Foreign Direct

INVESTMENT
T h e K e y t o A s i a s F u t u r e E c o n o m i c Gr o w t h ?

b y D e n n i s J . En c a r n a t i o n

THROUGHOUT 1 9 9 7 , East Asia s unf olding f inancial crises provoked scat hing crit iques of t he role of f oreign invest ors in t he regions downward spiral. According t o t he crit ics, t he same f oreign invest ment t hat had helped spawn t he East Asian economic miracle had come t o exacerbat e, if not cause, t he current problems. And f or many Asians, as well as f or analyst s elsewhere, f oreign invest ment remains a debat able part of
Dennis J. Encarnat ion is direct or of t he Asia-Pacific Policy Program at t he Cent er for Business and Government , Kennedy School of Government , Harvard
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t hese f ive economies f inanced t heir current But bef ore rushing t o judgment about f or- account def icit s and increased t heir f oreign eign invest ors in East Asia, it is import ant t o exchange reserves principally t hrough privat e remember t hat f oreign invest ors come in commercial borrowings, largely short -t erm many variet ies. Foreign debt must be dist in- debt regularly rolled over year af t er year. They guished f rom f oreign equit y. Among debt supplement ed t hese borrowings wit h addit ioninst rument s, short -t erm borrowings must be al f oreign loans f rom bondholders, t rade credidist inguished f rom long-t erm lending. Among t ors, and ot her nonbank lenders, as well as privat e lenders, commercial banks must be wit h f oreign port f olio invest ment s by mut ual dist inguished f rom nonbank credit ors, includ- f unds and ot her inst it ut ional invest ors int ering bondholders and t rade f inanciers. And of est ed in t hese emerging market s. course privat e lenders must be dist inguished During 1 9 9 7 t he pat t ern changed dramat if rom of f icial lenders, which can be mult ilat eral cally. A s mult iple crises unf olded, f oreign inst it ut ions or individual f oreign government s. direct invest ment and nonbank credit quickly Among t he f orms of f oreign equit y, f oreign became t he only remaining privat e sources of port f olio invest ment s in local st ock market s f oreign invest ment in all f iv e economies. b y m ut ual f und s and ot her in st it ut io nal Foreign commer cial banks wit hdrew large invest ors dif f er f rom f oreign direct invest - sums, as did f oreign port f olio invest ors. To ment s ( FDI) , t ypically by mult inat ional corpo- f inance t hese new f oreign invest ment out rat ions t hat consciously combine equit y own- f lows as well as ongoing current account ership wit h managerial cont rol. Even FDI must def icit s, t he f ive count ries had t o t urn t o of f ibe f urt her dissect edint o new crosscial, especially mult ilat eral, sources of border f lows and local earnings ext ernal f inancing. Bu t secu ring Wit h in c r ease d reinvest ed in t he host economy access t o such f unding necessit at where t hey were generat ed. ed individual negot iat ions wit h ex p o r t s c r it ic al t o Each of t hese f orms of f ort he IMFexcept in t he case of r ec o v er y , East A sian eign invest ment has respondMalay sia, w hic h has t o dat e g o v er nm en t s ar e ed dif f erent ly t o East Asias held t he IMF at bay. c o m p et ing f ie r c ely f o r ever-changing opport unit ies Th e In s t it u t e for f o r eig n d ir ec t and risks. Discerning t hese Int ernat ional Finance predict s d if f e r e n c e s is c r it i c al t o inv est m en t in e x p o r t - t hat t his y ear f oreign direct underst anding bot h t he likely invest ment will be t he sole pricauses o f , and t he pot ent ial vat e source of net f oreign capit al solut ions t o, t he regions current inf lows; t he only alt ernat ive will be f inancial crises. Among pot ent ial soluf unding f rom of f icial sources, principally t ions, f oreign direct invest ment f igures promi- t he IMF, t he World Bank, and ot her mult ilat ernent ly. Indeed, t hroughout t he crises, FDI has al inst it ut ions t hat impose major condit ions remained one of t he f ew privat e sources of on t heir lending. Not surprisingly, as ot her f oreign invest ment f or much of East Asia. And sources of f oreign invest ment dry up, governbecause f oreign direct invest ment of t en f acil- ment s in t he region have sharply escalat ed it at es t he cross-border t ransf er of f oreign t heir compet it ion f or f oreign direct invest t echnology as well as bet t er access t o f oreign ment . market s, a credible case can be made t hat it COM PET IT I ON FOR FOREI GN will become even more crit ical t o East Asias EX CH A N GE f ut ure economic growt h. Wit h increased export s crit ical t o recovery, all FD I I N T HE CRI SI S f ive government s are compet ing f iercely f or ECON OMIES f oreign direct invest ment in export -orient ed The ext ernal f inancing of East Asias f ive most pr o j ec t s. The Inst it ut e f o r Int ernat io nal af f lic t e d e c o n o m ie s In d o n esi a, Ko r e a, Finance est imat es t hat t he f ive will collect iveMalaysia, t he Philippines, and Thailandillus- ly record current account surpluses during t rat es f oreign invest ors varied responses t o 1 9 9 8 , t hanks bot h t o a cont ract ion in domest he f inancial crises ( see t able 1 ). Bef ore 19 9 7 t ic demand and relat ed import s and t o an

