Trade and Investment in a Globalising World (Series in International Business and Economics)

Trade and Investment in a Globalising World Essays in Honour of H. Peter Gray

Series in International Business and Economics Series Editor. Khosrow Fatemi

Titles include: BASU & MIROSHNIK Japanese Multinational Companies: Management and Investment Strategies BEANE The United States and GATT: A Relational Study CONTRACTOR Economic Transformation in Emerging Countries DUNNING Globalization, Trade and Foreign Direct Investment FATEMI International Public Policy and Regionalism at the Turn of the Century FATEMI International Trade in the 21st Century FATEMI The New World Order: Internationalism, Regionalism and the Multinational Corporations FATEMI & SALVATORE The North American Free Trade Agreement GHOSH New Advances in Financial Economics GRAY & RICHARD International Finance in the New World Order HAAR & DANDAPANI Banking in North America: NAFTA and Beyond KOSTECKI & FEHERVARY Services in the Transition Economies KREININ Contemporary Issues in Commercial Policy MONCARZ International Trade and the New Economic Order PRAKASH et al. The Return Generating Models in Global Finance Related Elsevier Science Journals International Business Review International Journal of Intercultural Relations Journal of International Management Journal of World Business World Development

Trade and Investment in a Globalising World Essays in Honour of H. Peter Gray

Edited by

Rajneesh Narula University of Oslo and The Norwegian School of Management (B.I.)

2001 PERGAMON An Imprint of Elsevier Science Amsterdam - London - New York - Oxford - Paris - Shannon - Tokyo

ELSEVIER SCIENCE Ltd The Boulevard, Langford Lane Kidlington, Oxford OX5 1GB, UK

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Contents

LIST OF TABLES AND FIGURES

vii

CONTRIBUTORS

ix

PREFACE

xi

1.

Globalization of Markets and Financial-Center Competition INGO WALTER 1

2.

Electronic Commerce: Its Effect on Service Industries CLIFF WYMBS

38

3.

Determinants of U.S. Direct Investment in the EU and Japan RAJNEESH NARULA AND KATHARINE WAKELIN 55

4.

Competitive and Comparative Advantages: The Determinants of Japanese Direct Investment Activity in Manufacturing

5.

YUI KlMURA AND THOMAS A. PUGEL

69

The Impact of Direct and Indirect FDI in Eastern Europe on Austrian Trade and Employment WILFRIED ALTZINGER AND CHRISTIAN BELLAK

86

6.

The Role of Foreign Owned Firms and some Determinants of Inward Foreign Direct Investment in the Moroccan Manufacturing Sector SAAD LARAQUI 113

7.

Incorporating Trade into the Investment Development Path JOHN H. DUNNING, CHANG-SU KIM AND JYH-DER LIN 135

8.

Evolutionary Understanding of Corporate Foreign Investment Behavior: U.S. Foreign Direct Investment in Europe JOHN HAGEDOORN AND RAJNEESH NARULA 156

vi

Contents

9.

Multinational Strategy and the Evolution of Environmental Standards in the Global Economy SARIANNA M. LUNDAN 10. Promotion of Products from Developing Countries: An Overview and Assessment of Import Promotion Efforts GEIR GRIPSRUD AND GABRIEL R.G. BENITO

185

199

APPENDIX: Curriculum Vitae of H. Peter Gray

217

AUTHOR INDEX SUBJECT INDEX

233 237

List of Tables and Figures TABLES

TABLE 1.1 Capitalization of Major Securities Markets Nominal Value Outstanding, 1998 (US$ billions) TABLE 1.2 Capital Market Activity, 1992-98 (US$ billions) TABLE 1.3 Global M&A Developments (Volume of Transactions in US$ billions and percentages) TABLE 1.4 Global Wholesale Banking and Investment Banking 1998. Full Credit to Book Running Manager Only (US$ millions) TABLE 1.5 Global Wholesale Banking and Investment Banking: Market Concentration TABLE 1.6 Global League Table of Leading Asset Managers (assets under management exceeding US$100 billion) TABLE 1.7 Financial Centers: Three Attribute Activity Matrix TABLE 2.1 Shifting from Physical to Electronic Markets: Changes in the Business Model TABLE 2.2 International Trade of Selected e-Commerce Firms, 1997 TABLE 3.1: Indicators of FBI in the Sample TABLE 3.2: Panel Results including Fixed Effects TABLE 4.1: Variables Used in the Analysis TABLE 4.2: Determinants of the FDI Intensity of Japanese Manufacturing Industries, 1981 TABLE 5.1 Share of Austrian FDI in total FDI of selected CEECs TABLE 5.2 Sales and Employment Performance of Direct and Indirect FDI TABLE 5.3 Main Differences between Austrian Direct and Indirect FDI in CEECs, 1991 and 1996 TABLE 5.4 Industrial Distribution of Austrian Direct and Indirect FDI in CEECs by Host Country Industry, 1996 TABLE 5.5 Regional Sales Structure of Parent Firms, 1995 (%) TABLE 5.6 Changes in Regional Sales Structure of Parent Firms, 1989-95 (%) TABLE 5.7 Expected Regional Sales Structure of Parent Firms, 1995-98 (%) TABLE 5.8 Regional Sales Structure of Affiliates, 1995 (%) TABLE 5.9 Intra-Firm (IF) Trade, 1996 (ATS mn) TABLE 5.10 OLS Regression Results for Parent Exports to CEECs TABLE 5.11 OLS Regression Results for Affiliate Exports to EU TABLE 5.12 OLS Regression Results for Parent Employment, 1995 TABLE 5.13 Motives of Foreign Investors in Austria TABLE 6.1 FDI by Country (in millions of Moroccan dirhams) TABLE 6.2 FDI by Industry (in Moroccan dirhams)

viii

List of Tables and Figures

TABLE 6.3 Comparisons between Different Regions: Degree of Profitability in the Different Regions TABLE 6.4 Gains from Moroccan Investments: Degree of Importance in Decision-making on EDI in Morocco TABLE 6.5 Strategic Motives for FDIs: Degree of Importance in Decisionmaking on FDI in Morocco TABLE 6.6 Firm Competitive Advantages in Morocco TABLE: 6.7 Moroccan Locational Advantages TABLE 6.8 Impact of Integration on Morocco TABLE: 6.9 Morocco/EU Relationship: Attractiveness of Morocco for FDI TABLE 7.1 The FDI Intensity of Korean and Taiwanese Imports and Exports and GNP per capita TABLE 7.2 Proportion of A, O, and B Type Imports and Exports as a Percentage of Total Imports and Exports TABLE 7.3 Inward and Outward Direct Investment and GNP per capita TABLE 7.4 Proportion of Inwards FDI (IDI) and Outwards FDI (ODI) Accounted by FDI Intensive Sectors TABLE 7.5 Proportion of A, O, and B Type FDI as a Percentage of Total FDI TABLE 7.6 The FDI Intensity of Korean and Taiwanese Trade and FDI TABLE 7.7 The FDI Intensity of Korean and Taiwanese Trade and FDI TABLE 7.8 Intra-industry Trade and FDI TABLE 8.1 FDI and Real GDP Growth Rates for Selected Periods, 1950-1990 TABLE 8.2 Imbalance Coefficient, Selected Years TABLE 9.1 Trade and Investment in Pulp and Paper (Sweden and Finland) TABLE 10.1 Establishment Year and Size of IPAs in OECD Countries TABLE 10.2 Statement of Goals of IPAs in OECD Countries TABLE 10.3 Distribution of the Support Activities of IPAs in OECD Countries FIGURES FIGURE 1.1 Distribution of International Bank Lending by Nationality of Reporting Banks FIGURE 1.2 The Foreign Exchange Market (Net Turnover, US$ trillion) FIGURE 1.3 Top 10 Financial Centers for Foreign Exchange, 1998 (estimated in billions of U.S.f) FIGURE 1.4 Centrifugal and Centripetal Locational Mapping of Financial Services FIGURE 2.1 How Changes in Information Affect Service Industry Returns FIGURE 5.1 Direct and Indirect FDI FIGURE 7.1 Four Stages in the IDP and TDPs of Industrializing Developing Countries FIGURE 8.1 Ratio of FDI Stock to Nominal GDP, 1950-90 FIGURE 8.2 Share of U.S. Manufacturing Worldwide, 1950-90 FIGURE 8.3 Trends in Relative GDP per capita, 1980 Prices, 1950-90 (U.S.A. = 100) FIGURE 9.1 Use of Chlorine in the Pulp and Paper Industry (Sweden and Finland) FIGURE 9.2 The Environmental Standards-setting Process FIGURE 10.1 A Typology of Governmental Strategies toward Internationalization

List of Contributors ABOUT THE EDITOR

Rajneesh Narula studied Electrical Engineering in Nigeria, and subsequently worked as an Aero-Electronics Engineer from 1983 to 1986. He completed an M.B.A. from Rutgers University, Newark, U.S.A., after which he worked in Hong Kong for IBM Asia/South Pacific as a Business Plans Analyst. After leaving Hong Kong in 1989, he was a Research Fellow in International Business and a visiting lecturer at Rutgers University, U.S.A., where he completed his Ph.D. He has also been a consultant for the UNCTAD, UNIDO and the European Commission as well as several international companies. From 1993 to 1998 he was an Assistant Professor in International Business and Research Fellow at MERIT, at Maastricht University, The Netherlands. He is currently a Professorial Fellow at the Centre for Technology, Innovation and Culture (TIK), University of Oslo and the STEP group, and Professor II in Strategy at the Norwegian School of Management (BI). His research interests include foreign direct investment theory, strategic alliances, competitiveness, technology, globalization, economic growth and government policy, Africa and the NICs. ABOUT THE CONTRIBUTORS

Wilfried Altzinger is Assistant Professor at the Department of Economics at the University of Economics and Business Administration, Vienna. Christian Bellak is Assistant Professor at the Department of Economics at the University of Economics and Business Administration, Vienna. Gabriel R.G. Benito is currently Professor of International Strategy and Head of the Globalization Programme at the Norwegian School of Management, BI. IX

x

Contributors

John Dunning is Emeritus Professor of International Business at the University of Reading, U.K., and State of New Jersey Professor of International Business at Rutgers University, U.S.A. Geir Gripsrud is the Tine/Gilde Professor of Marketing and Head of the Centre for Research on Cooperatives at the Norwegian School of Management, BI. John Hagedoorn is Professor of Strategic Management at the Faculty of Economics and Business Administration of the University of Maastricht, The Netherlands. Chang-Su Kim is a doctoral candidate in International Business at Rutgers University. Yui Kimura was Professor of Strategic Management and International Business at the Graduate School of Systems Management, University of Tsukuba, Tokyo, Japan. He passed away in 1999, as he and Tom Pugel were beginning work on the final draft of their chapter. Saad Laraqui is Assistant Professor in Business Administration at the Embry-Riddle Aeronautical University, Florida. Jyh-Der Lin currently works for AT&T, having recently completed his Ph.D. degree from Rutgers University. Sarianna Lundan is Associate Professor of International Business Strategy at the University of Maastricht, The Netherlands. Tom Pugel is Professor of Economics and International Business, as well as Chair of the International Business Area and Fellow of the Teaching Excellence Program, at the Stern School of Business, New York University. Katharine Wakelin is currently a Research Fellow at the Centre for Research on Globalisation and Labour Markets at the University of Nottingham, U.K. Ingo Walter is the Charles Simon Professor of Applied Financial Economics at the Stern School of Business, New York University. Cliff Wymbs is Assistant Professor at Baruch College, City University of New York.

Preface Book editing is rarely, if ever, a source of joy and ecstasy for the editor. When it is a first edited volume, he/she is motivated by thoughts of impending glory and great gobs of royalties that will accrue when the book hits the best-seller lists. One hums the melody from the Beatles' Paperback Writer incessantly, because one naively imagines that all good books go to paperback. By the second or third book, these dreams about wealth have evaporated, although a little hope lingers that some notoriety will be forthcoming, albeit only amongst one's immediate colleagues and the occasional relative. I peaked early: even my mother no longer shows any enthusiasm for my latest efforts. There are, in other words, diminishing returns on editing. This book is an exception to the rule. It has been an unmitigated pleasure to help in editing a festschrift in honour of Peter Gray. First, because Peter is a man of many parts. He combines personal charm with sparkling wit, and somehow manages to throw in some grace and a lot of warmth into everything he does. He lives life with gusto. He travels to the most remote locales and regales everyone with amazing stories. He buys drinks for impoverished Ph.D. students and prosperous professors alike at the drop of a hat, a fact that first endeared him to me. Second, because he is a scholar with a reputation that is justified. Not for him the security of a single, specialized field. He has wielded his pen without fear to tackle disparate areas of scholarship, and in almost all instances has left a indelible mark on his chosen target. His CV attests to this (which we have included as an Appendix to this volume). I have taken the liberty of only including his completed works, but it will come as no surprise to those of you who know him that the list of his 'work in progress' would make even the most prolific post-doctoral fellow green with envy, especially if one recalls that Peter is technically retired, and spends (along with Jean)

xii

Preface

a good proportion of his time doing a Jacques Cousteau impression in exotic spots. His penchant for scuba diving and a more than passing resemblance to Nautilus, are (I have heard it said) no coincidence. I shall leave it to the reader to think that one through. Ordinarily, dredging the scholarly waters for contributors to edited volumes is hard work, but not in this instance. Peter's friends and admirers span the globe. His competences and his capacity for listening with unfeigned interest to the most lame-duck of ideas (I speak from experience) thought up by his colleagues and students have won him a large fan club. More often than not, he helps to find that small gem in every bucket of hogwash. We have, for reasons of economy, decided to limit the contributions to co-authors, colleagues and former students. This too, is a large population, and covers a wide spectrum of research, until we decided to limit contributions to international trade, direct investment and macro-economic policy. Now this may appear (to the cynical reader) to provide us with categories you could drive a truck through, but it is just the sort of large canvas typical of Peter's work. Each contribution, apart from raising academic issues, also has profound (admittedly some more than others) policy implications. There is food for thought for every sort of economist and international business theorist. A veritable motley crew of contributions, contributors and ideas, all tied directly to Peter's body of work. The idea for this tome began, unsurprisingly enough, in a conversation with John Dunning as a 75th birthday tribute. With a little help from Khosrow Fatemi, we had some early contributions presented at a special session of the Annual Meeting of the International Trade and Finance Association (an organization which once had Peter as president) in Casablanca in May 1999. Sammye Haigh (as in 'heart of gold') was quick to suggest Pergamon as a possible publisher, an opportunity I am grateful for. Bob Hawkins originally came aboard as co-editor to make up for my vast inexperience with Peter's work and life. However, due to his various other commitments, he was unable to continue in this role. I'd like to thank him for his various inputs along the way. There are several people who were not, unfortunately, able to contribute for a variety of reasons, but who have provided encouragement and advice through the various phases of the book. Included in this number are Bob Stuart, Max Kreinin, John Dilyard, Lorna Wallace, Jean Gray and Bob Hawkins. Editorial assistance has been provided by Berit Nilsen Bua at the University of Oslo, and by Dolores Briante in Atlanta. I am grateful to Sudha

Preface

xiii

Menon for preparing the index. Their input has been invaluable, and I owe them a debt of gratitude. Peter, I've never done a festschrift before, but I believe the whole idea behind them is to say how grateful we are for you being who you are, and for sharing. If we were musicians, we'd have done a heavy metal concert entitled 'Peter Rocks'. But seeing as most of us aren't so gifted, we must do it the more painful way, by writing an academic tome with just the one exclamation mark. But my instinct tells me more of your friends will read this, than listen to a rock album! Rajneesh Narula Oslo, October 2000

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1 Globalization of Markets and Financial-Center Competition INGO WALTER1

I.

INTRODUCTION

Few developments in the world economy have been as dramatic or as far-reaching in their significance as the evolution of global financial markets in the latter part of the 20th century. Driven by rapid change in technologies and the attendant reduction in information and transaction costs, this has led to broad-based integration of financial markets, with great implications for efficiency in global capital allocation as well as for international macroeconomic linkages and policy-formation. Much of this activity is carried out in a limited number of financial centers, even though the ultimate sources of finance are overwhelmingly found in globally-dispersed private households, while ultimate users of finance are almost as broadly dispersed in corporate, government and individual borrowers and issuers around the world. These financial centers generate significant real economic gains for their respective national economies, gains that come in the form of improved income end employment, higher capital and labor productivity, and enhanced economic growth, as well as significant fiscal contributions. Financial services also constitute a significant sector in international service trade. Partly for this reason, the dramatic evolution of global finance has given rise to equally dramatic competition among the world's financial centers in a vigorous search for competitive advantage. The following section of this chapter defines what is meant by "globalization" in finance, and identifies the sources of value-added in the internationally-competitive financial services sector in terms of a "value-chain" that ultimately gives rise to the real economic

2

Ingo Walter

gains attributable to financial-center operations. The paper then presents available evidence as to where the relevant value-added activities actually take place, and examines the "centrifugal" and "centripetal" forces that determine the concentration or dispersal of value-added activity in financial intermediation, both inter-regionally and internationally.2 It then assesses the factors which appear to underlie the locational pattern of international financial centers that has evolved, and concludes with the outlook for the future pattern of financial centers in the global competitive environment. II.

