Fdi And Growth Vol-2, Un-escap, By Tarun Das

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Foreign Investment- Technology Transfer- Economic Growth Nexus in Asian Economies VOLUME - II EXECUTIVE SUMMARY AND RECOMMENDATIONS _______________________________________________________________________ _

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

ECONOMIC PACIFIC

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SOCIAL

COMMISS ION

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AS IA

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Foreign Investment- Technology TransferEconomic Growth Nexus in Asian Economies 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. * Author would like to express his gratitude to the ESCAP, particularly 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. December 1997

CONTENTS Contents

Paragraphs

1 Executive Summary and Recommendations A Major Conclusions 1.1 Basic characteristics of Asian economies (a) South Asia and SAARC (b) East Asia and South East Asia

1-164 2-116 2-8 4-5 6-8

1.2 FDI - Technology - Growth Nexus 1.3 Geographical and Sectoral Distribution of FDI (a) Regional distribution of FDI (b) FDI in selected countries of Asia 1 China 2 India 3 Japan 4 Republic of Korea 5 Taiwan, China 6 Philippines 7 Myanmer 8 Indo-China (Cambodia, Lao PDR, Vietnam) 9 USA’s direct investment in Asia (c) Sectoral distribution of FDI (d) Foreign Portfolio Investment (FPI)

9-25 26-56 26-31 32-51 32-34 35-39 40-41 42-43 44-45 46-47 48 49-50 51 52-55 56

1.4 Different Modes of FDI and Technology Transfer (a) Modes of foreign capital (b) Modes of foreign portfolio investment (c) Modes of technology transfer

57-67 57-62 63 64-67

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

68-74 68-71 72-74

1.6 Development of Infrastructure and Services 1.7 Policies and Strategies for Promoting FDI - Technology - Growth Nexus (a) Macro-economic policies (b) Fiscal and financial policies (c) Role of Special Economic Zones (d) Role of Small and Medium-Sized Industries (e) Role of Research & Development Expenditures (f) Infrastructure and human resource development

75-84 85-102 85-91 92-93 94-95 96-98 99-100 101-102

Contents

Paragraphs

1.8 Regionalisation and FDI Complementarities (a) ASEAN Experience (b) SAARC Experience (c) APEC Experience (d) ESCAP experience (e) Multilateral agreement on investment (MAI)

103-116 104-106 107-108 109 110-113 114-116

B. Recommendations

117-164

1.9 General recommendations

117-118

1.10 Policies and strategies for promoting FDI-Technology-Growth Nexus (a) Host country policies for FDI (b) Host country policies for foreign portfolio investment (c) Home country policies (d) The role of special economic zones (e) The role of small & medium sized industries (f) Role of R&D expenditure (g) Infrastructure & human resource development (h) Legal and institutional set-up (i) Fiscal and financial incentives

119-140 119-126 127-128 129-131 132 133-134 135 136-137 138-139 140

1.11 Different Modes of FDI & Technology Transfer

141-143

1.12 Advances in New Technologies (a) Industrial technology development (b) New technology and applications

144-149 144-146 147-149

1.13 Development of Infrastructure and Services

150-152

1.14 Regionalisation and FDI Complementaries (a) Technical assistance (b) Regional cooperation (c) Regional cooperation in SAARC

153-164 155-157 158 159-164

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 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 presents 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. (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-friendly 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, 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 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 ethnically related countries. 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 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 empirical 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 acquisitions) 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, privatisation 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 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 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 highlight 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 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 are 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 equipment’s (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, Mauritius and Cayman Island emerged as a major home country due to establishment of various offshore 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 up to 51% in 48 priority industries and up to 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 recipients 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 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 earlier 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 empirical 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 projectionist 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. 47. There is a high degree of correlation 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 commutative 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 is 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 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, plastics) 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 Vietnam 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 infrastructure 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 that neglected Asia in the 1980s is making largescale 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 international 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 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, equipment’s, 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 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 attractiveness 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 channeled 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 investors (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 adoption. 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 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 adaptation 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 SouthEast 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 regional 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, shipbuilding, 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 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, biotechnology and new materials. To this can be added emerging technology 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. 1.6 Development of Infrastructure and 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 enhance 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 transfer 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 guarantees” 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 outpaced 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 Caribbean ($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 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 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, huge 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 investors 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, Venezuela 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-vis 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 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’ location 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 location 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 forms 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 nontrade-related 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, 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 increasing 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 equipment, 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 concessional 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 interaction has been facilitated 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 differentiation. TNCs engaging in intensive R&D activities acquires a technological advantage over their competitors; and will be unwilling to share sophisticated 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, infrastructure 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 relief on R&D expenditure. (f) Infrastructure and Human Resource Development 101. Foreign investors need adequate local support facilities including capital markets, efficient physical, and 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 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 non-tariff 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 barriers 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 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. Attempts are also being made to form a sub-regional economic group through the Bangladesh, Bhutan, Nepal and India “growth quadrangle” (BBNI-GQ).

(c) APEC Experience 109. The most comprehensive form of multi-government cooperation in terms of both countries and the scope of issues addressed are 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 transfer. Financial and developmental institutions like 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 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 supranational powers like the EC. (c) There is hardly any linkage or dialogue 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 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 sectors themselves and through FDI will have to play an increasingly critical role in developing and modernising infrastructure base. In turn, governments will need to establish 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 benefits 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 unnecessary transaction 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 investment (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 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, prompt 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 accordance with international law standards and be

subject to due process. An expropriation should be for public purpose and nondiscriminatory, and prompt, 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 governance 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 decentralisation 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 agitation’s, with positive impact on private investment. (b) Host Country Policies for Portfolio Investment 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 portfolio 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. Developing 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 them 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 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 facilitate 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 facilitate 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 and encourage private sector funding of research institutions engaged in R&D. For effective role of R&D in the generation, development, adoption, 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) Infrastructure 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 educational 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 infrastructure 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 essential 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 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 conventional 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 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 temporary 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 international 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. 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 ownership 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 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 regional 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 resource 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 with the changing comparative advantages of the countries and regions. * 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 entirely 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 foreign 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 location attraction if closer linkages are established with neighbouring countries in order to generate larger markets and complementary location advantages. (b) Since almost all countries in the Asian and Pacific region are trying to attract foreign direct investment, a lot of competitive overbidding and unnecessary loss of resources could be avoided through some harmonisation 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 entrepreneurship, 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 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 strengthen 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 infrastructure 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 infrastructure 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 quotas when the Multi-Fiber 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.

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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, 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. ______(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.

Transnational

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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.