Frédéric Wehrlé and Hans Christiansen, OECD Directorate for Financial and Enterprise Affairs
For most of the past half century, countries around the world have gradually opened up to foreign investment, and with good effect. Investment from other countries has supported growth and development, created jobs and enhanced welfare. Today, as our data show, OECD economies retain only limited traditional regulatory restrictions to inward foreign investment in the form of foreign ownership ceilings and other discriminatory conditions. While many emerging economies are generally less open, they have made their legal regimes for foreign direct investment less restrictive. Ongoing monitoring by the OECD shows that these liberalisation efforts continued after the 2008 financial crisis.
However, since the 2000s, a new and opposing trend has emerged: the screening and review of foreign investment projects, particularly those by state-owned enterprises (SOEs), to mitigate risks to national security. In fact, a recent survey shows that more and more governments are introducing or enhancing screening mechanisms for inbound investment projects to identify and address perceived threats. A third of the 59 advanced and emerging economies that participate in our investment policy dialogue now operate such mechanisms. Several governments are now subjecting investment proposals involving SOEs to greater scrutiny, and at times prohibiting these investments. Some countries have established special rules for the review and admission of investments by SOEs or are considering new policies to address the issue.
Could the precedent offered by the Santiago Principles help to point a way forward? In 2008, following widely publicised concerns in some large OECD countries regarding high profile investment projects by non-OECD sovereign wealth funds (SWFs), the community of SWFs and their government owners adopted a code of good conduct, the Santiago Principles, that was motivated by a desire to ensure that countries would not use national security arguments as a cover for protectionism against foreign SWFs. A decade later, the upsurge of SOEs in global investment and related national security concerns expressed by recipient countries could motivate similar arrangements with respect to investment by foreign SOEs.
International investment by SOEs is a growing concern
The increasing participation of SOEs in the global marketplace, particularly as international investors, makes it all the more important to balance concerns about the good governance of SOEs and to maintain a level playing field. As bearers of state as well as commercial interests, SOEs may place their emphasis on strategic acquisitions, such as advanced technologies for example, on non-market terms. It is fitting therefore that the rise of SOEs should revive interest in investment policies related to national security.
Australia, for instance, screens all SOE investments, whereas it screens private investments only when they exceed a value threshold. Canada applies different trigger thresholds for the application of its net-benefit test if the investor is state-owned. The United States has established specific rules regarding SOEs as part of its national security review mechanism (CFIUS), which require investigation of all government-controlled investments concerning US businesses. Germany has just strengthened its review mechanism. France, Germany and Italy have called for EU policies to address the issue. Strengthening screening of foreign direct investment (FDI) on national security grounds is also under consideration in the Netherlands, the United Kingdom and the United States.
Heightened awareness of the implications of SOE investment has also been evident in more recent international investment agreements. The Trans-Pacific Partnership agreement (TPP), for example, dedicates an entire chapter to SOE investments, whereas in older agreements SOEs were effectively afforded a status broadly similar to that of private investors.
Governments have always been careful to secure policy space to safeguard national security needs. The OECD Codes of Liberalisation, for instance, just as many investment treaties, contain corresponding national security exceptions. These exceptions are typically self-judging, and the term “national security” is intentionally broad.
Because of the discretionary nature of invoking national security as a ground for restricting foreign investment, the OECD Guidelines for Recipient Country Investment Policies relating to National Security were issued as an OECD Recommendation in 2009. These guidelines offer a set of specific recommendations providing for non-discrimination, transparency and predictability, as well as regulatory proportionality and accountability, including effective safeguards against undue influence and conflict of interest.
Internationally agreed rules on SOEs would bring benefits
While concerns relating to SOE investments are legitimate–and many SOEs are less transparent than private firms–the imposition of outright or unqualified restrictions on SOE investments in recipient countries benefit neither host nor home countries as opportunities for mutually beneficial international investment are forgone.