WHAT DOES FINANCIAL GLOBALIZATION MEAN?

Globalization of finance encompasses a number of interrelated processes. These stretch across a spectrum between the principals in the generic financial inter-mediation process—between end-sources and end-users of funds. Banks fund themselves directly or indirectly with household, business or public-sector deposits that are deployed in the form of domestic and international credit portfolios (cross-border lending) that today shape globalized inter-mediated financial flows. Net savers have the alternative of purchasing insurance contracts and insurance-linked savings products, with the resulting claims and reserves deployed nationally and globally in securities portfolios, loans and direct participations, in line with the insurers' contractual obligations and actuarial reserve needs. Or net savers may purchase domestic or foreign securities, either directly or indirectly in the form of mutual funds, pension funds, trusts or other asset pools managed by fiduciaries. These are intended to optimize the balance of risk and return in line with investment objectives across asset classes whose total returns are not perfectly correlated in corporate, industry, currency, commodity or real-estate portfolios. The search for higher returns and international portfolio diversification (IPD) has long characterized asset-allocation strategies on the part of banks, insurance companies, and institutional investors, with various asset classes and associated derivatives making it possible to fine-tune portfolio profiles in conformity with specific lending and investment objectives. At the other end of the financial spectrum, businesses may borrow from banks in the form of unsecured or asset-backed straight or revolving credit facilities, or they may sell their own equities or debt obligations (e.g., commercial paper, receivables financing, fixed-income securities of various types) directly into the financial market. Consumers may finance purchases by means of personal loans from banks or by loans secured by purchased assets

Globalization of Markets and Financial-Center Competition

3

(mortgages, hire-purchase or instalment loans). These will appear on the asset side of the balance sheets of credit institutions on a fixed or revolving basis for the duration of the respective loan contracts, or they may be syndicated or sold-off to other banks or into the financial market in the form of structured securities backed by various types of bank receivables. Governments or public-sector entities can likewise borrow from credit institutions (sovereign borrowing) or issue full faith and credit or revenue-backed securities directly into the market. In turn, financing and asset portfolios can be repackaged and structured using currency and interest rate swaps and other contracts to tailor the transactions to the needs of the borrowers and issuers, on the one hand, and the lenders and investors on the other. The process easily crosses the boundaries of national financial systems so that, for example, a British corporation may be able to issue a local-currency security in Australia which, when purchased by local institutional investors and swapped into sterling, can provide lower all-in financing costs than local borrowing in the U.K. Or an American homeowner may find his dollar-denominated mortgage financed in part by a Japanese family that has invested in a yendenominated fixed-income mutual fund allocated in part to swapped U.S. asset-backed securities. Global markets for foreign exchange, debt and even equity have developed various degrees of "seamlessness" that have profoundly altered the modes and locations of world financial activity. Globalization in the financial market thus involves accessing the complete state-space of financial contracts, sources and users of finance worldwide in order to optimize the objective functions of financial end-users. In the process, significant value is added by financial intermediaries and markets—value that tends to be highly transaction-specific. It encompasses provision of price-discovery and trading services in various types of organized or OTC markets.3 It includes information utilities such as Bloomberg and Reuters, rating agencies such as Moody's and Standard & Poor's, portfolio diagnostic services such as Morningstar and Lipper Analytics, as well as securities and payments clearance and settlement services such as Euroclear and Swift. It also covers intermediaries' services in the structuring of financial contracts, underwriting and distribution of securities, and corporate finance and M&A advisory work. The value created in the inter-mediation process can be measured in the returns to the factors of production devoted to it both directly and indirectly—returns to labor, capital and land. The most successful financial centers generally employ large numbers of highly skilled, highly compensated individuals in the

4

Ingo Walter

financial inter-mediation process itself and in related sectors such as legal, accounting, publishing, consulting, and information technologies. Returns to capital involve interest and profit earned by lenders and investors resident in the major financial centers. Returns to land involve actual and imputed rents on the real estate used in financial centers, whose value is closely linked to the pace of financial activity. Related to the earnings of factors of production directly and indirectly employed in financial inter-mediation activities are tax receipts of local and regional governments. The battle among financial centers is, among other things, a battle for economic gains in one of the fastest-growing service industries in the global economy. Why do cities and countries struggle for position as financial centers? As noted, there is the direct, quantitative importance of the industry itself in terms of its contribution to economic activity, growth, employment, investment, the trade balance, tax revenues, and other economic performance benchmarks. Beyond this are indirect contributions that take into account vertical and horizontal linkages to sectors of the economy that are suppliers, users, and otherwise complementary to the financial services sector, such as travel and legal services, office equipment and the printing industry. Assessment of its overall contribution depends on the relevant input-output relationships—that is, how much each industry buys from (and sells to) every other industry in the national economy, and how much such activity would be lost if financial services were to migrate elsewhere.4 III.

WHAT FINANCIAL SERVICES ARE WE TALKING ABOUT?

It is useful to catalogue the specific kinds of financial inter-mediation services that make up the bulk of the activities in functional financial centers, from which the direct and indirect real-sector value-added derives. Each has its own mobility characteristics and locational dynamics. International Lending and Interbank Dealing

Loan syndication comprises the bulk of global wholesale lending activities carried out in financial centers, other than conventional trade finance. This involves the structuring of loans, backstops and credit enhancements, project financing and other commercial banking facilities in conjunction with clients, and then sellingdown participations to other banks. Selldowns may be quite limited (club deals) or may involve a very large number of banks in fully

Globalization of Markets and Financial-Center Competition

5

syndicated transactions. Deals are put together by lead-managers who earn origination fees and, jointly with other major syndicating banks, earn underwriting fees for fully committed facilities. These fees usually differ according to the complexity of the transaction and the credit quality of the borrower, and there are additional commitment, legal and agency fees involved as well. In some cases, loan participations are sold widely to other banks in loan-sales programs, and more recently loans have been packaged through special-purpose vehicles into securities that are sold to a broad range of institutional investors. Wholesale loans tend to be funded in the interbank market, either in domestic or Eurocurrency, through bank treasury operations' dealing desks that tend to be located in the major financial centers. While little information is available on value-added in international wholesale lending, it is clear that volume increased rapidly in the 1990s, from US$403 billion in 1992 to over US$1 trillion in 1995 and US$1.3 trillion in 1997.5 The nationality of the lending banks is presented in Figure 1.1, which shows a comparatively modest market share on the part of U.S., Canadian and Japanese banks and a very large share on the part of European banks—as of mid-1997, 55.5% of all cross-border lending was booked by European banks, 14.5% by North American Banks, 16.4% by Japanese banks, and 13.6% by banks based in other countries.6 However, the actual value-added and booking of syndicated lending transactions is North American Banks 14.5 %

Japanese Banks 16.4%

European Banks 55.5 %

Other Banks 13.6% FIGURE 1.1 Distribution of International Bank Lending by Nationality of Reporting Banks Source: Bank for International Settlements, The Maturity, Sectoral and Nationality Distribution of International Bank Lending, Basel, January 1998.

6

Ingo Walter

predominantly undertaken in London, with additional centers in New York, Hong Kong and Singapore. Foreign exchange operations are generally undertaken in a broker-dealer market structure dominated by the commercial banks, which cover both interbank and client-driven spot trades as well as foreign exchange and interest rate swaps and forward contracts. This trading activity likewise tends to be relatively concentrated geographically, and is strongly influenced by time-zone considerations—as is true of interbank funding operations. Whether it must be concentrated in the heart of a major financial center, however, is open to debate. Foreign exchange trading has expanded at a rapid pace during the 1980s and 1990s in comparison with global trade in goods and services, as Figure 1.2 indicates. According to the most recent (1999) survey of the Bank for International Settlements, London's foreign exchange volume is far ahead of competing financial centers, with almost twice the volume of New York and three times the volume of Tokyo, a market share that has grown over the years. Tokyo has suffered a significant market share loss against Singapore and Hong Kong in the Asian time-zone—see Figure 1.3.

450

402,4 400 350

321,6

300 250

229

200 131

150 100 50

35

17,5

2,7

1,5

0

1979

1984

1988

1992

1995

! Foreign Exchange • Exports of Goods and Commercial Services

Source:

FIGURE 1.2 The Foreign Exchange Market (Net Turnover, US$ trillion) Bank for International Settlements, International Trade Organization, 1999.

Globalization of Markets and Financial-Center Competition

New York $244

London $464

Copenhagen $ 29 Tokyo $161

Sydney $ 40 Paris $ 58

Singapore Frankfurt $ 80 $ 105 Hong Kong Zurich $91 $86 FIGURE 1.3

Top 10 Financial Centers for Foreign Exchange, 1998 (estimated in billions ofU.S.$) Source: Bank for International Settlements survey of 26 central banks published on October 19, 1999.

Capital Market Access, Trading and Research Underwriting new issues of debt and equity securities—both seasoned and initial public offerings—for a range of clients, including privatesector corporations, government-owned or government-controlled entities, sovereign governments and multilateral agencies, is a major area of activity of securities firms or securities departments of universal banks. The underwriting function involves purchasing the securities from the issuer and on-selling them either in public markets or to large institutional investors in the form of private placements, in the process incurring exposure to underwriting risk (market risk and event risk) and typically earning a "spread" between the buying and selling prices. In terms of the various instruments originated: Bond (fixed-income) underwriting is usually carried out through domestic and international underwriting syndicates of securities firms with access to local investors, investors in various foreign markets such as Switzerland (foreign bonds), and investors in offshore markets (Eurobonds) using one of several alternative distribution techniques. Placements may also be restricted to selected institutional investors (private placements) rather than the general public. Access to various foreign markets is facilitated by means of interest-rate and currency swaps (swap-driven issues). Some widely-distributed multi-market issues have become known as "global issues". In some markets, intense competition and deregulation have narrowed spreads to the point that the number of firms in underwriting syndicates has declined over time, and in some cases a single participating firm handles an entire issue—the so-called "bought deal".

8

Ingo Walter Commercial paper and medium-term note (MTN) programs maintained by corporations, under which they can issue short-term and medium-term debt instruments on their own credit standing and more or less uniform legal documentation, have become good substitutes for bank credits. Financial institutions provide services in designing these programs, obtaining agency ratings, and dealing the securities into the market when issued. In recent years, MTN programs have become one of the most efficient ways for borrowers to tap the capital market. Equity underwriting is usually heavily concentrated in the home country of the issuing firm, which is normally where the investor-base and the secondarymarket trading and liquidity is to be found. New issues of stock may be offered to investors for the first time (initial public offerings, or IPOs), to the general public on a repeat basis (seasoned issues), to existing holders of shares (rights issues) or only to selected institutional investors (private placements). Secondary market trading in cash instruments such as stocks, bonds, asset-backed securities, foreign exchange, and sometimes commodities such as cereal grains, pork bellies and metals—as well as derivatives on individual securities or commodities (mainly futures and options) or on indexes. Activities include customer trading (executing client orders), proprietary trading (for the firm's own account) and market-making (being prepared to quote both bid and offer prices), and arbitrage—buying and selling simultaneously in at least two markets to capitalize on price discrepancies between different markets for underlying financial instruments or derivatives, or between cash and derivatives markets (e.g., "program trading", computer-driven arbitrage between the futures and cash markets). There is also engagement in "risk arbitrage", usually involving speculative purchases of stock on the basis of public information relating to mergers and acquisitions. Brokerage, involving executing buy or sell orders for customers without actually taking possession of the security or derivative contract, sometimes including complex instructions based on various contingencies in the market. Research, into factors affecting the various markets as well as individual securities and derivatives. Securities research is made available to clients by more-orless independent analysts within the firm, whose opinion can be taken seriously. Analysts' careers depend on the quality of their insights, usually focused on specific industries or sectors. The value of research provided to clients depends critically on its quality and timeliness, and is often rewarded by business channelled though the firm, such as brokerage commissions and underwriting mandates. Closely allied are research activities—often highly technical modeling exercises—involving innovative financial instruments which link market developments to value-added for issuer-clients and/or investor-clients. Hedging and risk management mainly involves the use of derivative instruments to reduce exposure to risk associated with individual securities transactions or markets affecting corporate, institutional or individual clients. These include interest-rate caps, floors and collars, various kinds of contingent contracts, as well as futures and options on various types of instruments. It may be quicker, easier and cheaper, for example, for an investor to alter the risk profile of a portfolio using derivatives than by buying and selling the underlying instruments.

Securities market capitalization data, presented in Table 1.1 at the country level, show the U.S. with almost 47% of the global total

TABLE 1.1

Capitalization of Major Securities Markets Nominal Value Outstanding, 1998 (US$ billions) Bond Market

Country of Issuance

Government

USA

7550

EU11

4812 809

EU4 Total EU Japan Rest of the World

World Total

Source:

5621 3118

Corporations

5795 2319 692 3011

Euro & Foreign Bonds 738

1320 512

190

1212 764

1832 293 1224

16479

10782

4087

Total Bonds

Equity Market

Total Market Capitalization

14083 8451 2013 10464 4623 2178

13451

2496 4604

27534 12611 4764 17375 7119 6782

31348

27462

58810

4160 2751 6911

" o-

BIS, IFC.

n o 3

10

Ingo Walter

(outstanding bonds and stocks combined), followed by Japan with 12% and a combined European share of almost 30%. This is reflected in new-issue volume (excluding government bonds), depicted in Table 1.2 for the years 1992-98, with a U.S. share of about 64% of the global total. The European share of both market capitalization and new-issue volume should rise if introduction of the Euro leads to an increasingly integrated, capital market dominated by performance-driven issuers and investors. Corporate Finance

Corporate finance activities predominantly relate to advisory work on mergers, acquisitions, divestitures, re-capitalizations, leveraged buyouts and a variety of other generic and specialized corporate transactions: Mergers and acquisitions services involve fee-based advisory assignments to firms wishing to acquire others (buy-side assignments) or firms wishing to be sold or to sell certain business units to prospective acquirers (sell-side assignments). The M&A business is closely associated with the market for corporate control, and may involve advisories and fund-raising efforts for hostile acquirers or plotting defensive strategies and re-capitalization for firms subject to unwanted takeover bids. It may also involve providing independent valuations and "fairness opinions" for buyers or sellers of companies to protect against lawsuits from disgruntled investors alleging that the price paid for a company was either too high or too low. Such activities may be domestic, within a single national economy, or cross-border between a M&A buyer in one country and a seller in another. Re-capitalization tends to involve advice to corporations concerning optimum capital structure, increasing or decreasing the proportion of debt to equity in the balance sheet, types and maturity-structure of liabilities, stock repurchase programs, and the like. The securities firm may provide financial advice on these matters as well as supplying the required execution services through its capital markets activities. There are also advisory services regarding energy, transportation or project financing that require specialized industry expertise. Privatization became a major component of global wholesale financial services in the early 1980s, beginning with the U.K. and spreading to continental Europe and emerging market countries based on shifting political perceptions as to what types of economic activity belong in the public and private sectors, respectively. Privatizations have run the gamut from state-owned manufacturing and services enterprises to airlines, telecommunications, infrastructure providers, etc, using various approaches such as sales to domestic or foreign control groups, stock market flotation, global equity distributions, sales to employees share ownership plans, and so on. Value-added by financial services firms include buy-side and sell-side advisory assignments as well as initial and secondary public offerings and distribution of securities in the privatized enterprises. Privatization transactions are usually included in global M&A deal-flow data.

TABLE 1.2

Capital Market Activity, 1992-98 (US$ billions)

1998

1997

1996

1995

1994

1993

308.6

284.7 726.1

255.3

404.9 417.3

282.8

260.3

169.4

518.9

342.5

281.1

252.3 121.4

154.1

149.9

378 125.3

214.8

214.8

181.7

30.2 154.9

252.5 36.4

389.2 478.9

1738.4

1728.9

1329.6

International Issues Euro Medium Term Notes

598.0

420.0

Euro and Foreign Bonds

846.9

635.2

1444.9

1055.2

930

US Domestic New Issues Medium Term Notes Investment Grade Debt Collaterialized securities Below Investment Grade Municipal Debt

504.2 560.9

1992

69.5

428.2 53.7

161.3

287.8

231.7

1161.4

1075.5

1485.7

1164.1

392.6

251.6

96.9

385.1

257.2 485.2

149.8

537.4

482.7

335.9

636.7

742.4

632.5

432.8

C)

o Cr

o 3 O_

Total

Total Source:

Thompson Financial Securities Data Company, 1999.

£

n oT

o

I ru

12

Ingo Walter

Merchant banking involves financial institutions placing their clients' and their own capital on the line in M&A transactions and other equity participation. This could involve buying control of entire firms in order to restructure and eventually sell them, in whole or in part, to other companies or to the investing public. It may also involve large, essentially permanent stakeholdings in business enterprises, including board-level representation and supervision of management. Or it may involve short-term subordinated lending (bridge loans or mezzanine financing) to assure the success of an M&A transaction, intended to be quickly repaid out of the assets of the surviving entity. Other areas of significant direct investments may include real estate and leveraged lease transactions, for example.

