ECONOMIC AND SOCIAL COMMISS ION FOR AS IA AND

PACIFIC

Foreign Investment- Technology

Transfer- Economic Growth Nexus
in Asian Economies

VOLUME - II

EXECUTIVE SUMMARY AND

RECOMMENDATIONS
_______________________________________________________________________
_

DR. TARUN DAS

ECONOMIC ADVISER
MINISTRY OF FINANCE
GOVERNMENT OF INDIA

_______________________________________________________________________
_
ECONOMIC AND SOCIAL COMMISS ION FOR AS IA AND
PACIFIC

Foreign Investment- Technology Transfer-

Economic Growth Nexus in Asian Economies

VOLUME - II

EXECUTIVE SUMMARY AND RECOMMENDATIONS

_______________________________________________________________________
_

DR. TARUN DAS*

ECONOMIC ADVISER
MINISTRY OF FINANCE
GOVERNMENT OF INDIA

_______________________________________________________________________
_

* Prepared for the Industry and Technology Division (ITD), ESCAP, United Nations,
Bangkok as a part of their Project on Regional Dialogue on Promoting Industrial and
Technological Development and Complementarities: Challenges & Opportunities for
Cooperation in Light of Emerging Regional and Global Developments.

* Author would like to express his gratitude to the ESCAP, particularly the Industry and
Technology Division, United Nations, for providing an opportunity to write this Report,
and the Government of India, Ministry of Finance for granting necessary permission.
However, the paper expresses personal views of the author and should not be attributed
to the views of the Government of India.

December 1997
 CONTENTS

Contents Paragraphs

1 Executive Summary and Recommendations 1-164

A Major Conclusions 2-116
1.1 Basic characteristics of Asian economies 2-8
(a) South Asia and SAARC 4-5
(b) East Asia and South East Asia 6-8

1.2 FDI - Technology - Growth Nexus 9-25

1.3 Geographical and Sectoral Distribution of FDI 26-56
(a) Regional distribution of FDI 26-31
(b) FDI in selected countries of Asia 32-51
1 China 32-34
2 India 35-39
3 Japan 40-41
4 Republic of Korea 42-43
5 Taiwan, China 44-45
6 Philippines 46-47
7 Myanmer 48
8 Indo-China (Cambodia, Lao PDR, Vietnam) 49-50
9 USA’s direct investment in Asia 51
(c) Sectoral distribution of FDI 52-55
(d) Foreign Portfolio Investment (FPI) 56

1.4 Different Modes of FDI and Technology Transfer 57-67

(a) Modes of foreign capital 57-62
(b) Modes of foreign portfolio investment 63
(c) Modes of technology transfer 64-67

1.5 Advances in New Technologies 68-74

(a) Pattern of industrialisation in East Asia 68-71
(b) New Technology and Applications 72-74

1.6 Development of Infrastructure and Services 75-84

1.7 Policies and Strategies for Promoting 85-102
FDI - Technology - Growth Nexus
(a) Macro-economic policies 85-91
(b) Fiscal and financial policies 92-93
(c) Role of Special Economic Zones 94-95
(d) Role of Small and Medium-Sized Industries 96-98
(e) Role of Research & Development Expenditures 99-100
(f) Infrastructure and human resource development 101-102
Contents Paragraphs

1.8 Regionalisation and FDI Complementarities 103-116

(a) ASEAN Experience 104-106
(b) SAARC Experience 107-108
(c) APEC Experience 109
(d) ESCAP experience 110-113
(e) Multilateral agreement on investment (MAI) 114-116

B. Recommendations 117-164

1.9 General recommendations 117-118

1.10 Policies and strategies for promoting 119-140

FDI-Technology-Growth Nexus
(a) Host country policies for FDI 119-126
(b) Host country policies for 127-128
foreign portfolio investment
(c) Home country policies 129-131
(d) The role of special economic zones 132
(e) The role of small & medium sized industries 133-134
(f) Role of R&D expenditure 135
(g) Infrastructure & human resource development 136-137
(h) Legal and institutional set-up 138-139
(i) Fiscal and financial incentives 140

1.11 Different Modes of FDI & Technology Transfer 141-143

1.12 Advances in New Technologies 144-149

(a) Industrial technology development 144-146
(b) New technology and applications 147-149

1.13 Development of Infrastructure and Services 150-152

1.14 Regionalisation and FDI Complementaries 153-164

(a) Technical assistance 155-157
(b) Regional cooperation 158
(c) Regional cooperation in SAARC 159-164

Selected Bibliography :
List of Tables

1.1 Basic indicators of selected Asian countries: 1995

1.2 Average growth rates of GDP and value added in
industry in selected Asian countries: 1965-1996
1.3 Share of FDI inflows in gross fixed capital formation
by region and country in 1984-1994
1.4 Share of inward FDI stock in gross domestic product (GDP)
by region and country in 1984-1994
1.5 Net foreign direct investment as a share of GNP
by region and income group in 1990-1996
1.6 FDI inflows by host region and countries: 1984-1995

1.7 Top 10 home countries for FDI flows to selected

Asian economies in recent years :
A Bangladesh, Myanmer, Cambodia, China
B Hong Kong, India, Indonesia, Japan
C Laos, Malaysia, Mongolia, Pakistan
D Philippines, Singapore, South Korea, Sri Lanka
E Taiwan, Thailand, Vietnam, New Zealand

1.8A US FDI and related indicators in selected developing

Asian countries in 1992
1.8B Performance of US FDI in the manufacturing sector

1.9 Gross portfolio flows to developing countries by region

during 1990-1996
1.10 Infrastructure financing raised by developing countries
by region and type of instrument: 1986-1995
1.11 Privatisation revenues by sector: 1988-1995

1.12A Foreign exchange raised through privatisation in

developing countries: 1988-1995
1.12B Portfolio investment and foreign direct investment
in privatisation: 1988-1995

1.13A Comparative statement on Foreign Investment Regime in

selected countries in Asia.
1.13B Comparative statement on Foreign Investment Regime in
selected countries in Asia.

1.14 Potentials of South-Asian Sectoral Cooperation.

 EXECUTIVE SUMMARY AND RECOMMENDATIONS

1. The basic objective of the present study is to critically analyse various modes of
overseas direct investments (ODI) and to identify for promotion those forms which lead
to deepening of industrial and technological capability, forge greater linkages with
domestic economy, and contribute to sustained growth in environment characterised by
free flow of goods and services. This chapter summarises the main conclusions drawn
from other chapters and presents a set of recommendations covering overall issues for
promoting the nexus among foreign investment, technology transfer and overall
economic growth.

A. Major Conclusions

1.1 Basic Characteristics of Asian Economies

2. In recent years Asian economies exhibited remarkable economic vigor and dynamism
(Tables 1.1 and 1.2) and outperformed by a wide margin other developing regions and
industrial countries. As judged by ratios to GDP, investments, savings and exports made a
much higher contribution to growth in Asia than in the other regions. A trinity of
openness to trade, high investment and high savings rates coexisted in the fast-growing
economies of Asia. They achieved high economic growth by introducing capital and
technology from advanced countries, while enjoying the benefits of huge markets of
these advanced countries. In other words, the Asian economies are typical examples of
“catch-up” type economic growth. It is also indicative of the movement towards higher
value added and more technology-intensive activities.

3. The process of rapid growth in output and intraregional trade and investment in Asia is
sometimes called a “virtuous circle” of economic development. Foreign capital inflows
combined with a favourable policy environment, industrialisation and trade expansion to
achieve a sustained economic growth. The efficient use of resources, increased trade and
rapid growth have, in turn, stimulated an increase in the flow of intraregional investment.
This process gradually helped to internalise Asian growth and to reduce Asia’s
vulnerability to external shocks.

(a) South Asia and SAARC

4. Two themes characterised the past development approach in South Asia: a strong
economic role for the state and relatively inward-looking development policy. The broad
lessons of past development are that countries with more market-friendly and outward-
looking policies do better in generating growth and reducing poverty. While there is
general agreement in South Asia about the need of reforms, the pace has been uneven due
to mainly political issues. Recent progress is most visible in reforms in taxation,
industrial, external, public and financial sectors.
5. SAARC has completed more than a decade of its existence, but the process of
economic cooperation in the region has been slow. Nevertheless, SAARC has established
itself as an important regional grouping due to its large market space measured by the
size of its population and its potential purchasing power. The ongoing economic reforms
and globalisation by the SAARC economies have also made the region an attractive
destination for foreign direct investment and other capital flows.

(b) East Asia and South-East Asia

6. East Asia has a remarkable record of high and sustained economic growth and grew
faster than all other regions of the world in 1965-1996. They are also economically more
egalitarian in terms of the distribution of income, wealth and land. Although initially
called “the East Asian Miracle”, various World Bank studies concluded that there was no
“miracle” or “myth” for the outstanding performance of East Asia in the past three
decades, which can be explained fundamentally by efficient macroeconomic
management, investment in human capital and a judicious combination of sound
development policies and selective interventions based on twin pillars of “outward
orientation” and “market friendly environment”. There was no single or uniform “East
Asian model” or “a distinct East Asian path”. Although the “basics” of their development
policies were more or less uniform and they were quick to respond to macroeconomic
disequilibria with success, they adopted “heterodox approaches” regarding the “specifics”
of industrial, trade and technology development.

7. Openness of trade and emphasis on competitiveness of the manufacturing sector had

been pivotal to the economic success of the NIEs and the fast-growing economies of
Southeast Asia. Economic policies did not penalise the traded goods sector, and market
forces were allowed to determine the real exchange rate. A comparatively “level playing
field” allowed both the traded and non-traded goods sectors to grow vigorously,
complementing and supplementing each other in investment, production and trade. This
facilitated an efficient allocation of resources. The benefits of a more liberal trading
environment reached beyond the narrow efficiency gains highlighted by the theory of
comparative advantage. Other benefits include more competitive goods and factor
markets, increased investment including foreign investment, and the associated transfer
of knowledge and technology.

8. While overall the region performed impressively, there remain obstacles to sustained
development. Serious environmental damage associated with rapid urbanisation,
inadequate regulation and planning, inadequacy of infrastructure and incorrect pricing of
resources, continue to pose threats to sustained growth and impose major costs for
development in East and South East Asia.
1.2 FDI - Technology - Growth Nexus

9. In 1990s there was a significant change in the composition of external capital flows to
the developing countries with an increasing share of private capital from 44% in 1990 to
86% in 1996 and a corresponding declining share of official development finance. Asian
region received 50% of private finance in 1996 among the developing economies. Within
private capital, flows of foreign investment increased five-and-half times surpassing other
types of capital flows and constituting 54% of total capital flows to developing countries
in 1996.
10. The private capital flows are likely to be more beneficial since they are generally
accompanied by technology transfer and market access in the case of foreign direct
investment (FDI); diversified investor base in the case of bonds; and a reduction in the
cost of capital in the case of portfolio flows. Unlike other flows, FDI is a “package”
which contains capital alongwith management, technology and skill. Experience in
developing countries suggests that “unbundling” the FDI package by borrowing capital
from the international banks, purchasing technology through licenses and negotiating
management agreements, is less efficient in terms of productivity than the FDI package.

11. FDI, like trade, provides an important channel for global integration and technology
transfer. FDI also promotes export orientation and plays an important role in privatisation
and the provision of infrastructure. The ASEAN experience shows that FDI can promote
industrial growth, technology upgradation and export capabilities of the host countries
through the creation of intra-regional and extra-regional linkages. As regards sectoral
distribution, FDI tends to concentrate in industries using mature or standardised
technology and management skills.

12. There are different types of FDI such as natural-resource seeking, market-seeking,
technology seeking, cost-reducing, risk avoiding, export-oriented and defensive
competitive FDI. Natural resource seeking FDI, which consists of investment in mining,
processing, textiles, oil and gas is the earliest type of foreign investment. Until 1980s
market-seeking FDI was largely confined to the manufacturing sector motivated by “tariff
jumping” to take advantage of the regulated market, but due to the recent trends of
economic reforms and privatisation of infrastructure, sectors such as power,
telecommunications and financial services are attracting increasing amounts of foreign
investment. Industrial restructuring through mergers and acquisitions (M&As) have
emerged as a favourite route to FDI. Export-oriented FDI is guided by the “product life
cycle” theory of FDI, which postulates that as real wages increase due to economic
growth in a country, labour-intensive industries will relocate to countries at a lower level
of economic development. Regional groups (such as the European Union, NAFTA,
MERCOSUR, APEC, ASEAN and SAARC) also facilitate regionally integrated
production networks. Geographical distribution of direct foreign investment also favours
neighbouring and ethnically related countries.