Applying internationally agreed commitments to SOEs and their government owners would help reassure recipient country regulators by offering greater transparency, addressing potential distortions that may arise from state ownership, and ensuring that the SOE owners also observe high standards of governance, disclosure and accountability. In turn, these regulators could be expected to apply the same conditions to SOEs that they apply to investment proposals by privately-owned companies.
A similar outcome to that agreed by SWFs can be achieved for SOE investments today. After all, recommendations on good practices for governance, disclosure accountability and transparency of SOEs have already been agreed under the OECD Guidelines on Corporate Governance of State-Owned Enterprises. These guidelines include specific provisions by which the legal and regulatory framework for SOEs, as well as their practices, should ensure a level playing field and fair competition in the marketplace when SOEs engage in economic activities. If translated to an international market context, and if fully implemented, these provisions could fully address the concerns of investment regulators. The last element required to emulate the “Santiago arrangement” would be to secure a commitment by SOEs to abide by these standards.
This could help convince recipient countries to keep their economies open and to uphold both the letter and the spirit of the principles of OECD guidance on national security.
The OECD stands ready to help forge a mutually beneficial and trusted arrangement for SOEs so that home and host societies can reap the benefits of international investment, while addressing important security concerns that inhibit certain investments proposed by SOEs today.
References and further reading
OECD, Corporate governance of SOEs: Guidance and research, 2011-2017
OECD, Freedom of investment at the OECD, 2007-2017
OECD (2009), OECD Guidelines for Recipient Country Investment Policies Relating to National Security, Recommendation adopted by the OECD Council on 25 May 2009
OECD, FDI Regulatory Restrictiveness Index, 1997-2017
Shima, Y. (2015), The Policy Landscape for International Investment by Government-controlled Investors: A Fact Finding Survey, OECD Working Papers on International Investment, No. 2015/01, OECD Publishing, Paris.
Wehrlé, F. and J. Pohl (2016), Investment Policies Related to National Security: A Survey of Country Practices, OECD Working Papers on International Investment, No. 2016/02, OECD Publishing, Paris.
Marten van den Berg, Director-General for Foreign Economic Relations, Ministry of Foreign Affairs, The Netherlands
Today’s economy is unquestionably global. National markets for goods and services have become increasingly integrated. This process of globalisation has taken place over the past centuries. But during the period of 1987-2000 we saw a big leap in globalisation. And we saw a rapid development of Global Value Chains (GVC’s). Many countries have benefitted enormously from this process of globalisation. Not only high income countries, but also hundreds of millions of people in low and middle income countries have been taken out of poverty because of international trade and investment.
International trade and investment generate employment and income. But they are also a channel for knowledge transfer, technology flows and for specialisation according to comparative advantage. Through trade, firms get better access to cheaper and better quality inputs. And cheap imports raise consumer welfare. Openness matters for growth. This is why so many trade agreements have been negotiated between so many countries. Or why now 154 countries are a member of the WTO.
There is substantial evidence that trade agreements have a significant effect on trade and investment relations and therefore on jobs and productivity growth. However we should acknowledge that there are also income and distributional effects. Some sectors will experience significant expansions, other sectors will contract. Productive firms gain from international trade, others will lose. At the same time some workers will see a rise in their wages, others will see their wages stabilise or decrease. The famous “elephant graph” illustrates where there are losers (low-middle income group in US/Europe/Japan) and where we see winners (middle income class in China and India).
The shift in relative importance of different sectors as a consequence of international trade and investment generates labour and capital displacement. This will lead to adjustment costs for those that need to change employment. These adjustment costs have raised questions about the benefits of international trade and investment. But there are also concerns about fairness (unfair competition) and about the relation between international trade and investment regimes and labour and environment standards. And concerns that international regimes limit room for manoeuvre at a national level.
In 2007 the process of rapid globalisation came to an end. Growth in global trade today is less than half the growth during the two decades prior to the global financial crisis. This slowdown is largely the result of the decline in investment, the rebalancing of China and the shortening of the GVCs. But stalled liberalisation in trade and the increase of protectionism are also holding back international trade and investment.