While it is difficult to allocate value-added with respect to corporate finance and advisory services to particular financial centers, Table 1.3 provides data on the general geography of merger and acquisitions transactions. The volume of M&A deals in the 1980s was dominated by the U.S., with the European share of the global deal-flow rising dramatically in the early 1990s and both U.S. and European deal-flow expanding in the privatization and corporate restructuring boom of the late 1990s. Again, the advent of the Euro and continuing pressure for improved competitive performance at the industry level, together with a good deal of privatization left to be done in countries like France and Italy, could again raise the European share in the future. Advisory work on the bulk of major M&A transactions is carried out in London and New York, although much of the work for smaller transactions is executed in the regional financial centers. Some additional inferential evidence may be taken from the home-bases of the major firms in global finance. Table 1.4 shows the top 50 firms in terms of global deal-flow in 1998. Of the top 10, which handled 78% of the combined financial transaction volume, seven were American, three were European and none was Japanese (see Table 1.5). Of the top 20 firms, with a combined market share of over 97%, 11 were American, eight were European and one was Japanese. The Herfindahl-Hirshman index of market concentration for the top 10 firms increased from 328 in 1992 to 716 in 1998, and for the top 20 from 393 in 1992 to 764 in 1997, showing roughly a doubling of market concentration but still a very low absolute level.7 The dominance of the U.S. firms is evident. These are predominantly based in New York, although the value-added they generate occurs in various financial centers around the world. This balance could shift as the major European universal banks acquire or build significant market shares against their American rivals, especially if the Euro creates disproportionate growth in Europe's share of global transactionflow.

TABLE 1.3 1999*

Global M&A Development (Volume of Transactions in US$ billions and percentages) 1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

293.2 77.9

203.9

200.9 39.3

192.3 15.9 11.5 8.8

Transactions: US Domestic

353.5

801.8

488.3

330.7

218.5

199.8

101.1

119.3

108.5

124.9

250.1

US Cross-Border

230.5

106.5

58.4

34.9

33.5

40.5

73.0

85.6

193.3

European Cross-Border

307.5 173.1

101.9 242.4

84.5

Intra-European

292.2 305.9 291.4

151.8 72.4

85.6 57.1

59.9 33.0

91.0 43.0

US-European Cross Border All Other

(167.6) (210.3) (49.2) 116.6 118.6 116.2

(43.5)

(39.0)

(27.4)

117.2 53.8 (13.3) (22.8)

84.9

47.1

34.3

60.2

43.0

54.2

Global Total

1013.2

1599.6 978.5

713.7

552.8

406.9

261.7

316.5

78.5

73.2 (52.9)

86.4

50.2 54.9 41.4

127.2 130.1 97.7 74.3 (36.6) (46.3) 69.7 47.8

(38.2) 37.5

(28.3)

20.7 35.4 (17.4)

28.2

15.9

10.5

351.4

434.0

563.5

511.4

350.3

294.8

233.1

54.6

o Cr

(5.9)

US/Total (%)

57.6

68.4

60.3

63.5

52.0

48.3

42.4

45.6

59.6

47.4

37.3

32.8

58.2 37.3

58.8

Europe/Total (%)

40.6

35.1

35.5

42.3

48.7

51.8

36.3

72.6 27.6

72.5 27.5

81.5 19.0

89.3 8.7

US Domestic/Total (%)

34.9

50.1

50.0

46.3

39.5

49.1

38.6

37.7

30.9

28.8

44.4

57.3

58.2

68.1

82.5

* 1.1.99-8.31.99. Source: Securities Data Company.

n o

I

TABLE 1.4

Global Wholesale Banking and Investment Banking 1998. Full Credit to Book Running Manager Only (US$ millions)

Firm Rank 1998 (1997 in parentheses)

Goldman Sachs & Co (2) Merrill Lynch & Co (1) Morgan Stanley Dean Witter (4) Salomon Smith Barney/Citigroup (7/11) Credit Suisse First Boston (6) JP Morgan & Co. Inc. (5) Chase Manhattan Corporation (3) Lehman Brothers (8) Deutsche Bank/BT (15/16) Warburg Dillon Read/UBS (9) Bank of America Corp (14) Bear Stearns (12) Donaldson, Lufkin &Jenrette (13) ABNAMRO (17) Paribas/Societe Generale (25/41) Lazard Houses (18) Barclays Capital (19) Dresdner Kleinwort Benson (30) Rothschild Group (28) Nomura Securities (34) Schroder Group (22) BankBoston (38) First Union Corp (39) PaineWebber (23) HSBC (24) Top 25 Firms Top 10 as percentage of Top 25 Top 20 as percentage of Top 25

Global Securities Underwriting and Private Placements 388,765.9 549,797.3 404,497.5 366,353.8 290,502.0 250,064.7 122,602.9 264,339.6 158,681.0 201,809.6 57,975.7 140,608.7 111,498.7 127,077.6 153,649.0 -

81,236.9 54,611.5 -

58,998.1 -

24,972.3 57,604.2 57,260.5 3,922,907.5 76.41 96.44

Global M & A Advisory3 1,067,258.8 692,920.3 635,623.9 483,761.8 431,756.5 324,207.0 172,858.9 225,415.6 147,874.4 143,743.3 83,679.4 184,752.8 217,614.0 34,143.3 54,472.3 160,775.5 -

37,373.2 84,291.2 -

69,179.4 49,903.0 -

5,301,604.6 81.59 97.75

International Bank Loans Arranged

Medium Term Notes Lead Managed11

16,404.5 10,999.7

54,419.6 129,629.4 32,680.2 51,412.2 60,166.1 27,502.8 20,448.0 48,982.5 84,419.0 53,780.1 42,250.0 17,610.0

-

107,565.7 19,086.9 115,665.7 307,131.0 26,311.8 53,780.3 17,009.9 200,100.1 -

12,618.8 16,282.5 -

14,457.3 -

19,124.8 21,591.7 -

958,130.7 70.34 95.75

-

125,333.1 11,398.0 -

6,370.2 8,273.0 -

14,556.0 -

20,000.0 -

809,230.2 69.63 97.53

Total

1,526,848.8 1,383,346.7 1,072,801.6 1,009,093.5 801,511.5 717,440.2 623,040.8 565,049.5 444,754.7 416,342.9 384,005.2 342,971.5 341,731.5 302,836.5 219,519.3 160,775.5 102,064.4 100,257.7 84,291.2 73,554.1 69,179.4 69,027.8 66,564.0 57,604.2 57,260.5 10,991,873.0 77.88 97.09

Percent of Top

13.89 12.59 9.76 9.18 7.29 6.53 5.67 5.14 4.05 3.79 3.49 3.12 3.11 2.76 2.00 1.46 0.93 0.91 0.77 0.67 0.63 0.63 0.61 0.52 0.52

TABLE 1.4 Global Wholesale Banking and Investment Banking 1998. Full Credit to Book Running Manager Only (US$ millions) The Next Twenty Two: Firm Rank 1998 (1997 in parentheses)

CIBC Wood Gundy Securities (27) BANK ONE Corp Wasserstein, Perella (33) Enskilda Securities Natwest (20) RBC Dominion Securities (35) Prudential Securities (31) Bank of New York (32) Toronto-Dominion Bank and Tr (40) Commerzbank AG (37) First Tennessee Bank, N.A. Scotiabank-Bank of Nova Scotia Daiwa Securities (29) Banque Nationale de Paris (26) Fleet Financial Group Inc ING Barings (36) Bayerische H-V Bank of Montreal Trust Sakura Bank, Ltd. PNC Bank NA Wells Fargo Bank NA (50) Banque Internationale Lux SA

Global Securities Underwriting and Private Placements 12,594.8 -

39,208.6 -

26,587.5 -

11,778.3 21,357.4 -

10,623.1 -

Global M & A Advisory3 34,321.6 -

40,887.1 40,661.4 -

33,489.6 -

International Bank Loans Arranged 9,308.4 53,445.1 -

25,834.9 24,751.1 -

14,001.0 -

10,788.9 -

9,751.9 -

8,146.3 6,875.8 -

Medium Term Notes Lead Managed*3 -

10,000.0 13,500.0 11,700.0 -

10,000.0 9,124.3 -

5,744.5

Total

56,224.8 53,445.1 40,887.1 40,661.4 39,208.6 33,489.6 26,587.5 25,834.9 24,751.1 21,778.3 21,357.4 14,001.0 13,500.0 11,700.0 10,788.9 10,623.1 10,000.0 9,751.9 9,124.3 8,146.3 6,875.8 5,744.5

a Completed deals only. Full credit to both advisors to targets and acquirers. b Equal credit to both book runners if acting jointly. c To avoid overestimation, the top 25 total—US$10,991,873.0 million was used instead of the industry total—US$8,470,261.3 million. Sources: Securities Data Corporation.

Percent of Top 25C 0.66 0.63 0.48 0.48 0.46 0.40 0.31 0.31 0.29 0.26 0.25 0.17 0.16 0.14 0.13 0.13 0.12 0.12 0.11 0.10 0.08 0.07

n 0~

pOj

o. 3' n S' rt? 3 of

s>3

TABLE 1.5

Top Ten Firms % of Market Share Herfindahl Index Number of Firms from: USA

Europe Japan Top Twenty Firms % of Market Share Herfindahl Index Number of Firms from: USA

Europe Japan

Global Wholesale Banking and Investment Banking: Market Concentration

1990

1991

1992

1993

1994

1995

1996

1997

1998

40.6 171.6

46.1 230.6

56.0 327.8

64.2 459.4

62.1 434.1

59.5 403.0

55.9 464.6

72.0 572.1

77.9 715.9

5 5 0

7 3 0

5 5 0

9 1

9

9 1

8

8

7

1 0

0

2 0

3

0

2 0

80.5 392.7

75.6 478.4

78.1 481.4

76.0 439.5

81.2 517.6

93.3 620.9

97.1 764.0

8

15 4

15

14 5

14

13

11

6

7

1

0

0

8 1

11 1

1

5 0

0

Globalization of Markets and Financial-Center Competition

17

Investment Management and Investor Services

At the beginning of 1997 there was approximately US$27.4 trillion in assets under management worldwide, comprising some US$5.3 trillion in mutual funds, US$8.2 trillion in pension funds, US$6.4 trillion managed by insurance companies, and US$7.5 trillion in offshore private assets.8 This compares with roughly US$37 trillion in global banking assets and US$41.7 trillion in total capitalization of global stocks and bond markets. This enormous financial pool constitutes the market for global asset management services. There are a variety of asset-allocation services provided to institutional and individual investors, as well as technology-intensive investor services which reduce transaction costs, improve market information and transparency, and facilitate price discovery and trading: Asset management for institutions and individuals. With respect to institutions, major investors such as pension funds and insurance companies may allocate blocks of assets to be managed against specific performance targets or "bogeys" (usually stock or bond indexes). Closed-end or open-end mutual funds or unit trusts may also be operated by broker-dealers, banks, or fund management firms and either marketed to selected institutions or mass-marketed to the general investor community either as tax-advantaged pension holdings or to capture general household savings. Private banking to high net worth individuals usually involves assigning discretionary asset management to financial institutions within carefully crafted parameters. These may link asset management to tax planning, estates and trusts, and similar services in a close personal relationship with an individual private banking officer that involves a high level of discretion. Many private clients are confidentiality-driven, which makes them comparatively less sensitive to normal risk-return considerations and more sensitive to trust vested in the bank and the banker.9 Investor services and transactions infrastructure. There is an array of services that lie between buyers and sellers of securities, domestically as well as internationally, which are critical for the effective operation of securities markets. This centers on domestic and international systems for clearing and settling securities transactions via efficient central securities depositories (CSDs), which in turn are prerequisites for a range of services, often supplied on the basis of quality and price by competing private-sector vendors of information services, analytical services, trading services and information processing, credit services, securities clearance and settlement, custody and safekeeping, and portfolio diagnostic services.

In asset management, Switzerland (Zurich and Geneva) and London share the top spot, with very different businesses centered on private banking and institutional asset management, respectively. Other continental European asset management centers are far behind. As of 1992, 42.1% of pension assets under institutional

18

Ingo Walter

management were centered in the U.S., 35.1% in Japan, 10.7% in the U.K., 10.4% in France and less than 1% each in Switzerland, Germany, the Netherlands, Canada and Australia.10 Specifically with regard to equity fund management, London in 1996 ranked first with over US$1 trillion under management, followed by Zurich, Basel and Geneva combined with US$740 billion, Frankfurt with US$157 billion (excluding inter-corporate holdings), Edinburgh with US$138 billion and Stockholm with US$89 billion. None of the other European financial centers rank in the top 25. These numbers compare with US$1.5 trillion managed in Tokyo and US$896 billion in New York.11 Such rankings in the future are likely to shift as European financial integration continues, especially under a single currency, with greater polarization possible. No direct figures are available with regard to fee income generated from asset management activities. However, some evidence may be obtained from the location of the world's largest asset managers depicted in Table 1.6. Note that location is quite dispersed, and while the major financial centers such as London, New York and Tokyo are prominent, centers like Frankfurt, Paris, Boston, Munich, Zurich, Chicago, Pittsburgh and Baltimore are also important, as are unlisted specialist centers such as Geneva (private banking) and Bermuda (insurance and fund management). Investor services, notably clearance and settlement, are undertaken in the various national financial centers by central securities depositories such as the Depository Trust Company in the U.S., SICOVAM in France and Deutscher Kassenverein in Germany. Internationally, substantial cross-border transactions are handled either through bilateral links between national CSDs or through international CSDs, mainly Euroclear in Brussels and Cedel in Luxembourg. To summarize, each of the types of financial services enumerated above has its own locational attributes. Some are highly mobile and, given modern information and communication technologies, could be carried out more or less anywhere. Some are difficult to carry out effectively in isolation, or may require "bundling" with other types of financial or infrastructure services and are therefore less mobile. Still others require a high degree of centralization due to economies of scale or economies of agglomeration. IV.

LOCATIONAL MOBILITY OF FINANCIAL VALUE-ADDED

Financial intermediaries, as well as the end-users of the financial services discussed in the previous section, have access to a broad range of locational choices for carrying out their activities. Back-office

Globalization of Markets and Financial-Center Competition TABLE 1.6

Rank 1/1/99 1 2 3 4 5 6

7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42

19

Global League Table of Leading Asset Managers (assets under management exceeding US$100 billion)" Firm Kampo UBS AGa Fidelity Investments Deutsche Bank Groupb Groupe AXAC Barclays Global Investors Allianz (including PIMCO) Merill Lynch State Street Global Investors Capital Group Companies Zurich Groupd Mellon Financial Services Nippon Life Equitable Cos. Morgan Stanley Dean Witter Citigroup JP Morgan Putnam Investments Zenkyoren Vanguard Group Dai-Ichi Mutual Life TIAA-CREF Pimco Advisors Prudential Insurance Co. Bank of America Corp. Credit Suisse Group Northern Trust Company Mitsui Trust and Banking Franklin Group of Funds Sumitomo Mutual Life Fortis Group Amvescap National Westminster Banke Wellington Mgmt Co. General! Groupf Schroder Investment Man. American Express Chase Manhattan Corp. United Asset Mgmt. Group BNP Gestions8 Goldman Sachs Asset Mgmt Commercial Union

Country

AUM (US$ billion)

Japan Switzerland

1685 1167

USA

773 698 672 616 607 501 493 424 407 401 383 359 346 327 316 294 279 276 267 244 244 242 234 231 226 225 220 220 219 217 212 211 198 197 196 190 188 184 181 175

Germany France UK

Germany USA USA USA

Switzerland USA

Japan USA USA USA USA USA

Japan USA

Japan USA USA USA USA

Switzerland USA

Japan USA

Japan Belgium USA UK USA

Italy UK USA USA USA

France USA UK

20

Ingo Walter

TABLE 1.6 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76

77

Global League Table of Leading Asset Managers (assets under management exceeding US$100 billion)a Societe Generale First Union Corp. ING Groep Groupe Caisse des Depots MassMutual Aegon NV Metropolitan Life Dresdner Bank Group Lloyds TSBh Indocar (Credit Agricole) Meiji Mutual Life T. Rowe Price Assoc Mitsubishi Trust & Bank HypoVereinsbank Prudential Corp.1 Sumitomo Trust & Bank Nvest Cos. BlackRock Munchner Ruckversich Asahi Mutual Life Commerzbank Group BancOne Inv. Advisors Standard Life Daiwa Trust and Banking Yasuda Mutual Life Desjardin-Laurentian Janus Capital Corp. Fleming Investment Mgt. Federated Investors Grupo Intesa John Hanckok Deka Bank Sun Life Canada Daiwa Group Sun Life of Canada

a Includes Global Asset Management, b Including Bankers Trust Co., c Includes Guardian Royal Exchange, d Including Scudder Kemper Investments, e Includes Legal & General and Gartmore, f Includes Achener & Munchner, g Includes Paribas, h Includes Scottish Widows, i Includes Mutual & General.