13. Host countries can be classified according to four stages of development viz. factor-
driven (attracting FDI in processing, textiles and minerals exploitation), investment
driven (heavy and chemical industries, power, construction, transport and tele-
communications), innovation-driven (electronics, information technology, bio-
technology) and wealth-driven (attracting FDI to meet domestic demand and also
encouraging outward FDI flows).

14. Global FDI reached $315 billion in 1995, and the FDI growth (12.1%) in 1991-1995
was substantially higher than that of exports of goods and non-factor services (3.8%),
world output (4.3%) and gross domestic investment (4%). The recent boom in flows has
expanded the world’s total FDI stock, valued at $2.7 trillion in 1995 held by some 39,000
parent firms and their 270,000 affiliates abroad. About 90% of parent firms in the world
are based in developed countries, while two-fifths of foreign affiliates are located in
developing countries. The global sales of foreign affiliates reached $6.0 trillion in 1993
and continued to exceed the value of goods and non-factor services delivered through
exports ($4.7 trillion) - of which about 25% are intra-firm exports. Sales by foreign
affiliates in developing countries were $1.3 trillion equivalent to 130% of imports from
these countries. In 1993, $1 of FDI stock produced $3 in goods and services abroad.

15. Between 1980 and 1994, the ratio of global inward FDI stock to world GDP and the
ratio of FDI inflows to gross domestic investment doubled from 4.6% to 9.4% and from
2% to 3.9% respectively. The ratio of global FDI outward stock to world GDP and the
ratio of FDI outflows to gross domestic capital formation in developed countries also
doubled between 1980 and 1994, from 4.9% to 9.7% and from 2.1% to 4% respectively.

16. The pattern of investment and production in ASEAN followed the “flying geese”
pattern of evolving comparative advantage, and promoted regional integration through
“production sharing” which involved the setting up of multiplant production in different
countries. Technological advances lowered transportation costs and improved
telecommunications networks, which made location of production more sensitive to cost
differentials such as lower wages. ASEAN countries particularly attracted foreign
automobile manufacturers through the Brand-to-Brand Complementation scheme, which
provides for a diverse production base.

17. Trade and FDI go hand in hand. FDI has grown fastest among the countries, which
participated fully in the multilateral trade negotiations. Within the traditional structures of
manufacturing TNCs generating FDI-trade linkages, intra-firm sales tend to comprise
mainly flows of equipment and services from parent firms to their affiliates. If foreign
affiliates are located downstream, intra-firm trade consists mainly of parent firms’ exports
to affiliates; if they are upstream suppliers, they generate intra-firm imports for parent
companies.

18. Data on trade by United States parent firms and their affiliates abroad illustrate the
high and growing importance of intra-firm trade for TNCs. During 1983-1993, the share
of intra-firm exports in total exports of United States parent firms rose from 34 per cent
to 44 per cent; and the share of intra-firm imports in total imports rose from 38 percent to
almost one half. Data for TNCs based in Japan confirm the importance of intra-firm
trade in many manufacturing industries, especially those characterised by high research-
and-development intensities and firm-level economies of scale.

19. FDI has made significant contribution to economic growth in developing countries
by promoting exports and providing access to export markets. The export propensities
(measured by the ratio of exports to output) of U.S. foreign affiliates nearly tripled in the
past two decades. This ratio more than doubled and reached 39 percent in Latin America,
while the ratio remained high in Asia, ranging from 30 percent in the Republic of Korea
to more than 80 percent in Malaysia. The export propensities of Japanese affiliates also
have been increasing, most notably in East Asia, where their exports accounted for 34
percent of total sales in 1993. Japanese affiliates in China exported 53 percent of their
sales in 1992, up from less than 10 percent in 1986, directing 43 percent of their sales to
home markets in Japan.

20. Several empirical studies generally support the view that FDI promotes economic
growth in host countries by stimulating investment, and benefits of FDI tend to be greater
where policy distortions are fewer. Studies also conclude that (a) FDI has a larger impact
on growth than does domestic investment; (b) higher FDI inflows are associated with
higher productivity of human capital for the economy as a whole, indicating that FDI has
positive spillover effects through the training of workers; and (c) FDI does not crowd out
domestic investment, but instead seems to supplement it through vertical spillovers
leading to increased capital investment by suppliers and distributors.

21. FDI adds to the capital stock of the host country in many ways viz. green-field FDI
(establishing a new business), or ownership switching (through mergers and acquisitions)
or raising equity shares in joint ventures. In developed countries, most FDI is ownership
switching whereas it is mostly greenfield FDI or joint ventures in the developing
countries. However, privatisation related FDI has recently become an important form of
ownership-switching FDI for developing countries, although such FDI accounted for less
than 10% of cumulative FDI inflows to the developing countries in 1988-1993.

22. The financial capital generated, mobilised, transmitted and invested by the TNCs is
one of the FDI’s major contribution to a country’s growth and investment. For all the
countries that report such data to the UNCTAD, total profits of foreign affiliates
(reinvested and repatriated) amounted to $99 billion in 1993 or 8% of the global FDI
stock (UN-UNCTAD 1995). Over 50% was reinvested by the foreign affiliates and the
remainder was either repatriated or paid as dividends or circulated via equity flows and
intra-company loans. The net equity capital of TNCs for 40 countries that report such
data was $80 billion in 1993 amounting to 70% of the total FDI inflows in these
countries. Inter-country loans for 41 countries were $51 billion in 1993 (amounting to
37% of total FDI inflows in these countries). Repatriated profits for 27 countries for
which such data are available were $56 billion in 1993.

23. The significance of FDI in domestic capital formation can be judged from the ratio
of inward FDI flows in the gross fixed capital formation which reached the peak level of
24.5% in China in 1994, 26% in Malaysia in 1992, 47.1%% in Singapore in 1990, 37% in
Fiji in 1990, 61.3% in Vanuatu in 1994 and 96% in the Pacific least developed countries
in 1994 (Table 1.3).

24. Share of FDI stock in GDP was as high as 86.6% in Singapore in 1990, 46.2% in
Malaysia in 1994, 36.6% in Indonesia in 1990, 18% in China, 21% in Hong Kong and
36% in Maldives in 1994 (Table 1.4). FDI flows as a share of GNP (Table 1.5) also
indicates the importance of FDI in overall economic development. In 1996 it reached 2%
for developing countries as a whole, and 6.5% for Malaysia and Vietnam. East Asia has
sustained inflows equivalent to more than 4% of GNP in the 1990s.
 25. These figures do not capture the full role of FDI as an agent for growth and
structural transformation. In many countries FDI was instrumental in shaping industrial
structure, technological base and trade orientation. Perhaps the most significant
contribution of FDI is qualitative in nature. FDI embodies a package of growth and
efficiency-enhancing attributes. TNCs are important sources of capital, technology, and
managerial, marketing and technical skills. Their presence promotes greater efficiency
and dynamism in the domestic economy. The training gained by workers and local
managers and their exposure to modern organisational system and methods are valuable
assets.

1.3 Geographical and Sectoral Distribution of FDI

(a) Regional distribution of FDI

26. The FDI flows to developing countries have grown rapidly in 1990s and reached
$100 billion in 1995 and $110 billion in 1996. The share of developing countries in
global FDI flows increased from 19% in 1980 to 32% in 1995 (Table 1.6). As regards
sources, more than 80 percent of global FDI inflows originate in OECD countries and the
major home countries are the United States, United Kingdom, Germany, Japan and
France which accounted for two-thirds of global FDI outflows in 1990s. The main
suppliers of FDI to Latin America remain United States and Europe, while Japan has
emerged as the predominant partner in Asia. The dominant role of FDI from the United
States in Latin America and the Caribbean, from Japan in Asia and from Europe in Africa
underline the tendency of the TNCs from the “Triad” in building up regionally integrated
networks of affiliates.

27. The Asia and the Pacific is the new growth centre of the global economy with
China, ASEAN and NIEs as important players. FDI flows to Asia and the Pacific reached
$65 billion in 1995 accounting for 21% of global FDI flows and 65% of FDI flows to the
developing countries, compared with $20 billion in 1990 accounting for only 10% of
global FDI flows. East and South-East Asia alone received $62 billion in 1995, while
South Asia saw a doubling of inflows to $2.7 billion in 1995, mainly due to tripling of
inflows into India. Inflows of FDI to ASEAN-4 (Indonesia, Malaysia, Philippines and
Thailand) increased from $8.6 billion in 1994 to $14 billion in 1995. In 1990-1996 China
and ASEAN had a share of more than 80% in FDI inflows to Asian countries, with
Chinese share exceeding 50%.

28. Asian developing economies themselves are increasingly becoming outward

investors, reflected in the liberalisation of their outward FDI regimes and provision of
incentives for such investments. In 1995, the region with $43 billion FDI outflows
accounted for 90% of all developing country outflows with Hong Kong as the largest
outward investor. Most outward FDI is going in the region to take advantage of cost
differentials, liberal trade and FDI regimes and to allow export-oriented FDI to flourish.
Malaysian and Thai TNCs directed 60% of their FDI outflows to Asia in 1995; some
four-fifths of Hong Kong’s outward FDI went to China in 1995; a good part of
Singapore’s outward FDI is distributed to other ASEAN countries and China; and 60% of
China’s outward FDI remained in the region.

29. Surveys of FDI from developing countries highlight the following general features
(UNCTAD 1993a): (a) the geographic distribution of FDI favours neighbouring and
ethnically and culturally related countries. (b) FDI tends to concentrate in industries using
standardised technology and management skills or industries based on natural resources
(processing, textiles and minerals) or export-oriented industries (food processing,
automobiles, and electronics). (c) Most TNCs are involved in joint ventures, both to limit
their capital commitments and to obtain local managerial and organisational skills or
access to markets of their partners.

30. An analysis of the FDI flows to selected host countries in the Asia and Pacific
(Bangladesh, Cambodia, China, Hong Kong, India, Indonesia, Japan, Laos, Malaysia,
Mongolia, Myanmer, Pakistan, Philippines, Singapore, South Korea, Sri Lanka, Taiwan,
Thailand, Vietnam, and New Zealand) indicate that intra-Asian FDI flows constitute
major shares in FDI inflows to most of these host countries (only exceptions being Japan,
India and Pakistan). The share of Asian countries among the top 10 host countries ranged
from 45 percent in South Korea to around 90 percent in China, Mongolia and Cambodia
(Table 1.7A to 1.7E). The share of newly industrialised economies in the FDI flows to the
ASEAN countries increased from 25% in 1990-1992 to 40% in 1993-1994. More
generally, about 57% of the FDI flows from developing countries were invested within
the same region in 1994.

(b) FDI in selected countries in Asia

1 China, People’s Republic of

31. China is the principal driver behind the current investment boom in Asia. With an
inflow of $38 billion in 1995 China became the second largest recipient of FDI after the
U.S.A. in the world and the number one in the developing world, and became the home
for 38% of FDI flows to developing countries and 55% of FDI flows to Asian developing
countries. FDI inflows to China increased further to $42 billion in 1996. About 80% of
FDI inflows to China come from countries with predominantly Chinese populations, such
as Hong Kong, Macao, Singapore and Taiwan. Firms from those economies have certain
advantages in investing in China, e.g., better knowledge of market conditions and
reduced transaction costs owing to language advantages and family networks.

32. In 1979-1996, under the government’s open door policy, total FDI commitments in
China reached $400 billion and FDI inflows $135 billion by 260,000 enterprises, of
which 64% are equity joint ventures, 15% are co-operative joint ventures, and 21% are
wholly foreign-owned enterprises. About 50% of the country’s industrial turnover are due
to FDI and enterprises with foreign investment earned one-third of the country’s foreign
exchange, employing 17 million workers. As regards sectoral distribution of FDI, 50%
was concentrated in processing industries, 24% in other industries, 14% in real estate, 9%
in telecommunications and transport, and 3% for agriculture and fisheries in 1979-1994.
 33. In recent years, nearly 80 percent of FDI has been in small and medium-scale
export-oriented manufacturing industries, with the average investment increasing from
$0.5 million in the late 1980s to $2.5 million in 1995. Most of the investment was made
by overseas Chinese who had already established strong links to the main export markets
in Europe, Japan, and the United States. As a result of this boom in export-oriented FDI,
exports became the main engine of growth for the Chinese economy, and the country
significantly increased its share of world trade.