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increase in merchandise export s, including While t he t roubled economies of East Asia t hose linked t o f oreign direct invest ment . seek f oreign direct invest ment f rom abroad, Foreign direct invest ment has t hus emerged most of it comes f rom elsewhere in t he region. as an import ant source of f oreign exchange Japan has long been Asias largest source of f or crisis-af f lict ed economies not only on t heir f oreign direct invest ment . And Asia has f or capit al account , but also on t heir current years been second only t o t he Unit ed St at es account ( t hrough export s) . as a dest inat ion f or Japanese f oreign direct The role of f oreign direct invest ment varies invest ment . But during t he 1 9 9 0 s f resh out widely across t he regions economies and f lows of Japanese f oreign direct invest ment indust ries. Much of it is concent rat ed in man- began t o slow . At home t he popping of uf act uring, where government compet it ion is Japans bubble economy early in t he decade most int ense, especially in Sout heast Asia. combined wit h subsequent recessions t o limit There, Indonesia, Malaysia, and Thailand have t he value of f resh out f lows; while f inancial become dest inat ions f or f oreign direct invest - crises in Indonesia, Malaysia, and Thailandall ment and are likely t o remain so, as reinvest - host t o sizable shares of Japanese f oreign ed earnings grow along wit h economic recov- direct invest ment limit ed t he value of reinery. Korea has long sought t o limit f oreign vest ed earnings. These problems at home and direct invest ment in manuf act uring t hough abroad are likely t o diminish Japans relat ive elaborat e capit al cont rols. Alt hough Korea import ance as a source of f oreign direct has begun t o dismant le t hose cont rols, in v e st m e n t f l o w s t o o t h e r A s ia n t he economic impact of Koreas economies, especially t hose in f inanliberalizat ion remains in doubt cial crisis. g iv en t he u nev e n e xp er iMe an w h i le , o t h e r A s ia n A s i a s f i n an c i al ences of prospect ive f ore c o n o m ie s h av e b e c o m e c r i s e s ha v e b r o ug h t eign invest ors t here. more import ant sources of t h e Un i t ed St a t e s In f inanc ial ser v ic es, int ra-regional f oreign direct Korea has much in cominvest ment . Indeed, t he b ac k i n t o Eas t A s i a m o n w it h In d o n e s i a, int ra-regional bias of f ora s a r en ew ed Malaysia, t he Philippines, eig n d ir e ct inv est m e nt e c on om i c a nd and Thailand. In all f ive, f rom t hese o t her Asian p ol i t i c al a c t or f oreign direct invest ment in v e st o r s h as b e c o m e w i t h b r o ad in banking and ot her f inanmore pr o nou nced. cial services has long been According t o a recent st udy s ec ur i t y severely rest rict ed by capit al by t he Japan Ext ernal Trade i m pl i c at i o ns . cont rols t hat largely relegat ed Organiz at ion, by 1 9 9 6 Hong f oreign invest ors t o niche marKong had become East Asias chief ket s. But t hese cont rols have probasource of annual f oreign direct invest bly limit ed cross-border t ransf ers of f oreign ment inf lows. Est imat es of Hong Kongs FDI t echnology. In manuf act uring, Korea and ot her out f lows are no doubt boost ed by it s int ermecount ries have long pref erred t o unbundle diat ion of capit al f lows originat ing elsewhere t echnology f rom f oreign direct invest ment ( t ypically Taiwan and mainland China) . But whenever possible t hrough licensing agree- Hong Kong is likely t o maint ain it s st at us as a ment s. But in f inancial services, t echnology major f oreign invest or in it s own right , as well licensing t ends t o be much less common, mak- as a key cent er f or capit al int ermediat ion in ing f oreign direct invest ment more crit ical t o Asia, as long as it can cont inue t o weat her t he cross-border t ransf er of f inancial process- Asias f inancial crises. Should t hese crises es and product s, as well as managerial skills, spread, Hong Kongs st at us as a principal f rom more advanced market s. Foreign direct source of f oreign direct invest ment and ot her invest ment may t hus be crucial t o t he long- capit al out f lows t o t he rest of Asia increases t erm rest ruct uring of f inancial serv ices in t he risk t hat it will suf f er f rom t his cont agion. af f lict ed East Asian economies. According t o off icial st at ist ics, t he regions ot her newly indust rialized economiesKorea, I N T RA - A S I A N F O REI GN Singapore, and Taiwanare t he next largest D IRECT I N V EST MEN T sources of foreign direct invest ment . The of fi-

