). Infrastructure related sales accounted for 44 percent in both 1994 and 1995. 80. Privatisation continued to be an important channel for foreign investment (direct and portfolio equity) in 1990s. Total foreign investment raised from privatisation in 19881995 amounted to $58 billion, nearly two-thirds of which were in the form of foreign

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direct investment, with portfolio investment accounting for the remainder (Tables 1.12A and 1.12B). 81. TNCs invest in infrastructure projects in the form of FDI (greenfield investments or acquisitions through privatisation), BOT, BOO, BOOT, BOLT, BTO or variants of these schemes. There are various forms of BOO and BOT schemes in the region such as those for toll roads in China, India, Malaysia, and Thailand; telephone facilities in Indonesia, Sri Lanka and Thailand; power generation in India, China, Pakistan and Indonesia; and energy, transportation and water resources in the Philippines. 82. Various constraints such as high fixed or sunk costs, long gestation periods, price ceilings and other regulations on the operations of an infrastructure facility in host countries, and political risk (expropriation or nationalisation) have induced foreign investors to minimise equity commitments to such projects and to rely on debt (commercial loans and bonds) and non-equity financing (technical know-how, expertise, R&D cost sharing, trade credits and supply of capital goods). 83. There are constraints that arise out of the very nature of some of the ways in which infrastructure projects are financed. Given the perceived risk, investors require high rates of return. This necessarily requires user fees commensurate with the rate of return, which, in many developing countries, are too high to be sustainable. There are also environmental issues associated with infrastructure projects. Consequently, negotiations of BOT/BOO and similar schemes - in developing and developed countries - are typically very complex and long drawn out. 84. In recent years, a number of Asian investment funds have been created to mobilise international capital to finance Asia’s infrastructure. These funds provide medium and long-term finance (5-10 years) for infrastructure projects through equity (usually 10% or more) or convertible debt. Funds are raised from a diverse group such as institutional and private investors, TNCs, regional banks and multilateral organisations. The Asian Infrastructure Fund (AIF), in which the Asian Development Bank was an initial investor, was the first infrastructure investment fund in the region. The AIF is investing in utility, transportation and communications projects in China, Indonesia, Malaysia, Thailand, Philippines and Taiwan. Since then, several infrastructure investment funds, similar to international mutual funds, or unit trusts, have been set up. 1.7 Policies and Strategies for Promoting FDI - Technology - Growth Nexus (a) Macro Economic Policies 85. Inflows of FDI are determined by a complex set of economic, political and social factors and foreign investors look beyond the array of fiscal incentives offered. In recent years FDIs have been encouraged by economic reforms and particularly by liberal FDI regimes (in terms of currency convertibility, free repatriation, less performance criteria, tax holidays and other incentives, relaxation or abolition of screening requirements and

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limits on foreign equity etc.). Major policies and liberalisations on foreign investment regimes in 18 selected Asian countries are summarised in Tables 1.13A and 1.13B. 86. Other major factors that influence FDI flows include low wage rates and low production costs, higher rates of return, hugh domestic market, labour mobility, efficient infrastructure, an established legal and institutional set-up, administrative speed and efficiency, and above all liberal economic policies and stable economic situation. The formation of regional trading blocks such as NAFTA, ASEAN, APEC, SAARC etc. had also an important impact on the FDI pattern. In future, countries outside the regional blocks might have disadvantages in attracting FDI. 87. Foreign investors dislike any screening of investment except for national security, public health, individual safety, and environmental protection. They also dislike performance requirements such as export orientation, local content, value addition and foreign exchange requirements. Such requirements distort and discourage trade and investment, and result in diminished returns to both investors and host countries. 88. Foreign invetors like to have better of national treatment and most favoured nation treatment, as it maximizes the free flow of capital. Other key factors attracting FDI include free transfer of profits and dividends, adherence to international law standards on expropriation, international arbitration, protection of intellectual property rights (IPR), , and the right of the investor to employ management of its choice, regardless of any nationality. Since 1980, countries that guaranteed that profits could be repatriated attracted 93% of foreign investment flows. and countries adhering to the Convention of Settlement of Investment Disputes attracted 85% of foreign investment. 89. In recent years there has been a surge of foreign portfolio investment which includes both equity and bonds. Host country factors which are crucial for portfolio investment fall into three groups viz. the degree of political and macroeconomic stability and prospects for growth; the host country’s commitment to the process of economic and financial liberalization and reform; and the state of development of the host country stock exchange and the institutional and regulatory framework. 90. Developing countries have established investment promotion programmes which are often organised as a government department or as a quasi-government agency with private participation. In a few cases such as Mexico, Costa Rica, Vevezuela and Honduras, the promotion agency is funded and run by the private companies. Ironically, as developing countries liberalise FDI and trade regimes, multilateral companies appeared in many cases to have improved their bargaining power vis-a-v-s host countries. 91. The macro-economic policy framework and reforms constitute only some of the factors, albeit vital ones, for encouraging foreign investment. The country’s economic potential, human and natural resources and political stability and other factors that affect the risk and profitability of investment are equally important. Membership in bilateral tax treaties, and multilateral and regional investment guarantee arrangements are also seen as