Together with the decline in global trade, we see more and more people standing up against international trade and investment agreements. For example, neither candidate in the US presidential race supports a free trade agenda. In Europe there is a lot of resistance against TTIP. Also among economists we see a more intensive debate about the winners and losers of international trade and investment.
The lack of progress in trade liberalisation and the opposition to international trade and investment agreements is understandable, but still bad news. We should not forget that international trade and investment are important sources for productivity growth. In fact, it is one of the few proven sources of productivity growth in a world that is characterised by low productivity growth. And reducing trade costs in low and middle income countries where the poor live increases the competitiveness of the goods and services traded by poor people in the lower income groups. And in an increasingly digitalised world even start-ups and tiny companies can operate on a global scale (mini-multinationals), making open trade essential for SMEs. But the debate about those agreements is good news. In the past we probably were too much focused on the macro benefits of free trade and investment and did not sufficiently address the concerns among society of international trade and investment. Concerns about unfair elements of the international trade and investment system, about the negative effects of international trade on labor and environment standards, and about the adjustment costs of international trade and investment.
These concerns are genuine. How should we respond? Refusal to acknowledge these concerns undermines international trade and investment relations. So we have to rebalance our trade and investment policies. We have to shift from trying to organise a free trade regime to an architecture of a responsible trade and investment regime. We need to make the international trade and investment system fair and sustainable and inclusive. First we have to address the complexity issue of the system and include new economic and social developments. Secondly we need public discussion and consultation about those international trade and investment agreements. And finally, but perhaps most important, we need effective national policies to adequately complement international trade and investment policies.
Complexity and new issues
Through GVC’s markets and companies, including SMEs, are connected in many ways. Today our international markets are highly complex. It is almost impossible to regulate this complex system in a sustainable and fair way through a spaghetti bowl of regional and bilateral trade and investment agreements. We have to return to a more global architecture of the international trade and investment regime. We need a revival of the multilateral system. Therefore it is good news that we have seen small successes in the WTO negotiations in Bali and Nairobi. But a new success in Buenos Aires is also crucial. Not only on the Doha Development Agenda issues, but also on other issues relevant to international trade and investment. For example digital trade. But also on investment we have to focus more on a global architecture. The outcome of the G20 under Chinese presidency in concluding non-binding principles for investment was a very important step. We should continue on this path and international organisations like the OECD and UNCTAD can and should play a major role in this process. The issue of sustainability should be an integral part of this agenda. Therefore it is good news that among the non-binding principles for investment responsible business conduct is one of them. The OECD guidelines for Multinational Companies are of key importance here.
Get stakeholders involved
Second, it is extremely important that relevant stakeholders are involved in the process of designing and implementing international trade and investment agreements. CETA is a very good step forwards in this respect. Canada and the European Union have committed themselves to a stakeholder consultation process: employers, unions, business organisations and environmental groups are getting a key role in the implementation of CETA. In the future public discussions and stakeholder involvement should be an integral part of our international trade and investment agenda. That’s the way to make trade and investment a “race to the top” in terms of standards.
Complementary national policies
Finally, national policies need to effectively complement international trade and investment policies. More (pro-)active labour market and social security policies are needed to minimise adjustment costs. We need targeted education and skill policies to help vulnerable groups to keep up with the fast changing demands of labour markets. We need stronger tax policies to address the issue of inequality, e.g. implementing the OECD guidance on tackling Base Erosion and Profit Shifting (BEPS). In lower income countries national policies are needed in order to address challenges like lack of infrastructure and education to ensure that lower trade barriers actually benefits the poor.
To conclude, we need to shift from a free trade regime to a sustainable and inclusive trade and investment regime. And we need national policies to make globalisation work for all. I look forward to discuss this in the meeting of the Global Strategy group at the OECD on 28-29 November. These changes are needed and the only way to restore public trust and to build public support for globalisation and for an international trade and investment regime. And we absolutely need this, because international trade and investment are crucial engines for productivity growth, for implementing the SDGs and to abolish poverty.
