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International Internet Magazine. Baltic States news & analytics Saturday, 30.05.2020, 12:53

Foreign Direct Investment and Business Development

Dr. Tatyana Boikova, Assoc. Professor at the Baltic International Academy, Researcher at the Institute of Economics of Latvian Academy of Sciences, Riga, 12.11.2019.Print version
Report of the Session “The Investment Environment of Business Development: The Key Issues Faced by Foreign Investors” at the III International Economic Forum, Riga, Latvia, 1 November, 2019.

Many empirical studies show that long-term economic growth can be driven primarily by fixed investment that is influenced mostly by national saving. In particular, Figure 1 highlights the underlying trend in the relationship between fixed investment and GDP is positive for the Latvian economy. It is necessary to encourage investment activity as one of the driving forces of achieving sustainable and inclusive economic growth in Latvia.

Fig.1. Investment and GDP Growth in Latvia

Source. Eurostat data.


Empirical evidence revealed the existence of this relationship for other EU countries as well. For example, substantial differences in levels of gross fixed capital formation and real GDP per capita between Latvia, Estonia, Hungary, Ireland on the one hand and the United Kingdom, Italy, Luxembourg on the other hand indicate that the higher investment activity, the greater real GDP per capita growth rate, as depicted in Figure 2. Relative to these countries of Old Europe such a regularity can also be considered for Spain, the Netherlands, the USA, France, Finland, Austria, the Czech Republic, Cyprus, Croatia, Slovakia, Romania. Besides, this positive trend is also observed regarding Canada, Norway, Japan, and Sweden. Nonetheless, despite the cross-country differences in fixed investment levels between Sweden, Japan, Belgium, Denmark, Germany, Italy, and Luxembourg, percentage of real GDP per capita remains the same in these countries. Similarly, such variances there are between Norway and the United Kingdom. Meanwhile, another trend explicitly appears, when some countries like Italy, Luxembourg, Greece, Spain, the Netherlands, the USA, Portugal, Cyprus, especially Bulgaria, Malta, Slovenia, and Poland in terms of a lower gross fixed capital formation percentage achieved a much higher real GDP per capita percentage in comparison with Canada. Taking into account the cross-country differences in rates of gross fixed capital formation and real GDP per capita it should be noted that fixed investment is not the only or main source generating economic growth as it is shown in the empirical studies in this area.


Fig.2.Investment and Real GDP per capita, 2018

Source. Eurostat data.

Under the conditions of increasing openness of national economies and international competition foreign direct investment (FDI) became a key driver of competitiveness and business development and consequently can significantly contribute to long-term sustained economic growth. It is worth noting that from the standpoint of investors’ future intentions and possible investment trends dynamics, a crucial factor driving FDI decisions is investor confidence. According to the data of the Global Business Policy Council in 2019 the highest FDI confidence index is in the USA (2.10), Germany (1.90), and Canada (1.87). In addition to Germany, among European countries the top 10 on this index includes also the United Kingdom in the rankings (4), France (5), Italy (8). As shifts in sectoral FDI flows especially to high-tech manufacturing in developed markets show, FDI can affect economic performance across industries and firms to a greater extent through international technology transfer and R&D projects.

Fig.3. R&D Expenditure in the Business Enterprise Sector, % of GDP, 2017

Source. Eurostat data.


However, such an indicator of increasing the stock of knowledge as R&D expenditure performed within the business enterprise sector in the EU indentified challenges for promotion of knowledge-based long-term economic growth in countries of New Europe, as illustrated in Figure 3. The highest R&D intensity as a percentage of GDP in the EU is achieved in Sweden (2.42%), Austria (2.22%) relative to the EU average – 1.36%. Hence, Sweden and Austria are innovation leader and strong innovator, respectively. While this indicator in Bulgaria is 0.53%, Slovakia – 0.48%, Croatia – 0.42%, Lithuania – 0.32%, Romania – 0.29% and the lowest indicator is in Latvia – 0.14%.  