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an important element in providing a stable and attractive framework as it could reduce perceived risks. (b) Fiscal and Financial Policies 92. Fiscal, financial and other incentives remained an important part of a country’s investment promotion package. When all other factors are equal, incentives can tilt the balance in investors’ locational choices. This appears particularly true for “footloose industries” which choose among production sites with comparative costs; automobiles and food processing industries, for example, seem to be sensitive to a package of fiscal, tariff and financial incentives given by host countries. 93. Fiscal and monetary incentives play, however, only a minor role in the locational decisions of TNCs, and attract only those “fly-by-night” firms which exist on exploitation of incentives. This is not surprising since investment decisions are typically made because they promise to be profitable on the basis of market conditions alone; if incentives are offered, they become “icing on the cake”. While the effects of incentives on stimulating new investments are difficult to measure, they nevertheless represent substantial economic costs. Where incentives already existed, their sudden removal might produce negative effects; where they did not exist, their introduction might not produce net gains. A rational, efficient, equitable and internationally competitive tax system is more conducive to FDI than fiscal incentives. (c) The Role of Special Economic Zones 94. Of the many policies tried by the East Asian countries for accelerating growth, those associated with their export push hold the most promise for other developing economies. The export-push approach provided a mechanism by which industry moved rapidly toward international best practice and technology. Export processing zones are the most common form of subnational zones. A feature of these zones is the establishment of some subnational customs area that gives a preferred customs treatment to goods entering the area compared with goods entering non-zone parts of the country. These preferences are normally restricted to export activities. Export processing zones also give preferences or privileges relating to the establishment of foreign-owned enterprises and to nontraderelated instruments of government policies such as tax holidays or deferments, duty drawbacks or exemptions for raw materials, reduced rates in taxes and duties for capital goods, investment subsidy, preferences in government loans. EPZs and other economic zones are generally equipped with good infrastructure and support facilities. 95. A closely related form of subnational zone is the financial service zone, such as a financial offshore center. These zones essentially provide preferences for the finance service industries, analogous to those provided for manufactured goods in export processing zones. There are other subnational zones which are not international traderelated, such as science and technology parks. The number of these parks has increased rapidly in many Asian countries since 1980. Most science and technology parks in Asia have concentrated primarily on attracting foreign investors. Subnational zones are,

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therefore, an integral part of the wider pattern of intra-Asian trade development. Subnational and sub-regional zones have increased the intraregional share of total trade in goods and services and intraregional flows of FDI. Despite some failures, special economic zones have largely met their objectives by attracting FDI, creating employment and increasisng exports. (d) Role of Small and Medium Sized Industries (SMIs) 96. SMIs constitute a rather dynamic force in the economic development; they provide a sound market environment for the economic growth; reduce rural-urban disparities; and can swiftly adapt relatively simple but advanced technology. A dynamic SMI sector helps not only to generate employment but also to earn foreign exchange, upgrade the quality of the labour force, diffuse technological know-how, and utilise rural savings, surplus labour and local raw materials that may otherwise remain idle and unutilised. Small enterprises provide a source and training ground for the development of entrepreneurship and business management skills for medium and large undertakings. 97. Small and medium industries predominate output in a number of industrial sectors in many Asian countries such as Bangladesh, India, Pakistan, China, Korea, Indonesia and Philippines. Even they played a significant role in the economic development in Japan and Singapore (Das 1996, ESCAPE 1996). They are mainly in the textiles, garments, wood products, food processing, leather products, fabricated metals, machinery and equipments, rubber and plastic products, pottery, printing and publishing. In 1990 they accounted for 95% of establishments in Bangladesh, 98% in Thailand, 93% in Malaysia, 70% in Indonesia and 80% in the Philippines. In India the SSI sector accounts for 40% of the total turnover in manufacturing and 35% total exports. In China, SMEs accounted for 99% of the number of enterprises, 78% of employees, 64% of industrial turnover, 52% of corporate profits and 52% of fixed assets held by industry in 1990. In Japan, SMEs accounted for 99% of all business establishments, 74% of total work force, 52% of manufacturing exports, 62% of wholesale business sales and 7% of retail sales in 1991. In Taiwan, SMEs accounted for 90% of enterprises and 60% of exports in 1990. 98. On the other hand, there have been criticisms regarding the ability of small industries to realise economies of scale in production, procurement and marketing. So, they may experience larger unit costs despite low labour costs and advantages due to their proximity to the local markets. In many sectors, small units exist on the strength of the costly government support programmes in terms of reservation,price and purchase preference, priority and concessonal lending and fiscal concessions. (e) Role of Research and Development (R&D) Expenditure 99. There is a high degree of correlation between R&D expenditure and technological capability. Product design and manufacturing techniques have become interlinked and this interation has been fascilitated by computer-assisted techniques and technological innovations in semiconductors, electronics and robotics. This process requires continuous efforts in R&D in order to adapt to market demands by product innovations and

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differentiations. TNCs engaging in intensive R&D activities acquires a technological advantage over their competitors; and will be unwilling to share sophiscated production techniques through licensing. Korea provides a good example that an appropriate degree of interaction between industry and R&D institutions can generate tangible benefits to all concerned, while at the same time provide a substantial boost to research and development. Korea has also been successful in attaining reverse brain drain through the development of high technology. 100. Although heavy investment has been made in technical education, equipment, infrastucture and modern computers by many countries, it is observed that the technical institutions are inclined to do basic research devoid of practical needs of the industry. For example, India has virtually all basic, applied, hardware and software and R&D institutions, some of which have achieved world-class standards. But, these institutions failed to commercialise R&D activities, remain as isolated products of excellence without direct link with production. Since 1993 Government had encouraged private sector funding of research institutions by providing tax reliefs on R&D expenditure. (f) Infrastructure and Human Resource Development 101. Foreign investors need adequate local support facilities including capital markets, efficient physical, technological and human capital structure. The experiences of the East Asian countries indicate that success in absorbing, deploying and deepening industrial technology depends on efforts to develop local capabilities, particularly skill upgrading and local R&D efforts, which often require government intervention to overcome market failures in investment on R&D, and general and higher education. Active policies to upgrade human capital formation through provision of a high quality educational and training system are, therefore, priorities for the host countries. 102. Efficient supply of power, telecommunications and transport services are important in creating cost competitiveness. In this regard, attracting foreign investment and private management into infrastructure is particularly crucial. The legal/regulatory and institutional framework should be developed to pave the way for foreign investment. Improvements in rural infrastructure are also necessary to facilitate diversification and intensification in farm production and the expansion of off-farm activities. 1.8 Regionalisation and FDI Complementarities 103. Regional economic cooperation facilitates the free flow of goods, services, capital and labor across national boundaries and acts as an effective instrument for securing efficiency in the use of resources and thereby enhancing growth of all member countries. Intraregional capital flows, particularly FDI, have grown very rapidly over the past decade. They also entailed an increasing flow of technology associated with individual projects and embodied in the flow of capital equipment and intermediate inputs arising from projects. Japan and the NIEs are the source of much of this intraregional FDI. (a) ASEAN Experience

