1. The Concept of Foreign Direct Investment
In today's world, domestic capital is not sufficient for the development of countries that will ensure competitiveness in global markets. Foreign investments, that enter the host state as debt or capital, constitute important financial resources for developing economies. Throughout the history, states, especially developing countries, needed foreign investment to strengthen their economies and continue their development; thus they needed foreign investors to meet their various needs such as technological infrastructure, capital and expertise which they do not have or have limited. Then the question arises; is foreign direct investment still an indispensable resource for states?
The idea that "the investments that stay within the home state would be better for the development of this state" has already lost its validity. Foreign investment has become an indispensable element of the development of states in terms of labor, access to raw materials and opening to new markets.1 In order to carry out energy, infrastructure and natural resources investments which have high costs and requiring expertise, foreign investors are seen as indispensable in terms of financing and transfer of technology.2
In literature there are different definitions for foreign direct investment (FDI). According to one definition; foreign investment can be defined as the transfer of movable or immovable assets in whole or in part, from the country of origin to the host country for the purpose of using it to improve the welfare of the host country, under the control of the owner.3 But this definition ignores that the main objective of the investor, whether it is operating in its own country or in a foreign country, is always to make profit rather than to increase the welfare of the country.
To make a more general definition that takes into account the objectives of investors, a foreign direct investment can be defined as a long-term investment made by a firm or an individual in one country, into business interests located in another country, with all risks and profit opportunities. In the context of FDI, it is possible for an investor to invest in an enterprise in another country, as well as starting a new business, complete its investment through direct acquisition or even know-how transfer only.4
2. Historical Development of Foreign Direct Investments
The great accumulation of capital in money centers of the world, that is far in excess of the opportunities for home investments, has led to international investment extending over the entire surface of the earth.5 Indeed, the establishment of foreign investments was one of the chief motivations behind the expansion of European empires to the four corners of the world in early pre-modern period.6 It is known that the history of foreign investment in Europe goes back to ancient times and these investments are made in Asia, Middle East, Africa and other parts of the world.
One of the earliest examples of the foreign investment in its purest form is that of the Phoenicians, a civilization that flourished from 1500 BC in what is known as Israel and Palestine. Phoenicians traded by ships with the Greeks and established outposts around the Eastern Mediterranean from which day can sell goods from their homeland such as wood and textile. These lasting outposts are to be accepted as the permanent presence in foreign country.
A few centuries after Phoenicians, the Silk Road trading routes were established between Europe (Roman Empire), the Middle East and the Pacific Ocean, extending over 6000 km through the deserts, plains and mountains of Asia. The Silk Road remained a key link between Europe and Asia until the middle ages when sea transport to dominate international investment, as well as international trade. Beginning of the fifteenth century there was extensive economic relation between Europe and China, as well as India.
During the early fifteenth century and onwards Western European states began to establish permanent colonies in the locations better they have previously visited because of the trade missions. The Dutch East India Company was formed in 1602 in order to chase commercial activities in Indonesia can be described as the world's first multinational corporation. Also, the Portuguese begin establishing colonies in India and Africa, likewise the British and French. The latter two states also set up colonies in North America where fur trapping was a profitable enterprise. Portugal and Spain had also begun settling Central and South America by to mid-seventeenth century, driven by the pursuit of gold.7
In eighteenth to nineteenth centuries, investment was largely made in the context of colonial expansion. In this period, investments are unilateral from the imperialist states to the colonial states and they generally tended to natural resources.8 The practice of colonialism by the European powers was rooted in the economic objective of exploiting abundant resources and cheap labor available in lesser developed countries. It was done through military and administrative presence.
Wealth that has been generated from foreign investments was itself tied to the political goal of land acquisition and expansion of territorial sovereignty of the major European powers. The wealth from the colonies especially gold and silver, enriched the home country which in turn funded raise of greater armies and navies.
Early in the twentieth century, large part of world's infrastructure was developed through FDIs; these include electric power in Brazil, telecommunications in Spain. Likewise, German chemical companies were expanding outside Germany Before WWI like U.S. auto manufacturers. Also, British firms invested in consumer goods manufacturing abroad from an early date.
3. Developments in 20th Century
By 1914 the world stock of FDI was estimated at $15 billion; United Kingdom was the largest source of the investment, followed by the United States and Germany; on the other hand, United States was also the largest recipient of FDI. The stock of world FDI had risen to $66 billion by 1938 while the United Kingdom firms were still the largest investors. Most of the investment had been made in Latin America and Asia with the significant part in agriculture and mining. These patterns started shifting as the U.S. firms became the main source of FDI; manufacturing investment became more prevalent.9
While foreign investments to developing countries in the beginning of the twentieth century were mainly motivated by exploiting natural resources and building railways, these investments increasingly been in efficiency-seeking FDI (textiles and clothing in East Asia from the sixties, automobile industry in Asia and Latin America), and strategic asset-seeking FDI (technology activities in Singapore and Malaysia). For example, textile production shifted to developing countries such as Mauritius that had unused quotas for export to industrial country markets.10
In seventies commodity prices started escalating. This had two effects on FDI, one positive and one negative. First, high prices encouraged increased FDI in extractive sector, particularly oil and gas sectors.11 Second, balance of payment surpluses of commodity-exporting countries provided an abundant source of investable capital. This money was recycled to developing countries through large scale sovereign lending by commercial banks.
