Round Tripping FDI in Global Context

Global FDI to developing economies have been driven by profit opportunities as well as by the reduction of physical and institutional barriers to cross-borer capital mobility. The improvement in transportation and communication reduced the physical barriers while reforms in developing countries such as PRC led to new profit opportunities. Since the early 1980s, PRC emerged as a major global development frontier. The barriers to foreign trade and investment in PRC have declined steadily since, leading to PRC's accession to the World Trade Organization in late 2001. By the end of 2002, only a year after joining the WTO, PRC overtook the U.S. in FDI inflows, becoming the most attractive FDI destinations in the world and received $52.7 billion in FDI.

The dramatic achievement by PRC seems to suggest that today’s global economy is unprecedented in terms of opening and of the amount of FDI into developing countries. However, foreign capital flows into developing countries today are far below historical record achieved before the World War I. Gross value of foreign capital stock in developing countries peaked at 32.4% in 1914 but dropped to 4.4% in 1950 and recovered only to 10.9% by 1973 and 21.7% by 1998 (Maddison 2001, page 128). Hence, in spite of and market-oriented reform and technological advances during the last century, the world today is less open for capital flows to less developed countries than one hundred years ago.

This conclusion seems easier to accept if we regard capital flows to the developing economies as endogenously determined, depending on the capacity of the developing countries to create new capital in their home country. The more the developing countries are able to create new capital, the more income the developed economies will get from developing economies, and the more FDI from developed economies are likely to flow to developing economies. This seems to be the case before the World War I when British and other empires were deriving large incomes from their colonies and then re-invested part of these incomes back to their colonies. These sorts of foreign capital flows could be regarded as round tripping FDI in a broad sense and they are similar to what is happening now in PRC.

Capital flows among developed countries are much freer than between developed and developing countries because of better protection of property rights and less capital control in the developed economies. From 1989 to 1998, Japan's holding of net foreign assets increased from $294 billion to $1,153 billion while the U.S. holding of net foreign liabilities jumped from $49 billion to $1,537 billion (Maddison 2001, page 137). Clearly Japan has exported a large amount of capital to the U.S. in search of better risk-adjusted return and in preparation for its aging population, even when the policy environments in Japan, such as the volatility of exchange rate and the secular appreciation of yen, have not been favourable to Japanese investment in foreign assets.

Similar incentives for risk diversification should also exist for the Chinese capital. But due to exchange control the Chinese capital outflows have been artificially depressed and can only find their way out in the form of capital flight, e.g. through illegitimate channels such as mis-invoicing of exports and imports and smuggling etc. As we will discuss in the later sections, the scale of capital flight from PRC has been very large, indicating that a lot of new capital has been created in PRC during the last decade. This flight capital then forms the base for some of the FDI flows into PRC, or the so called round-tripping FDI. If we compare PRC's present conditions with historical experiences before the World War I, we should not be surprised by the rapid growth of FDI or round tripping FDI into PRC. The driving force behind the FDI is fundamentally the capacity of the receiving countries in creating profits and new capital. History and PRC's present experiences do not support the view that there is a level of fixed amount of FDI capital to be allocated or competed away among the developing countries. FDI is not a zero sum game!

Foreign invested enterprises in PRC have contributed to more than half of PRC's exports. PRC has been generating current account surplus since 1994 (see Table 1 [ PDF 70.8KB | 1 page(s) ]). As current account surplus simply means net savings or net export of capital, PRC is taking in FDI on the one hand and exporting capital to capital-rich economies like the United States on the other hand. How to reconcile these inconsistent patterns of capital flows? One way to understand these is to recognize that PRC has been creating a lot of new profits and new capital and some of the FDI into PRC are either Chinese flight capital returning home or foreign investors' incomes from PRC investing back to PRC. Since not all capital originally created in PRC went back to PRC, some of them have stayed aboard or "exported" aboard as reflected in PRC's current account surplus.

Most of global FDI, especially FDI among developed countries, is in the form of mergers & acquisitions rather than through green-field investment. In 2001, M&A amounted to as much as 80% of global FDI. Among all the M&A in 2001, 83.5% conducted in the developed countries, 31.1% in U.S. alone and only 5.8% in Asia and the Pacific region. But cross-border M&A are very similar to round tripping FDI except that they are not intended to get around of the regulation. Instead, they are for the purpose of getting the services of global financial markets since the mergers and acquisitions involve more in changes of ownership and control than in net transfers of capital across borders. As 80% of the global FDI are in the form of mergers and acquisitions, we should not be surprised to see global round tripping FDI to reach a level as high as 40% if we account the cross-border ownership swaps as in the mergers & acquisitions deals as round tripping FDI.