France USA

Netherlds France USA

Netherlds USA

Germany UK

France Japan USA

Japan Germany UK

Japan USA USA

Germany Japan Germany USA UK

Japan Japan Canada USA UK USA

Italy USA

Germany USA

Japan Canada

175 169 169 168 157 156 154 152 151 151 150 148 145 140 141 137 135 132 130 129 124 122 122 115 114 111 108 108 107 107 105 105 105 103 102

Globalization of Markets and Financial-Center Competition

21

operations (e.g., payments functions, clearing and settlement of financial transactions) can be physically separated from the marketing functions and the ultimate client interface with no loss of service quality and significant potential for cost improvement. In theory, only certain specific functions in today's technological environment still need to be carried out in direct physical proximity to the client; most others may ultimately gravitate toward the most costeffective siting. This is certainly true at the wholesale end of the industry, and it is becoming more true at the retail end of the financial services spectrum as remote-delivery (e.g., via the Internet) gradually captures a greater market-share. The financial services sector has thus become a much more "mobile" industry, one that is particularly sensitive to operating costs and regulatory burdens. Many banks, securities firms, insurance companies and asset managers—as well as their clients—today have access to a broad range of location choices for conducting their activities. Indeed, the financial services industry can be considered to cover a spectrum of activities that ranges from potentially highmobility functions such as data processing, investment management, institutional sales and trading, and remote-servicing of mass markets, to low-mobility functions that require direct and personal contact with clients such as corporate borrowers, municipal governments, investors and private individuals. The economics of high-mobility activities can be described as centrifugal, or supply-oriented. Modern information and transaction technologies make it increasingly possible to conduct such activities in remote locations in order to take advantage of lower labor or real estate costs and other production considerations that can differ widely both inter-regionally and internationally, as well as potential economies of scale and scope. Certainly, transactions processing can often be physically separated from the marketing of the financial transaction itself. Why undertake data-entry for insurance claims in Zurich, when Ireland offers plentiful lower-cost skilled and motivated labor, lower rents, and significant tax breaks, for example? Why not "pool" or "outsource" some processing-intensive activities to a vendor like IBM or Electronic Data Systems, which can do it cheaper and better with increased scale economies in low-cost locations, providing significant operating economies and at the same time liberating a large amount of capital? However, issues related to quality-control, speed, security, reliability, confidentiality and the value of information based on transaction flows may limit such rationalization of production. The economics of low-mobility financial activities can be described as centripetal—agglomeration- or demand-oriented. They are

22

Ingo Walter

driven by proximity and economies of agglomeration, personal contact, social relationships and other qualitative factors. There is no way to develop a private banking relationship, or to structure a complex corporate finance transaction involving investment bankers and lawyers, without close personal interaction. Although technically feasible, it is not entirely clear that a portfolio manager or securities trader can do his or her job as well in a remote location away from colleagues and competitors, and away from the excitement and "smell" of the market. Still, modern technology can often be used to convert "front-office" to "back-office" activities, and thereby loosen ties to client-linked and agglomeration-oriented locations. Technology is a major factor affecting the balance of centrifugal and centripetal forces acting on the location of financial activities, and therefore on the underlying economics of financial centers. Traditionally, the centripetal forces have dominated in the financial services industry, and have assured the dominance of the traditional financial centers. This now seems to be changing, permitting "unbundling" of financial activities and allowing the centrifugal forces to make themselves increasingly felt. One can envisage the mobility of functions within a circle that extends from those activities requiring direct and personal contact with clients such as corporate borrowers and issuers, government entities, institutional investors and fund consultants, and private individuals all the way out to back-office functions, investment management, and remote servicing of routine retail client transactions. One can also imagine a threshold, radiating out from the center of the circle in Figure 1.4, where the supply-related centrifugal forces may outweigh the demand or agglomerate centripetal forces for specific segments in the financial-services value-chain with a given state of technology. One can argue that this threshold has traditionally been biased toward centripetal forces, with the need for substantially all functions to be carried out in-house and on-site in major financial centers. The need to locate in proximity to clients, as well as to legal and accounting services and other firms competing in the market, have tended to bias location toward the these centers. The argument is that technological change, and the ability to "unbundle" the various financial functions, appear to have moved that threshold significantly to the periphery, with back-office activities, investment management, and remote client servicing easily done from sites well removed from the center of the firm itself and away from the traditional financial agglomerations. The key question for the traditional financial centers is how much further that threshold can still move

Globalization of Markets and Financial-Center Competition

23

Transactions processing • Brokerage • Private Banking Research Risk Management Corporate Advisory Securities Underwriting Securities Trading & Sales Loan Structuring & Syndication • Forex and Money Market •Dealing • Merchant Banking • Investor Services Asset Management

FIGURE 1.4

Centrifugal and Centripetal Locational Mapping of Financial Services

to the periphery, and how sensitive that movement is to factors such as labor cost and labor quality, tax and regulatory differences, and the available economic infrastructure, as discussed below. Once management of financial firms has determined that the mobility threshold can technically be overcome, and takes on a mind-set that relocation is feasible and may indeed be desirable, mobility inherently increases as the financial firm starts looking for alternatives, as the implementational issues are discussed, and the burden of proof may then become "why not move?", as opposed to "why move?". For example, relocation of back-office and data processing (DP) operations is perhaps the most mobile of a complex process of rationalizing information and transactions processing in financial firms. Back-office capacity must be on-line to handle existing and expected future business volume, transactions security, and a variety of contingencies ranging from power failures to software problems. It does not, however, imply that a New York or London or Frankfurtbased firm necessarily has to site its information processing there. The cost and reliability of transmitting information is an important factor determining location, as are the potentially significant economies of scale and scope that exist in back-office functions, regardless of their location, and explains a number of efforts to "outsource"

24

Ingo Walter

back-office functions—even "selling" back-office facilities to such firms and buying-back transactions processing services. Such efforts are likely to involve relocation of these functions to major DP "factories" serving multiple clients from remote sites. Other efforts involve "pooling" of back-office functions among a number of firms on a cost-sharing basis in order to rationalize these functions and drive down costs. This may require construction of new, high-capacity facilities, and in the course of the restructuring process the decision may be taken to locate such joint facilities at remote locations. On the other hand, measures that would achieve maximum cost economies may compromise proprietary information and complete control. For this reason, outsourcing and pooling of back-office functions has limits. It is certainly feasible for some functions, but probably not for others. Most initiatives toward back-office outsourcing and pooling in the investment banking industry, for example, have not borne fruit, unlike similar efforts in mass-retail transactions processing or securities custody. Competition among financial centers is thus in part a contest for market-share in centripetal value-added activities, and in part a battle to retain as much as possible of centrifugal value-added activities. V.

HOW DO FINANCIAL CENTERS COMPETE?

Two more or less distinct types of financial center can be identified. One is the functional center, where transactions are actually undertaken and value is created in the design and delivery of financial services. Examples of traditional functional centers include New York, London and Hong Kong across a wide range of financial activities from syndicated lending to M&A advisory services, and Boston, Chicago, Frankfurt, Paris and Tokyo in a more specialized range of activities. The other is the booking center for transactions whose underlying value is mainly created elsewhere. Examples in this category include the Bahamas, Cayman Islands, Channel Islands, Liechtenstein and Vanuatu. In order to attract financial booking business, one prerequisite is a favorable tax climate for non-residents, a benign regulatory and supervisory environment as well as (sometimes) strict financial secrecy or blocking statutes. Centers like Bermuda, Luxembourg, Singapore and Zurich might be considered among the established "dual-capacity" financial centers, combining both functional and booking dimensions, as well as several newer centers like Dublin, and Labuan in Malaysia. What kinds of factors seem to determine competitiveness among functional centers? A number of studies suggest that the following considerations seem to be of importance.12

Globalization of Markets and Financial-Center Competition

25

GNP growth. Financial services, along with labor and capital, are important resources (or inputs) determining real output, so that high-growth economies tend to become the home of important international financial centers. A large and growing economy, however, is no guarantee of exceptional performance as a financial center. Industrial base. An important national non-financial sector requiring a range of financial services may constitute the basis for a viable global or regional financial center. Again, it does not by itself assure the ability to compete for transactions generated elsewhere, or to prevent domestically-generated business from migrating to financial centers abroad. International trade-intensity. Countries that are relatively open to international competition and trade are more likely to develop financial centers than are more closed economies. Foreign direct investment- and trade-intensity. Banks and other financial firms tend to follow their clients abroad, so as to be in a better position to meet their needs (especially in the local currency). So countries with strong foreign direct investment inflows through acquisitions or greenfield projects, as well as large volumes of international trade, improve their chances of developing into financial centers. Stability. Political and macroeconomic stability have been important determinants of financial center development. Responsible fiscal and monetary policies reflected in low inflation and currency stability and convertibility, for example, are highly favorable attributes. So are perceptions of political continuity and predictability. Once lost, such characteristics can be very difficult to regain. Product range and propensity to innovate. A broad range of banking services, securities and derivatives, and strong innovative capabilities can be critical for successful financial centers. Centers which have developed into major wholesale players tend to be subject to relatively permissive regulators whose default response to a new product or a new financial structure is "yes, unless there are compelling reasons to prohibit", as opposed to "no, unless there are compelling reasons to permit". Infrastructure characteristics. This includes such attributes as time-zone overlaps, quality of the physical capital stock (transportation, communications, etc.), and efficiency of governmental services. Shortcomings in any of these areas may be impossible to overcome. Agglomeration economies and liquidity. The larger the number of financial firms already in place and the greater the volume of financial activity (market depth)—as well as the larger the percentage of the skilled work force active in the financial service industry—the more likely a financial center is to attract still more participants. A high degree of liquidity, notably for block trades and good after-hours trading capabilities, is critical for financial centers to attract significant wholesale business. It also includes a strong equity component—ranging from actively traded shares of large-cap global companies to IPOs and private equity—with significant turnover and deep institutional investor participation. Transparency. The issue here is whether transactions in a financial center are undertaken in a fair and open marketplace, and whether an adequate infrastructure exists for financial end-users and intermediaries. This includes the appropriate regulatory and enforcement infrastructure, mediation or arbitration, or

26

Ingo Walter

recourse to the courts in civil or criminal actions. Transparency applies both to dealing in financial instruments as well as in the financial instruments themselves, including making issuers as well as underwriters liable for incomplete or false information in the case of securities sold to the general public. It also includes a uniform accounting and legal infrastructure that meets global standards. Immediacy. The role of time is critical in the operation of financial centers—the time it takes to make a trade, affirmation and confirmation of the trade, as well as clearance and settlement of the trade. Basic standards that have been set by the international financial community such as immobilization and dematerialization of securities, delivery versus payment, clearance and settlement time, must be met or exceeded by a financial center that hopes to attract significant transaction volumes. Contestability. This criterion concerns whether firms are allowed to develop the access to clients and markets and the organizational forms necessary to compete effectively in a particular financial market. The presence of cartels and exclusionary market practices such as limitations on exchange membership or discrimination by regulators can do much to retard the development of a financial center. Labor force. Quality, motivation and availability especially of skilled labor critical in the supply of financial services is a determining factor in the success of financial centers. Openness to highly skilled and motivated labor and management from abroad, including attractive and hospitable living and working conditions, is an important related variable. Cost of operations. Comparative cost of labor and real estate required to produce financial services in relation to comparable costs in alternative locations is an important consideration, especially in an era of intense competition among financial firms. Low transactions costs, notably in the form of commissions and spreads, clearance and settlement services, back-office operations, custody services, telecommunications and other financial infrastructure services are critical for the success of wholesale financial centers. Taxation. Taxes enter into the competitive performance of financial centers in two ways. The first involves the taxation of capital income, and there is a long tradition of specialist financial centers that have done very well by capitalizing on tax avoidance and evasion on the part of depositors and investors under the protection of national sovereignty, financial secrecy and blocking statutes. Examples include the Channel Islands, Luxembourg, Switzerland and various Caribbean and Pacific islands. The second involves taxation of financial transactions and earnings of the financial intermediaries, where Ireland or Bermuda are good examples. Most tax-driven financial centers comprise "niche" players as against the major global wholesale centers where taxation tends to play a relatively minor role.13 Net regulatory burden (NRB). It is useful to think of financial regulation and supervision as imposing a set of "charges" and "subsidies" on the operations of financial firms exposed to them. On the one hand, the imposition of reserve requirements, capital adequacy rules, interest/usury ceilings and certain forms of financial disclosure requirements can be viewed as imposing implicit "taxes" on a financial firm's activities in the sense that they increase costs. On the other hand, regulator-supplied deposit insurance, lender-of-last-resort facilities and

Globalization of Markets and Financial-Center Competition

27

institutional bailouts serve to stabilize financial markets and reduce the risk of systemic failure, thereby lowering the costs of financial inter-mediation. They can therefore be viewed as implicit "subsidies" provided by taxpayers.14 The difference between these "charge" and "subsidy" elements of regulation can be viewed as the net regulatory burden (NRB) faced by financial firms in any given jurisdiction. Financial firms tend to migrate toward those financial environments where NRB is lowest—assuming all other economic factors are the same.13

Factors that do not appear to be important in determining the competitive position of financial centers, according to empirical studies, include the position of a particular city as a political capital, its age, or the role of the country in the shifting geopolitical environment.16 The significance of a city's role as central bank headquarters for its role as a global financial center is debatable. One can envisage a matrix, such as that in Table 1.7, which maps various financial inter-mediation activities against the attributes of financial centers and may be helpful in assessing their comparative locational sensitivity in one of the most structurally complex and dynamic industries in the global economy. It is an industry that has become truly high-tech, dynamic and capital intensive, yet remains a "people business" par excellence. The Market for Markets and the Location of Financial Activity Variations in the multi-dimensional operating conditions in financial centers—combined with the differential sensitivity of valueadded across the range of financial inter-mediation services supplied in global markets, regulatory competition and the existence of offshore markets—underscore the fact that financial services firms often face a range of location alternatives for executing transactions and performing support functions. Vigorous competition among financial services firms is today joined by equally vigorous competition among financial centers. This competition can be framed in terms of static and dynamic efficiency properties, with comparative weaknesses in efficiency, liquidity or creativity driving financial transaction-streams and the associated value-added to high-performance centers where they can form the basis of a major source of employment and economic growth. London, New York and Tokyo are battling for advantage on the world stage as financial "hubs." London (outside EMU, at least at the start) is itself vigorously competing for position against Frankfurt, Amsterdam, Luxembourg, Paris and Zurich on the increasingly level EU playing field. Meanwhile Tokyo, along with Hong Kong and Singapore, are maneuvering for competitive advantage in the Asia-Pacific region, both against each other and

Investment Services

Private Banking

Asset Management

Merchant Banking

Corporate Advisory

M&A Advisory

Risk Management

Research

Brokerage

Securities Trading

Equity Underwriting

CP/MTN Programs

Bond Underwriting

Foreign Exchange

Loan Syndication

Interbank Dealing

Trade Finance

n G.

X

X

X

n 3

^

Cfl

^

c«

cr

n-^?

^

X X

X

3

X

X

X

rt

X

X

X

n>

r

E

X

X X X

X

X

X X

X

X

X X X

"*

X X X

X

X X

X X

"
O rb 0_ -n 0

n3 era" 3

O 3 0) T-i

3

118

Saad Laraqui

US$1 and 10 million, one-half between US$10 and 50 million, and the remaining quarter between US$50 and 100 million. It appears that U.S. FDI growth is faster than the French; this is predictable given that U.S. firms entered the Moroccan market at a later stage. Also, we noticed that U.S. original and current FDI is greater than that of the French, the reason being that U.S. investment is more capital-intensive. Regarding the current percentage equity ownership in Moroccan affiliate, 100% of French firms have 51% and over, while only 63.6% of the U.S. firms have 51% and over. From the number of countries where U.S. and French firms have FDI outside Morocco, it appears that U.S. firms are involved in a greater number of countries than the French. Thus, U.S. firms are more global than the French ones. However, for the approximate size of their Moroccan FDI as a percentage of their worldwide FDI, it remains relatively low; between 0.1% and 3% for the French and between 1% and 2% for the U.S.

IV.

RESULTS OF THE FIELD STUDY

We reviewed the results under a number of 'headings' which have relevance to the eclectic paradigm. In addition to the distribution of the responses of the two groups of executives (French and American) , we tested to see if there is any statistically significant difference between the two means (U T = u 2 ).

TABLE 6.3

Comparisons between Different Regions: Degree of Profitability in the Different Regions French

U.S.

Morocco Other Developing Countries Home Country Other Developed Countries Worldwide

All

ml

si

m2

s2

m

3.27 3.33 5.67 5.22 4.88

1.27 1.0 1.32 1.72 1.13

4.75 3.5

1.26 0.71

6.0

0.0

6.0

1.41

3.67 3.36 5.73 5.36

5.0

0.0

4.9

s 1.4

0.92 1.19 1.63 0.99

Mest Ho: ulu2=0 -2.33 -0.36 -0.61 -0.96 -0.27

Note: m stands for means and s stands for standard deviation. Ho: vil—u2=0 is the null hypothesis.

