Foreign Direct Investments from Emerging Markets

The global market for foreign direct investment (FDI) has undergone significant changes in recent years, with the increasingly important role played by emerging market multinational enterprises (MNEs) being one of the most important among them. While outward FDI (OFDI) from these countries, in itself, is not new, the magnitude that this development has achieved has raised a host of issues, which we will examine in this volume. This opening chapter presents the factual background of this phenomenon, the impact of the financial crisis and recession on FDI flows, and the issues and challenges related to emerging markets’ high FDI flows.

We are certainly living in turbulent times. At the time of this conference, we discussed the thrilling possibilities for dynamic global development fueled by technological advances. Technology diffuses from one place to the other at lightning speed. The possibility for any place that was unproductive to become productive quickly in five, or ten, or twenty years, is greater than ever before in history, and China serves as an exemplar of this. At the same time, we caught glimmers of the steepest short-term business downturn in recent memory. In my observations, I will keep my eye on the medium term, the next ten to forty years, after we have ridden the waves of the current economic storm.

The importance, diversity, and scope of the operations of multinational enterprises (MNEs) in the global economy have grown exponentially. In 1960, the value of worldwide sales of foreign affiliates was about one-half of world exports. By 1982, the worldwide sales of foreign affiliates totaled US$2.7 trillion, roughly comparable to worldwide exports of goods and nonfactor services of US$2.4 trillion. By 2007, worldwide affiliate sales stood at US$31 trillion, which was almost twice as much as world exports of US$17 trillion (UNCTAD 2008, 10). Two-thirds of world trade involves MNEs and their affiliates as buyers or sellers, and one-third takes place among units of the same MNE corporate system. In 1982, the ratio of outward foreign direct investment (OFDI) to worldwide gross fixed capital formation was just 1%. In 1999, it had risen to approximately 14% (UNCTAD 2000, 4), and in 2007 it stood at 16.2% (UNCTAD 2008, 10). World foreign direct investment (FDI) outward stock, expressed as a percentage of world gross domestic product in current prices, increased rapidly, from 4.8% in 1982 and 10.8% in 1990, to 28.6% in 2007 (UNCTAD 2008, 10). In fact, global FDI inflows reached a historic high of $1,979 billion in 2007 (UNCTAD 2009). Amid a global financial and economic crisis, inflows declined by 14% to $1,697 billion in 2008 (UNCTAD 2009). This decline continued into 2009, with added momentum: preliminary data suggest that in the first quarter of 2009, inflows fell a further 44% compared with their level in the same period of 2008. A slow recovery is expected in 2010, gathering speed in 2011. The crisis has also changed the investment landscape, with developing and transition economies’ share in global FDI flows surging to 43% in 2008 (UNCTAD 2009).

The recent emergence of a number of high-profile multinational enterprises (MNEs) from emerging markets has triggered considerable research and debate on how to understand and appraise this phenomenon. This is notwithstanding the fact that in relative terms, measured as a share of total international foreign direct investment (FDI), the magnitude of the phenomenon remains relatively modest. The challenge for empirical research includes the question of whether the strategies and motives for the inter-nationalization of these MNEs can be considered fundamentally different from the strategies of firms from developed countries (Luo and Tung 2007), or whether their ownership advantages are fundamentally different from those of developed country MNEs (Mathews 2002; Luo and Tung 2007; Buckley et al. 2007; Li 2007). Increasingly described as “springboarding” (Luo and Tung 2007), the internationalization strategies of emerging market firms are characterized by their high-risk, aggressive, and “boom-and-bust” or radical nature, while targeting many customers in many foreign markets at once, in a strategy of entrepreneurial venturing (Yiu et al. 2007). Comparing developed country MNEs of the 1960s, with emerging market MNEs in the 2000s, Dunning, Kim, and Park (2008) identified a number of additional differences. These include forms of entry (alliances); motivation (asset augmentation); managerial approach (regional and geocentric); role of home governments (more active than in the past); regional destination; institutional triggers of internationalization rather than traditional motives related to neoclassical models; and the lack of firm-specific ownership advantages (177).

In this chapter, we use the logic of international business strategy to demonstrate that examples of worldwide integration are special cases that ignore the empirical realities of multinational enterprises (MNEs). In particular, simplistic thinking on globalization does not apply to MNEs from emerging markets. We briefly review empirical evidence that demonstrates that the world’s largest MNEs (including those from emerging markets) do not operate globally, but sell and produce the vast majority of their output within their home region of the triad. We develop an analytical framework which takes into account country-level and regional-level barriers to integration, and is useful in explaining the activities of MNEs from emerging markets. We explore the nature of the firm-specific advantages (FSAs) of emerging market MNEs but find that most of these firms rely on home country-specific advantages (CSAs) at this stage of their development. We finally apply this framework to issues in public policy toward foreign direct investment (FDI). We conclude that, from the viewpoint of international business strategy, prescriptive thinking is misleading if it is believed that MNEs from emerging markets can follow a global strategy of economic integration and assume market access to North American and European economies. Instead, MNEs from emerging markets need to develop strategies to accommodate the realities of intraregional integration and to overcome increasing host country regulations affecting inward FDI.

