Thursday 15 February 2018

FDI Screening: Implications for the Future

Two weeks ago, I spoke at an event where I commented on a very interesting paper from Copenhagen Economics (CE). The paper assesses the economics of EU Foreign Direct Investments (FDI) and the need to undertake screening in the EU. Economists are generally weary of setting up screening measures for foreign investments as it increases substantial costs for little economic reason.

Therefore, the recent proposal of the EC to introduce screening measures has more to do with political economy, wider geopolitical or even security reasons. For instance, one of the biggest concerns is that some of the recent FDI coming into the EU is from various emerging economies such as China, Kazakhstan and Russia, which still have many State-Owned Enterprises (SOEs) in their economies.

This according to economists is a problem, but a simple back-of-the-envelope calculation tells me that the share of this FDI in some sensitive sectors flowing from these countries with much SEOs involved is at most 3.5 percent of EU’s total incoming FDI. Hence, a first question appears: does that warrant an overall screening measure? Some trade-offs are involved as obviously economics doesn’t stand on its own here.

However, my intervention was about the future of foreign investments. In particular, the changing nature of investments the EU has received in recent years, namely investments in digital sectors. This should force policy makers to think about when proposing investment regulations, including screening.

First, although it is right to state that FDI brings along a great “footprint” as economist say, this is in fact much lower for digital investments. With “footprint” we mean economic activity such as employment, value-added and greater output. Footprints for tangible investments such as manufacturing are known to be high, but the recent UNCTAD (2017) report shows that this footprint from multinational digital companies is actually much lower.

This can be seen in the figure below that measures this footprint by taking the ratio from foreign sales over foreign assets. For manufacturing and telecoms this ratio is actually 1:1 (in case of telecoms the assets are high because of infrastructure investments). Yet for FDI coming from digital multinationals, foreign assets are typically lower leading to a much higher ratio (because of higher sales), which means a lower footprint.

Source: UNCTAD WIR (2017)

Second, intangible capital such as investment from digital companies are extremely mobile. A nice example of this intangible capital is given in a book by Haskel and Westlake (2017). They state that a company like Starbucks does invest, but not as grounded as for instance a multinational car company does in machines. The goodwill, management and coordination in which Starbucks needs to invest can be pulled out a country relatively easily. Intangible investments are much greater in digital sectors.

Third, spillovers from digital investments are much greater. This phenomenon can translate itself into positive wider productivity effects for the sector or country at large. But, there is a twist to this story: as spillover effects are greater and often digital (i.e. quick and non-physical), they may also lead to fast “idea-stealing” by competitors, leading companies to ardently reduce competition with much less productivity effects taking place due to lower spillovers.

All this leads me to think that if any policy maker wants to propose new investments regulations in what kind of form whatsoever, the policy maker should think about these changing features of FDI. The more so as sensitive sector in which some investment policies appear to be needed are in fact extremely digital-intensive, such as finance, utilities, computer technology and air transport.

I suspect that most if not all of these sectors will show similar signs of these new features of digital investments – if not now, then probably tomorrow. 

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