Foreign Direct Investment: The Key to Asia's Future Economic Growth?
Encarnation, Dennis J., Brookings Review
THROUGHOUT 1997, East Asia's unfolding financial crises provoked scathing critiques of the role of foreign investors in the region's downward spiral. According to the critics, the same foreign investment that had helped spawn the East Asian economic miracle has come to exacerbate, if not cause, the current problems. And for many Asians, as well as for analysts elsewhere, foreign investment remains a dabatable part of any proposed solution.
But before rushing to judgment about foreign investors in East Asia, it is important to remember that foreign investors come in many varieties. Foreign debt must be distinguished from foreign equity. Among debt instruments, short-term borrowings must be distinguished from long-term lending. Among private lenders, commercial banks must be distinguished from nonbank creditors, including bondholders and trade financiers. And of course private lenders must be distinguished from official lenders, which can be multilateral institutions or individual foreign governments. Among the forms of foreign equity, foreign portfolio investments in local stock markets by mutual funds and other institutional investors differ from foreign direct investments (FDI), typically by multinational corporations that consciously combine equity ownership with managerial control. Even FDI must be further dissected--into new cross-border flows and local earnings reinvested in the host economy where they were generated.
Each of these forms of foreign investment has responded differently to East Asia's ever-changing opportunities and risks. Discerning these differences is critical to understanding both the likely causes of, and the potential solutions to, the region's current financial crises. Among potential solutions, foreign direct investment figures prominently. Indeed, throughout the crises, FDI has remained one of the few private sources of foreign investment for much of East Asia. And because foreign direct investment often facilitates the cross-border transfer of foreign technology as well as better access to foreign markets, a credible case can be made that it will become even more critical to East Asia's future economic growth.
FDI IN THE CRISIS ECONOMIES
The external financing of East Asia's five most afflicted economies--Indonesia, Korea, Malaysia, the Philippines, and Thailand--illustrates foreign investors' varied responses to the financial crises (see table 1). Before 1997 these five economies financed their current account deficits and increased their foreign exchange reserves principally through private commercial borrowings, largely short-term debt regularly rolled over year after year. They supplemented these borrowings with additional foreign loans from bondholders, trade creditors, and other nonbank lenders, as well as with foreign portfolio investments by mutual funds and other institutional investors interested in these "emerging markets."
Table 1. Total External Financing for Indonesia, Korea, Malaysia, the Philippines, and Thailand (Billions of U.S. dollars)
1996 1997 Current account balance -54.9 -26.0 External financing (net) Foreign direct investment 7.0 7.2 Portfolio investment 12.1 -11.6 Commercial bank debt 55.5 -21.3 Nonbank private creditors 18.4 13.7 Multilateral financial institutions -1.0 23.0 Bilateral creditors 0.7 4.3 All other (net, including errors and omissions) -19.6 -11.9 Reserves (excluding gold) (- = increase; + = decrease) -18.3 22.7 1998 Current account balance 17.6 External financing (net) Foreign direct investment 9. …