34. In 1989-1994, Guangdong attracted $25 billion utilised FDI, or 30% of the country’s
total, most of which were in export-oriented industries. Over the same period,
Guangdong’s exports expanded by 34.7% annually, while the country’s exports grew by
only 18.2% per year. In 1994, foreign invested enterprises (FIEs) accounted for 39.5% of
Guangdong’s exports, compared with 28.7% in the country. As a result, Guangdong
recorded an average real GDP growth rate of nearly 18% per year since 1989, much
faster than the national average of 10.7%.

2 India

35. The total number of foreign collaborations approved in post-liberalisation period

(August 1991 to March 1997) amounted to 10729 of which 6092 proposals involved FDI
amounting to $34 billion. More than 86% of these FDI are in priority sectors such as
power and petroleum (24%), telecommunications (23%), financial services and hotels
(10%), chemicals (7%), automobiles (6%), electrical equipment’s (6%), metallurgical
industries (5%) and food processing industries (5%).

36. The average inflow of foreign investment to India increased from only $120 million
per annum in 1980s to $4.7 billion per annum in 1993-1996. Total portfolio investments
at $12.2 billion in 1993-1996 comprised $7 billion in equity shares purchased by FIIs
attracted to India by the prospects of higher return, $4.5 billion by GDR/Euro equities
and $0.7 billion by offshore and other funds raised by Indian firms interested in raising
capital abroad at a lower cost than from domestic sources.

37. The U.S.A., U.K., Japan, Germany and Non-resident Indians (NRIs) constituted the
major sources of foreign investment in India. In 1990s, however, Mauritius and Cayman
Island emerged as a major home country due to establishment of various offshore funds
in these countries to take advantages of tax haven. The increasing share of NICs like
Singapore, Hong Kong and Malaysia is also an interesting feature of the new pattern.

38. As a consequence of the amendment of the Foreign Exchange Regulation Act

(FERA) and automatic approval of foreign equity up to 51% in 48 priority industries and
up to 74% in 9 high priority industries, many of the existing firms have raised their
foreign equity above 50%. These constitute around 50 per cent of approvals since August
1991. An analysis of FDI approvals in 1990s also indicates a relatively higher proportion
of joint ventures in all industries except energy and textiles. Further, the proportion of
agreements with provisions for lump-sum payment, which is partly indicative of outright
purchase of technology, is also lower in 1990s.

39. Inflows of foreign investment to India are likely to increase further due to several
favourable factors. First, more than 85% of FDI inflows are in the core sectors, and the
pipeline of FDI is more than $40 billion. Second, with a market capitalization of $150
billion, India’s capital market is among the largest in world, and FIIs could own up to
30% of this market. Third, Indian firms have incentives to mobilize resources abroad so
long as the domestic lending rates remain above international levels.

3 Japan

40. Inward FDI flows to Japan increased from $940 million in 1986 to $4155 million in
1994. Share of manufacturing in total FDI inflows showed a declining trend, while that of
non-manufacturing had an increasing trend over the period. Chemicals, machinery,
commerce and trade, banking and insurance, and service sectors accounted for almost
80% of cumulative FDI inflows to Japan in 1950-1994. USA and Canada are the main
sources of FDI accounting for 45% of cumulative FDI to Japan in 1950-1994, followed
by Europe (30%) and affiliates of foreign businesses in Japan (11%).

41. Japanese outward FDI flows reached $57 billion in 1990 followed by some decline
in 1990s. Major recipients of Japanese FDI flows are USA, Asian NIEs and ASEAN.
Japanese overseas direct investment has aimed at exploiting the comparative advantage in
the region: investment in the Asian NIEs, shifted from labour-intensive industries
towards technology and service industries. In South Korea and Taiwan, over 80% of
Japanese investments were in manufacturing, mainly in chemicals, textiles, electronics
and electrical products, while in Hong Kong and Singapore, the investments have been
directed towards finance and commerce. Even in the ASEAN-4 and China, Japanese
investments have shifted in line with industrial growth in these countries (Chia, 1994).
For example, the share of textiles in total Japanese FDI in ASEAN declined from 20.4%
in 1985 to 11.8% in 1990; while that of electrical machinery rose from 4.9% to 20.6%
over the period.

4 Korea, Republic of

42. Republic of Korea provides an excellent example of how a capital importing

country can turn into a capital exporting country over time by sound economic
management and judicious combination of both inward and outward looking policies.
The sectoral distribution of inward FDI flows is also illuminating. In 1962-1995, out of
total FDI inflows of $14.5 billion, manufacturing accounted for 60% and services the
rest, but the sectoral distribution was completely reversed in 1994-95 with services
accounting for 61% of FDI flows. Within services, emerging sectors are trade, real estate,
finance and insurance as contrast to hotels and construction in earlier years. Chemicals,
automobiles and electronics are the dominant areas attracting FDI in manufacturing.
Distribution of FDI inflows in terms of equity ratios indicate that 70% of FDI was on a
joint venture basis and 30% was on 100 percent foreign equity.
 43. Asian economies supplied 44% of inward FDI to South Korea in 1962-1995 and
they received 46% of its outward FDI in 1991-1995. Within Asia, China and Indonesia
are major destinations for Korean outward FDI. Korea has been seeking locations for its
manufacturing investment in Asia. Although much of outward FDI was linked to trade
prospects, a significant share of North America in the South Korea’s outward FDI reflects
its desire to gain access to advanced technology from developed countries.

5 Taiwan, China

44. In 1952-1994 Taiwan attracted $19.4 billion of FDI, 86% of which was private
foreign investment from the developed industrial countries. The balance of FDI came
from oversees Chinese from different locations. Electronic and electrical products and
chemicals were the dominant industries accounting for 38% of the cumulative FDI
inflows. In recent years, Taiwan has liberalised its service sectors (including banking and
insurance) which attracted 30% of FDI in 1952-1994.

45. Taiwan became a major foreign investor with cumulative outward FDI flows of $8.9
billion in 1952-1994. USA and Malaysia were major destinations accounting for 28% and
13%, respectively, of cumulative outward FDI. Taiwan’s overseas investment provides an
empirical evidence of the investment life cycle theory, in which an investing country
initially generates the capacity to export and then turns host to foreign investment aimed
at jumping the projectionist barriers. Chemicals, electronics and electric products, and
banking and insurance were the major sectors accounting for 43% of cumulative outward
FDI in 1952-1994.

6 The Philippines

46. Manufacturing, services and financial institutions are the major sectors attracting
FDI inflows to Philippines, while USA, Japan and Hong Kong are the major sources of
FDI. Asia accounted for 64% of FDI flows to Philippines in 1994. Foreign equity
contribution to total equity ranged from 41% to 53% between 1986 and 1991, but the
foreign equity share dropped to 26% in 1992.

47. There is a high degree of correlation between FDI and technology transfer in the
Philippines. Of the top 10 countries ranked according to size of FDI in the Philippines,
seven are also the leading sources of technology imports: USA, Japan, South Korea, UK,
Netherlands, Australia and Singapore. The energy sector received the biggest
commutative foreign investments until 1995 due to the Government’s efforts to promote
energy development. Of the many types of technology transfer available, those involving
the actual transfer of know-how, trade marks, and patents constituted two-thirds of
collaboration contracts in 1986-1996. Majority of such technology is manufacturing-
related.

7 Myanmer
 48. Up to the end of 1995, UK was the largest investor in Myanmer followed by
Singapore and France. The same trends continued in 1996. Up to August 1996, UK
continued to be the largest investor in Myanmer with cumulative investments of $1
billion, closely followed by Singapore ($896 million), France ($465 million) and
Thailand and Malaysia with around $450 million each. The bulk of the funds have gone
to oil and gas, hotel and tourism, while other manufacturing sectors failed to attract
much FDI, despite Myanmer’s move in recent years to open up the economy.

8 Indo-China (Cambodia, Lao PDR, Vietnam)

49. Vietnam, Cambodia and Lao PDR, the three South East Asian countries generally
known as Indo-China, are on the road to economic transition at different paces and on
different scale. All of them are reshaping their policies to attract private investment
including foreign investment. Vietnam and Lao PDR have already become members of
ASEAN, and Cambodia may be admitted to ASEAN very soon. Cambodia’s corporate
tax rate of 9%, the lowest in the Asia-Pacific, is a very attractive feature for investment,
and the rise in manufacturing output has been boosted by FDI, particularly from Asia. In
Vietnam, FDI has increased from $1.8 billion in 1995 to $2.3 billion in 1996. Taiwan is
the largest investor in Vietnam followed by Japan, Singapore and Hong Kong, these four
countries accounting for 60% of total FDI.

50. Laos is expected to attract more FDI as costs rise in Vietnam. The key attractions are
low labour costs, relative political stability, and continued commitment to economic
reform. In addition, Laos’s strategic location to the larger markets of Thailand, Vietnam,
China and Myanmer is an advantage for foreign affiliates looking for a new base for
manufacturing. However, Lao DPR will need to improve its infrastructure to realise its
full potential as a regional hub.

9 United States Direct Investment in Asia

51. US FDI outflows and related indicators in 1992 in selected Asian countries are
given in Table 1.8A and certain performance parameters of the US FDI in the
manufacturing sector in Asia are indicated in Table 1.8B. At the end of 1992, Asia and
Pacific accounted for 16 percent of the US outward FDI stock and 18 percent of the US
FDI outflows. Major destinations in Asia for US outward FDI are Indonesia, Thailand,
Korea and Malaysia. These countries generally generated high returns for US FDI, which
was also mostly trade related.

(c) Sectoral Distribution of FDI

52. The sectoral distribution of FDI in developing countries is not well documented,
but it seems that in recent years services have increased their share to more than one
third, while manufacturing declined to one-half, with the remainder accounted for by
agriculture and mining. Within services financial services are a major component, with
trade, construction, and tourism also important. Within manufacturing the trend was to
move from lower-technology or labour-intensive industries (food, textiles, paper and
printing, rubber, plastics) to higher-technology industries (electronics, chemicals,
pharmaceuticals).

53. Sectoral distribution differs among regions depending on their level of development.
In most countries in Asia, FDI went primarily to the secondary sector (mainly
manufacturing), although investment in the tertiary sectors was of major importance for
some Asian countries. Some resource-rich countries like Indonesia, Papua New Guinea
and Vietnam also attracted FDI into the primary sector (mainly oil production). In Latin
America, new investment flows to the natural resources and services sectors have now
surpassed that in the manufacturing sector. In Africa, the bulk of FDI went to primary
sector.

54. The size and dynamism of developing Asia made it a favourable base for TNCs to
service rapidly expanding markets or to tap the tangible and intangible resources for their
global production networks. In addition, the region’s infrastructure financing for the next
decade will play a role in sustaining FDI flows to Asia. Countries are dismantling
barriers to FDI in infrastructure sectors, giving rise to large investment opportunities for
TNCs. Privatisation, although lagging behind other regions, is showing signs of taking
off particularly in manufacturing, mining, power, telecommunications, petroleum and
financial sectors. European union TNCs that neglected Asia in the 1980s is making large-
scale investment in Asian developing economies to take advantage of new opportunities
in power, petrochemicals and automobiles.

55. Transnational corporations in retailing, and other trading firms also played an
important role in the building up of export capabilities of several Asian economies. In
addition to linking local producers to foreign customers, they deepened the ties of those
economies to the international market place. Asian experiences also indicate that
contributions to international competitiveness and export performance are particularly
high in developing economies that are open to both trade and FDI.

(d) Foreign Portfolio Investment (FPI)

56. Portfolio flows to developing countries increased to $81 billion in 1995 but
remained below the peak level of $95 billion in 1993. Strong growth in equities and debt
raised portfolio flows to a record $134 billion in 1996, accounting for 30% of net
resource flows in 1996 compared with only 5% in 1990. Equity flows at $46 billion
accounted for 34% of these investments. An increasing share of foreign funds was
invested in local equity markets directly rather than through depository receipts or other
cross-border private equity placements. Debt instruments - mainly international bonds -
have always accounted for most portfolio flows to emerging markets. Portfolio debt
flows to developing countries - essentially bond issues in the international capital markets
- registered a record increase by 80% and reached a record level of $89 billion in 1996
(Tabe 1.9).