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104. ASEAN covering most of the Southeast Asian economies, has evolved a comprehensive regional trading arrangement, the ASEAN Free Trade Area, with an explicit time table for eliminating tariffs within the group by the year 2003 and for introducing its Common Effective Preferential Tariff (CEPT). Members have agreed to eliminate quantitative restrictions and nontariff barriers on trade in products in the CEPT, to cooperate in some areas of service trade and to explore cooperation in some nonborder issues such as harmonisation of standards, reciprocal recognition of tests and certification of products, and removal of bariers to FDI. An important feature of this Agreement is the intent to free the movement of capital and to increase investment, industrial linkages and complementarity among members. 105. As regards industrial cooperation, some positive results have been achieved in the ASEAN Brand-to-Brand complementation (BBC) in the automotive industry, which envisage manufacturing different components of a vehicle in different countries. ASEAN Industrial Cooperation (AICO) Scheme is the latest industrial cooperation program in the ASEAN, under which two participating companies from two different ASEAN countries should involve not only in the physical movements of goods but also in resource sharing and industrial complementation. Outputs of these companies enjoy a preferential tariff rate in the range of 0-5%. 106. To promote and protect intra-ASEAN investment, the ASEAN countries since 1976 have an Agreement providing most-favoured nation treatment to intra-ASEAN investment. Other important ASEAN integration efforts related to their efforts towards joint resource mobilisation and intra-ASEAN infrastructures. For example, the “ASEAN Minerals Cooperation Plan” was designed to develop downstream industries. Similarly, different ASEAN subsectoral programmes in energy cooperation promoted efficient use of coal in the subregion. The gas pipeline projects across the member States also proved useful for the subregion. (b) SAARC Experience 107. ASEAN is far more open than SAARC due to long-followed policies of export promotion and foreign investment. FDI inflows into ASEAN have been far more significant and instrumental in raising the industrial linkages and complementarities in the region. SAARC, on the other hand, has so far made little contribution to either regionalism or globalisation. Only recently SAARC has included activities on trade and investment as a part of its regional cooperation. There is, however, hope that as a first step SAARC members, having agreed on a free trade area, will promote regional trade cooperation as a building block towards globalisation. For its success, SAARC will need to agree on a clear policy towards foreign investment as a vehicle of technology upgradation and overall growth. 108. While there are only two formal regional trading arrangements in Asia (AFTA and SAPTA, there are economic cooperation of a more informal nature among countries in the region. These sub-regional economic zones (SREZs) are popularly referred to as

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growth triangles, growth polygons, or simply growth areas. The main focus of the SREZs is on the transnational movement of capital, labour, technology, and information and on the inter-country provision of infrastructure rather than on trade in goods and services. India, Thailand, Bangladesh and Sri Lanka, having a coastline on the Bay of Bengal, have formed a regional trade group on June 6, 1997, called the Bangladesh, India, Sri Lanka, Thailand Economic Cooperation (BIST-EC). Trade between these countries currently totals only $1 billion and is expected to improve substantially in the next decade due to predicted economic boom. Attemps are also being made to form a sub-regional economic group through the Bangladesh, Bhutan, Nepal and India “growth quadrangle” (BBNIGQ). (c) APEC Experience 109. The most comprehensive form of multi-government cooperation in terms of both countries and the scope of issues addressed is the Asia Pacific Economic Cooperation (APEC). This organisation was established in 1989 and currently has 18 member countries in Asia and the Pacific including the Unites States. The APEC forum is of special significance, as it is not founded on a formal agreement in accordance with the GATT. The member countries have agreed by consensus on a program of action to achieve a state of “free and open trade and investment” by the year 2010 for industrial country members and 2020 for developing country members. Many of the members have already made significant unilateral tariff reductions before the target date. There is an agreement on a set of APEC Nonbinding Investment Principles for investment flows in the region. These are intended to reduce restrictions on the international flow of portfolio investments. (d) ESCAP Experience 110. From its inception ESCAP has promoted economic co-operation in the Asian and Pacific region. ESCAP conceived the integrated communications infrastructure for the Asia and promoted regional cooperation in shipping, ports and technology tranfer. Financial and developmental institutions like the the Asian Development Bank, Asian Clearing House, The Asian and Pacific Centre for the Transfer of Technology, the Asian Reinsurance Corporation etc. were established at the initiative of ESCAP in order to promote economic co-operation in Asia. 111. Increasing levels of intraregional trade and investment are gradually shaping a truly interdependent regional economy in the Asia-Pacific region, based on the linkages of production structure and regional division of labour. They succeeded significantly in utilising the technological revolution to enhance their national comparative and competitive advantages. First, Japan and then the advanced countries of the region have become critical growth centres supplying FDI and technology to other economies of the region. 112. Although regional economic cooperation in ESCAP is being worked out at various levels, actual progress is limited due to a number of reasons: (a) All the subregional

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groups except ASEAN and the South Pacific Forum are about a decade old and it takes much time to build up confidence and trust among the members. (b) Asian regional groupings are only intercountry institutions and donot have supernational powers like the EC. (c) There is hardly any linkage or dialouge among the regional or subregional groups. 113. The opportunities for regional cooperation in the endogenous technological capability-building of ESCAP member countries are enormous. While advanced developing countries such as the NIEs have adequate domestic resources to attract technology and capital and to expand their technological capacity, a number of developing countries in the region (LDCs, island developing countries and disadvantaged traditional economies) remain outside the mainstream of economic development primarily because of poor, inappropriate or unfavourable local conditions in terms of skills, market size, technological and physical infrastructure. (e) Multilateral Agreement on Investment (MAI) 114. The vigorous growth of bilateral and regional investment agreements, the inclusion of certain FDI-related issues in the Uruguay Round agreements and the beginning of negotiations on a Multilateral Agreement on Investment in the OECD clearly indicate that both the developed and developing countries are moving towards liberalised trade and investment regime. 115. At the regional level, the mix of investment issues covered is broader than that found at the bilateral level, and the operational approaches to deal with them are less uniform. Most regional instruments are legally binding. Issues typically dealt with at the regional level include the liberalisation of investment measures; standards of treatment; protection of investments and disputes settlement; and issues related to the conduct of foreign investors (e.g. illicit payments, restrictive business practices, disclosure of information, environmental protection, and labour relations). 116. At the multilateral level, most agreements relate to sectoral or to specific issues. Particularly important among them are services, performance requirements, intellectual property rights, insurance, settlement of disputes, employment and labour relations, restrictive business practices, competition policy, incentives and consumer protection. It is at the multilateral level that concern for development is most apparent. This is particularly so in the case of the GATS, TRIPS and TRIMs agreements, as well as the (non-binding) Restrictive Business Practices Set, where special provisions are made that explicitly recognise the needs of developing countries. B. Recommendations 1.9

