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Unctad's World Investment Report 2004: There is virtue in FDI in services

G. Srinivasan

Unctad's latest World Investment Report stresses that FDI in services, as in other sectors, injects financial resources into a host economy. The report is a timely reminder to policy-makers that countries should fine-tune policies to benefit from opening up specific services without losing sight of the broader development and welfare objectives.

AS INDIA still debates whether it should hike the foreign direct investment cap, particularly in insurance, telecommunications and civil aviation and the Left Parties in the ruling UPA coalition continue to resolutely resist the move, the UN trade body has come out with a timely document .

The 2004 World Investment Report of the UN Conference on Trade and Development focusses on the structure of FDI having shifted towards services the world over.

Whereas in the early 1970s services accounted for only a quarter of the world FDI stock, and by 1990 this share was less than half, it had risen by 2002 to about 60 per cent, or an estimated $4 trillion. In contrast, the share of the primary sector in world FDI stock declined over the same period from 9 per cent to 6 per cent, and that of manufacturing fell even more, from 42 per cent to 34 per cent.

At the outset, Unctad clarifies that even as the services sector accounted, on an average, for 72 per cent of GDP in the developed economies, 52 per cent in developing countries and 57 per cent in Central and Eastern European (CEE) countries by 2001, most services are not tradable — they need to be produced when and where they are consumed.

The principal way to bring services to foreign markets, therefore, is through FDI. Firms have reacted by expanding their service production abroad. Traditionally, FDI in such services as banking, insurance and transportation had been undertaken by firms moving abroad to bolster trade or overseas manufacturing by their manufacturing clients.

Though this is still happening, the pattern has changed, with service providers investing more and more abroad on their own account, as they seek new clients and exploit their ownership advantages.

In non-tradable services, growth remains the principal location advantage for attracting FDI. In directly tradable services, the main location advantages are access to good information and communication technologies, an appropriate institutional infrastructure and the availability of productive and well-trained personnel at competitive costs.

The WIR states that FDI in services, as in other sectors, injects financial resources into a host economy and, to the extent that funds are raised internationally, they are a net addition to resource flows into the country.

A large part of services FDI is market-seeking non-tradable activity that does not contribute directly to foreign exchange earnings, Unctad argues, adding that alongside, they entail external payments — for instance, in the form of repatriated profits. FDI could thus have a negative impact on the balance of payments — a point being rammed home by all, particularly the Left parties.

However, Unctad is quick to note that counterbalancing such possible negative impacts is the potentially positive effect on consumers of final services and on producers using intermediate services in terms of better service provision and spillover effects.

FDI in services affects the provision of services in host economies in terms of supply, cost, quality and variety.

The financial strength of transnational corporations (TNCs), together with their ability to implement and manage complex systems, enables them to expand supply capacities rapidly in complex, capital-intensive services such as telecommunications and transportation.

Unctad thus cautions rightly that in the absence of appropriate government policies and regulations, TNCs' involvement in utilities and other basic services might lead to a spurt in prices, an inequitable distribution of services and limited access for the poorest segments of society.

Unctad recalls that even countries that have liberalised most of their service industries typically retain entry restrictions in specific services, such as media and aviation. The nature of restrictions and purpose for which these are put in place vary from industry to industry.

Even as services FDI can bring economic benefits, policy-makers need to strike a balance between possible efficiency gains and broader development objectives.

Again, concerns abound over the impact of services FDI on competition and the possible crowding out of domestic firms. But this depends considerably on initial conditions in a host country, especially the level of economic activity and service-industry development, and the market structure of service industries.

The fact remains that FDI can spur local service providers to become more competitive through demonstration and skills diffusions, thus helping them improve efficiency, the WIR says, adding that one of the biggest contributions of FDI in services to development is in the transfer of technology. Services TNCs can bring both hard technology (plant, equipment, industrial processes) and soft technology (knowledge, information, expertise, skills in organisation, management and marketing).

Unctad is of the view that FDI in intermediate services could directly and indirectly improve the efficiency of industrial products. Such services range from banking, insurance and business services to transport, electricity and telecommunications.

International hotel chains play a key role in promoting competitiveness in tourism by helping attract a critical mass of international tourists. Tourism is an important foreign exchange earner for developing countries through both equity and non-equity involvement.

Drawing differences in services and manufacturing though the fragmentation and globalisation processes are akin to both. The Unctad report says that while the services sector is much larger than the manufacturing sector, only some 10 per cent of its output enters international trade, compared with over 50 per cent for manufacturing.

Second, the pace of globalisation of services affected by the tradability revolution is faster than in manufacturing.

Third, whereas the relocation of goods production involves manufacturing firms only, service functions are offshored by companies in all sectors.

Fourth, the skill intensity is generally higher for offshored tradable services than for manufacturing located abroad, thus affecting white-collar jobs in particular.

Fifth, services that are offshored may be more footloose than relocated manufacturing activities because of lower capital-intensity and sunk costs, especially services that do not require high skills.

India, WIR notes, is the preferred destination for offshoring of a whole range of services. This is not just because its base of low cost and skilled labour attracts firms; India also has first-mover and agglomeration advantages.

Even as the outcry against outsourcing to developing countries is at its shrillest, particularly in the US, the WIR states that the total market for all offshore service exports is estimated at $32 billion in 2001, of which Ireland accounted for a quarter. The fastest growth is expected in the offshoring of IT-enabled services, which is forecast to expand from $1 billion in 2002 to $24 billion in 2007.

Even among the 1,000 largest firms in the world, 70 per cent still have not offshored any services to low-cost locations, though many plan to do so.

More recent estimates by business research groups of the likely impact concluded that 2 million offshored jobs might shift from the US to low-income countries by 2015; another concluded that 2 million offshored jobs could be created in the financial services industry alone, and that the total number of jobs affected for all industries could be 4 million.

Unctad says this should be compared with an average turnover of 4 million jobs every month in the US.

The report hits the nail on the head when it says that, in many cases, offshoring of services is a response to excess demand and the shortage of adequately trained people at home.

"Thus, every job created abroad as a result of offshoring does not necessarily equal a job lost in developed economies". Hence, instead of implementing protectionist measures, white-collar workers in developed countries threatened with job losses could be given assistance, analogous to the trade adjustment assistance provided to vulnerable workers in manufacturing.

Preventing offshoring because of its costs would only be a palliative and could well handicap income and employment growth in the longer term.

With unmistakable sternness, Unctad warns developed countries that holding back offshoring to avoid adjustments would reinforce the critics of globalisation, who argue that the rich countries only support globalisation when they reap immediate gains.

The challenge, therefore, is to maintain a milieu in which the benefits from FDI in services, in general, and offshoring, in particular, can materialise.

In sum, this year's WIR is a timely reminder to policy-makers about the virtues of FDI in services and how each country should fine-tune its policies to make a fortune from opening specific services without losing sight of broader development and welfare objectives.

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