1.4 Different Modes of Foreign Investment

and Technology Transfer
 (a) Modes of Foreign Capital

57. Empirical evidence indicates that private capital contributed more to economic
growth of the Asian developing countries than official aid, the relative importance of
which in total resource inflows declined since 1980s. There was also a change in the
structure of private flows. Until 1983, bank lending was the major mode of foreign
private flow to the Asian developing countries. Subsequently, the relative significance of
bank lending has declined and that of other modalities has increased. The share of
foreign direct investment has increased the most followed by bond lending and foreign
portfolio investment.

58. The major alternatives to syndicated bank lending are bonds, financing through new
instruments, foreign direct investment, foreign portfolio equity investment, and foreign
quasi-equity investments (such as joint ventures, licensing agreements, franchising,
management contracts, turnkey contracts, production sharing and international
subcontracting). Out of these the most popular modes are FDI, portfolio investment and
foreign quasi-equity investment as they involve risk sharing, sharing of managerial
responsibilities and the promotion of a more efficient use of resources. Foreign portfolio
investment, in addition, has a favourable impact on local capital markets. The
disadvantages are that there might be misuse of control and that foreign direct investment
might introduce inappropriate technology.

59. Country experiences indicate that the majority ownership was preferred mode of
FDI in capital intensive industries like chemicals, equipment’s, electronics and
automobiles, whereas joint ventures were preferred in traditional and primary industries
like textiles, food processing, paper products and metals.

60. TNCs generate technology through innovation and disseminate it within their
corporate system and business partners, and other firms in both home and host countries.
TNCs supply a mutually reinforcing package of resources consisting of capital, R&D,
technology skills, organisational and managerial practices and expansion of markets.
TNCs play their role through equity and non-equity investments which range from
wholly owned foreign affiliates through joint ventures to licensing, subcontracting and
franchising agreements. Although TNCs retain control on key assets and key posts of
production and distribution, they have a great deal of flexibility regarding the contents of
the package.

61. TNCs help in industrial restructuring in both home and host countries. Japan, South
Korea and Taiwan are the text book cases of successful industrial restructuring and
development with the help of the country’s own TNCs. At the initial stage of
industrialisation, they needed some FDI to build their automobiles, electronics, textiles
and apparel industries, but at a latter stage, these economies gave rise to their own TNCs
for further technological upgrading and industrial restructuring; and relocated production
abroad to take advantage of new markets.
 62. The recent surge in global FDI has been fueled by the cross-border Mergers and
Acquisitions (M&As) in industrial economies. Mergers and acquisitions are a popular
mode of investment for firms wishing to protect, consolidate and improve their global
competitive positions, by selling off divisions that fall outside the scope of their core
competence and acquiring strategic assets that enhance their competitiveness. About one
tenth of world-wide M&A sales took place in developing countries due to growing
availability and attractiveness of firms in Asia and privatisation programmes in Central
and Eastern Europe. Most large-scale cross-border M&As have taken place in the energy
distribution, telecommunications, pharmaceuticals and financial services industries. As a
result of ongoing liberalisation, the value of service-related M&As increased by 146%
between 1993 and 1995. The value of cross border M&As in banking and finance tripled
in 1995 to reach $100 billion.

(b) Modes of Foreign Portfolio Investment (FPI)

63. FPI in the emerging markets can be channeled through three main mechanisms:
direct purchases on local stock markets, country or regional funds; and issues of
depository receipts on foreign stock exchanges by the domestic companies. The size of
direct purchases in local markets depends on market developments that facilitate and
encourage such trading. In recent years, the opening of the local brokerage and
investment banking business to foreigners has facilitated such purchases. Developing
countries have also enhanced the limits of foreign equity, which can be held by the
foreign institutional investors (FIIs). In India FIIs and non-resident Indians are permitted
to hold up to 30 percent of total paid up capital of any listed or unlisted companies.

(c) Modes of Technology Transfer

64. There are various channels of technology transfer and adoption. These include
foreign direct investment, joint ventures, licensing, Original Equipment Manufacture
(OEM), Own-design and manufacture (ODM), sub-contracting, imports of capital goods,
franchising, management contracts, marketing contract, technical service contract, turn-
key contracts, international sub contracting, informal means (overseas training, hiring of
experts, returnees), overseas acquisitions or equity investments, strategic partnership or
alliances for technology. Other modes of technology acquisition include minority interest
in firms with R & D programmes, contracts for R&D to other companies and research
institutes, grants consortia, bilateral cooperative technology agreements, buying
technology embedded in products, material sub-assembly or processes. Out of these, the
most popular modes are licensing, joint ventures and foreign direct investment.

65. Original Equipment Manufacture (OEM) and Own - Design and Manufacture
(ODM) played a major role in East Asia in technology adaptation and upgradation,
eventually leading to independent designing and development. South Korea’s electronic
industry provides an interesting example of technological development under different
stages. In the 1980s the Chaebols took off and sought more independence from their
patrons. First, there was a switch from OEM to ODM. In the second stage, their
marketing strategy was to rely more on their own brand names. This strategy worked well
and by the early 1990s several of them established themselves as leading firms in the
global market, occupying fifth (Samsung), 12th (Goldstar-Electron) and 13th position
(Hyundai) in DRAM (dynamic random access memories) production, with aggregate
exports amounting to $106 billion in 1992.

66. Component supply through subcontracting with foreign affiliates helped domestic
component producers in several host countries to enter the vertically integrated
production chains of TNCs geared to export markets. Subcontracting arrangements are
common for consumer goods such as electronics, footwear, furniture, garments,
houseware and toys. In SouthEast and East Asia, networks of local producers (mainly
joint ventures with TNCs) have been established for component-supply to automobile
and electronics TNCs, with specialisation among plants in different countries to supply
the regional market.

67. The networks in automobiles mainly belong to Japanese TNCs which source
automobile parts through their foreign affiliates and their local subcontractors, taking
advantage of ASEAN regional cooperation provisions. In the electronics industry, such
networks have been established by United States as well as Japanese TNCs, beginning
with labour-intensive operations and moving towards increasingly sophisticated networks
of operations with cross hauling of products across national boundaries.

1.5 Advances in New Technology

(a) Pattern of industrialisation in East Asia

68. East Asian countries started industrialisation with textiles, household appliances and
other labour-intensive light industries. Then they moved to capital and knowledge
intensive industries such as steel, shipbuilding, petro-chemicals and synthetic rubber for
further industrialisation by way of forward linkages.

69. Another pattern, known as the “flying geese model” first developed by A. Kaname
in the 1930s and then by K. Akamatsu in 1956, postulates that Japan, the leader in
industrialisation and technological development in Asia, relocated its production
facilities to East Asia as its wages and other costs increased. This progression from Japan
to East Asia and then to Southeast Asia took on the form of an inverted “V” as the
economies of Pacific Asia began to fly together led by Japan.

70. Because of its closest geographical, cultural and educational proximity to Japan,
South Korea imported most of its technologies from Japan. Japan took the lion’s share
(52%) of technology transfer to Korea in 1980s followed by the USA (25%), Germany
(6%) and France (5%). As in Japan, the case of the Korean automobile industry is a
classical example of the infant industry development, which was well staged, financed
and promoted until the industry attained international competitiveness. All technology
acquisitions and adaptation by Korea were also carefully selected and sequenced.
 71. The Asian NIEs adopted a strategy of export-oriented industrialisation, which made
use of relatively cheap labor to compete in the international market. In contrast, Indonesia
and India initially adopted import-substituting industrialisation through various protective
and incentive measures for domestic industries. An important factor in East Asia’s
successful productivity-based catching up was openness to foreign ideas and technology.
Governments encouraged improvements in technological performance by keeping several
channels of international technology transfer open at all times.
(b) New Technology and Applications

72. A set of technology collectively referred to as New technology is a single most

profound source of technological progress of both of advanced and developing
economies, rapid globalisation and shifts in global trade. The term refers to innovative
development in electronics relating to informatics, computer hardware, software, tele-
communication, biotechnology and new materials. To this can be added emerging
technology namely renewable energy technologies like photovoltaic, remote sensing,
super conductivity and photonics. New technologies are knowledge intensive in contrast
to conventional capital intensive technologies. Moreover, new technologies are process
technologies rather than product technology. Therefore, they are not only scale free but
also have a very wide range of applications.

73. As for new materials, the sectoral range is even wider and includes material
industry, energy, automobile, semi-conductor, communications, precision machinery, air-
craft/ space, medical equipment/ instruments and life technology product like heart valve
and other synthetic human body parts. New technologies help to develop new
manufacturing location. The conventional need to look for resource base or cheap labour
is no longer required.

74. International technology markets are complex, imperfect and rapidly evolving.
However, some trends are significant. First, the pace of technological innovation is
quickening, led by both demand factors such as growing global competition and supply
factors such as breakthroughs in genetic engineering and solid state physics. Second, life
cycles of technological processes and products are shortening as a result of new
electronics-based technologies and increased participation in technology-intensive
industries. Third, rapid automation is transforming factor intensities of certain industries,
which are losing their labour-intensive character.

1.6 Development of Infrastructure and Services

75. Rapid technological developments in telecommunications and computers in the

1980s have made some services, especially information-intensive ones, more tradable.
The “long-distance” type of service does not necessarily require physical proximity
between the provider and the user. Live broadcasts, transborder data transmissions, and
traditional bank and insurance services fall under this category. The scope of long-
distance service transactions has greatly increased with the advance of technology. In
“long-distance” services, there is no need for any direct investment or movement of
labour.
 76. In the last few years there has been an increasing interest on the part of both
governments and private sector to enhance the role of foreign investment in infrastructure
development in East Asia and Pacific, and the Latin American countries. However, there
is a basic difference of experiences between Latin America and East Asia. Most countries
in Latin America encouraged outright sale or transfer of management/ majority share of
public enterprises, while East Asian countries encouraged private investment for creating
new capacities (World Bank 1994).

77. Because of lumpiness of huge capital, risk involved and the budgetary constraints,
developing countries are increasingly financing their infrastructure projects by external
commercial borrowing and increased use of bond and equity markets. Finance for
infrastructure typically comes in a package with equity, debt, commercial bank loans,
export credit guarantees, and contingent liabilities of the host government ranging from
“full faith and credit guarantees” to “comfort letters”.

78. Capital market finance for infrastructure increased more than eightfold since 1990
and reached $22.3 billion in 1995 (Table 1.10). The private sector outpaced the public
sector in external infrastructure finance although with the help of substantial government
guarantees. Compared to the public sector, the private sector relied more on loans than on
bonds or equity. But the growth has been uneven across the regions, countries and
sectors. East Asia raised the most finance (led by China, Indonesia, South Korea,
Malaysia, Philippines, Thailand) followed by Latin America. Power generation,
telecommunications and transport attracted the most external finance, while power
transmission and distribution and water supply lagged behind.

79. In 1988-1995 developing countries raised $130 billion through privatisation led by
Latin America and the Caribbean ($68 billion), Europe and Central Asia ($25 billion),
East Asia and the Pacific ($25 billion), South Asia ($6 billion), Sub-Saharan Africa ($3
billion) and Middle East and North Africa ($2 billion). Infrastructure related sales
accounted for 44 percent in both 1994 and 1995.

80. Privatisation continued to be an important channel for foreign investment (direct

and portfolio equity) in 1990s. Total foreign investment raised from privatisation in 1988-
1995 amounted to $58 billion, nearly two-thirds of which were in the form of foreign
direct investment, with portfolio investment accounting for the remainder (Tables 1.12A
and 1.12B).

81. TNCs invest in infrastructure projects in the form of FDI (greenfield investments or
acquisitions through privatisation), BOT, BOO, BOOT, BOLT, BTO or variants of these
schemes. There are various forms of BOO and BOT schemes in the region such as those
for toll roads in China, India, Malaysia, and Thailand; telephone facilities in Indonesia,
Sri Lanka and Thailand; power generation in India, China, Pakistan and Indonesia; and
energy, transportation and water resources in the Philippines.
 82. Various constraints such as high fixed or sunk costs, long gestation periods, price
ceilings and other regulations on the operations of an infrastructure facility in host
countries, and political risk (expropriation or nationalisation) have induced foreign
investors to minimise equity commitments to such projects and to rely on debt
(commercial loans and bonds) and non-equity financing (technical know-how, expertise,
R&D cost sharing, trade credits and supply of capital goods).

