Tuesday, January 3, 2012

South–South FDI and Development in East Asia

This paper attempts to measure the size of South–South foreign direct investment (FDI) in developing East Asia and the trends in it, the characteristics of the investing countries, and the investments themselves. It also summarizes the findings of studies in individual countries of the effects of these investments. The studies of individual countries will be used to try to find some consensus on differences between South–South FDI and North–South FDI. Among the comparisons of the two types of FDI summarized are findings about their industrial composition; their effects on their host countries and their host-country firms’ productivity, wages, and employment; and how these differ across industries.

The rising importance of South–South foreign direct investment (FDI) from developing countries to other developing countries was heralded in United Nations (2006). That new importance was emphasized by the fact that outflows from developing and transition countries were less affected by the 2009 contraction in FDI flows than those from developed countries (United Nations 2010, xix).1 FDI flows to developed countries suffered the worst decline, possibly because affiliates in developed countries were more dependent on reinvested earnings as a source of growth in FDI stocks than affiliates in developing countries, particularly those relatively new ones owned by other developing countries. A recent UNCTAD World Investment Report (United Nations 2010, 3) predicts that the “…shift in foreign investment inflows towards developing and transition economies is expected to accelerate…”.

Considering the importance of FDI from developing to other developing countries, it is unfortunate that most studies examine FDI between developed
countries (North–North FDI) or FDI from developed to developing countries (North–South FDI). This paper contributes to the literature by examining South–South FDI in developing East Asia.

All firms, whether from South or North, need to have firm-specific assets to compete with local firms in foreign markets. There are many reasons why the
competition might be more difficult for firms from the South than for those from the North. For instance, South firms tend to have weaker brand names and inferior technologies (Cuervo-Cazurra and Genc 2008). Moreover, host governments sometimes favor North FDI through subsidies and licenses because of the belief that they bring in more advanced technology and have access to a wider international distribution network (Stopford and Strange 1992).

However, it has been suggested that some other factors actually favor South FDI, at least in developing countries. More precisely, developing countries are typically characterized by relatively poor institutions. A lack of market mechanisms, poorly developed contracting and property rights, and poor infrastructure are obstacles that firms in developing countries need to address and overcome. The poor home market institutions will shape the business practices and organization of the firms. Once the developing country firms invest in other developing countries, their previous experience of working in a similar environment might turn out to be an advantage (Cuervo-Cazurra and Genc 2008). The business practices and distribution networks will be well adapted to other developing countries.

Robert E. Lipsey and Fredrik Sjöholm. Asian Development Review - Volume 28, Number 2. December 2011


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