The Role of Foreign Owned Firms

119

Relative Profitability

Both French and U.S. firms perceive FDI in Morocco as slightly above average (3.67). The responses are tabulated in Table 6.3. However, the French firms and U.S. companies are significantly different (t= -2.33) in terms of their profitability in Morocco. Given the way most questionnaires were filled in, we believe that the way that the profitability is measured against profitability in other regions is more a perception than based on actual figures. The French firms perceive their profitability in Morocco to be above average (4.75), which conforms to the traditional colonial approach of their multinational activity. However, the U.S. firms perceive themselves as less profitable (3.27). This conforms to their global multinational activity approach in North Africa where the foreign market is perceived as being an extension or part of their global market. It is also noteworthy that the French companies perceive Morocco as being more profitable than other developing countries while the U.S. firms perceive just the opposite, the rationale being that U.S. FDI in developing countries is more concentrated in Asia where profitability may be perceived to be higher. Looking at the degree of importance in decision-making in U.S. and French MNEs, gains from Moroccan FDI are weighted differently (Table 6.4). The U.S. firms are clearly concerned with their earnings before and after taxes (5.09 and 5.45), and they do not

TABLE 6.4

Gains from Moroccan Investments: Degree of Importance in Decision-making on FDI in Morocco U.S.

Gains from Moroccan investments 1. Earning before foreign taxes from the affiliate 2. Cash inflows to the parent after foreign and domestic taxes 3. Other contributions of affiliate to parent company

French

ml

si

5.09

1.76

5.45 1.64

m2

All

West

s2

m

s

Ho: ul -Vi2=0

4.6

1.76

4.94

1.61

0.56

1.13

2.2

1.3

4.67

1.76

5.49

0.81

4.0

2.12

2.38

1.71

-3.47

Note: m stands for means and s stands for standard deviation. Ho: ul-u2=0 is the null hypothesis.

120

Saad Laraqui

take into consideration other contributions of the affiliate to the parent company (1.64). Such an attitude is consistent with findings that tax and regulatory environment have an impact on FDI (Root and Ahmed 1979; Contractor 1981; Hartman 1984; Jun 1989; Shah and Slemrod 1990; Slemrod 1989; Lizando 1990; Wallace 1990; Brewer 1991; Grubertand Mutti 1991; Shell 1991; Li and Guisinger 1992). However, French MNEs have a different approach. They are concerned with their earnings before tax (4.6) but not after foreign and domestic tax (2.2). French companies have been involved economically from the beginning of the industrialization of Morocco and consequently know very well how to take advantage of the system. Consequently there is no clear relationship between the tax and regulatory environment and FDI, which is in accordance with various other studies (UNCTC 1988; IBRD 1991; Krugman 1991; Mody and Srinivasan 1991; Mody and Wheeler 1991; Bergsman 1992). This is why French firms are above average in terms of "other contributions of affiliates to parent company". It is a fact that the taxation system in Morocco is among the highest in the region but many firms are able to avoid its full impact; French firms are familiar with those practices but U.S. MNEs are extremely rigid when it comes to certain adjustments in business activities. For the U.S. firms, contributions other than financial do not weigh heavily which could be explained by the fact they do not have any flexibility in operating outside their own defined business framework. This strong rejection of the null hypothesis (t - 5.49) is a direct consequence of this difference in behavior. V.

STRATEGIC MOTIVES FOR FDI

In terms of strategic motives for FDI, Table 6.5 shows that there were some significant differences between U.S. and French MNEs' degree of market share protection (t = 3.14). By market share protection, we are referring to the fact that in some industries Morocco used to protect the foreign investor by keeping out competition from imports. The rationale behind it was the infantindustry argument, which is less accepted as a strategy in the 1990s because it allows investing firms to reap quasi-rents. The U.S. firms (5.45) strongly value this protection, and so do the French ones but at a lower level (3.8). U.S. MNEs in Morocco do not have the same in-depth knowledge of the Moroccan market as the French do and consequently require a certain level of protectionism to minimize their risk. The behavior of both groups is supported by studies that show a positive relationship between

The Role of Foreign Owned Firms TABLE 6.5

121

Strategic Motives for FDIs: Degree of Importance in Decision-making on FDI in Morocco

U.S.

1. Protection of market share of investing company versus competition 2. Increase in global sales and market share 3. Decreasing risk through geographic diversification 4. To acquire key resources/ assets 5. Gains from economies of scale and scope 6. Responding to host country's pressure to produce locally 7. Following customers into Morocco 8. Leading or following competitors into Morocco 9. Overcoming tariff or nontariff barriers imposed by host countries 10. To safeguard supplies of raw materials

Mest

All

s

Ho: ulu2=0

4.94

1.29

3.14

0.55

5.38

1.41

-0.05

3.4

1.52

3.44

1.67

0.06

1.57

3.4

1.95

2.75

1.69

-1.11

3.36

1.29

3.4

2.3

3.38

1.59

-0.04

2.91

2.07

5.0

1.0

3.56

2.03

-2.32

2.83

1.85

5.6

0.55

3.65

2.03

-3.54

2.82

1.83

5.0

1.0

3.5

1.9

-2.69

3.55

1.69

4.0

2.12

3.69

1.78

-0.49

2.8

2.35

4.8

1.3

3.47

2.23

-1.92

ml

si

m2

s2

5.45

1.04

3.8

1.1

5.36

1.69

5.4

3.45

1.81

2.45

Note: m stands for means and s stands for standard deviation. Ho: ul—u2=0 is the null hypothesis.

effective protection and FDI (Agodo 1978; Lall and Siddharthan 1982; Kumar 1990). Another strong difference between U.S. and French MNEs is in their tendency to follow their home country customers in the Moroccan market (t - -3.54). Because of the proximity of France and Morocco and the large number of Moroccans living in and visiting France, the French MNEs (5.6) can easily be aware of the potential markets in Morocco. This is not necessarily the case with U.S. MNEs (2.91) whose approach is more rational. The U.S. MNE's attitude supports a positive relationship (Papanastassiou and Pearce 1990). As for French MNEs, their attitude is line with studies of

122

Saad Laraqui

Caves (Buckley and Dunning 1976; Saunders 1982; Hollander 1984; Vahlne and Nordstrom 1992). French MNEs (5.0) have a stronger tendency than the U.S. ones (2.91) to respond to Morocco's pressure to produce locally; and the difference is statistically significant (t = -2.31). Similarly, the French firms have a stronger tendency to lead or follow their competitors into the Moroccan market. It appears that the colonial past of Morocco has given to the French MNEs a close link to the Moroccan economy. Top French management has an extensive network in Morocco that covers the highest sphere of decisions-makers. Consequently, it is easier for them to be informed about the competition and also easier to be pressured by the Moroccan government. Because of this privileged information, French investors may be less concerned with the effect of Morroco's political situation on FDI. Some research has shown that political instability does not really affect FDI decisions. (Chase et al 1988; Fatehi-Sedeh and Safizadeh 1989; Hyun and Whitmore 1989; Lizando 1990; Brewer 1991; Mody and Wheeler 1991). For the rest of the strategic motives for FDI we tested, we did not obtain any significant difference between U.S. and French firms. However for these motives they were all either above or below the 3.5 cut-off point except for the last motive tested; that is, the safeguarding of raw materials. French FDI can be described in some cases as natural resource seeking (4.8) which is not the case for U.S. FDI—none of the U.S. firms surveyed described its FDI as being instigated by natural resource seeking. The three-quarters of the U.S. MNEs surveyed were market seeking. Both U.S. and French MNEs put little weight to the following motives when elaborating their strategies: "decreasing risk through geographical diversification", "to acquire key resources/assets", and "gains from economies of scale and scope". However, they give more importance to motives such as "increase in global sales and market share" and "overcoming tariff and non-tariff barriers imposed by host countries".

VI.

DETERMINANTS OF FDI IN MOROCCO

Ownership-Specific Advantages

Applying the eclectic paradigm, our study identified several ownership (O) factors, which seek to capture the main competitive advantages of U.S. and French MNEs in seeking to service customers in Morocco or a neighboring foreign country (Table 6.6).

The Role of Foreign Owned Firms TABLE 6.6

Firm Competitive Advantages in Morocco French

U.S.

1. Size and scope of firm 2. International experience 3. Trade marks & brand image 4. Investment in training 5. Technological advantages 6. Knowledge of local tastes and requirements of business 7. Economies of scale in production or marketing 8. Economies of geographical diversification 9. Organisational capabilities 10. Entrepreneurial culture

123

Hest

All

Ho: ulu2=0

ml

si

m2

s2

m

s

4.64 5.64

1.5

6.0 5.6

1.0

2.61

5.06 5.63

6.1 4.6

1.6

5.36

1.8

4.4

1.71

-1.21 0.18 -0.54

4.3

-2.0 0.04

1.3

6.0

5.2 4.8

1.14 1.79 0.84

4.93 5.31 4.53

1.48 1.86 1.46 1.67 1.74 1.46

1.83

3.2

1.3

3.93

1.71

1.31

4.27

2.0

3.8

2.17

4.13

2.0

0.46

5.0 4.0

1.61 1.83

5.0 4.8

2.35 2.39

5.0

1.79 1.98

-0.79

1.57 1.84

5.8 5.6

4.27

0.4

0.0

Note: m stands for means and s stands for standard deviation. Ho: ul—u2=0 is the null hypothesis.

The first observation is that none of the null hypothesis has been rejected. In terms of ownership-specific advantages, there are no significant differences between U.S. and French MNEs. However, we could still look at what are the most important ownership advantages for the U.S. and French MNEs. For the U.S. firms, "trade marks and brand image" ranked number 1 (6.1), followed by "international experience" (5.64) and "technological advantages" (5.36), and the last being "entrepreneurial culture" (4.0). This seems to correspond to the traditional characteristics of a western multinational. For the French MNEs we have a slightly different picture. They ranked "size and scope of firm" first, and "economies of scale in production or marketing" last. It may look contradictory if we are dealing with capital-intensive industries where technology plays a major role in production. However, if there are no economies of scale in production, we are certainly dealing with low technology labor-intensive sectors. Given that France is the first foreign investor in Morocco, this corresponds to our findings in which our best fit was realized with our low-tech, labor-intensive cluster. The second highest ranked ownership advantage listed by the French firms is "trade marks and brand

124

Saad Laraqui

image" (5.8), and third were "investment in training" and "international experience" (5.6). Location-Specific Advantages The location-specific (L) advantages hypothesized by the eclectic paradigm are those which reflect the attractions offered by Morocco as a site for MNE activity (Table 6.7). Factors Affecting the Choice of Morocco as a Location for FDl Once again the null hypothesis has not been rejected for any of the determinants tested. In that respect the U.S. and French TABLE: 6.7

Moroccan Vocational Advantages

U.S.

Importance of the following factors in choosing Morocco 1. Size and growth rate of the Moroccan economy 2. Size and nature of the city in which you are located 3. General infrastructure of Morocco 4. Geographical position of Morocco 5. Government policy toward FDI 6. General political, social and economic stability in Morocco 7. Availability of good quality and low cost inputs 8. Presence of related firms (a) suppliers (b) competitors 9. Low real cost of labor 10. Availability of skilled labor force 11. Local labor force's work ethic

French

Mest

All

s

Ho: ulVi2=0

ml

si

m2

s2

5.3

1.34

4.6

1.14

5.07

1.28

3.1

2.08

4.8

1.3

3.67

1.99 -1.82

4.2

0.92

5.2

1.3

4.36

0.93 -1.9

3.8

1.62

5.0

1.58

4.2

1.66 -1.49

5.2 5.4

0.79 0.84

4.6 6.0

2.07 0.71

5.0 5.6

1.31 0.9 0.83 -1.49

5.0

1.41

3.8

1.3

4.6

1.45

3.56 4.0 4.5 4.44

1.51 0.58 1.18 1.24

3.6 4.0 3.8 4.8

0.89 1.0 1.1 1.64

3.57 4.0 4.27 4.57

1.28 -0.07 0.74 0.0 1.16 1.21 1.34 -0.52

5.11

1.27

4.25

1.71

4.85

1.41

Note: m stands for means and s stands for standard deviation. Ho: ul—u2=0 is the null hypothesis.

1.09

1.74

1.21

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MNEs are not significantly different. With the exception of "size and nature of the city in which you are located" (3.1 and 4.8, respectively, for U.S. and French firms) both MNEs score at the right side of scale (3.5-7). This exception is explained by the fact that French companies are more sensitive to the acute problem of congestion in the Casablanca area. This attitude shows a positive relationship between FDI decisions on grounds of quality of location. Looking at the way these determinants have been ranked by each MNE, we have two completely different profiles. U.S. corporations ranked "size and growth rate of the Moroccan economy" (5.3) as the most important factor. As such their FDI decisions are positively related to market size and characteristics (Green and Cunningham 1975; Kobrin 1976; Root and Ahmed 1979; Dunning 1990; Papanastassiou and Pearce 1990). The U.S. MNEs ranking of other factors was: second "government policy toward FDI" (5.2), third "local labour force's work ethic" (5.11), and the last "size and nature of the city in which you are located" (3.1). For the French corporations the ranking was as follows: first "general political, social and economic stability in Morocco" (6.0), second "general infrastructure of Morocco" (5.2), third "size and nature of the city in which you are located" (4.8), and the last "presence of suppliers" (3.6). The key to explaining these differences probably lies in the history of their economic involvement with Morocco. Impact of Events Related to Integration Since the end of the 1950s and the beginning of the formation of the European Union, all the countries around the Mediterranean sea have become very concerned about how the integration of neighboring countries will impact their economies. Obviously the fear of a 'Fortress Europe' triggered much anxiety among economic leaders of these countries. Even today, and especially after the Middle East and North Africa Economic Conference in Cairo (November 1996), it appears that there are plenty of doubts about the direction that many of these countries are taking. It is not clear whether the world is looking at more economic integration or at the emergence of the Nation-States. Given its past colonial relationship with France, Morocco has a lot at stake with the completion of the EU and the different possibilities of its own economic integration with neighboring countries in the area (Table 6.8). With regard to integration, no significant difference were formed between U.S. and French businesses. The integration of the EU is

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Saad Laraqui TABLE 6.8

Impact of Integration on Morocco French

U.S. ml

Impact of the following events on your FDI in Morocco 1. Integration of the EU 4.17 2. Disintegration of the Soviet 3.5 Union and East European Bloc 3. Creation of the United 4.91 Maghreb Arab

si

m2

Rest

All

Ho: ulu2=0

s2

1.34 1.09

4.4 3.0

1.14 0.82

4.24 3.38

1.25 1.02

-0.36 0.99

0.94

3.75

2.22

4.6

1.4

1.58

Note: m stands for means and s stands for standard deviation. Ho: ul—u2=0 is the null hypothesis.

perceived as having a positive impact on FDI in Morocco (4.24). The rationale is that Morocco is an ideal place for industries that will be transferred out of Europe. Of course Morocco will be competing with Eastern European countries and the former Soviet Bloc for U.S. and French FDI. For that reason, the disintegration of the Soviet Union and the East European Bloc is perceived as having a negative impact on Moroccan FDI (3.38). The creation of the United Maghreb Arab (UMA) is perceived to be highly desirable by both groups even though some firms prefer a limited integration between North African countries; the main reason being to exclude Libya from being part of the UMA. A few corporations are neutral and do not see any additional advantage of integration, their rationale being they are already present in all these markets. The general tendency supports Morocco's application to become a member of the EU (Table 6.9; 5.18). If Morocco becomes a member of the EU, this will add commercial attractiveness to this country because home consumers' alignment with Europeans in consumption habits will enlarge home market size. We will also see a further liberalization of the Moroccan economy, and to a lesser extent possible synergy with other European markets (especially Spain, Portugal, Canary Islands). The availability of monetary assistance will enhance the commercial position of the country. Other advantages would be the alleviation of import duties and foreign exchange restrictions. We can also foresee a social security structure

The Role of Foreign Owned Firms TABLE: 6.9

12 7

Morocco/EU Relationship: Attractiveness of Morocco for FDI U.S.