General recommendations

117. The SAARC is rich in natural resources which are not fully utilised. The region is faced with the common problems of poverty and unemployment. Economic cooperation

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in the region is an effective instrument for improving the welfare of the people. A sustainable growth path for the region must be based on continued economic reforms, dynamic capital market, human resource development and improvement in infrastructure and environment. 118. As regards East Asia, future development strategy must focus on the development of efficient infrastructure, flexible and responsive financial system and competent management. As the region’s infrastructure needs are large, the private sector themselves and through FDI will have to play an increasingly critical role in developing and modernising infrastructure base. In turn, governments will need to estblish the appropriate institutional, regulatory and legal frameworks to attract and secure such investment. 1.11 Policies for promoting FDI-Technology-Growth Nexus (a) Host Country Policies for FDI 119. For host countries, the policy agenda for increasing FDI inflows and for drawing maximum beneits from them includes the following priorities: ensuring a stable economic environment conducive to sustained economic growth, encouraging the development and upgrading of local industrial and technological capabilities, strengthening infrastructure and human resource development, and providing requisite legal, regulatory and institutional set up. Those countries that have only recently been open to FDI need to ensure that the “open door policy” is maintained and remains stable. They should examine the possibility of a further liberalisation of FDI regimes; the harmonisation of FDI and related policies on industry, trade and technology; and improving the efficiency of their administrative set-up for investment approvals. To the extent possible, host countries should seek to avoid competitive bidding, enhance exchanges of information and promote transparency in order to reduce unnecesary transactions costs. 120. All countries in the region should pay particular attention to the firms from neighbouring countries, so as to capitalise the growing intra-regional investment. Special attention needs to be given to small and medium-sized enterprises whose special needs dictated by their limited financial and managerial resources and insufficient information may call for incentives for the joint ventures among the small and medium-sized TNCs. 121. Successfully enticing one important TNC to locate in a country can trigger a chain reaction that leads to substantial sequential and associated investment. The most obvious targets are firms already established in a country. Governments can strive to encourage sequential invest-ment (including reinvested earnings), which can provide positive demonstration effects for potential new investors: a satisfied foreign investor is the best commercial ambassador a country can have. Policy makers should be concerned when foreign investors leave the host country due to deteriorating local conditions. Emphasis on after-investment and investment-facilitation services for current investors is therefore crucial. This may involve the creation of joint committees consisting of representatives

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of government, foreign affiliates and local employees to avoid conflicts and to resolve problems that can lead to relocation. Also, an Ombudsperson can be appointed to handle complaints about unreasonable delays and undue demands by government officials on business people. 122. Free, promt and unrestricted transfers in any freely usable currency should be permitted for all funds related to an investment. The bottom line to a business is the ability to make profits and to distribute funds to partners and shareholders. Expropriations should only occur in accodance with international law standards and be subject to due process. An expropriation should be for public purpose and nondiscriminatory, and promt, adequate and effective compensation must be paid. 123. Firms must be confident that they can obtain a fair hearing in the event of a dispute, and must have reciprocal ability to seek international arbitration. Investors should have full access to the local court system, but also have the choice to take the host parties directly to third party international binding arbitration to settle investment disputes. 124. One of the most important determinants of a foreign affiliate’s impact on the technology and skills in a host country is the extent of its forward and backward linkages with local firms. Foreign-direct-investment policy should therefore have a trade component as TNCs are interested in whether a country is suitable for inclusion in their intra-firm division of labour. At the same time, trade policy should have an FDI component, to take advantage of the market access that TNC systems provide. Generally, FDI should not be encouraged either entirely for import substitution (e.g. tariff incentives) or completely for export-promotion (e.g. export-processing zones). Since FDI is a package, it should be treated as such. The composition of the package that can be attracted very much depends on a country’s characteristics, including its level of development. 125. The developing countries should focus more intensely on the goverance issues and accelerate efforts aimed at improving the efficiency of the public sector enterprises in the provision and quality of services, cost recovery, regulatory oversight, and in the establishment of a facilitating business environment. They should also undertake bold reforms at the local governments and micro levels to promote efficient decentalisation for timely implementation of infrastructure and social sector programs. 126. The legal framework governing labor markets must be reformed to institute a market-based bargaining process that is free from interference by the government or trade unions, and a system of severance liabilities that conform free market conditions and developing country norms. De-politicisation of industrial relations will benefit both the workers, businesses, and the economy by eliminating the costly economy-wide agitations, with positive impact on private investment. (b) Host Country Policies for Portfolio Investment

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127. The strengthening of local capital and stock markets is essential for the development and broadening of the domestic investor base and the establishment of a healthy private sector. In this respect, privatization has a role to play in broadening the investment base. A prudent regulatory framework alongwith transparency and efficiency of price dissemination are also necessary to ensure investors’ confidence in the stock market. 128. Among the main issues to be tackled for BOT financing schemes in infrastructure are the need to restructure some utility sectors, the need for an improved regulatory environment, and measures to reduce demand risks and foreign exchange risks. (c) Home Country Policies 129. With domestic outward FDI policies liberalised, developed home countries must supplement their domestic policies with international instruments aimed at protecting and facilitating outward FDI. They should improve FDI liberalisation standards generally and encourage level playing field among themselves. 130. Few developing countries and economies in transition have paid due attention to outward FDI policies; typically these are subsumed under general capital-control policies which, in turn, are quite restrictive. There is a need to liberalise further capital markets and foreign exchange rules and regulations so as to move towards full convertibility on capital account. 131. As regards portfolio investment, the enormous potential represented by the pool of savings held by institutional investors in the OECD countries may increasingly seek investment outlets other than those offered by the mature markets. However, home country regulations concerning outward portolio investments can be a major constraint on outward portfolio investment. In most developed countries, savings institutions such as insurance companies and pension funds face ceilings on the share of foreign assets in their portfolio and are usually subject to prudent investment and diversification norms. As the investment managers become more familiar with emerging markets, a relaxation of home country policies concerning portfolios of institutional investors could lead to a multiple increase of portfolio investment to developing countries. (d) The Role of Special Economic Zones 132. Deveoping countries must focus on export-promotion and development of EPZs or special economic zones. Success of EPZs depends on a favourable investment climate, skilled labour force and an active local business community and government’s support for the EPZs, while failures are attributable to poor locations, inadequate infrastructure, excessive costs and mismanagement. EPZs of developing countries should try to avoid stiff competition among themselves to offer increasingly generous incentives for attracting foreign investors, as this will erode their net benefits in the medium and long term (UNCTAD 1993). The long-term viability of EPZs also requires that their operations