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Muc h of t his int ra-Asian f oreign direct invest ment , especially t hat Kor ea, f rom Hong Kong and Taiwan, is conM al ay s i a, t he Phi l i ppi nes , and T hai l and c e n t r at e d in m a in la n d Ch i n a. ( Bi l l i ons of U.S. dol l ar s) According t o World Bank est imat es, last year China at t ract ed more t han 1996 1997 1998 half of t he project ed $ 7 0 billion in f oreign direct invest ment f lowing int o Asia. This st at us is quit e new: Cur r ent ac c ount bal anc e - 5 4 .9 - 2 6 .0 1 7 .6 as recent ly as 1 9 9 0 , China was second t o Singapore as a recipient of Ex t er nal f i nanc i ng ( net ) new FDI inf lows. Any est imat es of For ei gn di r ec t i nv es t m ent 7 .0 7 .2 9 .8 Chinas FDI inf lows must be correct Por t f ol i o i nv es t m ent 1 2 .1 - 1 1 .6 - 1 .9 ed f or t he circular f low ( roundt ripCom m er c i al bank debt 5 5 .5 - 2 1 .3 - 1 4 .1 ping ) of f oreign direct invest ment Nonbank pr i v at e c r edi t or s 1 8 .4 1 3 .7 - 3 .2 f rom, and t hen back t o, China nearly all via Hong Kong. But af t er M ul t i l at er al f i nanc i al i ns t i t ut i ons - 1 .0 2 3 .0 correct ing f or roundt ripping t hat 1 8.5 may make up as much as a quart er of all FDI of f icially recorded in China, Bi l at er al c r edi t or s 0 .7 4 .3 6 .1 China st ill account s f or well over t wo-f if t hs of FDI f lows int o Asia. A l l ot her ( net , inc ludin g err or s and o m issio ns) - 1 9 . 6 - 1 1 . 9 The ro undt ripp ing of Chinese - 5.7 invest ors is one sign t hat governRes er v es ( ex c lu ding g o ld ) ment compet it ion f or FDI ext ends ( - = i nc r eas e; + = dec r eas e) - 1 8 . 3 2 2 .7 - 2 7 .1 well bey o nd t he t r o u b le d ec o n o m ies o f So u t h e ast A si a. Sour c e: Inst it ut e f o r In t er nat io nal Fi nanc e, Cap it al Flo w s i n Chinas discriminat ory applicat ion of invest ment incent ives so st rongly cial st at ist ics underest imat e t he relat ive value f av o r s Ho n g Ko n g an d o t h e r f o r eig n of t heir FDI, especially t hat of Korea and invest ors t hat domest ic Chinese invest ors Taiwan, where hom e-government policies f eel compelled t o roundt rip t hrough Hong have oft en conf lict ed wit h corporat e st rat e- Kong t o qualif y f or Chinese government congies. At any rat e, Koreas relat ive import ance cessions when t hey ret urn t o China. But as a regional source of foreign direct invest - int ra-regional, int er-government al compet iment is likely t o decline as it adjust s t o it s own t ion does not end here. China and ot her f inancial crisis and t o relat ed crises in ot her Asian government s, f or example, may also Asian economies, such as Indonesia, t hat host compet e in devaluing t heir currencies t o sizable shares of Korean FDI. By comparison, boost export s f rom exist ing ( f oreign and Singapore and Taiwan, having been largely domest ic) producers, as well as t o at t ract spared t he current crises, may see t heir rela- new invest ment s f rom prospect ive ( again, t ive import ance as Asian sources of int ra- f oreign and domest ic) producers. By t his regional f oreign direct invest ment grow. log ic, currenc y dev aluat io ns out side o f Dampening t his prospect , however, is t he China, across much of t he rest of East Asia, heavy concent rat ion of t heir FDI in Indonesia, have int ensif ied pressure on Chinese policyMalay sia, t he Philipp ines, an d Thailand. makers t o respond by devaluing t heir own Regardless, t he newfound st at us of Singapore f ixed-rat e currency, t hus raising t he spect er and especially Taiwan has already begun t o of a downward spiral of exchange rat es produce subt le but import ant changes in t he across t he region, as government s and specpolit ical economy of East Asia, as evidenced ulat ors alike respond t o compet it ive presrecent ly by Taiwans diplomat ic f orays across sures. t he region. Because China and ot he r East A sian economies are increasingly int egrat ed, not so CHIN A A N D B EY ON D much t hrough t rade but t hrough foreign direct
T able 1 .

