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Foreign Direct Investment

Susanna Laksonnen-Craig

University of Toronto

Foreign Direct Investment (FDI) is typically defined as a lasting interest of a resident entity in one economy – the direct investor – in an entity resident in another country – the direct investment enterprise. A lasting interest can usually be assumed if the direct investor has ownership of a minimum of 10 percent of the ordinary shares, voting power or equivalent in the direct investment enterprise (IMF 1993). The liberalization of capital markets and privatization gave a significant boost to foreign direct investments: there was a steady increase in FDI until 2000, when annual FDI inflows in the world reached 1,397 billion USD. Economic slowdown has since reduced FDI flows - the global inflow in 2004 was 648 billion USD. Despite the significant growth in FDI since the mid-1980s, FDI flows still remain at around one-tenth the magnitude of trade flows, the alternative means for supplying foreign markets. The majority of FDIs are cross-border mergers and acquisitions (M&As); greenfield investments constitute only a small share of total FDI, especially in the flows between developed countries. (UNCTAD 2006)
 

As in other industries, foreign direct investments have increased rapidly in forest industry since the 1990s, but, globally, the forest sector share of total FDI is small. In 1999, the share of the wood and wood products industry of the world’s FDI inward stock was only 1.5 percent (UNCTAD 2001). In the Americas, the FDI stock of the US forest industry abroad grew from 5 billion USD in the beginning of the 1980s to 19 billion USD by 2004, whereas the FDI into forest industry in the U.S. rose to almost 11 billion USD in 2004 (BEA 2006). There was a similar trend in the Canadian forest industry’s FDI as it increased from 2 billion CAD in 1983 to 12 billion CAD in 2004 while foreign investments in the wood and paper industry in Canada grew from 3 billion CAD to 14.5 billion CAD (Statistics Canada 2006). In South America, Brazil and Chile have been the main recipients of foreign direct investments. The stock of inward FDI in the forest sector increased in Brazil from 1 billion USD in 1990 to 3 billion USD in 2003, while in Chile the cumulative FDI increased from 170 million USD in 1990 to 1.4 billion USD in 2004 (Central Bank of Brazil, 2004; Foreign Investment Committee, 2004). Argentina and Uruguay have also received increasing inward FDI flows to the forest sector. For example, the FDI to forestry in Uruguay was almost 60 million USD in 2004. The majority of the investments in the Americas are made in pulp and paper industry.
 

There are two distinct motives for FDI and foreign production. Market-oriented investments are due to market-seeking and the desire to supply markets locally. These market-oriented investments are categorized as horizontal foreign direct investments (HFDI). The other main motivation is to find low-cost production locations and to profit from differences in factor prices. These types of production-oriented investments are categorized as vertical foreign direct investments (VFDI). The trade-offs associated with HFDI and VFDI are diminishing economies of scale and the costs of geographically disintegrated production, respectively (Barba Navaretti and Venables 2005).
 

In general, empirical research has indicated that market size, input costs, transportation costs and political stability are important country determinants for foreign direct investments (e.g., Wheeler and Mody 1992, Chakrabarti 2001, Markusen and Maskus 2002). Trade costs and barriers (e.g., Chakrabarti 2001, Blonigen 2002), exchange rates (e.g., Goldman and Kolstad 1994, Bénassy-Quéré et al. 2001), agglomeration (e.g., Braunerhjelm and Svensson 1998, Barrel and Pain 1998), and tax rates and differentials have also been shown to influence spatial FDI decisions (e.g., Brainard 1997, Devereux and Griffith 1998).
 

The same determinants are likely to be major factors in the forest sector. To date, both market size and exchange rates have been shown to have an impact on FDI (Uusivuori and Laaksonen-Craig 2001, Laaksonen-Craig 2004, 2006). In natural resource dependent sectors, such as forest industry, the availability of the resource also appears to play an important role. For example, in Brazil and Chile the increasing roundwood supply, particularly of exotic plantation species, seemed to influence FDI. In the US and Canada, a large roundwood supply seemed to cause foreign direct investments but, conversely, the FDI did not affect the roundwood supply (Laaksonen-Craig 2004). In another study concerning Brazil and Chile, both market size and roundwood supply had an affect on FDI, indicating both market-seeking and resource-seeking behaviour (Laaksonen-Craig 2006). So far there is no research evidence of export-platform FDI, that is, FDI in one market in order to supply the home or third market.  However, large pulp mill investments in small countries such as Uruguay surely will be aimed at  export markets.

Posted:  June 2006

Updated: 22 April  2007