DTE Factsheet: FOREIGN DIRECT INVESTMENT

What is FDI?

Foreign Direct Investment (FDI) is an important feature of an increasingly globalised economic system. It occurs when a company based in one country makes a long-term investment in a company located in another country. The 'home country' company may gain partial or total control of the 'host country' company. The direct investor does this by purchasing an existing overseas enterprise, providing capital to start a new one or buying 10% or more of it.

FDI typically involves investments in productive assets, for example the purchase or construction of a factory, the purchase of land, equipment or buildings or the construction of new equipment or buildings by a foreign company. The reinvestment of company earnings and the provision of long-term and short-term loans between parent and affiliate enterprises are also classified as direct investment. New types of FDI are now developing e.g. licensing high tech ventures.

Most FDI is in wholly owned or nearly wholly owned subsidiaries. This includes joint ventures and strategic alliances with local firms. Joint ventures involving three or more parties are usually called syndicates and are most often formed for specific projects such as large construction or public works projects that might involve a wide variety of expertise and resources for successful completion. The term FDI does not usually include foreign investment in stock markets.

FDI in Indonesia

The Investment Law No. 1/1967 was passed to attract foreign investment to help build up the national economy. The Indonesian Investment Co-ordinating Board (BKPM) gives approval for all FDI. Foreign investors have been reluctant to invest in Indonesia during the last decade due to concerns about political and economic instability. Now there are signs that the climate is changing: there has been a 70 per cent increase in foreign direct investment in the first half of 2005, along with 5 per cent to 6 per cent economic growth since late 2004. Britain, Japan, China, Hong Kong, Singapore, Australia and Malaysia were important sources of new FDI in early 2005. According to UNCTAD¹ statistics, total FDI inflows into Indonesia amounted to US$1.023 billion in 2004 (latest available figures), compared with US$0.145 bn in 2002, $4.678 bn in 1997 and $6.194 bn in the peak year of 1996.

Multi-national companies that want to tap natural resources, access lucrative or emerging markets, and keep production costs down by accessing low-wage labour in developing countries are FDI investors. Classic examples of FDI include Canadian mining companies building mines in Indonesia or Malaysian palm oil companies taking over Indonesian plantations. Cargill, Exxon, BP, Heidelberg Cement, Newmont, Rio Tinto and Freeport McMoRan and INCO all have foreign direct investments in Indonesia. However, most FDI in Indonesia is in the manufacturing sector in Java, not natural resources in the regions.

One important aspect of FDI is that the investor gains control - or at least significant influence - over the management and production of a company overseas. This is different from portfolio or indirect investment, where foreign investors purchase the stock or bonds of local companies, but do not control them directly. Also, FDI is usually a long-term commitment. It is therefore more valuable to a country than other forms of investment that can be withdrawn at the first sign of trouble.

FDI as an economic indicator

FDI now plays a major role in the internationalization of business. Profound changes have occurred in the size, scope and methods of FDI in the last decade. These are due to changes in technology, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privatisation of many industries. New information technology systems and cheap global communication have made management of foreign investments far easier.

The greatest impact has been in developing countries, where annual foreign direct investment flows have increased from an average of less than $10 billion in the 1970s to over $200 billion in 1999. FDI in the 'Third World' now makes up nearly one quarter of global FDI. China is the world's largest host country for FDI. Larger multinational corporations and conglomerates still make the overwhelming percentage of FDI (source: UNCTAD). Middle-income ASEAN countries such as Malaysia, Thailand, Indonesia and the Philippines are now facing the major challenge of improving their competitiveness and attractiveness as hosts to FDI in a rapidly changing economic environment.

It is worth noting that Overseas Development Assistance (ODA) used to be the main source of the development funds in developing countries. In 2000, total ODA was only a half its pre-1990 level. Private finance, through FDI, has become the biggest source of 'development' funding². This huge increase of FDI is a result of the massive growth of TNCs in the global economy. From 7,000 multi-national companies in 1960, the number has soared to more than 63,000 with approximately 690,000 affiliations or subsidiaries by the late 1990s³. More than 75% of these corporations are originally from developed countries in Western Europe and North America, while their subsidiaries operate mainly in developing countries, such as Indonesia. This is the picture of the private sector which is estimated to have control over two-thirds of international trade.⁴

Governments pay close attention to FDI because the investment flows into and out of their economies can have a significant impact. Economists consider that FDI is a major driving force for economic growth as it contributes to national economic measures like the Gross Domestic Product (GDP), Gross Fixed Capital Formation (total investment in a host economy) and the balance of payments. They also argue that FDI promotes development because, for the host country or company that receives the investment, it can provide a source of new technologies, processes, products, organisational systems and management skills. It can provide a company with new markets and marketing channels, cheaper production facilities, and access to new technology, products, skills and financing.