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should be properly integrated with the overall economic and industrial development strategy of the country. (e) Role of Small and Medium Sized Industries (SMIs) 133. A wide range of opportunities can be seized by small-scale, labour-intensive industries. It is particularly so in the Asian region where horizontal division of labour through trade and joint-venture projects are increasing sharply. For example, the latest venture by Japanese automakers in South-east Asia suggests that specialised components can be produced at factories in several countries for use in a single, shared final product. 134. The following measures need to be given priority for strengthening the SMI sector : * It is necessary to fascilitate the transfer of technology to the SMEs by suitable arrangements such as regional information networks and provision of timely and adequate finance to SMEs. * Adequate backward and forward linkages need to be established between small and large units in terms of sub-contracting, production sharing, manufacture of parts and components etc. * Suitable measures may be taken to enhance the access of the SMI sector to information particularly relating to external markets, foreign investment and better technology. * Vertical expansion of the SMEs may be limited due to reservation of items and limits on investment for the SMEs. A review of the reservation policy and investment limits is necessary to fascilitate capacity expansion, technology upgradation and economies of scale. * Much of the existing growth of SMEs has taken place in and around the metropolitan areas, but the balanced regional growth requires that the process of industrialisation needs to be extended to the countryside. In this respect, the experience of China in setting up Township Enterprises on a large scale may be particularly relevant for other developing countries. * SMEs are most vulnerable to trade protectionism. Undesirable tariffs and non-tariff restrictions on their products must be removed to enhance the export potentials of SMEs. (f) Role of R&D Expenditures 135. The R&D expenditure in many developing countries like India (0.9% of GNP), Pakistan (0.6%), Philippines (0.7%) and Thailand (0.5% of GNP) are considerably lower than that in USA (2.7%), United Kingdom (2.3%), Japan (3%), Germany (2.9%) and South Korea (2.8%). Asian developing countries must allocate more resources on R&D

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and encourage private sector funding of research institutions engaged in R&D. For effective role of R&D in the generation, development, adaption, assimilation and diffusion of industrial technologies, public research institutions must try to commercialise R&D activities with necessary linkages with the private sector and production activities. (g) Infratructure and Human Resource Development 136. Efficient physical infrastructure and human capital are critical overheads that investors seek. For the more dynamic traded goods and services, telecommunications are the most important fascilitator of FDI, and technological and organisational innovations drive FDI into those countries which have trained and skilled workforce and fairly high educatonal standards. This points to the overriding importance of developing countries to invest more in the development of human resources, infrastructure and services. It also highlights the risk of being marginalised for the least developed countries with a low level of skilled labour force and infrastructural constraints. 137. The existence of a dynamic local business sector creates a supportive environment through efficient networks of local suppliers, service firms, consultants, partners or competitors. It is, therefore, necessary to concentrate efforts on the development of local entrepreneurship. Equally important is the availability of high quality telecommunications and transport systems, energy supply and other utilities. (h) Legal and Institutional Set-up 138. Many of the difficulties faced by governments in handling foreign investment, and by the foreign investors setting up in a host country, derive from the absence of a clear civil, commercial and criminal legal system. Given a set of laws, it is esential that foreign investors are treated equally with domestic investors. Not only is this a moral issue, but there are strong practical arguments against giving foreign investors privileges that domestic firms do not enjoy (and vice versa). Domestic firms will launder money to become foreign investors if this will give them subsidies that they cannot otherwise receive. Chinese publicly owned enterprises use transfer pricing at other than arms’ length to become foreign investors in China, or they form joint ventures within foreign firms to benefit from subsidies to foreign investors. Giving entrepreneurs of Indian origin special privileges by India are also inequitable and inefficient. Continued reforms will attract the worthwhile investors among them without incentives. 139. In open economies, such as Singapore, Hong Kong or Mauritius, only minimal special foreign investment laws and regulations are necessary and administrative costs are negligible. Most developing countries like India are faced with a transition period. The experience of countries such as Indonesia, Malaysia, Taiwan and Thailand suggests that the transition can be managed well. The faster an economy is reformed, the easier the management of foreign investment. Regulations can be simple and their administration transparent. (i) Fiscal and monetary incentives

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140. The competition among the host countries to attract FDI has intensified the use of incentives to such an extent that the situation is often referred as an “investment war”. Host countries get trapped in the “prisoner’s dilemma” leading to competitive bidding in which all participants are left worse off than the situation of no bidding. It will be beneficial for the host countries to arrive at a harmonisation of policies, to ensure more transparency on FDI regime, and to exchange information about their regulatory regime and other FDI-related policies and to share their experiences on the impact of FDI on the costs and benefits to the economy. 1.11 Different Modes of FDI and Technology Transfer 141. An important reason favouring FDI or joint venture with TNCs/MNCs is to improve upon economies of scale and take advantage of specialised skills across countries. There is a growing trend to network and form joint ventures such that different stages of production are carried out in different countries. There is also the need to merge and become competitive vis-a-vis larger MNCs position. Pooling of R&D resources is another reason for a group of large companies joining hands. Another reason for shift in FDI through MNCs is the emergence of new technologies like computer software, CNC machinery and new materials. All of these technologies are easily available with the firms in advanced countries and cannot be obtained through convensional licensing. 142. Embodied technology transfer through capital goods imports will be the most important source of technology and the cheapest way of technology acquisition for any Asian developing country. Japan initially acquired foreign technologies by reversing the engineering process (disassembling and reassembling imported machinery). The engineers and technicians began with the end-product and worked back to find the components, their inter-relationships, and the technologies. This mode of technology acquisition required established engineering capabilities. Licensing agreements are the most effective way to suit local needs and conditions. But, this mode of transfer is costly and involves a process that is more complex and time consuming than other modes. Turnkey projects are the easiest way to establish new factories, but rarely transfer needed technologies unless the recipient makes conscious efforts to acquire them. 143. As far as technology acquisition and assimilation are concerned, developing countries can learn much from the Korean experiences. The Korean lessons indicate that technology can be upgraded only through conscious and steady efforts to improve available technologies, and that the most effective way to achieve such progress is through interaction with a competitive market. The Korean experience also indicates that technologies are best learnt by workers in the workplace. 1.12 Technology Development and Advances in New Technologies (a) Industrial technology development