Morocco-EU membership

French

All

West

ml

si

M2

s2

m

s

Ho: ytlu2=0

5.42

1.16

4.6

2.51

5.18

1.63

0.96

Note: m stands for means and s stands for standard deviation. Ho: pi—u2=0 is the null hypothesis.

implemented, and local companies that would have better access to EU markets. The U.S. firms unanimously scored between 4 and 7 on the scale, and their standard deviation is relatively low at 1.16. However, the French firms are spread across the entire scale with a high standard deviation of 2.51. The argument is that the French investments serve mainly the domestic market and do not foresee in the future any real advantage in having Morocco as part of the EU because they are already present all over Europe. This argument is limited in scope since it does not take into consideration the static effects of economic integration which improve the efficiency of resource allocation, and the dynamic effects which involve internal and external efficiencies that are the result of changes in market size. The rationale behind French investments in Morocco often need to be linked to the historical colonial past of these two countries. Internalization-Specific Advantages The final set of advantages—the internalization (I) advantages—address the issue of the form or modality of overseas involvement. We did not test empirically any specific variable, but it is rather interesting to note that the majority of understandable or intelligible answers came from U.S. MNEs. On the one hand, it seems that most French corporations have a pre-set relationship with Morocco dating from colonial times. Questions related to internalization were left blank, with question marks or with a few words generally about market control. On the other hand, most U.S. corporations have clearly stated their management philosophy or corporate policies and the

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rationale behind them. The strongest arguments were made for the 100% ownership, to better market their products, to have a development plan along the parent company criteria, and to have the ability and control to undertake large projects funded by the World Bank or other international development agencies. Some firms have clearly stated that they prefer to avoid joint ventures and strategic alliances with local partners. The absence of a well-defined and fair legal framework to protect their own interests is felt. Any other nonequity arrangements would not become more important over the next 5 years even though some firms may consider some logistical arrangements with competitors, which would provide some economies of scale. VII. CONCLUSION The Future of FDI in Morocco: Obstacles and Challenges

We could almost say that the two groups are echoing each other in their perceptions of the obstacles to future FDI in Morocco. The main obstacles are the slowness of the administration to grant permits and negotiate major issues, the unfair taxation system with little or no tax incentives, and the lack of clear, fair and respected 'rules of the game' especially regarding legal procedures. Other issues such as the lack of infrastructure and the improvement of the local education system have been mentioned. The challenges are clear. There is a need to lower or totally remove these obstacles. As stated by an executive of a U.S. MNE, "immediate action instead of lip service" is needed to improve the general investment climate. A modernized government system without corruption is required to implement the reforms needed to liberalize the economy (exchange rate, interest rate, privatization, creation of capital markets, modernized regulations). The challenge is also to make all these changes and be able to attract new investments in sectors such as infrastructure, tourism, trade, and manufacturing. According to the survey questionnaire, there are numerous economic benefits to the Moroccan economy, which arises from foreign direct investment. The main ones in the short term are higher employment, improved quality of products and services, training of local people in modern business methods, foreign exchange earnings, and supply of the local market with a state-ofthe-art technology. Subsequent benefits are development and economic growth. More specific issues have been raised such as the professional assistance to address the needs of improving the

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information infrastructure, and the privatization process that should yield higher revenues to the State. Morocco is nearing the point where it has adopted the critical mass of policies needed for a quantum jump in economic performance led by the private sector. Already, the early real devaluation, coupled with a shift in relative incentives toward exports, has helped to produce the tremendous growth in manufactured exports during the 1980s. Morocco also begins the new century with an important opportunity to deepen its integration with the industrialized nations, notably the European Communities but also North America and Japan. Thus, the vision for Morocco's future must accord with this progressively closer association with industrialized countries, with all the attendant requirements for more liberalized external trade to become more efficient, more widely used industrial norms and standards to compete in export markets, stronger auditing and better financial disclosure to compete for international capital, more active efforts to assure and promote domestic competition, and stronger measures to accelerate social development. In general, Moroccan economic growth rates in the past are a poor guide for what the future should be. During 1960-90, compared with 67 other developing countries, Morocco was average (with an annual GDP growth rate averaging slightly above 5%), despite the fact that many policies in Morocco—low inflation, a low parallel exchange rate premium, and high public expenditure on economic services—were well above average. The 1980s were generally worse—in Morocco as elsewhere in the developing world—with GDP growth 2 percentage points lower than in the 1970s; but the 1980s were a period of stringent adjustment with minimal foreign investment and continued recourse to rescheduling to deal with a substantial debt overhang. In general, Morocco has underperformed, held back by repressive financial policies, inward trade biases, non-productive public expenditures, a negative attitude toward foreign investment, and controls on private sector activities. The latter part of the 1980s provides a glimpse of what can be achieved: for example, non-phosphate manufactured exports grew by over 15% a year in constant prices during 1986-91, taking advantage of strong export incentives; and foreign direct investment increased by about 150% in 2 years, after government virtually eliminated controls. The example of other countries also shows what should be possible in Morocco. For example, GDP in the nine highest performing East Asian economies expanded an average of 2

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percentage points faster per year than in Morocco during 1960-90. A normative vision for the future should be based on some overall targets for the beginning of the 2000s, and some benchmarks against which to monitor progress in the action program designed to achieve the targets. A sign of success would be that private investment rises from its current level of 12-13% of GDP to 15-18%. By then, the private sector should account for a substantial share of electricity generation, telecommunications services, water distribution and other municipal services, and the operation of various infrastructure installations including ports, airports, industrial zones, and highways—in contrast to its negligible share in these activities today. For industry, during the beginning of the 2000s, Morocco should aim to approach double-digit growth of private industrial output, an even faster growth of exports, a rising contribution of manufacturing to GDP and to exports, increased equity investment in industrial assets (and technology) especially from abroad, and more competitive products (as manifested in more diversified export products and markets). For tourism, the emerging growth strategy seeks to increase both the number of tourists (doubling non-Maghreb arrivals to 3 million per year by 2000 would represent less than 5% annual growth since the peak year of 1987) and the share of high-spending tourists. Tourism should be expected to rise as a share of GDP, and as a share of foreign exchange earnings. Achieving these targets, however, will require strong effort and investment to restructure the sector, aimed at diversifying the tourism product, improving quality to encourage repeated visits, and strengthening international promotional efforts. The challenge is to encourage the private sector to organize and take the lead in these tasks. Here again, MNEs can play an important role. The targets for private sector agriculture are more difficult to set, especially if closer integration with the EU reduces the protection for low-value grain crops and gives greater market access for higher value fruits, vegetables, and processed goods. Government support for the private sector should be guided by a broad principle—neutrality of macroeconomic incentives, including trade and tax policy—across sectors. Any special incentives should be aimed at encouraging more private spending in key areas, for example developing technology, and improving labor. Public expenditures should be increasingly coupled with private spending to assure high quality economic infrastructure and related services, including improved basic health and education of the work force.

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Main Findings

Given the globalization of the world economy, it is not surprising that there are no major differences between the behavior of French and U.S. multinationals. We found very few statistical differences. The rationale behind the few differences in terms of behavior are related to the fact that France has a level of understanding of the Moroccan market that cannot be duplicated by any other country due to French colonialism in North Africa and the time factor. Also, it is rather interesting to notice that the degree of importance of each variable tested in the study corresponds to the major findings in the literature of international business. In terms of Morocco as a location for FDI, U.S. and French MNEs gave a lot of weight to the "size and growth rate of the Moroccan economy" (5.07) and to the "general political, social and economic stability in Morocco" (5.6). In terms of ownership-specific advantages that U.S. and French firms possess, "international experience" (5.63), "technological advantages" (5.31), and "size and scope of the firm" appeared to be the main strengths of the surveyed firms. However, for each country the ranking of these variables is often different which is usually linked to some business behavioral differences. As the Moroccan currency is pegged to a basket of international currencies to help stabilize it, U.S. and French MNEs are not overly concerned by exchange rate stability on their foreign direct investments. Other researchers show similar findings that support this lack of relationship between the factor and FDI (Lizando 1990; Wallace 1990; Froot and Stein 1991; Mody and Srinivasan 1991). Although wages are low in Morocco, they have not been major factor pulling FDIs into the country. As such there is no real relationship between real wage costs and FDI decisions of the MNEs (Papanastassiou and Pearce 1990; Kravis and Lipsey 1982). The majority of the determinants that did not show any significant relationship outside of the realm of Gray's study of international economic involvement. In the light of our findings it appears that Gray's determinant classifications into the five categories (differences in resources; financial factors; transborder impediments to the flows of goods and investment; internal differences in the commercial environment; and cultural factors) is particularly significant (Gray 1999). This is not entirely collaborated by the Narula and Wakelin (1998) findings that show how country-level determinants affect international competitiveness of a country but that can probably be explained by the level of industrialization in Morocco.

1 32

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REFERENCES Agodo, O. (1978) The Determinants of US Private Manufacturing Investments in Africa, Journal of International Business Studies, 9(3):95-107. Bergsman, J. (1992) Private Communication, July, World Bank, Washington, DC. Brewer, T. (1991) Foreign Direct Investment in Developing Countries: Patterns, Policies and Prospects, World Bank PRE Working Paper, No. 712, Washington, DC. Buckley, PJ.C. and Dunning, J.H. (1976), The industrial structure of US direct invesent in the UKs, Journal of International Business Studies, 7, Summer, 5-13. Chase, C.D., Huhle, J.L. and Walther, C.H. (1988) The Relevance of Political Risk in Direct Foreign Investment, Management International Review, 8(2):31-38. Contractor, FJ. (1981) International Technology Licensing Compensation: Costs and Negotiation, Lexington Books, Lexington, Massachusetts. Dunning, J.H. (1990) The Globalization of Firms and the Competitiveness of Nations, The Crafoord Lecture, 1989. Lund: Lund University Press. Dunning, J.H. (1993a) Multinational Enterprises and the Global Economy, Addison Wesley, Wokingham, Berkshire. Fatehi-Sedeh, K. and Safizadeh, H.M. (1989) The Association Between Political Instability and Flow of Foreign Direct Investment, Management International Froot, K. and Stein, J.C. (1991) Exchange Rates and Foreign Direct Investment: An Imperfect Capital Market Approach, Quarterly Journal of Economics, 106, November: 1191-1217. Gray, H.P. (1999) Global Economic Involvement - A synthesis of Modern International Economics, Copenhagen Business School Press, Copenhagen. Green, R.T. and Cunningham, W.H. (1975) The Determinants of US Foreign Investment: An Empirical Examination, Management International Review, 15:113-120. Grubert, H. and Mutti, J. (1991) Taxes, tariffs and transfer pricing in multinational corporation decision taking, Review of Economics and Statistics, 73:285-293. Hartman, D. (1984) Tax Policy and Foreign Direct Investment in the United States, National Tax Journal, 37:475-488. Hollander, A. (1984) Foreign Location Decision by US Transnational Firms: An Empirical Study, Managerial and Decision Economics, 5(1):7-18. Hyun, J.T and Whitmore, K. (1989) Japanese Direct Foreign Investment: Patterns and Implications for Developing Countries, Working Paper Industry Series, No. 1, Industry and Energy Department, Washington. IBRD (1991) The Role of Foreign Direct Investment, Development Committee Meeting Paper, World Bank, Washington, DC. Jun, J. (1989) Tax Policy and International Direct Investment, NBER Working Paper, No. 3048. Kobrin, S.J. (1976) The Environmental Determinants of Foreign Direct Investment: An Expost Empirical Analysis, Journal of International Business Studies, 6:29-42. Kravis, I.B. and Lipsey, R.E. (1982) The Location of Overseas Production for Exports by US Multinational Firms, Journal of International Economics,

12:201-223.

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Kumar, N. (1990) Multinational Enterprises in India, Routledge, London. Lall, S. and Siddharthan, N.S. (1982) The Monopolistic Advantages of Multinationals: Lessons from Foreign Investment in the US, The Economic Journal, 92:668-683. Li, J. and Guisinger, S. (1992) The Globalisation of Service Multinationals in the 'Triad' Nations: Japan, Europe and North America, Journal of International Business Studies, 23:675-696. Lizando, S. (1990) Foreign Direct Investment, IMF Working Paper, International Monetary Fund, Washington, DC. Mody, A. and Srinivasan, K. (1991) Foreign Direct Investment Study, mimeo, World Bank, Washington, DC. Mody, A. and Wheeler, D. (1991) Foreign Direct Investment Study, mimeo, World Bank, Washington, DC. Narula, R. and Wakelin, K. (1998) Technological Competitiveness, Trade and Foreign Direct Investment, Structural Change and Economic Dynamics, 9:373-387. Papanastassiou, M. and Pearce, R.D. (1990) Host Country Characteristics and the Sourcing Behavior of UK Manufacturing Industry, Discussion Papers in International Investment and Business Studies, Series B, Vol. II, No. 140, Department of Economics, University of Reading. Root, F.R. and Ahmed, A. (1979) Empirical determinants of manufacturing direct foreign investment in developing countries, Economic Development and Cultural Change, 27(4):751-767. Saunders, R.S. (1982) The Determinants of Inter-industry Variation of Foreign Ownership in Canadian Manufacturing, Canadian Journal of Economics, 15(l):77-84. Shah, A. and Slemrod, J. (1990) Tax sensitivity of foreign direct investment: An empirical assessment, Working Paper Series, Washington DC: The World Bank June. Shell (1991) Foreign Direct Investment Study, mimeo, World Bank, Washington, DC. Slemrod, J. (1989) Tax Effect of Foreign Direct Investment in the US: Evidence from Cross-country Comparison, National Bureau of 'Economic Research, July. UNCTC (1988) Transnational Corporations in World Development: Trends and Prospects, 4th Survey, United Nations, New York. Vahlne, J.E. and Nordstrom, KA. (1992) Is the Globe Shrinking: Psychic Distance and the Establishment of Swedish Sales Subsidiaries During the Last 100 Years, mimeo, Stockholm. Wallace, C.D. (1990) Foreign Direct Investment in the 1990s: A New Climate in the Third World, Martinus Nijhoff Publishers, Boston and London.

NOTES 1.

The author would like to thank seminar participants of the Ninth International Conference of the International Trade and Finance Association in Casablanca, Morocco (June 1999). In particular, I thank Peter Gray and Rajneesh Narula for helpful comments.

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2.

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The selection of affiliates of French and the United States is designed to contrast two different business cultures as well as to identify the importance of a close historical/colonial association.

Incorporating Trade into the Investment Development Path JOHN H. DUNNING, CHANG-SU KIM AND JYH-DER LIN1

I.

INTRODUCTION

This chapter has an explicit purpose. It is to take a first step in incorporating trade levels and patterns into the notion of the investment development path (IDP)—a notion which seeks to relate the stock of inward and outward direct investment (inward FDI and outward FDI) position of countries to their stages of development and economic structures. The chapter proceeds as follows. In the following section, we present a truncated overview of the IDP, and why we believe that, by relating its trajectory to the changing levels and patterns of trade—viz. the trade development path (TDP)—we may better understand the combined interaction between the two modes of cross-border transactions and the pace and pattern of economic development. In the next section, we briefly describe the contents of the IDP and TDP and formulate a number of general propositions. Then we set out some specific hypotheses, which seek to relate the changing sectoral structure of trade and FDI in Korea and Taiwan over the last 30 years to the growth of their gross national product (GNP) per capita. The last part briefly summarizes our conclusions. II.

SOME ANALYTICAL ISSUES

The IDP

The IDP seeks to explain the international direct investment position of a country in terms of the juxtaposition between the locational 735

136

John H. Dunning, Chang-su Kim andJyh-der Lin

attractions of its endogenous resources, capabilities and markets, visa-vis those of other countries, and the ownership or competitive advantages of its firms vis-a-vis those of other nationalities. More specifically, it avers that, as countries increase their gross national product (GNP) per capita and the created asset component of their resources and capabilities,3 so the level, significance and pattern of their inward FDI and outward FDI, and the relationship between them displays a systematic change. In their earliest stage of economic development (Stage 1), countries have few location-specific (L) advantages to attract inward FDI, and their firms possess virtually no ownership-specific (O) advantages to engage in outward FDI. As countries begin to industrialize—and the focus of this paper is on two industrializing countries—the quality of their indigenous and immobile resources and capabilities, including their institutional capabilities and social infrastructure, improves, as does their domestic spending power. This starts to attract inward FDI, but, at this stage—Stage 2—apart from a limited amount of natural resource and created asset seeking investment, outward FDI is still minimal. This, however, changes in Stage 3 as indigenous firms start to generate their own O-specific advantages. They tend to exploit these firstly by exports, and then, as their foreign markets expand and/or the costs of home-based production rise, by outward FDI. At this stage too, in order to become global players, industrializing country firms begin to seek out foreign technology, management skills and organizational expertise, by means of mergers and acquisitions (M&As) or strategic alliances,4 particularly with firms from the more industrialized countries. Eventually, in the later stages of the IDP,5 outward FDI might well exceed inward FDI—at least for a time—after which there is a tendency for net outward FDI to gravitate towards, and fluctuate around zero, or at very low levels relative to the total value of inward and outward FDI.6 The countries we are considering in this chapter would appear to be entering Stage 4 of their IDPs, inasmuch as, in the 1990s, outward FDI of both Korea and Taiwan began to exceed inward FDI (see Table 7.3). Notwithstanding the fact that the recent Asian crisis has caused a reconfiguration of their international direct investment positions, notably by raising the L advantages of both countries, and lowering the O advantages of Korean and Taiwanese firms—and/or their ability to acquire foreign created-assets—there is no doubt that the time-span of their transition from Stage 1, or early Stage 2 to Stage 4 has been considerably shorter than that of their earlier counterparts in Europe and the U.S. Inter alia, the emergence of the global innovating economy, and the increasing speed at which technological and organizational advances can be