In chapter 5, Alan Rugman argues convincingly that existing theories of globalization cannot be simply transplanted onto multinational enterprises (MNEs) from emerging markets. Rugman’s main conclusion is that, from the viewpoint of international business academic research, it is misleading to believe that emerging market MNEs can, in their pursuit of European and North American markets, follow the same strategies as MNEs from developed economies. Rather, emerging market MNEs must develop strategies to expand within their geographic regions.

Emerging market multinational enterprises (MNEs) have had difficulties making decisions involving their international strategic plans. These difficulties stem largely from the lack of a historical foundation for making decisions on international trade and investment, due to the relatively recent appearance of these firms as important players in the international arena. This makes it difficult to predict what might become a future success or failure in global markets. Brazilian MNEs are also experiencing these same obstacles, related to a lack of familiarity with the transnationalization process. However, in recent years, their degree of transnationalization has increased, as evidenced by a number of companies that appear regularly in the “Top Twenty Brazilian MNEs” ranking.

Over a historically brief period (a decade and a half), Russia has become a major outward-investing country on the global stage. According to data from the United Nations Conference on Trade and Development (UNCTAD), Russia’s registered outward foreign direct investment (OFDI) stock increased from US$2 billion in 1993, to US$255 billion in 2007 (UNCTAD 2008), making it the fifteenth most important source economy of investments worldwide, and the second largest among emerging markets, behind Hong Kong (China) only and ahead of Brazil, China, India, and South Africa (figure 8.1). However, the onset of a major financial crisis in the second half of 2008, which affected Russia’s economy significantly, raises questions about the immediate future, as well as the long-term sustainability, of those large outward investments.

Outward foreign direct investment (OFDI) from India has increased rapidly over the past two decades. In international terms, however, it remains negligible. The fact that Indian OFDI accounted for a mere 0.2% of global OFDI stocks at end-2007 (UNCTAD 2007a) only serves to underline this fact. In posing the question of why we should be concerned with Indian OFDI, the answer will not be found in macroeconomic data on trends and patterns in Indian OFDI. Rather, the need to study Indian OFDI arises from its idiosyncratic nature, particularly with regard to the substantial number of acquisitions undertaken by Indian firms in the Triad (United States, Western Europe, Japan-Australia) within the past decade. The need to focus on Indian OFDI from a microeconomic level of analysis becomes somewhat urgent given that Indian firms accounted for 60% of all mergers and acquisitions (M&As) undertaken by firms from Brazil, Russia, India, and China (the BRIC countries) in the Triad between 2000 and 2007 (Bertoni, Elia, and Rabbiosi 2007). Most acquisitions of Indian enterprises have received little media coverage, since most targets have been rather small. However, Tata Motors’ takeover of Jaguar and Land Rover has significantly increased media coverage of Indian multinational enterprises (MNEs). This chapter seeks to complement and build upon macroeconomic analyses of Indian OFDI, which have given us a substantial overview of the trends and patterns of this phenomenon, by providing a microeconomic level of analysis that aims to “disentangle the strategies and characteristics” (2–3) of India’s OFDI. Such an analysis can provide us with a comprehensive analysis of the drivers of and motivations behind Indian investments.

China’s outward foreign direct investment (OFDI) has developed extremely rapidly over the past few years, rising from US$2.5 billion1 in 2002 to US$26.5 billion in 2007. Between 1978 and 2002, the accumulated value was US$30 billion, rising to US$57.2 billion by 2005, US$73.3 billion by 2006, and US$117.9 billion by 2007. By the end of 2007, a total of 7,000 Chinese firms had invested in 173 countries (MOC 2008). By 2008, China (including Hong Kong) had become the seventh largest source of OFDI worldwide, Chinese OFDI flows overtaking those of Japan (UNCTAD 2008). In addition to establishing new plants and subsidiaries overseas, Chinese firms have been rapidly acquiring well-known firms worldwide as a new form of transnational investment. Outward foreign acquisitions began in the late 1990s, logging US$344 million (nonfinance FDI) in 2000 and US$507 million in 2001. It jumped to US$2.8 billion in 2002, but subsequently fell to US$1.6 billion. However, since 2004 there has been an unprecedented rise, to US$3.9 billion in 2004 and US$6.5 billion in 2005, 53% of the total OFDI of the year (MOC and State Statistics Bureau 2006, 11). Outward acquisitions by Chinese nonfinance firms rose to US$15.8 billion during the first half year of 2008—61.6% of the total (MOC 2008). Table 10.1 lists the details of these acquisitions between 2004 and 2008.