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144. If the industrial or technological catch-up process follows the so-called “flying geese” pattern of development, with Japan leading the way in Asia followed by the NIEs, ASEAN and South Asia, it is essential to establish a regional mechanism which will facilitate the division of labor in transferring appropriate technologies. For example, Japanese technologies may be modified to fit into the needs of the NIEs, which in turn, may be modified to suit the needs of ASEAN and South Asian countries. 145. The best incentive framework for ITD is to provide constant competition to enterprises in a stable macroeconomic environment. Full exposure to world competition may, however, have to be tempered by the fact that a new entrant has to incur the costs and risks of gaining technological knowledge and experience, when its competitors in more advanced countries have already gone through the learning process. This may be a case for temporaty and limited infant industry protection. But, it has to be carefully designed, sparingly granted, strictly monitored, and offset by measures to force firms to aim for world standards. 146. The supply of human capital, technical support services, foreign technology, S&T infrastructure and finance can suffer from market failures. They therefore require government intervention and policy support, and their most effective use calls for selectivity and coherence. Much of ITD support work must focus on market friendly or functional interventions to strengthen the infrastructure, improve its relations with enterprises, help small and medium-sized firms with their special information and support needs, augment the supply of finance for technology investments, and build up requisite skill needs for efficient industrial operations and growth. (b) New Technology and Applications 147. Countries like Korea, China and India stand to gain substantially by revitalising their economies to become internationally competitive not only in new technologies but also in many other industries with the use of time and material saving production processes like CNC/CAD/CAM integrated manufacturing, flexible manufacturing systems, just in time production systems etc. Likewise, the bio-technology has a wide range of application ranging from food processing, pharmaceuticals, chemicals, agriculture and allied sectors, mining, soil fertility etc. 148. The high technologies are R&D intensive and their development requires large risky investments, and it is non-viable for developing countries to make an effort to become technologically self-reliant in all high technology sectors. A developing country like India which is not in a position to undertake organised R&D on a high scale through its own efforts has two options: either to license international R&D collaborations for upgrading its technological design capability or to allow foreign direct investment and joint ventures for state of art technology. In the Indian context the second option has been largely accepted. 149. Being knowledge intensive, it appears logical to have great scope for internatiional collaborations. But, it is unlikely that advanced countries will be willing to collaborate to

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transfer new technologies. An alternative option is to allow university departments and research institutes to take up sub-contracted work for the multinationals/ transnational corporations who have not only resources but also the marketing network. The establishment of a regional technology network system will no doubt accelerate technological capabilities and industrial development in these countries. This is an area where private sector efforts should be supported and coordinated jointly by the public sector and regional development organisations. 1.14 FDI and development of infrastructure and services 150. The financial requirements for infrastructure are vast. India needs about $400 billion during 1997-2006 for its infrastructure development. Present growth rates in East Asia suggest that such investment requirements will be $1.4 trillion during the next decade; for China alone, the figure is over $700 billion. In Latin America, requirements are about $600-800 billion (World Bank, 1995b). Another projection made by the Asian Development Bank indicates that investment demand for infrastructure in Asia (excluding Japan and the NIEs) will amount to about $1 trillion in 1994-2000. This includes $300$350 billion of investment for the power sector alone to the year 2000, $300-$350 billion for transportation, $150 billion for telecommunications, and $80-$100 billion for water supply and sanitation. The investment for infrastructure is projected to increase from 5 per cent of GNP per annum to 7 percent of GNP. 151. The private sector participation in management, financing or owership will in most cases be needed to ensure a commercial orientation in infrastructure. Public-private partnership has promise in financing new capacity. Guarantees from host governments, multilateral institutions and export credit agencies play an important and legal role to mitigate the policy uncertainties and commercial and foreign exchange risks inherent in large-scale infrastructure financing. But, these should not be taken as substitutes for correcting sectoral distortions or removal of market imperfections. 152. The lessons of experience in East Asia indicate that South Asian countries are required to have priority attention in the following five areas while formulating country strategies to enhance private participation in the provision of infrastructure: * Overall country objectives, strategy and priorities; * Reform of policy, legal and regulatory framework; * Facilitation and increased transparency of government decisions * Unbundling and mitigation of risks; and * Mobilisation of private term lending. 1.14 Regionalisation and FDI Complementarities 153. Major benefits will come from removing restrictions that impede flows of people, capital, and goods, and that segment geographically contiguous markets. In addition, there is considerable untapped potential for regional cooperation in power, transportation, and distribution ( particularly petroleum products), which would reduce the costs of

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doing business. There will be an important pull effect on growth throughout Asia if the remaining impediments to local and foreign investors are removed. Such regioinal cooperation and integration should be seen not as a substitute for opening up to the global economy, but as a way of assisting firms to connect to global markets at lower cost. 154. Three lessons can be drawn from past developments on FDI policies. First is that progress in the development of international investment rules is linked to the convergence of rules adopted by individual countries. Second is that an approach to FDI issues that takes into account the common advantage, is more likely to gain widespread acceptance and to be more effective. Third is that in a rapidly globalising world economy, the list of substantive issues entering international FDI discussions is becoming increasingly broader and complex and include the entire range of questions concerning factor mobility. (a) Technical Assistance 155. Industrial and technology development depends crucially on the development of basic infrastructure. Multilateral agencies including the International Development Association (IDA) can help the developing countries by providing financial and technical support and investment guarantees for the development of infrastructure and human resources. They can also play a more catalytic role in mobilising funds from a wide range of private sources using all the available means. 156. Multilateral financial and development institutions and bilateral donors have played an important role by providing financial and technical assistance to the countries of South Asia in the areas of improved education, health services and family planning. External assistance should further be increased and continued to be provided on concessional terms, given the long term nature of investment in human capital and its link to poverty alleviation, skill formation and enhancement of industrial productivity and efficiency. 157. The World Bank, IFC, ADB, ESCAP, UNIDO and UNCTAD are engaged in the provision of technical assistance, consultancy and advisory services with regard to the development of the private sector, human resoure development, and promotion of nondebt-creating financial flows, and FDI in particular. Although the experience with technical assistance received from these institutions have been found to be very valuable, there is scope for improvement in the following fields: * Promotion of regional cooperation in human resource development, R&D, S&T development, technology blending, use of information technology, and computer training and facilities. * Studies on public sector enterprises reforms, privatisation and industrial restructuring to promote industrial relocation and diversification in accordance wth the changing comparative advantages of the countries and regions.