International trade: Free, fair and open? Patrick Love, OECD Insights
Conventional wisdom holds that countries with lower taxes attract higher levels of foreign direct investment (FDI). At first glance, this intuitive assumption seems to be supported by the evidence. Some tiny jurisdictions with low or no taxes on foreign investment do seem to attract more FDI than major economies, but “investment” is the wrong term for billions of dollars that flow in and out of these places as part of the strategies multinationals use to pay less tax.
A new methodology for calculating FDI has been developed at the OECD to provide a clearer and fuller picture of FDI flows. Long time series of these new generation FDI statistics are not yet available. In the meantime, we analysed the financial statements of around 10,000 multinationals to model the relationships between their capital spending; rates of return; and tax holidays and exemptions, among other factors of investment. We found that tax holidays and exemptions do matter in investment decisions, but they are not the only factor and not necessarily the most important.
At the same time, governments around the world have become increasingly concerned with “double non-taxation”, i.e., companies not paying tax in either the country where they make their profits or the country where their headquarters are. Double non-taxation is one of the targets of the OECD/G20 project to counter tax base erosion and profit shifting (BEPS). Over 120 countries have participated in the project in recognition of the fact that a country trying to tackle BEPS on its own would probably lose out to more generous rivals. With the recent release of the final BEPS package, and the ongoing work on exchange of tax information, governments are well equipped to meet this challenge. However, governments also have three additional means at their disposal to prevent tax abuses without undermining investment.
Public governance of tax incentives according to internationally-agreed best practices. The new tax chapter of the OECD Policy Framework for Investment (PFI), used by dozens of countries and regions such as the South African Development Community and the Association of Southeast Asian Nations, provides multilaterally-agreed guidance to help countries avoid potential abuses of tax incentives and resist undue pressure to offer tax incentives. The PFI calls for incentives to be granted only following a proper legislative process. The PFI also provides guidance on the implementation and administration of tax policy regarding investment, for instance on making sure different levels of government are working together, addressing capacity constraints in tax offices, establishing criteria for analysing the costs and benefits of incentives, and providing for “sunset clauses” that say how long the agreement stays in force. This ultimately works in favour of the broader business community concerned with public sector transparency and a level playing field. As this issue is of particular relevance for developing countries, the OECD, in collaboration with the IMF and World Bank, has also developed Options for Low Income Countries’ Effective and Efficient Use of Tax Incentives for Investment.
Clarifying the degree of exposure of tax measures to investor claims under investment treaties. Many governments see investment treaties as a way to increase the investor confidence and long-term trust needed to encourage investment. However, there is concern that some investors and law firms are claiming that sovereign states who change tax regimes to phase out excessive advantages, or who enforce tax laws more energetically, are violating investment treaties and should pay compensation. Most investment treaties currently apply to tax measures, but to differing degrees. Some of these treaties – especially more recent ones – contain mechanisms that give the state parties the power to make joint determinations on individual tax measures, but these are still the exception: only 3.6% of the 2060 treaties in a sample the OECD analysed contain a clause of this kind related to tax measures. Other investment treaties limit the types of claims that can be brought against tax measures and permit, for example, only claims for expropriation.
Clarifying the scope of application of investment treaties to tax measures can help provide a more certain policy landscape for governments and investors. Under the legally binding OECD Code of Liberalisation of Capital Movements, certain tax measures can amount to a restriction to the free flow of capital and can fall within the scope of the Code. But the Code gives governments adequate policy space – for example, taxes that are not identically applied to residents and non-residents but are levied in accordance with widely accepted principles of international tax law, are not considered as a discriminatory restriction under the Code.