Tot al Ex t er nal Fi nanc i ng f or Indones i a,

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invest ment and ot her capit al flows, government policies and corporat e st rat egies in one economy inevit ably shape policies and st rat egies elsewhere in t he region. Thus, t he f inancial crises af f lict ing Indonesia, Korea, Malaysia, t he Philippines, and Thailand quickly can spill beyond t heir nat ional borders, as t he case of Charoen Pokphand (CP) shows. A Sino-Thai conglomerat e wit h FDI spread across t he af flict ed economies of Sout heast Asia, CP is also one of t he oldest and largest f oreign invest ors in China. But according t o recent press report s, CPs regional invest ment s in China and elsewhere are now t hreat ened by it s dif ficult ies in rescheduling it s mount ing debt bot h at home and abroad. CPs case, hardly unique, illust rat es how int ra-Asian FDI cont ribut es t o a larger cont agion ef f ect t hreat ening t o spread f inancial crises across t he region, back and f ort h bet ween Asias home and host economies. I M PL I CA T IO N S FOR T HE UN IT ED ST A T ES The Unit ed St at es runs a much smaller risk of import ing Asias f inancial cont agion t hrough f oreign direct invest ment . Out side of Japan, Asia has t ypically account ed f or only about 1 0 percent bot h of t he cumulat ive st ocks of U.S. f oreign direct invest ment abroad and of annual U.S. FDI out f lowsonly slight ly more t han U.S. FDI in Sout h America. And more t han t hree-f if t hs of t he cumulat ive st ock of U.S. f oreign direct invest ment in East Asia is in Singapore and Hong Kong, bot h largely unaf f ect ed t o dat e by t he regions f inancial crises. According t o t he JETRO st udy cit ed above, during 1 9 9 6 bot h Japan and Hong Kong had FDI inf lows int o East Asia wit h a dollar value double t hat of inf lows f rom t he Unit ed St at es. U.S. inf lows even lagged t hose of t he 1 2 -member European Union. But t he East Asian f inancial crises are likely t o increase bot h t he import ance of East Asia t o American mult inat ionals and t he relat ive import ance of U.S. f oreign direct invest ment t o t hat regions economies. Helping t o f und t his expansion is t he robust prof it abilit y recorded by American mult inat ionals at home. Indeed t he U.S. press is replet e wit h news of American mult inat ionals seeking t o exploit new opport unit ies in East Asia result ing f rom sharp declines in local share prices and a sharp rise in t he relat ive value of t he U.S. dollar. Exploit ing t hese new Asian opport unit ies are a Whos Who of American mult inat ionalsGeneral Mot ors in Korea and China, Ford in t he Philippines, Cit ibank and GE Capit al in Japan, t o name but a f ew. Such U.S. f oreign direct invest ment is likely t o f igure prominent ly in t he f ut ure growt h and st ruc30

t ural adjust ment of a growing number of East Asian economies. Viewed more broadly, t he ant icipat ed increase in U.S. f oreign direct invest ment across East Asia heralds a much larger set of import ant changes in t hat regions polit ical economy. Asias f inancial crises have brought t he Unit ed St at es back int o t he region as a renewed economic and polit ical act or wit h broad securit y implicat ions. Not t hat long ago, Americas wit hdrawal f rom Asia was a hot t opic widely debat ed on bot h sides of t he Pacif ic.The response of t he U.S. government and American mult inat ionals t o Asias f inancial crises has largely ! ended t hat debat e.

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