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* Consultancy and training aimed at technology upgrading and skill improvement for the growth and globalisation of SMEs with special attention to entrepreneurs from rural areas, ethnic minority areas, economically backward areas, ethnic and backward classes, and women and young entrepreneurs. * The promotional efforts in favour of SMEs cannot be entirey undertaken by government agencies alone. Multilateral agencies must accord a much greater role to private sector business confederations, chambers of commerce and industry, and relevant non-governmental organisations (NGOs) to enable them to provide SMEs with training, consultancy and information services. * Regional technical assistance programmes on harmonisation of national and regional policies and plans for private sector development and foreign investment. * Promotion of technology management, evaluation, assessment and enterprises cooperation for the blending of indigenous technology and imported technology. * Improvement of the institutional machinery, administrative and legal framework with a view to facilitating foriegn investment flows and improving the data base on FDI and portfolio flows. * Advisory services for developing countries to strengthen capital markets and to attract foreign portfolio investment. * Technical support for developing countries and countries in transition to upgrade their institutional capacity to identify, design, negotiate, and implement schemes on BOT/BOO/BOLT. * Promotion of a regional collective R&D efforts in specific industries which have general applicability in most countries (like textiles, automobiles, electronics and informatics etc.). (b) Regional Cooperation 158. Asian countries are going through a phase of economic liberalisation which provides a solid foundation for the success of intra- and inter-regional cooperation. They need to make greater efforts to create a more liberal trading and investment environment for reduction of wide disparities in the levels of income and market size, and to have cost-sharing and distribution of benefits. The economic exchange and cooperation among the Asian economies can be strengthened by the following measures: (a) At the regional level, since the FDI has increasingly become market driven, host country would increase their locational attraction if closer linkages are established with neighbouring countries in order to generate larger markets and complementary locational advantages.

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(b) Since almost all countries in the Asian and Pacific region are trying to attract foreign direct invstment, a lot of competitive overbidding and unnecessary loss of resources could be avoided through some harmonisaion of policies of different governments at national, bilateral, regional and global levels. (c) Instead of competing for foreign capital, the countries should undertake appropriate policy reforms which will not only encourage more savings and investment internally but also help the return of flight capital to the Asian region. (d) At the regional level, countries should cooperate with one another to modernise their financial systems to cope with the increase in trade and cross-border capital flows. They should try their best to facilitate intraregional funding and to reduce the impact of any global credit crunch. (e) Another aspect of regional cooperation that is of growing importance is the sharing of information. Regional cooperation can reduce the transaction costs of gathering information, and through economies of scale, can reduce the research and development costs. In this respect, the Regional Investment Information and Promotion Service for Asia and the Pacific (RIIPS) and the Asia Pacific Centre for Transfer of Technology (APCTT) have made significant contributions. But, there is scope for improvement in their databanks and regional information networks on FDI opportunities in the region, technological breakthroughs in industries, TNCs operations, profiles of FDI and investment laws in various countries. (f) National governments as well as regional and interregional organisations must facilitate contacts, cooperation and mutually business relations among enterprises and entrepreneurs for building up internal strength of industries. (g) The sheer magnitude for investment required for technological R&D needs subregional pooling of limited resources (financial, physical and human) to obtain the best possible leverage. (h) It may be desirable to establish a regional investment guarantee facility. A major problem in attracting investment funds to the developing countries is the perceived risk of confiscation, civil strife, and political turmoil. (i) For the least developed countries which lack the capacity to undertake comprehensive efforts to develop local capacity, there is an urgent need for more active support by the donor community in such areas as strengthening the private sector and local entreneurship, building institutional capacity, improving physical infrastructure and enhancing human resource development. (j) At a broader level, the Asian Development Bank, can play a complementary role in enhancing regional cooperation to attract more private international capital into the Asian and Pacific region. The Asian Development Bank should expand its catalytic role in

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private sector financing which started in 1987 and should also augment its resources for the Asian Infrastructure Fund. (k) Other multilateral financial institutions will also have to strenthen their catalytic role through co-financing and guarantee with a view to encouraging participation of private capital in the development process, particularly in South Asia. (c) Regional Cooperation in SAARC 159. South Asia has much to learn from the experience of successful regional endeavours such as ASEAN, EU, NAFTA and APEC. A new concept of open regionalism which seeks not only to reduce intra-regional barriers in economic interaction, but also to lower external barriers which are not part of the cooperation arrangement has emerged in the post-GATT world trade scenario. 160. In order that SAPTA becomes an effective instrument for intra-SAARC trade and investment expansion, many supporting steps are required. These include steeper reduction in the trade barriers than that provided under the WTO agreement, increase in supply capabilities for additional exports, expansion of investment flows in the region, and replacement of product by product approach by across the board tariff and non-tariff concessions. SAARC countries will need to agree on a clear policy towards foreign investment as a vehicle of technology upgradation and overall growth. 161. Several areas of cooperation which might have an marginal impact on India, the major SAARC partner, could have far-reaching effects on the smaller partners such as the Maldives, Nepal, Bhutan and Bangladesh - e.g. regional promotion of tourism, establishment of linkages in the service and infrastructural sectors, a regional clearing union arrangement and joint research and development schemes. Also, rather than competing in certain commodities such as rubber, jute,tea, and textiles, the SAARC members may consider cooperation in the production, marketing and transportation of these commodities. Similarly, there would be an advantage in intra-regional transfer of technologies through the creation of regional joint ventures and joint or sub-regional training schemes. Confederation of Indian Industries (CII) has identified many other areas of South Asian Sectoral Cooperation which are summarised in Table 1.14. 162. SAPTA alone is unlikely to improve intra-regional trade unless other schemes of regional cooperation are introduced, aimed at creating greater complementation among the economies of the region (e.g.investment and production partnerships, such as regional/ bilateral joint ventures), and creating efficient infrastructural linkages, especially in terms of transport, communications and information exchange. 163. In order to accelerate the pace of regional trade liberalisation, it might be preferable to adopt two tracts - one being the region-wide slower track, and the other, a series of bilateral agreements between the more advanced countries within the group. There are already some bilateral initiatives between India and Pakistan, India and Sri Lanka, India and Bangladesh and India and Nepal. Sectoral cooperation such as a SAARC Textile Council can also boost economic and trade relations within the region. Textile is a priority sector as developing countries will no longer benefit from preferential