83. There are constraints that arise out of the very nature of some of the ways in which
infrastructure projects are financed. Given the perceived risk, investors require high rates
of return. This necessarily requires user fees commensurate with the rate of return, which,
in many developing countries, are too high to be sustainable. There are also
environmental issues associated with infrastructure projects. Consequently, negotiations
of BOT/BOO and similar schemes - in developing and developed countries - are typically
very complex and long drawn out.

84. In recent years, a number of Asian investment funds have been created to mobilise
international capital to finance Asia’s infrastructure. These funds provide medium and
long-term finance (5-10 years) for infrastructure projects through equity (usually 10% or
more) or convertible debt. Funds are raised from a diverse group such as institutional and
private investors, TNCs, regional banks and multilateral organisations. The Asian
Infrastructure Fund (AIF), in which the Asian Development Bank was an initial investor,
was the first infrastructure investment fund in the region. The AIF is investing in utility,
transportation and communications projects in China, Indonesia, Malaysia, Thailand,
Philippines and Taiwan. Since then, several infrastructure investment funds, similar to
international mutual funds, or unit trusts, have been set up.

1.7 Policies and Strategies for Promoting

FDI - Technology - Growth Nexus

(a) Macro Economic Policies

85. Inflows of FDI are determined by a complex set of economic, political and social
factors and foreign investors look beyond the array of fiscal incentives offered. In recent
years FDIs have been encouraged by economic reforms and particularly by liberal FDI
regimes (in terms of currency convertibility, free repatriation, less performance criteria,
tax holidays and other incentives, relaxation or abolition of screening requirements and
limits on foreign equity etc.). Major policies and liberalisations on foreign investment
regimes in 18 selected Asian countries are summarised in Tables 1.13A and 1.13B.

86. Other major factors that influence FDI flows include low wage rates and low
production costs, higher rates of return, huge domestic market, labour mobility, efficient
infrastructure, an established legal and institutional set-up, administrative speed and
efficiency, and above all liberal economic policies and stable economic situation. The
formation of regional trading blocks such as NAFTA, ASEAN, APEC, SAARC etc. had
also an important impact on the FDI pattern. In future, countries outside the regional
blocks might have disadvantages in attracting FDI.
 87. Foreign investors dislike any screening of investment except for national security,
public health, individual safety, and environmental protection. They also dislike
performance requirements such as export orientation, local content, value addition and
foreign exchange requirements. Such requirements distort and discourage trade and
investment, and result in diminished returns to both investors and host countries.

88. Foreign investors like to have better of national treatment and most favoured nation
treatment, as it maximizes the free flow of capital. Other key factors attracting FDI
include free transfer of profits and dividends, adherence to international law standards on
expropriation, international arbitration, protection of intellectual property rights (IPR), ,
and the right of the investor to employ management of its choice, regardless of any
nationality. Since 1980, countries that guaranteed that profits could be repatriated
attracted 93% of foreign investment flows. and countries adhering to the Convention of
Settlement of Investment Disputes attracted 85% of foreign investment.

89. In recent years there has been a surge of foreign portfolio investment, which
includes both equity and bonds. Host country factors which are crucial for portfolio
investment fall into three groups viz. the degree of political and macroeconomic stability
and prospects for growth; the host country’s commitment to the process of economic and
financial liberalization and reform; and the state of development of the host country stock
exchange and the institutional and regulatory framework.

90. Developing countries have established investment promotion programmes, which

are often organised as a government department or as a quasi-government agency with
private participation. In a few cases such as Mexico, Costa Rica, Venezuela and
Honduras, the promotion agency is funded and run by the private companies. Ironically,
as developing countries liberalise FDI and trade regimes, multilateral companies
appeared in many cases to have improved their bargaining power vis-a-vis host countries.

91. The macro-economic policy framework and reforms constitute only some of the
factors, albeit vital ones, for encouraging foreign investment. The country’s economic
potential, human and natural resources and political stability and other factors that affect
the risk and profitability of investment are equally important. Membership in bilateral tax
treaties, and multilateral and regional investment guarantee arrangements are also seen as
an important element in providing a stable and attractive framework as it could reduce
perceived risks.

(b) Fiscal and Financial Policies

92. Fiscal, financial and other incentives remained an important part of a country’s
investment promotion package. When all other factors are equal, incentives can tilt the
balance in investors’ location choices. This appears particularly true for “footloose
industries” which choose among production sites with comparative costs; automobiles
and food processing industries, for example, seem to be sensitive to a package of fiscal,
tariff and financial incentives given by host countries.
 93. Fiscal and monetary incentives play, however, only a minor role in the location
decisions of TNCs, and attract only those “fly-by-night” firms, which exist on
exploitation of incentives. This is not surprising since investment decisions are typically
made because they promise to be profitable on the basis of market conditions alone; if
incentives are offered, they become “icing on the cake”. While the effects of incentives
on stimulating new investments are difficult to measure, they nevertheless represent
substantial economic costs. Where incentives already existed, their sudden removal
might produce negative effects; where they did not exist, their introduction might not
produce net gains. A rational, efficient, equitable and internationally competitive tax
system is more conducive to FDI than fiscal incentives.

(c) The Role of Special Economic Zones

94. Of the many policies tried by the East Asian countries for accelerating growth,
those associated with their export push hold the most promise for other developing
economies. The export-push approach provided a mechanism by which industry moved
rapidly toward international best practice and technology. Export processing zones are the
most common forms of subnational zones. A feature of these zones is the establishment
of some subnational customs area that gives a preferred customs treatment to goods
entering the area compared with goods entering non-zone parts of the country. These
preferences are normally restricted to export activities. Export processing zones also give
preferences or privileges relating to the establishment of foreign-owned enterprises and to
nontrade-related instruments of government policies such as tax holidays or deferments,
duty drawbacks or exemptions for raw materials, reduced rates in taxes and duties for
capital goods, investment subsidy, preferences in government loans. EPZs and other
economic zones are generally equipped with good infrastructure and support facilities.

95. A closely related form of subnational zone is the financial service zone, such as a
financial offshore center. These zones essentially provide preferences for the finance
service industries, analogous to those provided for manufactured goods in export
processing zones. There are other subnational zones, which are not international, trade-
related, such as science and technology parks. The number of these parks has increased
rapidly in many Asian countries since 1980. Most science and technology parks in Asia
have concentrated primarily on attracting foreign investors. Subnational zones are,
therefore, an integral part of the wider pattern of intra-Asian trade development.
Subnational and sub-regional zones have increased the intraregional share of total trade in
goods and services and intraregional flows of FDI. Despite some failures, special
economic zones have largely met their objectives by attracting FDI, creating employment
and increasing exports.

(d) Role of Small and Medium Sized Industries (SMIs)

96. SMIs constitute a rather dynamic force in the economic development; they provide a
sound market environment for the economic growth; reduce rural-urban disparities; and
can swiftly adapt relatively simple but advanced technology. A dynamic SMI sector helps
not only to generate employment but also to earn foreign exchange, upgrade the quality
of the labour force, diffuse technological know-how, and utilise rural savings, surplus
labour and local raw materials that may otherwise remain idle and unutilised. Small
enterprises provide a source and training ground for the development of entrepreneurship
and business management skills for medium and large undertakings.

97. Small and medium industries predominate output in a number of industrial sectors
in many Asian countries such as Bangladesh, India, Pakistan, China, Korea, Indonesia
and Philippines. Even they played a significant role in the economic development in
Japan and Singapore (Das 1996, ESCAPE 1996). They are mainly in the textiles,
garments, wood products, food processing, leather products, fabricated metals, machinery
and equipment, rubber and plastic products, pottery, printing and publishing. In 1990 they
accounted for 95% of establishments in Bangladesh, 98% in Thailand, 93% in Malaysia,
70% in Indonesia and 80% in the Philippines. In India the SSI sector accounts for 40%
of the total turnover in manufacturing and 35% total exports. In China, SMEs accounted
for 99% of the number of enterprises, 78% of employees, 64% of industrial turnover,
52% of corporate profits and 52% of fixed assets held by industry in 1990. In Japan,
SMEs accounted for 99% of all business establishments, 74% of total work force, 52% of
manufacturing exports, 62% of wholesale business sales and 7% of retail sales in 1991. In
Taiwan, SMEs accounted for 90% of enterprises and 60% of exports in 1990.

98. On the other hand, there have been criticisms regarding the ability of small
industries to realise economies of scale in production, procurement and marketing. So,
they may experience larger unit costs despite low labour costs and advantages due to their
proximity to the local markets. In many sectors, small units exist on the strength of the
costly government support programmes in terms of reservation, price and purchase
preference, priority and concessional lending and fiscal concessions.

(e) Role of Research and Development (R&D) Expenditure

99. There is a high degree of correlation between R&D expenditure and technological
capability. Product design and manufacturing techniques have become interlinked and
this interaction has been facilitated by computer-assisted techniques and technological
innovations in semiconductors, electronics and robotics. This process requires continuous
efforts in R&D in order to adapt to market demands by product innovations and
differentiation. TNCs engaging in intensive R&D activities acquires a technological
advantage over their competitors; and will be unwilling to share sophisticated production
techniques through licensing. Korea provides a good example that an appropriate degree
of interaction between industry and R&D institutions can generate tangible benefits to all
concerned, while at the same time provide a substantial boost to research and
development. Korea has also been successful in attaining reverse brain drain through the
development of high technology.

100. Although heavy investment has been made in technical education, equipment,
infrastructure and modern computers by many countries, it is observed that the technical
institutions are inclined to do basic research devoid of practical needs of the industry. For
example, India has virtually all basic, applied, hardware and software and R&D
institutions, some of which have achieved world-class standards. But, these institutions
failed to commercialise R&D activities, remain as isolated products of excellence without
direct link with production. Since 1993 Government had encouraged private sector
funding of research institutions by providing tax relief on R&D expenditure.

(f) Infrastructure and Human Resource Development

101. Foreign investors need adequate local support facilities including capital markets,
efficient physical, and technological and human capital structure. The experiences of the
East Asian countries indicate that success in absorbing, deploying and deepening
industrial technology depends on efforts to develop local capabilities, particularly skill
upgrading and local R&D efforts, which often require government intervention to
overcome market failures in investment on R&D, and general and higher education.
Active policies to upgrade human capital formation through provision of a high quality
educational and training system are, therefore, priorities for the host countries.

102. Efficient supply of power, telecommunications and transport services are important
in creating cost competitiveness. In this regard, attracting foreign investment and private
management into infrastructure is particularly crucial. The legal/regulatory and
institutional framework should be developed to pave the way for foreign investment.
Improvements in rural infrastructure are also necessary to facilitate diversification and
intensification in farm production and the expansion of off-farm activities.

1.8 Regionalisation and FDI Complementarities

103. Regional economic cooperation facilitates the free flow of goods, services, capital
and labor across national boundaries and acts as an effective instrument for securing
efficiency in the use of resources and thereby enhancing growth of all member countries.
Intraregional capital flows, particularly FDI, have grown very rapidly over the past
decade. They also entailed an increasing flow of technology associated with individual
projects and embodied in the flow of capital equipment and intermediate inputs arising
from projects. Japan and the NIEs are the source of much of this intraregional FDI.

(a) ASEAN Experience

104. ASEAN covering most of the Southeast Asian economies, has evolved a
comprehensive regional trading arrangement, the ASEAN Free Trade Area, with an
explicit time table for eliminating tariffs within the group by the year 2003 and for
introducing its Common Effective Preferential Tariff (CEPT). Members have agreed to
eliminate quantitative restrictions and non-tariff barriers on trade in products in the
CEPT, to cooperate in some areas of service trade and to explore cooperation in some
non-border issues such as harmonisation of standards, reciprocal recognition of tests and
certification of products, and removal of barriers to FDI. An important feature of this
Agreement is the intent to free the movement of capital and to increase investment,
industrial linkages and complementarity among members.
 105. As regards industrial cooperation, some positive results have been achieved in the
ASEAN Brand-to-Brand complementation (BBC) in the automotive industry, which
envisage manufacturing different components of a vehicle in different countries. ASEAN
Industrial Cooperation (AICO) Scheme is the latest industrial cooperation program in the
ASEAN, under which two participating companies from two different ASEAN countries
should involve not only in the physical movements of goods but also in resource sharing
and industrial complementation. Outputs of these companies enjoy a preferential tariff
rate in the range of 0-5%.

