Weak Track Record on Global Inward FDI

Inward flows of FDI are important for host developing economies as a direct source of external capital and foreign exchange, for the potential technology and knowledge spillovers that may occur, and for the market access they offer for new exports. IFDI is also considered the more stable form of capital inflows compared with portfolio investment flows. Policy makers in emerging markets liberalized their incoming foreign investment programs amid the tightening of commercial bank lending in the 1980s. FDI is more likely to expand national gross capital formation if it does not crowd out domestic investment and comes as new “greenfield” investment, as opposed to an acquisition of a local firm (a “brownfield” investment), which essentially reflects a transfer of capital ownership.

The potential externalities, especially those related to knowledge transfers, provide an economic rationale for some governments to offer special incentives to foreign investors relative to national investors. This knowledge refers to production processes, managerial and organizational practices, logistics, and information about exporting. Knowledge diffusion may result from direct training, employee turnover, and demonstration effects. Evidence of positive knowledge spillovers is mostly seen in the improved productivity of a multinational enterprise’s network of suppliers. The impact on directly competing national firms is mixed, stimulating investment in local firms closer to the technology frontier and leading to contraction and exit of less competitive firms. The impact of FDI on exports is channeled through increases in productivity and access to foreign markets. In some cases, foreign multinational firms have the capacity to affect the entire comparative advantage of an economy, as in the well-known cases of Intel in Costa Rica and Samsung in Vietnam. In addition to direct job creation, multinational firms tend to pay higher wages.5

Key features of South Asia’s performance on IFDI are highlighted in the next paragraphs and figures.

South Asia shows weak performance relative to low- and middle-income economies in other regions in attracting global FDI (figure 1.1). The region was home to only 1.3 percent of the global stock of IFDI of US$39.5 trillion in 2017,6 despite producing more than 4 percent of global gross domestic product (GDP). Most foreign investment flows are between high-income economies. Middle-income and low-income economies, as shown in figure 1.1 (non-high-income economies in the figure), receive only 19 percent of all IFDI stock, of which 46 percent is situated in East Asian nonhigh-income economies.

Most IFDI to low- and middle-income economies (91 percent) comes from highincome economies. The main sources of IFDI are regional high-income economies for East Asia and Pacific (64 percent) and for Europe and Central Asia (71 percent) (blue-shaded regions in figure 1.1), but extraregional high-income economies for the other low- and middle-income regions (green-shaded areas are larger than blue-shaded areas). The highest value of IFDI from low-and middle-income regions (sum of orange- and red-shaded areas) is in East Asia and Pacific (US$162 billion) and Sub-Saharan