Incorporating Trade into the Investment Development Path

13 7

transferred across national boundaries has helped speed up the process of industrialization. Government policy towards inbound and outbound FDI has also played an important role. For example, for most of the period under review, the Korean government restricted, by one means or another, the amount and/or type of inward FDI allowed; while, in the case of Taiwan, no outward FDI was allowed in mainland China until the late 1980s. In addition to the general proposition that the nature of trajectory of a country's IDP will be related to its GNP per capita and to such locationspecific variables as size, economic structure, absorptive capacity, openness and government policy towards FDI,7 the character and composition of both inward FDI and outward FDI is also likely to change as development proceeds. In Stages 1 and 2 of the IDP, for example, both inward and outward FDI flows are predominantly of the natural resource and market seeking type.8 At the same time, both inward FDI and outward FDI are likely to be between different industrial sectors, i.e., FDI will be mfer-industry in character. In Stages 3 and 4, as the economic structure of countries is increasingly directed towards the production of Schumpeterian (S) goods and services,9 and tends to converge with that of more advanced industrial countries, FDI flows become more of the efficiency and strategic asset-seeking variety. Moving through these stages, the composition of inward FDI and outward FDI then becomes increasingly m£ra-industry,10 and less inter-industry in character. It also tends to become knowledge and/or information intensive. The TOP

The relationship between trade and economic development is a well-researched topic.11 In this chapter, we are primarily concerned with the product composition of manufacturing imports (M) and exports (X); and how these change—particularly in their created asset intensity—as development proceeds. Our general proposition is that, at relatively low levels of GNP per capita, an industrializing country will engage primarily in inter-industry trade, importing products with a higher created asset content than those they export. As development proceeds, the created asset intensity of both M and X increases, with that of X lagging that of M. As this occurs, the proportion of intra-industry trade to total trade increases, and particularly so in the case of those products which are themselves created asset intensive. For the most part, scholarly research on the determinants of the TDP and IDP has proceeded independently, although in a schema introduced in 1986, and revised in 1995 (see Dunning and Norman

138

John H. Dunning, Chang-su Kim andJyh-der Lin

1986; Dunning 1995), an attempt was made to show how, as countries proceeded along their development paths, and as technological progress and human resource development led to an intensification of the created asset component of all products,12 so the relative significance of both intra-industry trade and intra-industry FDI would rise. At the same time, the schema suggested that, as a result of inter-industry, inbound FDI (which, almost by definition, is created asset intensive13), the created asset intensity of the host country's exports is accelerated, and with it, the growth of intraindustry trade. Finally, as a country becomes fully industrialized (i.e., it reaches Stages 4 or 5 of its IDP), much of its efficiency and strategic asset-seeking FDI is with other industrialized, or rapidly industrializing nations; and hence is of an intra-industry FDI kind. The above paragraphs then suggest there is likely to be some interface between the TDP and the IDP both at a macro-level—with both trade and FDI increasing their significance relative to the GNP of countries—and at a sectoral level. Part of this interaction may be sequential; and it is a hypothesis of this paper that changes in the industrial structure of the IDP generally lags that of the TDP; and part may occur simultaneously, as FDI and trade either complement, or substitute for, each other.14 But, whatever the case, the paradigm underpinning the explanation of trade, FDI and economic development is that of dynamic comparative advantage, suitably modified from its initial formulation, to include (1) created immobile assets, and (2) the ownership-specific advantages of particular firms. In the following section, we seek to empirically test some of these ideas, from the experience of the Korean and Taiwanese economies between 1968 and 1997. However, prior to this, in Figure 7.1, we summarize the kinds of interaction, which we might expect to find between the created asset intensity of imports and exports and that of inward and outward direct investment flows, as development proceeds; and also how we might expect the IDPs and the TDPs of countries to interact with each other. As a proxy for created asset intensity, we have taken the FDI intensity of each of the manufacturing sectors in Korea and Taiwan (at a 2, 3 or 4 digit level, depending on the data available),15 and classified these into three groups; viz. above FDI intensity (Asectors), average FDI intensity (O sectors) and below average intensity (B sectors). Further details of this procedure are set out in Appendix 7.1. III.

SOME SPECIFIC HYPOTHESES

The first hypothesis (HI) relates to the nature of the TDP. HI consists of two parts. Hla is that the proportion of total manufactured

Incorporating Trade into the Investment Development Path

139

imports accounted for by average or above average FDI intensive goods (A and O goods) will rise quite sharply in the first two stages of Korean and Taiwanese IDP, but in the third phase it will rise less sharply or even fall. This slowing down phase reflects the fact that imports of less FDIintensive goods are likely to rise, as the domestic production of these becomes less competitive in Korea and Taiwan. The second part of HI (Hlb) is that the proportion of manufactured exports accounted for by A and O goods will accelerate as economic development proceeds, but will lag that of imports. In respect of Hla the respective coefficients and J^ values were estimated by regressing imports on GNP2 as well as on GNP, in order to take account of a possible curvilinear relationship between imports and GNP. As to Hla, the data in Table 7.1 uphold a monotonous rather than a curvilinear relationship between imports and GNP. In the case of regressing imports on GNP, the correlation coefficients are higher and the ^rs are more respectable than the coefficients and ^s between imports and GNP2. The relevant correlation coefficients, their significance, and l¥s for the whole of the 30-year period are shown at the bottom of the table. In the case of Taiwanese FDI intensive imports, the sharpest rise occurred in Stage 2 of their IDP, i.e., during the 1980s. The share of this category of Korean imports rose between 1968 and 1976, then fell back in the following 5 years. Between 1982 and 1995 it fluctuated around 60-70%, since when it has risen sharply. The second part of the first proposition (Hlb) is also broadly upheld by the data. As between Taiwan and Korea, the former seems to have more clearly followed a TDP consistent with the principle of dynamic comparative advantage. In the case of Taiwan, we see that the AX+OX/TX ratio steadily rose throughout the period. In the case of Korea, however, the AX+OX/TX ratio fluctuated, as did the Am+Om/Tm ratio. As predicted, the A^+O^/T^ ratio is seen to have consistently lagged the Am+Om/Tm ratio, although the gap between these ratios steadily narrowed throughout the period. By the mid 1990s, consistent with the proposition that, as a country reaches some maturity in its industrial development—i.e., reaches Stage 4—the export of FDI intensive products is seen to be rising much more quickly than the import of such products. Our data also show that, in spite of its relatively higher GNP per capita, Taiwan lagged behind Korea in its A+O/T ratio until the 1990s in the case of imports, and the late 1990s in the case of exports. One explanation for this lagging may be the fact that the economic transformation of the Korean economy, compared with that of Taiwan, has tended to be dominated by large conglomerates. The economies of size enjoyed by these companies may well have

140

John H. Dunning, Chang-su Kim and Jyh-der Lin TABLE 7.1

The FDI Intensity of Korean and Taiwanese Imports and Exports and GNP per capita GNP per capita ($) Korea

SI 1968 1969 S2 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S4 1992 1993 1994 1995 1996 1997 Coefficients

tf2

54 68 85 103 124 158 216 285 385 489 649 821 964 1176 1327 1556 1758 1943 2255 2636 3126 3485 4158 4948 5457 6009 6805 7740 8486 9046 GNP GNP2

Imports ((Am+Om)/Tm) Exports ((AX+OX)/TX)

Taiwan

Korea

304 345 389 443 522 695 920 964 1132 1301 1577 1920 2344 2669 2635 2823 3167 3297 3993 5275 6333 7512 7954 8815 10470 10852 11597 12396 12872 13198

55.8 57.0 51.1 54.6 63.9 62.2 65.3 64.6 69.1 56.7 60.4 61.8 54.4 59.2 62.1 64.7 65.5 68.7 66.1 64.0 65.1 63.3 61.7 60.4 60.4 66.0 65.4 63.9 74.8 74.7 0.0002 1.1 8e~7 0.2315

Taiwan

33.2 32.0 33.0 29.3 27.1 25.2 27.9 32.8 32.9 34.4 52.7 52.6 51.3 51.9 50.9 53.0 57.4 56.7 60.0 61.5 61.5 62.4 62.8 62.9 63.5 61.8 64.1 65.9 68.8 67.9 0.0075*** -3.1e~7** 0.6282

Korea

Taiwan

10.1 10.6 5.2 7.3 37.1 38.9 36.3 38.3 32.4 18.3 18.1 21.0 19.3 17.9 15.0 17.7 20.7 21.6 25.6 34.1 36.1 35.4 36.4 37.9 40.2 42.4 46.8 53.2 56.3 58.2 0.0038**

13.6 22.6 11.1 10.7 10.5 10.2 15.7 15.9 13.6 15.6 22.2 22.8 25.1 25.2 24.8 26.7 29.3 30.5 31.8 34.3 38.8 40.2 43.8 45.8 48.6 51.4 53.3 57.9 59.3 60.9 0.0035***

0.5967

0.9213

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. The relevant equations for imports (Im) and exports (Ex) were as follows. IM = a+b*GNP+c*GNP2, Ex = a+b*GNP The coefficients and R2 for the imports were estimated by regressing imports on GNP2 as well as GNP in order to examine the curvilinear relationship between imports and GNP. It is difficult to precisely identify the span of each of the stages of development based upon the_ international investment position of the two countries, as both their GNPs per capita and policies towards inward and outward FDI in any given year differ from each other. But very roughly and in both cases, Stage 1 lasted between 1968 and 1969, Stage 2, which, in fact, can be broken down into two sub-periods (1970-78 and 1979-85), 1970-85, Stage 3 1986-91, and Stage 4 1992-97.

Incorporating Trade into the Investment Development Path

141

enabled them to engage in trade and FBI with a high created asset content at a relatively earlier stage of their industrial development. In Table 7.2, we set out some details of the changing industrial structure of Korean and Taiwanese imports and exports between 1968 and 1997. We find, as predicted, that the coefficients of correlation between the most FDI intensive imports and exports (A type goods) and GNP per capita are strong and positive at a 1% or 5% level; and that—again as predicted—the correlation between the least FDI intensive imports and exports (B type goods) were strongly negative, again at a 1% or 5% level. The relationship between goods of average FDI intensity (O goods) and GNP per capita was more mixed. The second hypothesis (H2) relates to the relationship between the IDP and the level and structure of a country's economic development. As with HI, H2 is sub-divided into two parts. H2a avers that both inward and outward FDI will be positively correlated with the level of economic development (i.e. GNP per capita), and that, initially, outward FDI will lag inward FDI, but later will rise more rapidly than it, before settling into a "fluctuating equilibrium."16 H2b relates the IDP to the structure of economic development. It suggests that the proportion of FDI directed to the production of above average or average FDI intensive (A+O/T) goods will rise as countries move along their IDPs, but with the proportion of FDI intensive goods accounted for by outward FDI lagging that of inward FDI. The data on inward FDI and outward FDI—as set out in Table 7.3—though less detailed or comprehensive than that on trade, support H2a. The correlation coefficients between manufacturing inward FDI and outward FDI for Korea and Taiwan and GNP per capita are positive and significant at a 1% level. The respective coefficients for the proportion of outward FDI to inward FDI are less buoyant though still significant. This is partly because, in the early part of the period, there were large percentage fluctuations in the values in both variables (and particularly outward FDI), and partly because, at the end of the period, there was a marked resurgence in inward FDI in both Korea and Taiwan, and a cutback in outward FDI in the case of Korea. The data set out in Table 7.4 suggest that H2b is only modestly supported. The correlation coefficient between the share of above average or average FDI intensive inward FDI and outward FDI flows and GNP per capita is positive for both countries, but only significant in the case of inward FDI for Taiwan and outward FDI for Korea. The disaggregated FDI data into three degrees of created asset intensity deliver more detailed information on H2b. As Table 7.5

TABLE 7.2 GNP per head ($) Korea Taiwan SI 1968 1969 S2 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S4 1992 1993 1994 1995 1996 1997 Coefficients

F?

54 68 85 103 124 158 216 285 385 489 649 821 964 1176 1327 1556 1758 1943 2255 2636 3126 3485 4158 4948 5457 6009 6805 7740 8486 9046

304 345 389 443 522 695 920 964 1132 1301 1577 1920 2344 2669 2635 2823 3167 3297 3993 5275 6333 7512 7954 8815 10470 10852 11597 12396 12872 13198

Proportion of A, O, and B Type Imports and Exports as a Percentage of Total Imports and Exports

Type A Korea Taiwan Imports Exports Imports Exports 26.9 30.1 33.4 35.4 42.4 49.7 36.0 43.6 43.7 31.7 33.2 34.6 31.8 33.4 34.7 35.0 33.9 33.5 44.8 43.9 47.6 45.6 43.7 43.1 45.4 46.7 46.1 46.2 54.6 57.4 0.002*** 0.5894

0.0 0.0 0.0 0.0 28.8 30.1 26.0 22.4 20.3 10.4

9.2 10.7

8.7 7.9 8.0 10.4 12.5 13.7 20.7 25.1 27.1 25.9 25.9 27.9 30.5 33.8 38.6 45.7 49.1 52.0 0.004*** 0.6597

15.0 14.3 16.6 12.4 10.4

8.5 10.9 12.0 11.6 12.3 28.9 28.6 26.2 27.2 28.2 29.1 32.0 31.5 32.8 34.4 35.7 36.8 37.5 36.7 39.9 39.4 40.7 41.8 42.6 44.4 0.0021** 0.5412

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. Im (or, Ex) = a+b*GNP for each type of A, O and B.

8.3 17.6

5.8 5.8 6.2 5.7 9.5 8.8 5.9 6.4 13.8 14.0 15.4 15.3 15.2 16.4 19.0 19.8 21.0 23.3 26.4 27.1 29.9 31.2 33.2 35.2 36.7 40.8 42.9 47.1 0.0027*** 0.9410

TypeO Korea Taiwan Imports Exports Imports Exports 10.1 28.9 26.9 10.6 17.7 5.2 7.3 19.2 21.5 8.3 12.5 8.8 29.3 10.3 16.0 21.0 25.5 12.2 8.0 25.2 8.9 27.3 27.3 10.3 22.7 10.6 10.0 25.8 27.4 7.6 7.3 29.7 31.6 8.3 7.9 35.2 21.3 8.9 9.0 20.1 9.0 17.5 17.7 9.5 18.0 10.4 17.3 10.0 20.5 9.6 8.7 19.3 19.3 8.2 17.7 7.4 20.2 7.2 17.3 6.2 -0.0009* -0.0001 0.2477 0.0352

18.3 17.7 16.4 17.0 16.7 16.7 16.9 20.8 21.3 22.2 23.8 24.0 25.1 24.8 22.7 23.9 25.4 25.2 27.2 27.1 25.8 25.6 25.2 26.2 23.6 22.4 23.5 24.1 26.2 23.5 0.0005 0.2303

5.3 5.0 5.3 4.9 4.3 4.5 6.3 7.0 7.6 9.2 8.4 8.8 9.7 9.9 9.6 10.2 10.2 10.6 10.8 11.1 12.5 13.1 13.9 14.6 15.4 16.2 16.6 17.1 16.4 13.9 0.0008*** 0.7829

TypeB Korea Imports Exports 44.2 43.0 48.9 45.4 36.1 37.8 34.7 35.4 30.9 43.1 39.6 38.2 45.6 40.9 37.9 35.3 34.6 31.3 33.9 36.0 34.9 36.7 38.3 39.6 34.1 34.0 34.6 36.1 25.1 25.3 -0.0012** 0.4306

89.9 89.4 94.8 92.7 62.9 61.1 63.7 61.7 67.6 81.7 81.9 79.0 80.7 82.1 84.4 82.2 79.3 78.4 70.4 65.9 63.9 64.6 63.6 62.1 59.8 57.6 53.2 46.8 43.7 41.8 -0.0039** 0.5982

Imports

Taiwan Exports

66.8 68.0 67.0 70.7 72.9 74.8 72.1 67.2 67.2 65.6 47.3 47.4 48.7 48.1 49.1 47.0 42.6 43.3 40.0 38.5 38.5 37.6 37.2 37.1 36.5 38.2 35.9 34.1 31.1 32.1 -0.0026** 0.4685

86.4 77.4 88.9 89.3 89.5 89.8 84.3 84.1 86.5 84.4 77.8 77.2 74.9 74.8 75.2 73.3 70.7 69.5 68.2 65.7 61.2 59.8 56.2 54.2 51.4 48.6 46.7 42.1 40.7 39.1 -0.0035*** 0.9207

s



3•3 I

a c 3

3'

Cro

n flj Cra In C •^ §' 3

a. s03

3' (—

TABLE 7.3 GNP per capita ($) Korea Taiwan

Inward and Outward Direct Investment and GNP per capita

Inward FDI ($ mil.) Korea Taiwan Total Man. Total Man.

Outward FDI ($ mil.) Korea Taiwan Total Man. Total Man.

54 68 85 103 124 158 216 285 385 489 649 821 964 1176 1327 1556 1758 1943 2255 2636 3126 3485 4158 4948 5457 6009 6805 7740 8486 9046

is cumulated value.