FDI and advocacy

Opponents note that FDI gives another meaning to the expression "Think globally, act locally". They argue that FDI benefits the home country (the country from which the investment originates) more than the host country (the destination of the investment). Multi-national conglomerates can wield great power over smaller and weaker economies. They can drive out much local competition. FDI can enable a manufacturer to increase its total production capacity (often at much lower cost than in the home country); get closer to its foreign markets; open locally-based sales offices in the host country; circumvent trade barriers and avoid foreign government pressure for local production.

Campaigners can lobby against FDI by making companies aware of the financial risks of investing in production which is environmentally or socially not sustainable. A history of conflict, or a poor human rights record in part of the host country where the foreign investment is intended, makes it more difficult for companies to get political risk insurance. Multi-national companies should also be pressed to adopt the highest international standards on indigenous peoples' rights, environmental controls and health & safety requirements. The UN's Global Compact, the Equator Principles and OECD corporate governance principles can be used to stop banks and other agencies financing investments which are socially or environmentally damaging. Many other companies now have their own corporate social responsibility guidelines. Direct action in and around AGMs for shareholders of international companies has also been an effective tool in generating publicity.

One possibility of influencing foreign investment is to promote ethical or socially responsible investment (SRI). Although not part of the mainstream, the market for SRI has shown a significant increase. In the UK, SRI has reached £7.1bn. In the US, ethical investment scheme has reached US$153bn by 2000: a rapid increase from US$12bn in 1995. Around 12% of total investment managed in the US is reported to be part of SRI schemes⁵.

Liberalisation and FDI in Indonesia

The first Investment Law introduced (1/1967) by Suharto's New Order regime said clearly that some types of business were entirely closed to foreign companies. Ports, electricity generation and transmission, telecommunications, education, airlines, drinking water, railways, nuclear power and the mass media were all considered areas of strategic importance for the state and people's everyday lives which should not be under foreign influence (Para 6:1).

Yet, a year later, the Foreign Investment Law (6/1968) declared: "National companies are those where at least 51% of its share is owned by state or national private companies. Foreign investors may buy up to 49% of the share." Later, the Indonesian government issued a decree guaranteeing foreign investors the possibility of owning to 95% of shares in companies involved in "... ports; production and transmission and distribution of public electricity; telecommunication; airlines, cruise ships, railways; drinking water; nuclear power stations; and the mass media" (PP 20/1994 Paras 2:1 and 5:1).

Under Susilo Bambang Yudhoyono, the GoI held an International Infrastructure Summit on 17 Jan 2005 and, more recently, a summit on state-owned companies in 25-26 Jan 2005.

1. The Infrastructure summit resulted in the explicit decision that all infrastructure projects were open to foreign investors to make profit, without any exceptions. Restrictions would only be created by competition between companies. The government also clearly stated that there would be no difference in the treatment of Indonesian and foreign businesses operating in Indonesia.
2. The State Industries summit (BUMN) made clear that all state-owned companies will gradually be sold off to the private sector. Put simply, this means no goods and services will be provided by the government at low cost with subsidises from taxes. In future, all public goods and services will be commercial ventures with their provision purely guided by the profit motive.

These new policies demonstrate the process of liberalisation currently taking place in all sectors of Indonesia's economy and show the importance of FDI to the Indonesian government. The spirit of clauses in the Indonesian Constitution intended to protect strategic public goods and services has come to an end.

Notes:
¹ United Nations Conference of Trade and Development
² UNCTAD (1999), World Investment Report
² Gabel and Bruner (2003), Global Inc. - An atlas of the multinational corporation. p. 2
⁴ UNCTAD (2000), World Investment Report
⁵ See, for example, www.uksif.org/

Sources:
This factsheet draws heavily on:
www.going-global.com/articles/understanding_foreign_direct_investment.htm and www.jubileedebtcampaign.org.uk/

Other relevant websites are:
www.bkpm.go.id/ - Indonesia's Investment Co-ordination Board website
www.worldbank.org/data - facts and figures on development indicators
www.unctad.org/ - A number of reports on global and regional investment trends, www.oecd.org - global foreign investment trends, country investment guides
www.opic.gov/ - Outline of the financing and insurance programmes available for American firms investing overseas.

This Factsheet was prepared by Down To Earth (dte@gn.apc.org), in October 2005, with substantial inputs from Yanuar Nugroho, Director of Business Watch Indonesia and secretary general of Unisosdem (yanuar-n@unisosdem.org).