So, developing countries became more interested in on sovereign borrowing than attracting FDI. Also, in late seventies, economic buoyancy of many developing countries encouraged policy makers to pursue inward-oriented approaches. Followed by, a number of countries tightened policy restrictions on FDI. Investors responded by reducing their FDI in developing countries.12
Economic stagnation continued in the first half of eighties. Commodity prices started falling, industrial countries faced recession and global interest rates became higher; all of these factors triggered a debt crisis. Inward-looking and state-oriented economic policies resulted in low productivity and insulation from global economy. That's why many countries started structural adjustment programs to reorient their economies toward private sector, international trade and competitiveness. These adjustments also involved reduced tariffs, liberalizing business environment, deregulating of FDI. In response to these changes, FDI flows to developing countries began to increase in second part of eighties.
Governments continued to open up more areas to private sector in nineties; especially infrastructure became increasingly open to private sector and FDI in infrastructure grew rapidly. In nineties privatization also played an important role in attracting FDI. Countries like Argentina, Chile and Columbia, where the privatization was open to foreign investors, they attracted the most foreign investors to their countries.13
Direction and composition of the FDIs also changed in time. In early 1900s, two thirds of world FDI was flowing to developing countries. In 1914, on the eve of WWI, FDI accounted for 40 per cent of GDP in developing countries. Now, this has changed, FDI to developed countries is as much as FDI to developing countries. The level and composition of foreign investments have also changed over time.
In 1914, 70% of US FDI in developing countries was in agriculture, mining or petroleum; 26% was in services; and just 1% in manufacturing. In 1998 these figures were 14%, 59% and 27% respectively.14 Thus, there has been a marked change from natural resources FDI towards knowledge-intensive activities.
4. Current Developments
Today, foreign direct investments and foreign investors are increasing their importance and share in the international arena. In 2015, international direct investments increased by 38% to $ 1.7 trillion, the highest figure since the 2009 crisis.
Starting from 2015 FDIs have a downward trend, the decline had third consecutive year fall in FDI. Global FDI flows also continued their slide in 2018, falling by 13 per cent to $1.3 trillion from a revised $1.5 trillion in 2017. In the first half of 2019, global FDI flows also decreased by 20% compared to the last half of 2018, to USD 572 billion. FDI flows dropped by 5% to USD 361 billion in Q1 2019 and by 42% to USD 210 billion in Q2 2019. Despite this decline, direct investments are still one of the most important actors in the global economy both for developed and developing economies.
Nowadays, when the world is trying to cope with the coronavirus epidemic, the economies of the countries have been hit hard. This extraordinary situation and rapid spread of the virus are being felt worldwide and impacting all business sectors. It was a crisis like no other, shutting down factories and schools, closing borders and putting half of humanity under some form of lockdown. It has led to a strong drop in the cash-flow of companies and to a threat of mass insolvencies. Unfortunately, it's not over, with cases continuing to mount worldwide and economies continue to suffer losses.
Developed and developing states have allocated large budgets to combat this disease and a recession has already begun. It can be estimated that the impact of this crisis situation on economies will be long-term. Countries will need to take some measures to overcome this problem in the economy as soon as possible; but it is difficult for these measures taken within the country to be sufficient for the economy to recover. At this point, foreign investments and foreign investors increase their importance. Foreign investments will be of great importance in providing the resources needed by countries for reorganizing economies.
1. Salacuse, (2019) J. W. The Law of Investment Treaties. Oxford: Oxford University Press, p. 47.
2. Vig, Z. (2019). Taking in International Law. Budapest, p. 11.
3. Sornarajah, M. (2010). The International Law on Foreign Investment. Cambridge: Cambridge University Press, p .4.
4. In the field of international agreements law, there is no uniform definition of the concept of "foreign investment". There is no comprehensive document regulating all aspects of foreign investment, including all or the majority of the relations between home and host states. Both multilateral investment agreements on regional or specific economic issues, as well as bilateral investment agreements for mutual incentives and protection of investments, have an investment definition within their structure that may vary depending on the scope, subject matter of the agreement and the relations between the parties to the agreement.
5. McLachlan, C., Shore, L., & Weiniger, M. (2010). International Investment Arbitration: Substantive Principles. Oxford: Oxford University Press, p. 3.
6. Collins, D. (2017). An Introduction to International Law. Cambridge: Cambridge University Press, p. 6.
7. Collins, p. 7-8.
8. Kronfol, Z. A. (1972). Protection of Foreign Investment - A Study in International Law. Leiden, p. 14-16; Sornarajah, p. 19.
9. International Finance Corporation - Foreign Investment Advisory Service. (1997). Foreign Direct Investment. Washington, D.C., p. 12.
10. International Finance Corporation - Foreign Investment Advisory Service, p. 12.
11. This increased FDI mostly benefited Congo, Ecuador, Indonesia and Nigera.
12. Colombia, Kenya and Pakistan were some countries where FDI fell sharply in 1970s. Also, Chile, Egypt, Venezuela, and Zambia had massive disinvestments. See International Finance Corporation - Foreign Investment Advisory Service, p. 12.
13. International Finance Corporation - Foreign Investment Advisory Service, p. 13.
14. Twomey, M. (2000). A Century of Foreign Investment in the Third World. London, table 3.14, p. 55.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.