Violations of tax laws by investors may also be relevant to the application of investment treaties. This is because illegality of the initial investment is increasingly expressly recognised as a bar to treaty coverage and, for instance, the recently-negotiated Comprehensive Trade and Economic Agreement between the EU and Canada would limit the definition of investments to those made “in accordance with law”.
Communicating collectively to companies the expectation that they should obey not only the letter but also the spirit of tax law. The OECD Guidelines for Multinational Enterprises (the Guidelines), a set of recommendations to companies by OECD and non-OECD governments, call on enterprises to comply with both the letter and spirit of the tax laws and regulations of the countries in which they operate and not to seek or accept exemptions outside the statutory or regulatory framework related to taxation. Complying with the spirit of the law means discerning and following the intention of the legislature. Tax compliance also entails co-operation with tax authorities to provide them with the information they require to ensure an effective and equitable application of the tax laws. The Guidelines’ recommendation that enterprises should also treat tax governance and tax compliance as important elements of their oversight and broader risk management systems is reinforced by the recently revised Principles of Corporate Governance. Governments should increase their efforts to raise public awareness of the tax chapter of the Guidelines in support of their broader agenda to modernise and cooperate on tax policies.
Trade and FDI drive economic globalisation and help stimulate the growth of national economies. Fair and efficient tax systems are central to sharing the fruits of that growth equitably among nations and citizens. The challenge for governments is to put in place policies that attract investment and enable them to collect their fair share of taxes.
Mounting fears of another slowdown in the global economy call for bolder policy responses. Trade and investment are a case in point.
The latest WTO forecasts suggest 2015 will be the fourth year running that global trade volumes grow less than 3%, barely at—or below—the rate of GDP growth. Before the crisis, trade was growing faster than GDP. In addition, global flows of foreign direct investment (FDI) remain 40% below pre-crisis levels. If we are to achieve the ambitious Sustainable Development Goals agreed in New York in late-September, and underpin broad-based improvements in living standards, we need to reignite these twin engines of growth and we need to do it for the ultimate goal of improving people’s prospects and wellbeing.
Trade and investment have always been intertwined in business, but they have never quite come together in policymaking. In a world of Global Value Chains (GVCs), characterised by the fragmentation of production processes across countries, the interdependencies between trade and FDI are sharper. Technological improvements, reductions in transport and communications costs, and regulatory developments allow firms to combine multiple channels–- imports, FDI, movement of business personnel, licenses — to optimize their international business strategies. Businesses do not think in terms of trade or investment, but in terms of maximizing expected profitability. On the contrary, policymakers have long addressed trade and investment on separate tracks. In the face of new economic realities, policymakers need to up their game.
The symbiosis between trade and investment is more complex than ever before. Multinational enterprises (MNEs) play a key role in this relationship, with their activities driving a large share of world trade. The decision of a firm to invest in a foreign country is influenced by the ease with which it can sell its products, but also by how easy it is to source inputs from its affiliates (intra-firm trade) or independent suppliers (extra-firm trade) abroad. Hence, trade barriers become indirect barriers to investment. In addition, “world factories” make emerging trade patterns more complex, as not only goods and services cross borders, but capital, people, technology, and data do too. Without a transparent framework, it is also difficult to upgrade and upscale responsible business conduct.
Services are an increasingly critical node in the relationship between trade and investment. The WTO’s General Agreement on Trade in Services (GATS) explicitly recognizes this by defining FDI in services as one of the four ways in which services can be traded (mode 3, or ‘commercial presence’). This reflects how trade and investment interact with one another. Clearly, services will be central in any further efforts to liberalize investment and to improve the business environment. The OECD FDI Regulatory Restrictiveness Index shows that investment barriers are overwhelmingly in the services economy. Reforms in backbone services, notably digital services, transport, and logistics are key to unclogging GVCs. Domestic reforms to allow for more competition in the service sectors is also a source of growth and equality. Moreover, there is untapped potential in services value chains that could be realized if services markets were opened further. The OECD Services Trade Restrictiveness Index (STRI) provides a tool for identifying these barriers and measuring their costs, in order to prioritize and sequence reforms.
