The purpose of this chapter is to shed light on longer-term capital mobility and foreign direct investment (FDI) in the EU. 1 In principle, FDI requires freedom of establishment and, if possible, the national treatment in foreign markets. It is a distinct type of international capital flow as it has a strong risk-taking and, most often, industry-specific dimension. In addition, it is coupled with a transfer of technological know-how, as well as management and marketing skills.
Capital moves among countries in the form of portfolio and direct investment. Portfolio investment is most often just a short-term movement of claims which is speculative in nature. The main objectives include an increase in the value of assets and relative safety. This type of capital mobility may be induced by differences in rates of interest. The recipient country may not use these funds for investment in fixed assets which may be repaid in the long run, so these movements of capital may be seen by the recipient country as hot, unstable and ‘bad’. Volatility of portfolio investment complicates their analysis. The large number of portfolio investments, made in many cases by brokers, obscures who is doing what and why.
Foreign direct investment permits the investor to acquire a lasting, partial or full, control over the investment project. The investor does not only employ own funds, but also knowledge and management. These investments are long-term in nature. They may increase the productive capacity of the economy, so they are often lured by host countries as something which is becoming, cold and ‘good’. FDI may not be found in perfectly competitive markets, hence market imperfections may explain them. They include expected profits, market presence (particularly where markets grow rapidly), avoidance of tariff and NTBs, integration of operations in different locations, economies of scale, externalities and differences in taxation. FDI is a better way to obtain foreign capital than loans. Funds are often invested in longer-term projects and managed by experts. The project debt is serviced only to the extent that profit is made, which is not the feature of foreign loans.
Foreign direct investment is often the result of decisions by transnational corporations (TNCs). Therefore, FDI may be a relatively good proxy for the investment activities of TNCs (keeping in mind that TNCs may control operations abroad by simply giving licences).
There are three main types of TNC activities. They involve investments that are: import substituting, resource based and rationalized (Dunning, 1988, p. 54). Import