Even a decade ago, discussing Slovene multinational enterprises (MNEs) in Slovenia would have been akin to swearing. MNEs were perceived as the “bad guys,” transferring profits abroad, hiding, and creating unbalanced development. MNEs were considered responsible for many of the country’s economic problems and for leading to a culture of political dependency. MNEs were synonymous with large firms from Western industrialized countries, exploiting other (frequently less-developed) countries. Until very recently, Slovenia’s own MNEs—that is, those originating in Slovenia and operating abroad—did not feature in public debates. Neoclassical thinking was also prevalent in academia during the 1990s: investing abroad was considered unpatriotic because capital was needed at home (Svetličič 1996, 4). As recently as 2008 (following the “Top 25 Slovene MNEs” press release by Vale Columbia Center on Sustainable International Investment (2008)), several major Slovene newspapers sought to interview the authors on whether Slovene firms were, in fact, MNEs, as the general belief has been that Slovenia does not have MNEs.

According to the United Nations Conference on Trade and Development (UNCTAD), South-South foreign direct investment (FDI) has been growing rapidly, from an estimated US$6.5 billion in 1990 to some US$60 billion as of 2004 (UNCTAD 2006). UNCTAD estimates that there are over 20,0 multinational enterprises (MNEs) headquartered in emerging markets; many with significant potential to expand further their overseas presence. With global FDI flows estimated at US$1.5 trillion in 2007, and flows from emerging markets an estimated US$210 billion in 2006 (figure 12.1), South-South FDI is poised to increase further.

In scholarly and political circles, the economic gains to a country of attracting inward foreign direct investment (IFDI) are now largely uncontested. Such investments are generally perceived to bring a number of benefits to a host economy, not least in relation to employment, productivity levels, organizational and managerial practices, backward and forward linkages, technology, and greater participation in the international division of labor (Buckley and Casson 1998). In recognition of these benefits, much of the policy debate concerning foreign direct investment (FDI) has revolved around IFDI policies and international investment agreements (IIAs), with capital exporting countries usually seeking greater market access, nondiscriminatory treatment, and investment protection in host countries that improves the competitiveness of their own multinational enterprises (MNEs), and developing countries offering increasingly attractive investment policy regimes (UNCTAD 1995). One outcome is that policies toward IFDI have now become relatively well established, wide ranging, and transparent among both developed and developing countries. At the same time, our understanding of the relationship between policy and inward investing firm behavior is reasonably well advanced (Rugman and Brewer 2001).

Following in the footsteps of the developed countries, more and more firms from emerging markets have gradually accumulated sufficient technological and other capabilities—also known as firm-specific advantages—to allow them to expand their operations to other countries and can consequently be labeled multinational enterprises (MNEs) (van Agtmael 2007). As a result, flows of outward foreign direct investment (OFDI) from emerging markets have increased significantly over the past thirty years (chapter 1; Gammeltoft 2008).

What role do government policies play in the process of enterprises’ outward foreign direct investment (OFDI), especially enterprises from emerging markets? As emerging market OFDI retains the momentum of stable and rapid development, more and more scholars (Deng 2004; Peng, Wang and Jiang 2007; Witt and Lewin 2007; Yamakawa, Peng, and Deeds 2008) are paying attention to the institutional factors, in addition to the strategic motivations (Luo 2007) that drive enterprises abroad. However, the main thrust of this scholarly research is to assess the normative and cognitive pillars (Scott 1995, 33) of institutions; few studies explicitly focus on the role of OFDI regula-tion. We proceed, instead, with a pragmatic elaboration of the important role of governmental policies of encouragement, illustrated by several examples from China, relevant to the international business (IB) field.

Not too long ago, the topic of multinational enterprises (MNEs) from developing countries was something of a novelty. In the mid-1980s, when I first began to teach a graduate course on the economics of the MNE, I would always devote one of thirteen classes to the topic (in part, selfishly, because in addition to industrial organization, my other field is development and, therefore, I found the topic fascinating). I recall just how thin the literature on this issue was then, both empirical studies and conceptual work. It was a struggle to put together interesting—and rigorous—material for the students. Today, as reflected by this conference volume, the flows of outward foreign direct investment (OFDI) from emerging markets have become substantial, both in volume and in breadth, although certainly they are much smaller than are flows from the advanced countries, where MNEs have a very long history. Settling on a course reading list now would be something of a challenge.