106. To promote and protect intra-ASEAN investment, the ASEAN countries since
1976 have an Agreement providing most-favoured nation treatment to intra-ASEAN
investment. Other important ASEAN integration efforts related to their efforts towards
joint resource mobilisation and intra-ASEAN infrastructures. For example, the “ASEAN
Minerals Cooperation Plan” was designed to develop downstream industries. Similarly,
different ASEAN subsectoral programmes in energy cooperation promoted efficient use
of coal in the subregion. The gas pipeline projects across the member States also proved
useful for the subregion.

(b) SAARC Experience

107. ASEAN is far more open than SAARC due to long-followed policies of export
promotion and foreign investment. FDI inflows into ASEAN have been far more
significant and instrumental in raising the industrial linkages and complementarities in
the region. SAARC, on the other hand, has so far made little contribution to either
regionalism or globalisation. Only recently SAARC has included activities on trade and
investment as a part of its regional cooperation. There is, however, hope that as a first
step SAARC members, having agreed on a free trade area, will promote regional trade
cooperation as a building block towards globalisation. For its success, SAARC will need
to agree on a clear policy towards foreign investment as a vehicle of technology
upgradation and overall growth.

108. While there are only two formal regional trading arrangements in Asia (AFTA and
SAPTA, there are economic cooperation of a more informal nature among countries in
the region. These sub-regional economic zones (SREZs) are popularly referred to as
growth triangles, growth polygons, or simply growth areas. The main focus of the SREZs
is on the transnational movement of capital, labour, technology, and information and on
the inter-country provision of infrastructure rather than on trade in goods and services.
India, Thailand, Bangladesh and Sri Lanka, having a coastline on the Bay of Bengal, have
formed a regional trade group on June 6, 1997, called the Bangladesh, India, Sri Lanka,
Thailand Economic Cooperation (BIST-EC). Trade between these countries currently
totals only $1 billion and is expected to improve substantially in the next decade due to
predicted economic boom. Attempts are also being made to form a sub-regional
economic group through the Bangladesh, Bhutan, Nepal and India “growth quadrangle”
(BBNI-GQ).
 (c) APEC Experience

109. The most comprehensive form of multi-government cooperation in terms of both

countries and the scope of issues addressed are the Asia Pacific Economic Cooperation
(APEC). This organisation was established in 1989 and currently has 18 member
countries in Asia and the Pacific including the Unites States. The APEC forum is of
special significance, as it is not founded on a formal agreement in accordance with the
GATT. The member countries have agreed by consensus on a program of action to
achieve a state of “free and open trade and investment” by the year 2010 for industrial
country members and 2020 for developing country members. Many of the members have
already made significant unilateral tariff reductions before the target date. There is an
agreement on a set of APEC Nonbinding Investment Principles for investment flows in
the region. These are intended to reduce restrictions on the international flow of portfolio
investments.

(d) ESCAP Experience

110. From its inception ESCAP has promoted economic co-operation in the Asian and
Pacific region. ESCAP conceived the integrated communications infrastructure for the
Asia and promoted regional cooperation in shipping, ports and technology transfer.
Financial and developmental institutions like the Asian Development Bank, Asian
Clearing House, The Asian and Pacific Centre for the Transfer of Technology, the Asian
Reinsurance Corporation etc. were established at the initiative of ESCAP in order to
promote economic co-operation in Asia.

111. Increasing levels of intraregional trade and investment are gradually shaping a truly
interdependent regional economy in the Asia-Pacific region, based on the linkages of
production structure and regional division of labour. They succeeded significantly in
utilising the technological revolution to enhance their national comparative and
competitive advantages. First, Japan and then the advanced countries of the region have
become critical growth centres supplying FDI and technology to other economies of the
region.

112. Although regional economic cooperation in ESCAP is being worked out at various
levels, actual progress is limited due to a number of reasons: (a) All the subregional
groups except ASEAN and the South Pacific Forum are about a decade old and it takes
much time to build up confidence and trust among the members. (b) Asian regional
groupings are only intercountry institutions and donot have supranational powers like the
EC. (c) There is hardly any linkage or dialogue among the regional or subregional
groups.

113. The opportunities for regional cooperation in the endogenous technological

capability building of ESCAP member countries are enormous. While advanced
developing countries such as the NIEs have adequate domestic resources to attract
technology and capital and to expand their technological capacity, a number of
developing countries in the region (LDCs, island developing countries and disadvantaged
traditional economies) remain outside the mainstream of economic development
primarily because of poor, inappropriate or unfavourable local conditions in terms of
skills, market size, technological and physical infrastructure.

(e) Multilateral Agreement on Investment (MAI)

114. The vigorous growth of bilateral and regional investment agreements, the inclusion
of certain FDI-related issues in the Uruguay Round agreements and the beginning of
negotiations on a Multilateral Agreement on Investment in the OECD clearly indicate that
both the developed and developing countries are moving towards liberalised trade and
investment regime.

115. At the regional level, the mix of investment issues covered is broader than that
found at the bilateral level, and the operational approaches to deal with them are less
uniform. Most regional instruments are legally binding. Issues typically dealt with at the
regional level include the liberalisation of investment measures; standards of treatment;
protection of investments and disputes settlement; and issues related to the conduct of
foreign investors (e.g. illicit payments, restrictive business practices, disclosure of
information, environmental protection, and labour relations).

116. At the multilateral level, most agreements relate to sectoral or to specific issues.
Particularly important among them are services, performance requirements, intellectual
property rights, insurance, settlement of disputes, employment and labour relations,
restrictive business practices, competition policy, incentives and consumer protection. It
is at the multilateral level that concern for development is most apparent. This is
particularly so in the case of the GATS, TRIPS and TRIMs agreements, as well as the
(non-binding) Restrictive Business Practices Set, where special provisions are made that
explicitly recognise the needs of developing countries.

B. Recommendations

1.9 General recommendations

117. The SAARC is rich in natural resources, which are not fully utilised. The region is
faced with the common problems of poverty and unemployment. Economic cooperation
in the region is an effective instrument for improving the welfare of the people. A
sustainable growth path for the region must be based on continued economic reforms,
dynamic capital market, human resource development and improvement in infrastructure
and environment.

118. As regards East Asia, future development strategy must focus on the development
of efficient infrastructure, flexible and responsive financial system and competent
management. As the region’s infrastructure needs are large, the private sectors themselves
and through FDI will have to play an increasingly critical role in developing and
modernising infrastructure base. In turn, governments will need to establish the
appropriate institutional, regulatory and legal frameworks to attract and secure such
investment.

1.11 Policies for promoting FDI-Technology-Growth Nexus

(a) Host Country Policies for FDI

119. For host countries, the policy agenda for increasing FDI inflows and for drawing
maximum benefits from them includes the following priorities: ensuring a stable
economic environment conducive to sustained economic growth, encouraging the
development and upgrading of local industrial and technological capabilities,
strengthening infrastructure and human resource development, and providing requisite
legal, regulatory and institutional set up. Those countries that have only recently been
open to FDI need to ensure that the “open door policy” is maintained and remains stable.
They should examine the possibility of a further liberalisation of FDI regimes; the
harmonisation of FDI and related policies on industry, trade and technology; and
improving the efficiency of their administrative set-up for investment approvals. To the
extent possible, host countries should seek to avoid competitive bidding, enhance
exchanges of information and promote transparency in order to reduce unnecessary
transaction costs.

120. All countries in the region should pay particular attention to the firms from
neighbouring countries, so as to capitalise the growing intra-regional investment. Special
attention needs to be given to small and medium-sized enterprises whose special needs -
dictated by their limited financial and managerial resources and insufficient information -
may call for incentives for the joint ventures among the small and medium-sized TNCs.

121. Successfully enticing one important TNC to locate in a country can trigger a chain
reaction that leads to substantial sequential and associated investment. The most obvious
targets are firms already established in a country. Governments can strive to encourage
sequential investment (including reinvested earnings),, which can provide positive
demonstration effects for potential new investors: a satisfied foreign investor is the best
commercial ambassador a country can have. Policy makers should be concerned when
foreign investors leave the host country due to deteriorating local conditions. Emphasis
on after-investment and investment-facilitation services for current investors is therefore
crucial. This may involve the creation of joint committees consisting of representatives
of government, foreign affiliates and local employees to avoid conflicts and to resolve
problems that can lead to relocation. Also, an Ombudsperson can be appointed to handle
complaints about unreasonable delays and undue demands by government officials on
business people.

122. Free, prompt and unrestricted transfers in any freely usable currency should be
permitted for all funds related to an investment. The bottom line to a business is the
ability to make profits and to distribute funds to partners and shareholders.
Expropriations should only occur in accordance with international law standards and be
subject to due process. An expropriation should be for public purpose and
nondiscriminatory, and prompt, adequate and effective compensation must be paid.

123. Firms must be confident that they can obtain a fair hearing in the event of a
dispute, and must have reciprocal ability to seek international arbitration. Investors
should have full access to the local court system, but also have the choice to take the host
parties directly to third party international binding arbitration to settle investment
disputes.

124. One of the most important determinants of a foreign affiliate’s impact on the
technology and skills in a host country is the extent of its forward and backward linkages
with local firms. Foreign-direct-investment policy should therefore have a trade
component as TNCs are interested in whether a country is suitable for inclusion in their
intra-firm division of labour. At the same time, trade policy should have an FDI
component, to take advantage of the market access that TNC systems provide. Generally,
FDI should not be encouraged either entirely for import substitution (e.g. tariff
incentives) or completely for export-promotion (e.g. export-processing zones). Since FDI
is a package, it should be treated as such. The composition of the package that can be
attracted very much depends on a country’s characteristics, including its level of
development.

125. The developing countries should focus more intensely on the governance issues
and accelerate efforts aimed at improving the efficiency of the public sector enterprises in
the provision and quality of services, cost recovery, regulatory oversight, and in the
establishment of a facilitating business environment. They should also undertake bold
reforms at the local governments and micro levels to promote efficient decentralisation
for timely implementation of infrastructure and social sector programs.

126. The legal framework governing labor markets must be reformed to institute a
market-based bargaining process that is free from interference by the government or trade
unions, and a system of severance liabilities that conform free market conditions and
developing country norms. De-politicisation of industrial relations will benefit both the
workers, businesses, and the economy by eliminating the costly economy-wide
agitation’s, with positive impact on private investment.

(b) Host Country Policies for Portfolio Investment

127. The strengthening of local capital and stock markets is essential for the
development and broadening of the domestic investor base and the establishment of a
healthy private sector. In this respect, privatization has a role to play in broadening the
investment base. A prudent regulatory framework alongwith transparency and efficiency
of price dissemination are also necessary to ensure investors’ confidence in the stock
market.
 128. Among the main issues to be tackled for BOT financing schemes in infrastructure
are the need to restructure some utility sectors, the need for an improved regulatory
environment, and measures to reduce demand risks and foreign exchange risks.

(c) Home Country Policies

129. With domestic outward FDI policies liberalised, developed home countries must
supplement their domestic policies with international instruments aimed at protecting and
facilitating outward FDI. They should improve FDI liberalisation standards generally and
encourage level playing field among themselves.

130. Few developing countries and economies in transition have paid due attention to
outward FDI policies; typically these are subsumed under general capital-control policies
which, in turn, are quite restrictive. There is a need to liberalise further capital markets
and foreign exchange rules and regulations so as to move towards full convertibility on
capital account.

131. As regards portfolio investment, the enormous potential represented by the pool of
savings held by institutional investors in the OECD countries may increasingly seek
investment outlets other than those offered by the mature markets. However, home
country regulations concerning outward portfolio investments can be a major constraint
on outward portfolio investment. In most developed countries, savings institutions such
as insurance companies and pension funds face ceilings on the share of foreign assets in
their portfolio and are usually subject to prudent investment and diversification norms. As
the investment managers become more familiar with emerging markets, a relaxation of
home country policies concerning portfolios of institutional investors could lead to a
multiple increase of portfolio investment to developing countries.

(d) The Role of Special Economic Zones

132. Developing countries must focus on export-promotion and development of EPZs

or special economic zones. Success of EPZs depends on a favourable investment climate,
skilled labour force and an active local business community and government’s support for
the EPZs, while failures are attributable to poor locations, inadequate infrastructure,
excessive costs and mismanagement. EPZs of developing countries should try to avoid
stiff competition among them to offer increasingly generous incentives for attracting
foreign investors, as this will erode their net benefits in the medium and long term
(UNCTAD 1993). The long-term viability of EPZs also requires that their operations
should be properly integrated with the overall economic and industrial development
strategy of the country.