There is still no global set of rules governing investment and trade, however. Apart from GATS, two other WTO agreements—TRIMS and SCM–cover aspects of FDI, but they are not comprehensive. The OECD Codes are also a reference on capital flows, but does not address the link with the trade dynamics. The void has been filled with a complex network of nearly 3,000 bilateral investment treaties (BITs) of different quality and with different coverage.. Investors and States need certainty. A uniform regime would help, providing a consistent interpretation of the rules that apply to investment flows, taking into account the interest of all stakeholders. We urgently need a clear, coherent and coordinated approach at multilateral level. Multiplying the number of BITs further muddies the water and moves us further away from the multilateral ideal. A better way forward may be to start consolidating and replacing BITs on the road to a comprehensive multilateral framework. We also need to take a hard look at investment dispute settlement mechanisms, transparently addressing stakeholders’ legitimate concerns.
Replace BITs with what? Regional Trade Agreements (RTAs) are already providing some closer policy linkages. Over 330 RTAs contain comprehensive investment chapters, reflecting more advanced thinking of how trade and FDI interact in the real economy. These agreements also cover ‘deep integration’ disciplines that are essential to investments, such as movement of capital, business persons, intellectual property rights, competition, state-owned enterprises, and anti-corruption. New generation RTAs are not perfect, but they are taking us several steps forward in addressing the services-trade-investment-technology nexus. Being regional, however, they are not applied uniformly at a global level, and create their own overlaps and incoherence. It would therefore be useful to create clearer rules for co-existence among RTAs and mega-regional blocs. Above all, it is important to foster information-sharing on emerging practices from these negotiations, so that good practices can be diffused more widely and uniformly, and provide a pathway for multilateral convergence. In this way, RTAs and mega-regionals can become the building blocks of an integrated and truly multilateral trade and investment regime.
We are at a critical juncture, both economically and politically. The global economy needs a helping hand for recovery from the global financial crisis and to give people the improvements they expect in their daily lives. At the same time, we have both an opportunity and obligation to upgrade the policy framework to meet the changing reality of how trade and investment are conducted across the world, to enhance policy coordination, and to ensure that both have a positive impact on people’s well-being. Mega-regional agreements like TTIP and TPP are on track to deliver new frameworks over the coming months. These can be stepping stones towards the future of global trade and investment rules. As these mega-regional deals approach the finish line, the 10th WTO Ministerial in Nairobi in December is an opportunity to break the current impasse in the Doha Round. Finally, all of this is taking place as we enter a new “Post-2015” era with the new SDGs, where trade and investment are expected to do more of the heavy-lifting in global development.
Against this backdrop, the G20-OECD Global Forum on International Investment (GFII), being held on 5 October 2015 in Istanbul, back-to-back with the meeting of G20 Trade Ministers, will bring together the trade and investment policy communities—along with the business community–to reflect on the main axes of a pragmatic strategy to enhance the international regime for investment, including through closer links with trade. The agenda cannot be delayed: trade and investment decisions must go hand-in-hand in policy, just as they do in global business.
In today’s post, Michael Gestrin of the OECD Directorate for Financial and Enterprise Affairs looks at whether declines in the EU’s flows of foreign direct investment (FDI) simply reflect a particularly severe FDI cycle or whether there might also be structural factors involved.
At the start of the 2007 crisis, global foreign direct investment (FDI) stocks actually declined, and even today, global flows of FDI are still 40% below their pre-crisis peak. Generally, OECD countries were the sources of the biggest declines while many emerging economies experienced increases in FDI flows. Europe has been one of the worst affected regions. EU inflows are down 75% and outflows are down 80% from their pre-crisis levels.
