[Seri column] Road to recovery leads across borders

Global foreign direct investment, which represents companies’ business activities in foreign countries, reached a record $1.9 trillion in 2007. World economic growth, liberalization, deregulation and the internationalization strategies of multinational enterprises since 2003 were the major contributors to this record amount. However, the global financial crisis originating in the United States hung like a cloud over the upward trend, dragging down FDI to $1.6 trillion in 2008.

The impact of the global financial crisis on developed countries has been more significant. While FDI inflows into developing countries increased by 7.2 percent between 2007 and 2008, those into developed countries decreased by 25.3 percent in the same time period. There has been extreme shrinkage in FDI flows directed toward financial services, automobiles and other consumer products because of diminished global demand. In contrast, more FDI has moved into new growth engine industries such as renewable energy, resources and environment-related industries.

The financial crisis could have both positive and negative impact on global FDI prospects. Lower asset prices and industry restructuring stemming from the crisis may create new investment opportunities among rich multinationals, especially from developing countries. New growth engine industries will attract more FDI than other industries that are losing their attractiveness because of dented global demand. Government emergency measures will also help boost FDI.

However, positive consequences from the crisis could be overwhelmed by negative effects. Reduced corporate profit and tightened credit conditions triggered by the crisis constrain firms’ ability to invest. Also, increased uncertainties in global markets incite firms to implement more risk-averse strategies such as divestments, retrenchment finance or cancellation of international investment projects.

The United Nations Conference on Trade and Development forecasts that global FDI will be in decline over the next two to three years. UNCTAD’s projections on FDI are based on three scenarios and emphasize the role of government in each case.

The first one is a V-shaped scenario, which is the most optimistic. This scenario expects that FDI will continue its slide in the second half of 2009 but then bounce back quickly. The “U” scenario is the middle ground, which anticipates gradual recovery will start in 2011. The last one is “L,” which is the most pessimistic. This scenario proposes that the downward trend will continue until 2012. UNCTAD also forecast that the trend of global FDI will be determined according to the efficiency of government policies, the depth and length of the global recession and the speed of a recovery in investor confidence.

One critical government policy that can hamper global FDI is protectionism. In previous recessions, governments deregulated FDI measures in order to recapitalize domestic firms or to improve the balance of payment. However, this time many governments are passing new restrictions on FDI and justifying them as needed steps for national security, to raise tax revenue or to ensure fair competition.

For example, on May 4, 2009 the Obama administration announced a tax reform titled “Leveling the Playing Field.” Its main thrust is to remove tax breaks for U.S. firms that invest overseas. The measure is part of a package of international tax reforms that the Obama administration predicts will raise $210 billion over the next 10 years and create more jobs domestically.

However, many economic interest groups assert that the reform ignores the contribution of U.S. multinationals to the American economy and impairs their competitiveness in global markets. This kind of protectionist measure will encourage retaliation from other governments and lead to even less FDI.

Considering the reduction in FDI and rise in protectionist measures, not only will there be more competition to attract FDI, but also any dramatic increase in global FDI is not expected in two or three years.

Therefore, the role of policy makers in conquering the current financial crisis and increasing FDI is to overcome the temptation toward protectionism and create a more investment-friendly environment. A good example of protectionism is “beggar-thy-neighbor” policies, which advance the interests of single nations at the expense of fellow nations. As seen during the Great Depression of the 1930s, government policies aimed at trade balance, inflation and unemployment hampered trading partners by imposing import restrictions and devaluing currencies. The policies did not cause the depression, but were a major factor in deepening and prolonging it.

In addition, governments’ emergency measures during the current crisis should be implemented temporarily and transparently with an exit strategy that removes government assistance when economies are back to the normal to ensure fair competition on a global level.

*The writer is a visiting research fellow at Samsung Economic Research Institute and professor at Konkuk University. For more SERI reports, please visit www.seriworld.org.

by Kim Zu-kweon