(e) Role of Small and Medium Sized Industries (SMIs)

133. A wide range of opportunities can be seized by small-scale, labour-intensive

industries. It is particularly so in the Asian region where horizontal division of labour
through trade and joint venture projects are increasing sharply. For example, the latest
venture by Japanese automakers in South-east Asia suggests that specialised components
can be produced at factories in several countries for use in a single, shared final product.

134. The following measures need to be given priority for strengthening the SMI sector
:

* It is necessary to facilitate the transfer of technology to the SMEs by suitable

arrangements such as regional information networks and provision of timely and
adequate finance to SMEs.

* Adequate backward and forward linkages need to be established between small and
large units in terms of sub-contracting, production sharing, manufacture of parts and
components etc.

* Suitable measures may be taken to enhance the access of the SMI sector to
information particularly relating to external markets, foreign investment and better
technology.

* Vertical expansion of the SMEs may be limited due to reservation of items and limits
on investment for the SMEs. A review of the reservation policy and investment limits is
necessary to facilitate capacity expansion, technology upgradation and economies of
scale.

* Much of the existing growth of SMEs has taken place in and around the metropolitan
areas, but the balanced regional growth requires that the process of industrialisation needs
to be extended to the countryside. In this respect, the experience of China in setting up
Township Enterprises on a large scale may be particularly relevant for other developing
countries.

* SMEs are most vulnerable to trade protectionism. Undesirable tariffs and non-tariff
restrictions on their products must be removed to enhance the export potentials of SMEs.

(f) Role of R&D Expenditures

135. The R&D expenditure in many developing countries like India (0.9% of GNP),
Pakistan (0.6%), Philippines (0.7%) and Thailand (0.5% of GNP) are considerably lower
than that in USA (2.7%), United Kingdom (2.3%), Japan (3%), Germany (2.9%) and
South Korea (2.8%). Asian developing countries must allocate more resources on R&D
and encourage private sector funding of research institutions engaged in R&D. For
effective role of R&D in the generation, development, adoption, assimilation and
diffusion of industrial technologies, public research institutions must try to commercialise
R&D activities with necessary linkages with the private sector and production activities.

(g) Infrastructure and Human Resource Development

 136. Efficient physical infrastructure and human capital are critical overheads that
investors seek. For the more dynamic traded goods and services, telecommunications are
the most important fascilitator of FDI, and technological and organisational innovations
drive FDI into those countries which have trained and skilled workforce and fairly high
educational standards. This points to the overriding importance of developing countries to
invest more in the development of human resources, infrastructure and services. It also
highlights the risk of being marginalised for the least developed countries with a low
level of skilled labour force and infrastructure constraints.

137. The existence of a dynamic local business sector creates a supportive environment
through efficient networks of local suppliers, service firms, consultants, partners or
competitors. It is, therefore, necessary to concentrate efforts on the development of local
entrepreneurship. Equally important is the availability of high quality
telecommunications and transport systems, energy supply and other utilities.

(h) Legal and Institutional Set-up

138. Many of the difficulties faced by governments in handling foreign investment, and
by the foreign investors setting up in a host country, derive from the absence of a clear
civil, commercial and criminal legal system. Given a set of laws, it is essential that
foreign investors are treated equally with domestic investors. Not only is this a moral
issue, but there are strong practical arguments against giving foreign investors privileges
that domestic firms do not enjoy (and vice versa). Domestic firms will launder money to
become foreign investors if this will give them subsidies that they cannot otherwise
receive. Chinese publicly owned enterprises use transfer pricing at other than arms’
length to become foreign investors in China, or they form joint ventures within foreign
firms to benefit from subsidies to foreign investors. Giving entrepreneurs of Indian origin
special privileges by India are also inequitable and inefficient. Continued reforms will
attract the worthwhile investors among them without incentives.

139. In open economies, such as Singapore, Hong Kong or Mauritius, only minimal
special foreign investment laws and regulations are necessary and administrative costs
are negligible. Most developing countries like India are faced with a transition period.
The experience of countries such as Indonesia, Malaysia, Taiwan and Thailand suggests
that the transition can be managed well. The faster an economy is reformed, the easier the
management of foreign investment. Regulations can be simple and their administration
transparent.

(i) Fiscal and monetary incentives

140. The competition among the host countries to attract FDI has intensified the use of
incentives to such an extent that the situation is often referred as an “investment war”.
Host countries get trapped in the “prisoner’s dilemma” leading to competitive bidding in
which all participants are left worse off than the situation of no bidding. It will be
beneficial for the host countries to arrive at a harmonisation of policies, to ensure more
transparency on FDI regime, and to exchange information about their regulatory regime
and other FDI-related policies and to share their experiences on the impact of FDI on the
costs and benefits to the economy.

1.11 Different Modes of FDI and Technology Transfer

141. An important reason favouring FDI or joint venture with TNCs/MNCs is to

improve upon economies of scale and take advantage of specialised skills across
countries. There is a growing trend to network and form joint ventures such that different
stages of production are carried out in different countries. There is also the need to merge
and become competitive vis-a-vis larger MNCs position. Pooling of R&D resources is
another reason for a group of large companies joining hands. Another reason for shift in
FDI through MNCs is the emergence of new technologies like computer software, CNC
machinery and new materials. All of these technologies are easily available with the firms
in advanced countries and cannot be obtained through conventional licensing.

142. Embodied technology transfer through capital goods imports will be the most
important source of technology and the cheapest way of technology acquisition for any
Asian developing country. Japan initially acquired foreign technologies by reversing the
engineering process (disassembling and reassembling imported machinery). The
engineers and technicians began with the end-product and worked back to find the
components, their inter-relationships, and the technologies. This mode of technology
acquisition required established engineering capabilities. Licensing agreements are the
most effective way to suit local needs and conditions. But, this mode of transfer is costly
and involves a process that is more complex and time consuming than other modes.
Turnkey projects are the easiest way to establish new factories, but rarely transfer needed
technologies unless the recipient makes conscious efforts to acquire them.

143. As far as technology acquisition and assimilation are concerned, developing

countries can learn much from the Korean experiences. The Korean lessons indicate that
technology can be upgraded only through conscious and steady efforts to improve
available technologies, and that the most effective way to achieve such progress is
through interaction with a competitive market. The Korean experience also indicates that
technologies are best learnt by workers in the workplace.

1.12 Technology Development and Advances in New Technologies

(a) Industrial technology development

144. If the industrial or technological catch-up process follows the so-called “flying
geese” pattern of development, with Japan leading the way in Asia followed by the NIEs,
ASEAN and South Asia, it is essential to establish a regional mechanism which will
facilitate the division of labor in transferring appropriate technologies. For example,
Japanese technologies may be modified to fit into the needs of the NIEs, which in turn,
may be modified to suit the needs of ASEAN and South Asian countries.
 145. The best incentive framework for ITD is to provide constant competition to
enterprises in a stable macroeconomic environment. Full exposure to world competition
may, however, have to be tempered by the fact that a new entrant has to incur the costs
and risks of gaining technological knowledge and experience, when its competitors in
more advanced countries have already gone through the learning process. This may be a
case for temporary and limited infant industry protection. But, it has to be carefully
designed, sparingly granted, strictly monitored, and offset by measures to force firms to
aim for world standards.

146. The supply of human capital, technical support services, foreign technology, S&T
infrastructure and finance can suffer from market failures. They therefore require
government intervention and policy support, and their most effective use calls for
selectivity and coherence. Much of ITD support work must focus on market friendly or
functional interventions to strengthen the infrastructure, improve its relations with
enterprises, help small and medium-sized firms with their special information and support
needs, augment the supply of finance for technology investments, and build up requisite
skill needs for efficient industrial operations and growth.

(b) New Technology and Applications

147. Countries like Korea, China and India stand to gain substantially by revitalising
their economies to become internationally competitive not only in new technologies but
also in many other industries with the use of time and material saving production
processes like CNC/CAD/CAM integrated manufacturing, flexible manufacturing
systems, just in time production systems etc. Likewise, the bio-technology has a wide
range of application ranging from food processing, pharmaceuticals, chemicals,
agriculture and allied sectors, mining, soil fertility etc.

148. The high technologies are R&D intensive and their development requires large
risky investments, and it is non-viable for developing countries to make an effort to
become technologically self-reliant in all high technology sectors. A developing country
like India which is not in a position to undertake organised R&D on a high scale through
its own efforts has two options: either to license international R&D collaborations for
upgrading its technological design capability or to allow foreign direct investment and
joint ventures for state of art technology. In the Indian context the second option has been
largely accepted.

149. Being knowledge intensive, it appears logical to have great scope for international
collaborations. But, it is unlikely that advanced countries will be willing to collaborate to
transfer new technologies. An alternative option is to allow university departments and
research institutes to take up sub-contracted work for the multinationals/ transnational
corporations who have not only resources but also the marketing network. The
establishment of a regional technology network system will no doubt accelerate
technological capabilities and industrial development in these countries. This is an area
where private sector efforts should be supported and coordinated jointly by the public
sector and regional development organisations.
 1.14 FDI and development of infrastructure and services

150. The financial requirements for infrastructure are vast. India needs about $400
billion during 1997-2006 for its infrastructure development. Present growth rates in East
Asia suggest that such investment requirements will be $1.4 trillion during the next
decade; for China alone, the figure is over $700 billion. In Latin America, requirements
are about $600-800 billion (World Bank, 1995b). Another projection made by the Asian
Development Bank indicates that investment demand for infrastructure in Asia (excluding
Japan and the NIEs) will amount to about $1 trillion in 1994-2000. This includes $300-
$350 billion of investment for the power sector alone to the year 2000, $300-$350 billion
for transportation, $150 billion for telecommunications, and $80-$100 billion for water
supply and sanitation. The investment for infrastructure is projected to increase from 5
per cent of GNP per annum to 7 percent of GNP.

151. The private sector participation in management, financing or ownership will in

most cases be needed to ensure a commercial orientation in infrastructure. Public-private
partnership has promise in financing new capacity. Guarantees from host governments,
multilateral institutions and export credit agencies play an important and legal role to
mitigate the policy uncertainties and commercial and foreign exchange risks inherent in
large-scale infrastructure financing. But, these should not be taken as substitutes for
correcting sectoral distortions or removal of market imperfections.

152. The lessons of experience in East Asia indicate that South Asian countries are
required to have priority attention in the following five areas while formulating country
strategies to enhance private participation in the provision of infrastructure:

* Overall country objectives, strategy and priorities;

* Reform of policy, legal and regulatory framework;
* Facilitation and increased transparency of government decisions
* Unbundling and mitigation of risks; and
* Mobilisation of private term lending.

1.14 Regionalisation and FDI Complementarities

153. Major benefits will come from removing restrictions that impede flows of people,
capital, and goods, and that segment geographically contiguous markets. In addition,
there is considerable untapped potential for regional cooperation in power, transportation,
and distribution ( particularly petroleum products), which would reduce the costs of
doing business. There will be an important pull effect on growth throughout Asia if the
remaining impediments to local and foreign investors are removed. Such regional
cooperation and integration should be seen not as a substitute for opening up to the global
economy, but as a way of assisting firms to connect to global markets at lower cost.

154. Three lessons can be drawn from past developments on FDI policies. First is that
progress in the development of international investment rules is linked to the convergence
of rules adopted by individual countries. Second is that an approach to FDI issues that
takes into account the common advantage, is more likely to gain widespread acceptance
and to be more effective. Third is that in a rapidly globalising world economy, the list of
substantive issues entering international FDI discussions is becoming increasingly
broader and complex and include the entire range of questions concerning factor
mobility.

(a) Technical Assistance

155. Industrial and technology development depends crucially on the development of

basic infrastructure. Multilateral agencies including the International Development
Association (IDA) can help the developing countries by providing financial and technical
support and investment guarantees for the development of infrastructure and human
resources. They can also play a more catalytic role in mobilising funds from a wide range
of private sources using all the available means.
156. Multilateral financial and development institutions and bilateral donors have
played an important role by providing financial and technical assistance to the countries
of South Asia in the areas of improved education, health services and family planning.
External assistance should further be increased and continued to be provided on
concessional terms, given the long term nature of investment in human capital and its link
to poverty alleviation, skill formation and enhancement of industrial productivity and
efficiency.