Inflows into the EU are currently around $200 billion, down from $800 billion at the peak of the global FDI cycle in 2007 (see figures). Outflows are also currently around $200 billion, down from $1.2 trillion in 2007. For the rest of the world, a global economy “without” the EU is doing quite well. In this global economy, inflows recovered strongly starting in 2010 and reached new record heights in 2011, at just over $1.2 trillion. With respect to outflows, the FDI crisis was limited to a one-year decline of 20% in 2009. Although world-minus-EU outflows have not grown over the past three years, they have been at record levels.
Part of the strong performance of the world-minus-EU can be explained by the growing importance of the emerging markets, in particular China, as sources and recipients of FDI. In 2012, emerging markets received over 50% of global FDI flows for the first time, and China is now consistently among the world’s top three sources of FDI.
The crisis initially gave rise to a significant gap between the non-EU OECD countries and the rest of world with respect to both inflows and outflows, just as it did for the EU (see figures). A big difference, however, is that for the non-EU OECD countries the gap closed after only two years. While the EU and the world-minus-EU group have been going in different directions ever since the start of the crisis, the non-EU OECD group and its rest-of-world counterpart appear to have returned to a similar cycle after parting ways for a much shorter period during 2008-9.
Comparing the EU and non-EU-OECD shares of world inflows and outflows highlights the extent to which the positions of these two groups have reversed in recent years (see figures). At the turn of this century the EU accounted for over 50% of global inflows and 70% of global outflows. By 2013 both shares were down to 20%. Conversely, the non-EU-OECD countries have seen their shares of global FDI inflows and outflows recover to pre-crisis levels. This group overtook the EU in 2010 in terms of its share of both inflows and outflows, thus reversing the historical relationship.
Why? The greatest declines in inward FDI in the EU have been from within Europe itself (see figures). Before the crisis around 70-80% of the region’s inward FDI consisted of intra-EU investment. Today only 30% of inward FDI is intra-EU. This sharp decline in the share of FDI that EU countries receive from their EU neighbours also helps to explain the decline in outward EU FDI.
The decline in the share of intra-EU in total EU inward FDI would seem to suggest a lack of confidence on the part of EU investors in their own regional market. One tempting explanation for this is that these declines have been concentrated in a sub-set of EU countries that have experienced particularly difficult economic conditions (such as Greece, Ireland, Portugal, and Spain) during the crisis.
This has not been the case. The FDI crisis in Europe has been broad-based, with the bulk of the declines in FDI flows concentrated in the largest economies. France, Germany, and the UK accounted for 50% of the $600 billion decline in FDI inflows between 2007 and 2013. Over the same period, Greece, Ireland, Portugal, and Spain accounted for only $14 billion, or 2%, of the inflow decline. With respect to outflows, France, Germany, and the UK accounted for 59% of the $1 trillion decline between 2007 and 2013. Over the same period, Greece, Ireland, Portugal, and Spain accounted for 12% of this decline.
Part of the explanation for the decline in investment in Europe is linked to an increasing share of international divestment relative to international mergers and acquisitions (M&A, see figures). While pre-crisis levels averaged around 35%, they reached almost 60% in 2010-11 and now stand at around 50%. In other words, for every dollar invested, 50 cents is divested. Consequently, net international M&A investment in Europe is currently at its lowest levels in a decade, at around $100 billion.
The clear “leader” in this regard is the consumer products segment, with a divestment/investment ratio of 148%. This means that for every dollar invested in consumer products over the past six years, around one and a half dollars was divested. This is an example of investment de-globalisation. Domestic and international M&A in Europe have generally followed the same pattern: both are on track to reach their lowest levels in a decade (see figures). Conditions that are holding back international investment in Europe would seem to be discouraging domestic investment as well.
From a policy perspective, the challenges of breaking out of this regional investment slump are daunting but urgent. A useful starting point is the recognition that a supportive environment for productive international investment needs to reflect the evolving needs of international investors. Such a supportive environment has three dimensions.