Global FDI stock increased from $636 billion in 1980 to $6258 billion in 2000, an increase of almost ten folds. During the same period, world trade volume increased only about three folds from $4 trillion in 1980 to $12.5 trillion in 2000. This is mainly due to the increasing importance of mergers and acquisitions related FDI, which could be regarded as a kind of round tripping FDI.

PRC's share of global FDI increased from a low base of 1.7% in 1990 to a peak of 13% in 1994. After 1994, PRC's share of global FDI declined steadily to only 2.7% in 2000 largely due to massive M&A activities in the developed economies during the tech bubble. After the burst of tech bubble, global FDI dropped 50% in 2001 but PRC's FDI was growing steadily, contributing to a recovery of PRC's share in global FDI to 6.4%, which is consistent with its trade expansion to 4.3% of the global export by 2001. From comparing PRC’s FDI with the global FDI trends we may conclude that the global round tripping FDI through mergers and acquisitions are much larger and more volatile than PRC's round tripping FDI.

FDI into PRC have exceeded $40 billion since 1996 and have been growing steadily every year since 1990. This puts pressures on other developing countries, especially its Asian neighbours. The Asia-7, including India, Indonesia, Malaysia, Philippines, Republic of Korea, Singapore, and Thailand, with more population than PRC, only had $33 billion FDI inflows at their peak year of 1997. After the Asian financial crisis in 1997-1998, the Asia-7's FDI inflows declined dramatically to only $18 billion by 2001. The Asian financial crisis however did not slow FDI flows into the developing economies as a whole. FDI into developing economies excluding PRC recorded steadily growth from $34 billion in 1990 to $147 billion in 1997, and peaked at $197 billion in 2000, and then fell to $158 billion in 2001 (Cheong and Xiao 2003).

In 2001, per capita FDI inflows are $120 for the world, $420 for the developed economies, $42 for the developing economies excluding PRC, $37 for PRC, and only $12 for the Asia-7. Apparently, based on these statistics PRC is winning the competition for FDI inflows over its neighbours. However, recognizing the significance of round tripping FDI in PRC, which is as high as 30% to 50% according to the estimation in this paper, would narrow this gap. As pointed out previously, this gap in FDI inflow is driven primarily by the capacity of the hosting countries in creating new capital. If there is any competition, it is more of competition on domestic reform, which can increase the economy's capacity to create new capital (e.g. profitmaking opportunities) and less of competition on a fixed amount of global FDI inflows.

According to the FDI statistics, the access to foreign capital is unequal with 5 billion population in the developing countries, 80% of the world, receiving only $2.1 trillion out of 6.8 trillion total in the FDI stock by 2001. In 2001, per capita FDI stock is $1,118 for the world, $3,763 for the developed economies, $478 for all developing economies excluding PRC, $309 for PRC, and only $220 for the Asia-7. Again, it is useful to remember that this inequality in FDI stock is exaggerated by large components of round tripping FDI in the form of mergers and acquisitions in the case of developed economies or in the form of round tripping FDI in the case of PRC.

The developed economies provided most of the global FDI stock but its share is declining from 95.8% in 1980 to 87.8% in 2001. In the last decade, Hong Kong, China emerged as a major financial centre for facilitating capital flows into PRC. Hong Kong, China's outward FDI stock increased from $2.3 billion in 1985 to $375 billion in 2001, exceeding Japan's $300 billion. In 2001, Hong Kong, China captured 5.7% of global FDI outward stock, compared with only 4.6% for Japan. A significant part of Hong Kong, China's outward FDI into PRC however is "round-tripping" Chinese capital. We will give a detailed estimation on the scale of PRC's round tripping FDI through Hong Kong, China and other source regions in section 6.

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1. kundan singh
   (posted 04 September 2006 / 10:10:07 AM)
   
   
   
   Thank you for this paper on round tripping. I am currently writing my masters thesis on the reasons for growth of fdi in China and India. Round tripping plays a part in the limitations of this research. The information has been useful in my thesis.
   
   Thank you
   
   Kundan Singh