157. The World Bank, IFC, ADB, ESCAP, UNIDO and UNCTAD are engaged in the
provision of technical assistance, consultancy and advisory services with regard to the
development of the private sector, human resource development, and promotion of non-
debt-creating financial flows, and FDI in particular. Although the experience with
technical assistance received from these institutions have been found to be very valuable,
there is scope for improvement in the following fields:

* Promotion of regional cooperation in human resource development, R&D, S&T

development, technology blending, use of information technology, and computer training
and facilities.

* Studies on public sector enterprises reforms, privatisation and industrial restructuring

to promote industrial relocation and diversification in accordance with the changing
comparative advantages of the countries and regions.

* Consultancy and training aimed at technology upgrading and skill improvement for
the growth and globalisation of SMEs with special attention to entrepreneurs from rural
areas, ethnic minority areas, economically backward areas, ethnic and backward classes,
and women and young entrepreneurs.

* The promotional efforts in favour of SMEs cannot be entirely undertaken by

government agencies alone. Multilateral agencies must accord a much greater role to
private sector business confederations, chambers of commerce and industry, and relevant
non-governmental organisations (NGOs) to enable them to provide SMEs with training,
consultancy and information services.

* Regional technical assistance programmes on harmonisation of national and regional

policies and plans for private sector development and foreign investment.

* Promotion of technology management, evaluation, assessment and enterprises

cooperation for the blending of indigenous technology and imported technology.

* Improvement of the institutional machinery, administrative and legal framework with

a view to facilitating foreign investment flows and improving the data base on FDI and
portfolio flows.

* Advisory services for developing countries to strengthen capital markets and to attract
foreign portfolio investment.

* Technical support for developing countries and countries in transition to upgrade their
institutional capacity to identify, design, negotiate, and implement schemes on
BOT/BOO/BOLT.

* Promotion of a regional collective R&D efforts in specific industries which have

general applicability in most countries (like textiles, automobiles, electronics and
informatics etc.).

(b) Regional Cooperation

158. Asian countries are going through a phase of economic liberalisation, which
provides a solid foundation for the success of intra- and inter-regional cooperation. They
need to make greater efforts to create a more liberal trading and investment environment
for reduction of wide disparities in the levels of income and market size, and to have
cost-sharing and distribution of benefits. The economic exchange and cooperation among
the Asian economies can be strengthened by the following measures:

(a) At the regional level, since the FDI has increasingly become market driven, host
country would increase their location attraction if closer linkages are established with
neighbouring countries in order to generate larger markets and complementary location
advantages.

(b) Since almost all countries in the Asian and Pacific region are trying to attract foreign
direct investment, a lot of competitive overbidding and unnecessary loss of resources
could be avoided through some harmonisation of policies of different governments at
national, bilateral, regional and global levels.

(c) Instead of competing for foreign capital, the countries should undertake appropriate
policy reforms, which will not only encourage more savings and investment internally
but also help the return of flight capital to the Asian region.
 (d) At the regional level, countries should cooperate with one another to modernise
their financial systems to cope with the increase in trade and cross-border capital flows.
They should try their best to facilitate intraregional funding and to reduce the impact of
any global credit crunch.

(e) Another aspect of regional cooperation that is of growing importance is the sharing
of information. Regional cooperation can reduce the transaction costs of gathering
information, and through economies of scale, can reduce the research and development
costs. In this respect, the Regional Investment Information and Promotion Service for
Asia and the Pacific (RIIPS) and the Asia Pacific Centre for Transfer of Technology
(APCTT) have made significant contributions. But, there is scope for improvement in
their databanks and regional information networks on FDI opportunities in the region,
technological breakthroughs in industries, TNCs operations, profiles of FDI and
investment laws in various countries.

(f) National governments as well as regional and interregional organisations must

facilitate contacts, cooperation and mutually business relations among enterprises and
entrepreneurs for building up internal strength of industries.

(g) The sheer magnitude for investment required for technological R&D needs
subregional pooling of limited resources (financial, physical and human) to obtain the
best possible leverage.

(h) It may be desirable to establish a regional investment guarantee facility. A major

problem in attracting investment funds to the developing countries is the perceived risk of
confiscation, civil strife, and political turmoil.

(i) For the least developed countries which lack the capacity to undertake
comprehensive efforts to develop local capacity, there is an urgent need for more active
support by the donor community in such areas as strengthening the private sector and
local entrepreneurship, building institutional capacity, improving physical infrastructure
and enhancing human resource development.

(j) At a broader level, the Asian Development Bank, can play a complementary role in
enhancing regional cooperation to attract more private international capital into the Asian
and Pacific region. The Asian Development Bank should expand its catalytic role in
private sector financing which started in 1987 and should also augment its resources for
the Asian Infrastructure Fund.
(k) Other multilateral financial institutions will also have to strengthen their catalytic
role through co-financing and guarantee with a view to encouraging participation of
private capital in the development process, particularly in South Asia.

(c) Regional Cooperation in SAARC

 159. South Asia has much to learn from the experience of successful regional
endeavours such as ASEAN, EU, NAFTA and APEC. A new concept of open regionalism
which seeks not only to reduce intra-regional barriers in economic interaction, but also to
lower external barriers which are not part of the cooperation arrangement has emerged in
the post-GATT world trade scenario.

160. In order that SAPTA becomes an effective instrument for intra-SAARC trade and
investment expansion, many supporting steps are required. These include steeper
reduction in the trade barriers than that provided under the WTO agreement, increase in
supply capabilities for additional exports, expansion of investment flows in the region,
and replacement of product by product approach by across the board tariff and non-tariff
concessions. SAARC countries will need to agree on a clear policy towards foreign
investment as a vehicle of technology upgradation and overall growth.
161. Several areas of cooperation which might have an marginal impact on India, the
major SAARC partner, could have far-reaching effects on the smaller partners such as
the Maldives, Nepal, Bhutan and Bangladesh - e.g. regional promotion of tourism,
establishment of linkages in the service and infrastructure sectors, a regional clearing
union arrangement and joint research and development schemes. Also, rather than
competing in certain commodities such as rubber, jute, tea, and textiles, the SAARC
members may consider cooperation in the production, marketing and transportation of
these commodities. Similarly, there would be an advantage in intra-regional transfer of
technologies through the creation of regional joint ventures and joint or sub-regional
training schemes. Confederation of Indian Industries (CII) has identified many other
areas of South Asian Sectoral Cooperation which are summarised in Table 1.14.

162. SAPTA alone is unlikely to improve intra-regional trade unless other schemes of
regional cooperation are introduced, aimed at creating greater complementation among
the economies of the region (e.g. investment and production partnerships, such as
regional/ bilateral joint ventures), and creating efficient infrastructure linkages, especially
in terms of transport, communications and information exchange.

163. In order to accelerate the pace of regional trade liberalisation, it might be

preferable to adopt two tracts - one being the region-wide slower track, and the other, a
series of bilateral agreements between the more advanced countries within the group.
There are already some bilateral initiatives between India and Pakistan, India and Sri
Lanka, India and Bangladesh and India and Nepal. Sectoral cooperation such as a
SAARC Textile Council can also boost economic and trade relations within the region.
Textile is a priority sector as developing countries will no longer benefit from preferential
quotas when the Multi-Fiber Arrangement is disbanded in the year 2005, and it is an
important component of SAARC country exports. In order to rise to the challenge of
open competition, SAARC producers need to pool their design, marketing and
technological resources.

164. With rapid growth in the ASEAN economies, wages and labour costs have been
rising considerably. SAARC countries need to adopt policies which would favour
the relocation of some labour-intensive production from ASEAN and NIEs to
SAARC countries as the NIEs and Japan and even some ASEAN countries such
as Malaysia and Thailand have become important sources of FDI. All these
Southeast Asian countries have a common interest with SAARC countries in
creating trade-generating joint ventures. India became an ASEAN ‘dialogue
partner’ in 1992-93 and a ‘sectoral dialogue partner’ in 1996, the ASEAN
countries view India as long-term potential market. India can exploit this
opportunity by facilitating and encouraging private sector contacts with ASEAN
entrepreneurs.
 Selected Bibliography

Asian Development Bank (1995). Asia : Development Experience and Agenda, ADB
Theme Paper 3, Asia Development Bank, Manila.

______(1997a). Asian Development Outlook 1997 and 1998, Oxford University Press,
Hong Kong.

______(1997b). Emerging Asia - Changes and Challenges, Asian Development Bank,

Manila.

Brooks, D.H. and Leuterio, E.E. (1997). Natural resources, economic structure and
Asian infrastructure, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD.

Chakwin, Naomi and Hamid, Naved (1997). Economic environment in Asia for
investment, in Investing in Asia, ed.C.P.Oman et.el.1997.

Chia, Siow Yue; and Tsao Yuan Lee (1994). Economic Zones in Southeast Asia, in Asia
Pacific Regionalisation: Readings in International Economic Relations, ed. R. Garnaut
and P. Drysdale, Pymble, Haeper Educational Publishers.

Das, Tarun (1993a). Structural Reforms and Stabilisation Policies in India - Rationale
and Medium Term Outlook, in Economic Liberalisation and its Impact, ed. S.P.Gupta,
pp.20-56, Macmillan India Ltd, New Delhi. 1993.

______(1993b). Macro-economic Framework, Special Economic Zones and Foreign

Investment in India, Ad-Hoc Working Group on Investment and Financial Flows,
UNCTAD, Geneva, pp.1-75,June 1993.

______(1996). Policies and Strategies for Promoting Private Sector’s Role in Industrial
and Technological Development, Including Privatisation in South-Asian Economies,
Report prepared for the Industry and Technology Division, ESCAP, United Nations,
Bangkok; and published by the United Nations, New York, 1996.

ESCAP (1993). Economic and Social Survey of Asia and Pacific 1992, Part 2,
Expansion of Investment and Intraregional Trade as a vehicle for Enhancing Regional
Economic Co-operation and Development in Asia and Pacific, United Nations, New
York.

______(1994) Proceedings of the Regional Seminar on Investment Promotion and

Enhancement of the Role of the Private Sector in Asia and the Pacific, United Nations,
New York.
 ______(1996) Policies and Strategies for Promoting Private Sector’s Role in Industrial
and Technological Development, Including Privatisation in South-Asian Economies,
U.N., New York.

______(1997) Economic and Social Survey of Asia and the Pacific 1997- Asia and the
Pacific into the Twenty First Century: Development Challenges and Opportunities, U.N,
New York.

Estanislao, Jesus (1977). The institutional environment for investments in Chin and
ASEAN: current situation and trends, in Investing in Asia, ed. C.P. Oman et. el. 1997,
OECD.

International Monetary Fund (1997). World Economic Outlook - Globalisation,

Opportunities and Challenges, May 1997, Washington, D.C.

Lall, Sanjaya (1993). Policies for Building Technological Capabilities : Lessons from
Asian Experience, Asian Development Review, Vol.11, No.2, pp.72-103, Asian
Development Bank, Manila.

Oman, C.P., Brooks, D.H. and Foy, C. (1997). Investing in Asia, Development Centre,
The Organisation for Economic Co-operation and Development (OECD).

Research and Information System (RIS) for the Non-Aligned and Other Developing
Countries (1995). SAARC Survey of Development and Cooperation 1995, New Delhi.

UNCTAD (1992). World Investment Report 1992: Transnational Corporations as

Engine of Growth, United Nations, Geneva.

______(1993a). World Investment Report 1993: Transnational Corporations and

Integrated International Production, U.N.

______(1993b). Report of the Ad Hoc Working Group on Investment and Financial

Flows; Non-Debt-creating Finance for Development; No. TD/B/40(1)/12 and
TD/B/WG.1/8, July 1993, U.N., Geneva.

______(1994). World Investment Report 1994: Transnational Corporations,

Employment and Workplace, United Nations, Geneva.

______(1995). World Investment Report 1995: Transnational Corporations and

Competitiveness, United Nations, New York.

______(1996). World Investment Report : Investment, Trade and International Policy

Arrangements, United Nations, Geneva.

World Bank (1993). The East Asian Miracle: Economic Growth and Public Policy,
Oxford University Press.
 ______(1994a). World Development Report - Infrastructure for Development,
Washington, D.C.

______(1997a). Global Development Finance, Washington, D.C.

______(1997b). World Development Report 1997, Washington, D.C.

Xiaoqiang, Zhang (1997). Investment in China’s future, in Investing in Asia, ed. C.P.
Oman et. el. 1997, OECD.

Yamazama, Ippie (1997). APEC and investment, in Investing in Asia, ed. C.P. Oman et.
el. 1997, OECD.