The European Union (EU) boasts one of the world’s most liberal foreign direct investment (FDI) regimes (OECD 2007). EU member states are hosts to MNEs in most sectors, from virtually every corner of the globe, and many of the new FDI players from emerging markets opt for the EU as host. In the context of increased FDI flows from 2004, peaking at an historic US$1.9 billion in 2007, the EU—like most countries—was rightly criticized for increasing the implementation of restrictive policies and practices with an aim to limit inward FDI (IFDI) as and when governments thought barriers necessary or desirable (UNCTAD 2008). The EU has been criticized by various business executives from emerging markets for raising protectionist barriers to their firms, including Gazprom (Traynor 2007) and Mittal (as chronicled by Bouquet and Ousey 2008). The financial crisis and economic recession triggered by the collapse of the sub-prime market in the United States since 2007 changed the international context for FDI policy significantly. UNCTAD (2009) estimated that IFDI and cross-border mergers and acquisitions (M&As) to the EU declined by around one third in 2008: this represents the largest decline in any part of the world. Even larger declines are predicted for 2009. Governments in the EU are divided over needing short-term capital investment to guarantee jobs and economic growth, and the requirement that they satisfy medium- to long-term political and economic concerns, which fueled the rise of FDI restrictions in the first place. These concerns could escalate if the temptation toward protectionism is not firmly resisted.

Among emerging market multinational enterprises (MNEs), none have received more attention than those headquartered in China. Within the span of fewer than ten years (2000–2007), they invested an estimated US$68 billion abroad, for a total stock of US$96 billion at the end of 2007 (figures 18.1 and 18.2), catapulting China into the ranks of the leading outward investors among emerging markets. This investment takes place in all sectors (and especially services) (table 18.1) and regions of the world (table 18.2), “through more than 5,000 Chinese investment entities [having] established nearly 10,000 overseas enterprises through direct investment across 172 countries and/or economies” (OECD 2008, 71).

International investment is an important driver behind sustainable economic growth, contributing to higher employment, spillovers of technology and skills, and greater productivity. The Organisation for Economic Co-operation and Development (OECD) has a rich tradition of facilitating international cooperation, policy analysis, and advice to governments on how best to enhance the positive contribution of investment in their economies.1 Given the interlinked nature of the global economy—which brings both enormous benefits and potential drawbacks—a challenge for the OECD in the coming years will be to engage both members and nonmembers to continue promoting open, stable, transparent, and predictable investment regimes. Following a brief review of current OECD investment instruments and trends in the openness to international investment, this chapter argues that the OECD can contribute to maintaining and building trust in the international investment regime by adapting existing tools to nonmember states, expanding the number of countries that adhere to the investment instruments, and involving selected emerging markets and developing countries in the next revision of these instruments.

Attracting foreign direct investment (FDI) has become an indispensable economic development tool for countries, regions, and cities. Worldwide, there are estimated to be over 10,000 government agencies at the national and subnational levels with a remit for attracting inward investment. Many of these agencies are large, well funded, and professionally staffed organizations with overseas office networks and significant influence over policy making.

Foreign direct investment (FDI) has expanded at a rapid pace. In 2007, the outward stock of world FDI totaled over US$15.5 trillion, up roughly US$12 trillion from the 1997 stock of US$3.7 trillion (UNCTAD 2009). Much of this growth has come from multinational enterprises (MNEs) based in developed countries members of the Organisation for Economic Co-operation and Development (OECD). But FDI from developed countries is no longer the only significant source of FDI. Emerging market MNEs (any corporation with headquarters located in an emerging market and affiliates elsewhere) have contributed a rising share to world outward FDI (OFDI). In 2007, FDI flows from Brazil, China, India, Mexico, and Russia made up roughly 5% of the world’s OFDI flows. In 1997, the same figure was only 2% (ibid.).1 By 2017, we might see this share rise above 10%, and perhaps reach 15%.

Lawyers are interlopers when the discussion concerns the business challenges that multinational enterprises (MNEs) from emerging markets face today, and are likely to face in the future. As many readers might know from their own (perhaps not entirely pleasant) encounters with lawyers, lawyers ask a lot of questions before they offer advice to their clients. They are notoriously cautious and curious. Accordingly, in this chapter, I would like to raise some of the questions a lawyer would want those running emerging market MNEs to answer, before beginning to suggest the legal ways forward. In doing so, I will begin by outlining some of the background realities that inspire these questions.

The growing list of multinational enterprises (MNEs) from emerging market economies is attracting increasing attention in both government and academic circles. It is one of the least expected aspects of the rising importance of emerging markets within the global economy. The speed with which events are unfolding, as emerging market investors acquire western corporate icons or establish operations in distant markets, means that our understanding of the driving forces and of the likely implications is still in its infancy. Our understanding also often lags behind policy reactions in home and host countries.