304 345 389 443 522 695 920 964 1132 1301 1577 1920 2344 2669 2635 2823 3167 3297 3993 5275 6333 7512 7954 8815 10470 10852 11597 12396 12872 13198

0.72 0.98 0.68 0.37 0.93 0.76 0.59 0.53 1.16 1.80 1.28 1.50 1.80 2.72 1.51 1.94 0.84

0.30 0.02 0.50 0.31 0.05 0.76 0.29 0.38 0.90 1.63 0.72 1.15 2.16 5.42 3.32 1.85 1.17 0.0004* 0.4598

0.02 0.00 0.00 0.01 0.03 0.01 0.04 0.02 0.03 0.08 0.02 0.03 0.09 0.03 0.03 0.03 0.07 0.06 0.07 0.07 0.19 0.39 0.67 0.93 0.61 1.37 0.99 0.46 0.88 0.68

0.03 0.00 0.00 0.01 0.05 0.02 0.04 0.02 0.03 0.13 0.02 0.03 0.09 0.03 0.04 0.03 0.07 0.06 0.06 0.07 0.12 0.40 0.63 0.71 0.51 1.17 0.69 0.31 0.76 0.44 0.00006*** 0.8807

Incorporating Tr

1.8 1.8 66 13 90 0.0 0.1 86 109 12 0.4 0.5 107 58 139 1.0 29 163 1.2 132 3.7 127 4.1 80 58 3.4 175 249 3.2 221 7.0 7.3 160 128 189 1.4 2.4 118 83 52 3.9 4.4 124 53 142 94 12.3 13.8 164 * 80 3.0 38 138 68 213 101 5.2 98 6.3 9.3 111 329 195 232 435 97 466 131 37.2 42.0 21 7.4 11.0 34 109 263 115 396 152 233 380 9.6 12.0 121 128 2 112 9.9 83 341 404 11.0 36 72 122 67 33.7 39.0 9 29 559 193 502 35.1 219 541 42.0 8 168 236 702 184 364 584 35.9 57.0 770 477 242 71.6 367 984 103.0 109 375 1419 626 86.0 219.0 478 559 1183 894 212 742 649.8 931.0 454 943 1628 504 2418 812 915.3 1611 1445 969 1552.0 895 596 2302 885.8 677 1656.0 1511 1177 941 1778 1242 378.5 887.0 693 803 605 1461 742 1206 1044 599 1876 703. 1 1137 1661.0 527 1213 542.4 781 3581 2179 1617.0 1317 402 1630 1813 4949 1941 553.8 2939 1357.0 883 2925 622.4 817 6220 3203 1930 2460 3562 2165.0 6971 2348 4266 978.1 2737 2894.0 2245 5845 0.0718*** 0.0553*** 0.4666*** 0.156*** 0.678 0.8811 0.6317 0.7231 If Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. The relevant equations for FDI were as follows: inward FDI (or, outward FDI and outward FDI/inward FDI) = a+b*GNP.

SI 1968 1969 S21970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S41992 1993 1994 1995 1996 1997 Coefficients

Outward FDI/Inward FDI ($ mil.) Korea Taiwan Total Man. Total Man.

Q. fT

3' 3" 3o> 3" fi £ 2 r3 "iu n5

o"

"0

3 3 ~o Si ^

144

John H. Dunning, Chang-su Kim and Jyh-der Lin

TABLE 7.4

Proportion of Inwards FDI (IDI) and Outwards FDI (ODI) Accounted by FDI Intensive Sectors GNP per capita ($)

SI 1968 1969 S2 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S4 1992 1993 1994 1995 1996 1997 Coefficients rf

Korea

Taiwan

54 68 85 103 124 158 216 285 385 489 649 821 964 1176 1327 1556 1758 1943 2255 2636 3126 3485 4158 4948 5457 6009 6805 7740 8486 9046

304 345 389 443 522 695 920 964 1132 1301 1577 1920 2344 2669 2635 2823 3167 3297 3993 5275 6333 7512 7954 8815 10470 10852 11597 12396 12872 13198

ODI ((A0+O0)/T0) Korea

53.8 75.0 84.5 55.2 84.8 47.4 59.7 60.4 85.2 91.0 94.1 89.1 92.7 82.8 89.3 93.1 93.0 94.6 93.4 93.9 92.2 91.3 94.3 95.3 84.4 90.2 88.0 80.1 91.2 85.2 0.0017 0.1226

Taiwan

75.1 88.9 83.7 40.8 87.1 71.0 60.6 77.9 78.9 83.4 86.0 67.6 47.0 77.1 70.2 90.6 94.5 86.6 87.9 78.7 79.8 80.8 80.0 80.8 87.9 75.0 81.6 94.8 83.6 56.3 0.0009* 0.2346

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. IDI (or, ODI) = a+b*GNP.

Korea

6.8 56.2 89.9 79.8 80.1 31.0 30.5 35.6 34.5 66.6 53.6 55.5 64.4 67.4

71.2 75.6 65.6 0.0033* 0.5415

Taiwan

65.6 n.a. 24.2 56.7 42.8 54.9 56.5 32.7 41.4 88.6 69.3 71.8 96.1 44.3 0.00 36.6 82.1 86.7 81.5 87.3 87.9 89.9 74.5 38.5 63.3 62.3 71.9 57.5 59.5 65.2 0.0019 0.2031

to

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Incorporating Trade into the Investment Development Path ^ac'eOj^i-H^c^tOThtd-HOOinooO

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145

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. IDI (or, ODI) = a+b*GNP for each type of A, O and B.

x Tt< CM

oc

CM

co co -^ m to Ci cr. '— co 10 CD co to to x

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8486 ] 1996 1997 9046 Coefficients

146

John H. Dunning, Chang-su Kim and Jyh-der Lin

shows, throughout the period, for each of these types, there were relatively large percentage fluctuations for both inward FBI and outward FDI for both Korea and Taiwan. Nonetheless, taking the A and O types together, the data modestly upholds our predictions, and the expected minus coefficients for the least FDI intensive products (B/T) ratio, though not significant, provide a consistent support for the idea that, as development proceeds, the structure of inward FDI and outward FDI undergoes systematic change. The conclusive remarks for H2b, however, should be reserved at this point. The classification of FDI into A, O and B types is conducted at the 2-digit SIC level, which is less detailed and hence less reliable in examining sectoral compositions and their patterns of change. We now turn to examining the relationship between the pattern of the IDP and TDPs. What might this relationship be? Our hypothesis (H3), following the discussion of the two paths set out earlier in the paper and in Figure 7.1, is that both inward FDI and outward FDI flows in above and average FDI intensive sectors will be positively correlated with their counterparts in trade; but that (A+O) inward FDI will lag (A+O) imports but lead (A+O) exports while (A+O) outward FDI will lag (A+O) exports. As set out in Table 7.6, both inward FDI and outward FDI flows in FDI intensive sectors are positively related to the trade flows in FDI intensive sectors, with surges in the FDI intensity of inward FDI and outward FDI broadly corresponding to those of exports and imports. Moreover, the positive coefficients of all the equations support the proposition that imports leads inward FDI, that inward FDI leads exports; and also that exports lead outward FDI, though only two out of the six coefficients were statistically significant.17 We checked the proposition on a sequence separately for trade and FDI. As shown in Table 7.7, the A+O imports ratio led the A+O exports ratio. When it comes to the FDI data, however, these did not support the leading and lagging sequence between the inward and outward FDI A+O ratios. This may be explained by the fact that an industrial upgrading of both economies has been directed intentionally by government policy which, in the early stages of the IDP, made a conscious attempt to attract FDI towards more capital-intensive sectors, and in the later stages, towards more technology-intensive sectors. These complexities might have prevented us from obtaining a more robust result in practice with respect to the sequencing of imports, inward FDI, exports and outward FDI in Table 7.6. Our fourth hypothesis (H4) is based on the idea that, as countries develop, the determinants of trade and FDI become less closely

Incorporating Trade into the Investment Development Path

147

Low Resource and Capability Base - Small Domestic Markets (GNP per capita < $1000 (1994 values)) Exports (X) mainly in less FDI intensive sector (B) Imports (M) mainly in medium FDI intensive sector (O) Intra-industry trade relatively low

Stage 1 ^

Modest inward FDI, and mainly in less / medium (B and O) FDI intensive sector Virtually no outward FDI Intra-industry FDI low

Improving Resource and Capability Base - Rising Domestic Markets (GNP per capita $1000 - $3000) Exports (X) still mainly in B sectors but increasing in O sectors Imports (M) as in stage 1, but some also in A sectors Intra-industry trade still low but increasing

Stage 2

More inward FDI, mainly in B and O sectors outward FDI beginning mainly in B and O sectors Intra-industry FDI low

Created Asset Intensity and Indigenous Base Now Becoming Significant - Rising Domestic Markets (GNP per capita $3000 - $10000) Exports (X) now largely O but some A. B type exports becoming relatively less important Imports (M) increasing % of O and A type products Intra Industry trade now becoming significant

Stage 3

inward FDI now being concentrated in O and A sectors outward FDI increasing in O type products and some asset-seeking outward FDI in A sectors Intra industry FDI beginning to increase

Approaching Mature Industrialization: Relatively Rich and Sophisticated Markets (GNP per capita $10000 ) Exports (X) now mainly of FDI intensive products (O and A) Imports (M) are mixed as some B and O products cheaper to import than produce domestically. But imports of A type products rising. Intra-industry trade has a high % of total trade.

Stage 4

inward FDI increasingly concentrated in O and A sectors outward FDI rising faster, and sometimes exceeding inward FDI concentrated in O and A sector Intra-industry FDI is an important component of all cross-border FDI flows.

FIGURE 7.1 Four Stages in the IDP and TDPs of Industrializing Developing Countries Note These stages, and the GNP per capita data, assume that there is no, or relatively few, restrictions on either inward or outward FDI and trade flows.

related to the comparative advantages of their natural resource endowments, and more to that of their created assets; and also the presence or absence of firm specific scale economies, including those which result in inward FDI or outward FDI. Figure 7.1 has

TABLE 7.6

The FDI Intensity of Korean and Taiwanese Trade and FDI •

SI 1968 1969 S21970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S4 1992 1993 1994 1995 1996 1997 Coefficients tf2

Imports ((A m +O m )/T m ) Korea Taiwan 55.8 33.2 57.0 32.0 51.1 33.0 54.6 29.3 63.9 27.1 62.2 25.2 65.3 27.9 64.6 32.8 69.1 32.9 56.7 34.4 60.4 52.7 61.8 52.6 54.4 51.3 51.9 59.2 50.9 62.1 53.0 64.7 65.5 57.4 68.7 56.7 66.1 60.0 64.0 61.5 65.1 61.5 63.3 62.4 61.7 62.8 60.4 62.9 60.4 63.5 66.0 61.8 65.4 64.1 63.9 65.9 74.8 68.8 74.7 67.9

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. IDI = a+b*Im, Ex = a+b*IDI, ODI = a+b*Ex.

Korea 53.8 75.0 84.5 55.2 84.8 47.4 59.7 60.4 85.2 91.0 94.1 89.1 92.7 82.8 89.3 93.1 93.0 94.6 93.4 93.9 92.2 91.3 94.3 95.3 84.4 90.2 88.0 80.1 91.2 85.2 0.1623 0.0047

Taiwan 75.1 88.9 83.7 40.8 87.1 71.0 60.6 77.9 78.9 83.4 86.0 67.6 47.0 77.1 70.2 90.6 94.5 86.6 87.9 78.7 79.8 80.8 80.0 80.8 87.9 75.0 81.6 94.8 83.6 56.3 0.2345* 0.1054

Exports ((A^+OJ/TJ Korea Taiwan 13.6 10.1 22.6 10.6 11.1 5.2 10.7 7.3 10.5 37.1 38.9 10.2 15.7 36.3 15.9 38.3 13.6 32.4 15.6 18.3 18.1 22.2 22.8 21.0 25.1 19.3 17.9 25.2 24.8 15.0 26.7 17.7 29.3 20.7 30.5 21.6 31.8 25.6 34.3 34.1 38.8 36.1 35.4 40.2 43.8 36.4 45.8 37.9 48.6 40.2 51.4 42.4 53.3 46.8 57.9 53.2 59.3 56.3 60.9 58.2 0.0157 0.1866** 0.0048 0.2066

ODI ((A (> +( Korea

6.8 56.2 89.9 79.8 80.1 31.0 30.5 35.6 34.5 66.6 53.6 55.5 64.4 67.4 71.2 75.6 65.6 0.6904 0.0201

Taiwan 65.6 n.a. 24.2 56.7 42.8 54.9 56.5 32.7 41.4 88.6 69.3 71.8 96.1 44.3 0.0 36.6 82.1 86.7 81.5 87.3 87.9 89.9 74.5 38.5 63.3 62.3 71.9 57.5 59.5 65.2 0.3425 0.0339

<s^

0 .__ •

O c 1

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CL ~*

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TABLE 7.7

SI 1968 1969 S21970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S41992 1993 1994 1995 1996 1997 Coefficients If

Imports ((A m +O I n)/T,J Taiwan Korea 55.8 33.2 32.0 57.0 51.1 33.0 54.6 29.3 27.1 63.9 25.2 62.2 65.3 27.9 64.6 32.8 69.1 32.9 56.7 34.4 52.7 60.4 61.8 52.6 54.4 51.3 51.9 59.2 50.9 62.1 53.0 64.7 57.4 65.5 56.7 68.7 60.0 66.1 61.5 64.0 61.5 65.1 62.4 63.3 62.8 61.7 60.4 62.9 63.5 60.4 61.8 66.0 64.1 65.4 65.9 63.9 68.8 74.8 67.9 74.7

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level Ex = a+b*Im, ODI = a+b*IDI.

The FDI Intensity of Korean and Taiwanese Trade and FDI Exports ((A x +O x)/T x ) Taiwan Korea 13.6 10.1 22.6 10.6 11.1 5.2 10.7 7.3 10.5 37.1 38.9 10.2 15.7 36.3 15.9 38.3 32.4 13.6 15.6 18.3 18.1 22.2 22.8 21.0 25.1 19.3 17.9 25.2 24.8 15.0 26.7 17.7 29.3 20.7 30.5 21.6 31.8 25.6 34.3 34.1 38.8 36.1 35.4 40.2 43.8 36.4 45.8 37.9 48.6 40.2 42.4 51.4 46.8 53.3 57.9 53.2 59.3 56.3 60.9 58.2 0.3993** 0.7301*** 0.1711 0.2565

IDI ((Aj-t Korea 53.8 75.0 84.5 55.2 84.8 47.4 59.7 60.4 85.2 91.0 94.1 89.1 92.7 82.8 89.3 93.1 93.0 94.6 93.4 93.9 92.2 91.3 94.3 95.3 84.4 90.2 88.0 80.1 91.2 85.2

Taiwan 75.1 88.9 83.7 40.8 87.1 71.0 60.6 77.9 78.9 83.4 86.0 67.6 47.0 77.1 70.2 90.6 94.5 86.6 87.9 78.7 79.8 80.8 80.0 80.8 87.9 75.0 81.6 94.8 83.6 56.3

ODI ((A o +O,U )/T 0 ) Taiwan Korea 65.6 n.a. 24.2 56.7 42.8 54.9 56.5 32.7 41.4 88.6 69.3 71.8 96.1 6.8 44.3 0.0 56.2 89.9 36.6 79.8 82.1 80.1 86.7 31.0 81.5 30.5 87.3 35.6 87.9 34.5 89.9 66.6 74.5 53.6 38.5 55.5 63.3 64.4 62.3 67.4 71.9 57.5 71.2 59.5 75.6 65.6 65.2 0.0847 -0.3413 0.0006 0.0658

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already suggested that in their early stages of development, countries will primarily engage in inter-industry trade. This is followed by inter-industry FDI. Later, and partly as the result of inward FDI, intra-industry trade will start to rise, and then eventually—usually much later—intra-industry FDI will also take place. The fourth hypothesis, like the first two, can also be broken into two parts. The first (H4a) is that the proportion of intra-industry trade18 for A and O type products will be positively related to GNP per capita. The second (H4b) is that the growth of intra-industry FDI for A and O type products will also be positively correlated with GNP per capita, but will lag the growth of intra-industry trade. As the data in Table 7.8 and respective correlation coefficients and F^s show, there is some support for H4a, i.e., that intra-industry trade is positively related to economic development. In respect of H4b, there is also some suggestion that the growth of intra-industry FDI lags that of intra-industry trade. However, there is no real evidence that intra-industry FDI for A and O type products grows as economy develops. Again FDI sectoral classification at a 2-digit level hampers any definitive analysis of these issues. IV. CONCLUSIONS

The main conclusion of this chapter is that the understanding of the contents and determinants of the IDP is considerably enriched when trade levels and patterns are encompassed within its ambit. Statistical data from the Korean and Taiwanese economies generally support the idea of an integrated TDP and IDP, and that the growth of each tends to be positively correlated with GNP per capita, and with the created asset intensity of the manufacturing sector. As development proceeds, the composition of both trade and FDI becomes more FDI-intensive, with intra-industry trade and intraindustry FDI, assuming an increasing proportion of all trade and FDI, but with intra-industry FDI lagging that of trade. These results are consistent for both Korea and Taiwan. Indeed little country variance exists, which supports the idea that the two economies have followed similar economic development paths. There is also a strong suggestion that changes in the sectoral composition of exports lag those of imports. However, there is no evidence that the FDI intensity of outward FDI follows that of inward FDI. Interestingly, for both Korea and Taiwan, the A+O/T ratio of FDI was consistently higher than that of trade. This may imply that both Korea and Taiwan are special cases of truncated, FDI-centered economic development—the explanation of which is somewhat different from what our general theorizing would suggest.

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