The fastest growing economies in Asia have benefited from foreign direct investment (FDI)-oriented innovation activity, increasing substantially their innovative capacities that will be a crucial determinant of global competitiveness. Figure 4 displays that real GDP growth rate in South Korea, Singapore, Hong Kong, and Thailand considerably exceeded the level of this indicator in the Euro area.

Fig.4. Real GDP Growth

Source. Eurostat, UNCTAD data.


Moreover, according to UNCTAD data the Asia-Pacific region received significant especially greenfield FDI inflows to the manufacturing and services sector. In particular, China becomes an investment destination for FDI in high value-added industries and Thailand aims to attract more FDI in technology-based manufacturing and services. By data of ASEAN Investment Report (2018) the ASEAN telecommunication industry will have continuing and increasing FDI inflow in the development of ICT infrastructure in the long run. Besides, East Asia and the Pacific become one of the most improved regions with their competitiveness performance upward trend (+1.78%) in the world. Economies of this region perform better than Europe and North America on the Product market and the Financial system pillars of the Global Competitiveness Index. In such dimension as the ICT adoption pillar the East Asia and the Pacific region economies actually have achieved a similar level of performance like Europe and North America. While the positive percentage change of this region performance in ICT adoption (4.4%) is greater than the pace of change (3.7%) in Europe and North America. Furthermore, in terms of changes in competitiveness performance there are also cross-regional differences in the Innovation capability pillar, most notably for economies of East Asia and the Pacific with significant improving (+2.0%) versus the unchanged trend on this pillar in Europe and North America. These disparities indicate that competitiveness of the East Asia and the Pacific economies is driven mostly by the progress in ICT adoption, financial system, innovation capability and improving macroeconomic stability that contributed to a favorable investment environment. Despite sharp declining global FDI flows mainly in developed countries and transition economies in 2018, nevertheless according to the annual data of UNCTAD, FDI inflows to developing Asia rose by 4 percent to $512 billion, especially in China, Hong Kong (China), Singapore, Indonesia as well as India and Turkey. Receiving 39 percent of global FDI inflows, Asia became the largest region with a growing share of FDI in the world.


The overall positive trend also appears in the relationship between shares of extra-European FDI inflows and EU GDP. More specifically, this effect reflected in a steady and higher growth dynamics for the Netherlands, Spain, Italy, France, the United Kingdom, and Germany. Noteworthy, the highest percent of EU FDI is concentrated in science-intensive industries like manufacture of computer, electronic and optical products as well as in services sectors in terms of number of foreign firms and share of foreign assets in the sector. Besides, these industries and sectors, especially R&D, IT services, financial services and insurance have the highest number of mergers and acquisitions deals and also the highest concentration of foreign investment as to the value of the greenfield projects. At the same time, the growing share of foreign assets is greater in the sector of mining and quarrying. Another peculiarity of FDI in the EU is high inward FDI stocks, mainly in small countries as Luxembourg, Malta, Cyprus, the Netherlands, Ireland, and Belgium. Furthermore, namely, the Netherlands and Cyprus, like Germany, show maximum positive changes in total extra-EU inward FDI stocks. Similarly, such a trend there is relative to change in inward extra-EU FDI flows that also indicates maximum percentage points for the Netherlands and Cyprus, like the United Kingdom.   


The empirical estimates of various sectoral trends of FDI in the international investment landscape highlighted that the size and growth rate of the economy are not significant among fundamental determinants of FDI inflow in European countries. The major trends in actual FDI flows in the world’s most dynamic economies point that investor preferences and the investment opportunities are influenced to a greater extent by taxation, the technological and innovation capabilities, conducive macroeconomic environment, regulatory transparency, digital infrastructure, level of openness, skilled workforce, and integration into international value chains that can contribute to companies competitiveness and profitability.



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