First, investors generally favour predictable, open, transparent, rules-based regulatory environments, much along the lines put forward by the OECD’s Policy Framework for Investment. Where impediments to investment have not been addressed by governments this often has more to do with implementation challenges rather than disagreement over principles. For example, it is widely accepted that excessive ‘red tape’ is an obstacle to investment but in many countries this is still often cited by business as being one of the most important impediments to doing business. In Europe, many such impediments represent relatively easy opportunities for improving the regional investment climate.
The second dimension concerns important changes in the structures and patterns of global investment flows as well as in the way MNEs are organising their international operations. This is reflected in investment de-globalisation and “vertical disintegration” which has seen MNEs become more focused on their core lines of business over time and more reliant upon international contractual relationships for organizing their global value chains.
Finally, Europe would seem to be confronting a competitiveness puzzle in which declining competitiveness is discouraging investment, and declining investment is in turn undermining competitiveness. A few years ago, OECD Secretary General Angel Gurría outlined six policy recommendations for getting Europe back on a sustainable growth path that also hold for investment:
- Further develop the Single Market.
- Ease excessive product market regulation;
- Invest more in R&D and step up innovation.
- Make sure that education and training institutions deliver highly sought after skills.
- Increase the number of workers participating in labour markets and make markets more inclusive to address social inequalities.
- Reform the tax system, including by reducing the tax wedges on labour.
It’s often overlooked, but the past decade saw a very substantial increase in the amount of money foreign companies invested in Africa – what’s known as foreign direct investment (FDI). In 2000, FDI was worth about $9 billion; by 2008 it had risen almost tenfold to $88 billion. To put that in perspective, that was double the $44 billion provided for African countries in official development assistance (ODA) in 2008.
Europeans will need to work a bit harder if they want their economies to attract overseas investment. That’s the message from Gao Xiqing, President and CIO of the China Investment Corporation (CIC), the Chinese sovereign wealth fund that searches the world for investment opportunities.
Mr. Gao is one of the panellists on a session at the OECD Forum entitled, “Financing Future Growth”, which has covered a wide range of themes and topics this afternoon. The activities of sovereign wealth funds are a big talking point. Mr. Gao has spoken frankly about the suspicions such funds sometimes encounter.
“We never seek to control any industry,” Mr. Gao says, “but we often find governments in Europe saying you better not invest in our institutions because we fear you.” He’s been describing his fund’s reluctance to take an active role in companies in which it invests, saying it rarely tries to intervene and never seeks to take control of an industry.
Perhaps ironically, Mr. Gao has also been criticising European’s attitudes to capitalism. “A hundred and sixty years ago, Marx said a phantom of communism is hanging around Europe – that’s still the case. We do meet governments saying we don’t like capitalism.” According to Mr. Gao, Europe can’t expect to grow if it has people working 20-hour weeks. As for his fund’s investment in Europe, he says it will have to look very carefully at whether politicians in Europe are prepared to pursue policies that will allow the continent to grow as it did in the past.
But his stance hasn’t gone without criticism. John Monks, General Secretary of the European Trade Union Confederation, says there is a lot of concern in the European labour movement about human rights and democracy. “You are government bodies, and you reflect the policies of your government,” he has said to Mr. Gao. “If we don’t agree with you, don’t expect us to be uncritical.”
Keeping the focus on emerging and developing countries, Carolyn Ervin, Director of the OECD’s Financial and Enterprise Affairs department, has been highlighting the role for private investment in driving development. Pension funds hold more than $20 trillion in assets, representing a huge reservoir of potential investment funding. But, she says, even at the local level, private firms can be crucial partners for investment in areas like infrastructure.
With a banker on the panel – Franco Bassanini, chairman of Italy’s Cassa Depositi e Prestiti – it was probably inevitable that the panel would produce at least a hint of “banker bashing”. He’s acknowledged that some of the criticism of bankers is “not unfair”, but says regulators must also share the blame. Asked by moderator Larry Elliott, Economics Editor of The Guardian newspaper, what he’d like to see changing over the next 12 months, he says he’d like to see banks becoming so good that they were “regarded not as part of the problem, but part of the solution”.