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quotas when the Multi-Fibre Arrangement is disbanded in the year 2005, and it is an important component of SAARC country exports. In order to rise to the challenge of open competition, SAARC producers need to pool their design, marketing and technological resources. 164. With rapid growth in the ASEAN economies, wages and labour costs have been rising considerably. SAARC countries need to adopt policies which would favour the relocation of some labour-intensive production from ASEAN and NIEs to SAARC countries as the NIEs and Japan and even some ASEAN countries such as Malaysia and Thailand have become important sources of FDI. All these Southeast Asian countries have a common interest with SAARC countries in creating trade-generating joint ventures. India became an ASEAN ‘dialogue partner’ in 1992-93 and a ‘sectoral dialogue partner’ in 1996, the ASEAN countries view India as long-term potential market. India can exploit this opportunity by facilitating and encouraging private sector contacts with ASEAN entrepreneurs. Selected Bibliography Asian Development Bank (1995). Asia : Development Experience and Agenda, ADB Theme Paper 3, Asia Deelopment Bank, Manila. ______(1997a). Asian Development Outlook 1997 and 1998, Oxford University Press, Hong Kong. ______(1997b). Emerging Asia - Changes and Challenges, Asian Development Bank, Manila. Brooks, D.H. and Leuterio, E.E. (1997). Natural resources, economic structure and Asian infrastructure, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD. Chakwin, Naomi and Hamid, Naved (1997). Economic environment in Asia for investment, in Investing in Asia,ed.C.P.Oman et.el.1997. Chia, Siow Yue; and Tsao Yuan Lee (1994). Economic Zones in Southeast Asia, in Asia Pacific Regionalisation: Readings in International Economic Relations, ed. R. Garnaut and P. Drysdale, Pymble, Haeper Educational Publishers. Das, Tarun (1993a). Structural Reforms and Stabilisation Policies in India - Rationale and Medium Term Outlook, in Economic Liberalisation and its Impact, ed. S.P.Gupta, pp.20-56, MacMillan India Ltd, New Delhi. 1993. ______(1993b). Macro-economic Framework, Special Economic Zones and Foreign Investment in India, Ad-Hoc Workong Group on Investment and Financial Flows, UNCTAD,Geneva, pp.1-75,June 1993.

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______(1996). Policies and Strategies for Promoting Private Sector’s Role in Industrial and Technological Development, Including Privatisation in South-Asian Economies, Report prepared for the Industry and Technology Division, ESCAP, United Nations, Bangkok; and published by the United Nations, New York, 1996. ESCAP (1993). Economic and Social Survey of Asia and Pacific 1992, Part 2, Expansion of Investment and Intraregional Trade as a vehicle for Enhancing Regional Economic Co-operation and Development in Asia and Pacific, United Nations, New York. ______(1994) Proceedings of the Regional Seminar on Investment Promotion and Enhancement of the Role of the Private Sector in Asia and the Pacific, United Nations, New York. ______(1996) Policies and Strategies for Promoting Private Sector’s Role in Industrial and Technological Development, Including Privatisation in South-Asian Economies, U.N.,New York. ______(1997) Economic and Social Survey of Asia and the Pacific 1997- Asia and the Pacific into the Twenty First Century: Development Challenges and Opportunities, U.N, New York. Estanislao, Jesus (1977). The institutional environment for investments in Chin and ASEAN: current situation and trends, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD. International Monetary Fund (1997). World Economic Outlook - Globalisation, Opportunities and Challenges, May 1997, Washington, D.C. Lall, Sanjaya (1993). Policies for Building Technological Capabilities : Lessons from Asian Experience, Asian Development Review, Vol.11, No.2, pp.72-103, Asian Development Bank, Manila. Oman, C.P., Brooks, D.H. and Foy, C. (1997). Investing in Asia, Development Centre, The Organisation for Economic Co-operation and Development (OECD). Research and Information System (RIS) for the Non-Aligned and Other Developing Countries (1995). SAARC Survey of Development and Cooperation 1995, New Delhi. UNCTAD (1992). World Investment Report 1992: Transnational Corporations as Engine of Growth, United Nations, Geneva. ______(1993a). World Investment Report 1993: Transnational Corporations and Integrated International Production, U.N.

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______(1993b). Report of the Ad Hoc Working Group on Investment and Financial Flows; Non-Debt-creating Finance for Development; No. TD/B/40(1)/12 and TD/B/WG.1/8, July 1993, U.N., Geneva. ______(1994). World Investment Report 1994: Employment and Workplace, United Nations, Geneva.

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______(1995). World Investment Report 1995: Transnational Corporations and Competitiveness, United Nations, New York. ______(1996). World Investment Report : Investment, Trade and International Policy Arrangements, United Nations, Geneva. World Bank (1993). The East Asian Miracle: Economic Growth and Public Policy, Oxford University Press. ______(1994a). World Development Report - Infrastructure for Development, Washington, D.C. ______(1997a). Global Development Finance, Washington, D.C. ______(1997b). World Development Report 1997, Washington, D.C. Xiaoqiang, Zhang (1997). Investment in China’s future, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD. Yamazama, Ippie (1997). APEC and investment, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD.

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