Introduction
Firms today operate in a global economy best analysed as comprising a number of interacting regional subsystems, of which the European economy – and primarily the European Union (EU) – provides a key example. These subsystems are cemented by ties of history, culture and trade and, notably in the second half of this century, by political institutions and initiatives. Within each subsystem foreign direct investment (FDI) plays a central role, in both integrating the individual subsystem and in providing linkages between subsystems through the activities and policies of multinational enterprises (MNEs). Of growing concern, not only to MNEs themselves but also to national and supranational policymakers, is to what extent these regional subsystems and the integration processes by which they are created shape patterns of investment within and between them. For several reasons, the European Union is an exemplary laboratory in which to investigate the interplay between FDI and regional sub-system development.
While the modern business environment poses many challenges to firms, additional challenges are presented to those firms whose production facilities and final markets are situated within an emerging subsystem, as is the case during regional economic integration. Developments which frequently accompany the formation of a subsystem include significant amendments and additions to national legislation, intensifying competition in final markets and greater availability of efficiency-enhancing production locations. Consequently, it becomes an increasing imperative for firms operating in an evolving subsystem, especially indigenous firms, to supplant a local or national perspective with one that is international or, more specifically, regional in outlook. At the vanguard of this shift in orientation are European firms. Not only is regional integration most advanced in the EU, but the process is very much ongoing. This is exemplified by the continued widening of the EU, with the accession of new Member States, and deepening – evidenced by the Single Market Programme (SMP) and Economic and Monetary Union (EMU).
Regional integration in Europe has coincided with a substantial expansion in the flow of FDI throughout the global economy over the past two decades. This has been promoted to a considerable degree by the removal of many national barriers to capital movement via privatisation programmes and market liberalization, especially in developing countries, and by the continued popularity of large-scale cross-border mergers and acquisitions among firms from the developed countries (Barrell and Pain, 1999). European countries have figured highly in these global FDI flows, and continue to do so. During the 1990s, the EU as a whole consistently received around half of the worldwide inbound investment to the developed countries (UNCTAD, 1998), from both member state firms (intra-EU FDI) and firms from countries outside the EU (extra-EU FDI). Individual nation states within the EU are also major players in worldwide flows. In 1996, Germany was third only to the USA and UK as an investing nation, while the UK was the second largest host (with the USA in first position), and Germany taking a relatively minor role (UNCTAD, 1998). The question arises to what extent the relative attractiveness of these countries as investment locations can be attributed to their membership of an advanced regional sub-system such as the EU.
The MNE's decision whether or not to invest into (or divest from) a regional subsystem and where this investment (divestment) should occur is influenced, at least in part, by the pattern and pace of integration in the subsystem. At the same time, convergence is affected through the act of investment. This reciprocal relationship between FDI and regional integration is brought into particularly sharp focus in Europe. Moreover, divergence in the rates at which integration is progressing has created within Europe a number of discrete yet overlying sub-regional subsystems. These internal contrasts exert a profound influence over the location by European and non-European MNEs of footloose economic activity within the region. An appraisal of European investment flows provides insights as to how the pace and progress of integration shapes investment patterns within, as well as to, a regional subsystem.
An understanding of how regional integration reconfigures business activity, especially cross-border investment, is of course of considerable concern to both national and supranational policy-makers. During regional integration, the relationship between FDI and the member states of a regional subsystem undergoes radical change. It is clear that nations which comprise a subsystem both compete and collaborate in order to maximise their individual and collective shares of footloose investment and reap the benefits that MNEs can bring, while at the same time attempting to minimize the negative externalities of divestment. Of course, it is natural that national policy should be determined by national agendas. MNEs have traditionally exercised a profound influence on both. But as subsystems consolidate, regional policies imposed to sway investment location decisions of MNEs in a manner that maximises for the region the gains from investment may well prove detrimental to individual member states, especially those deficient in requisite country-specific locational advantages. The management of this potential conflict of interest poses clear challenges to national and supranational policy-makers alike.
The aim of this paper is to investigate the strategic response of firms, in terms of their investment behaviour, to the sub-regional subsystems that have emerged as a consequence of the widening and deepening of European integration. A comparative analysis is made of the annual investment flows of Europe's premier investing countries, namely Germany, France, the Netherlands and the UK, together with the most important non-European investor in Europe, the USA, and how these flows are influenced by the various phases of European integration. This is achieved in the context of certain groupings of European host nations that can be regarded, to differing degrees, as sub-regional subsystems. These country groupings are the EC12, the EU15, the EMU (or 'Eurozone') countries, and the five Central and Eastern European (CEE5) countries that are candidates for accession to the EU. We then examine more closely the significance of these flows for Germany, highlighting certain implications for policy that shifts in FDI flow can have for member states of a regional sub-system.
Regional Subsystems and the MNE
The world business system is an interaction of regional subsystems, each with its own internal dynamic. In recent times multi-country subsystems have been established as a direct consequence of policy-led integration initiatives adopted by governments, but this has not always been the case. Classic instances of integration have also occurred, for example, through the interdependencies that arise from preferential trading arrangements, common institutional systems and cultural links commonly found between former imperialist powers and their ex-colonies (Agarwal, 1999). Such relations highlight the fact that member countries in a regional subsystem have not necessarily needed to be adjacent, although geographic proximity is a very strong driving force in regional economic integration today. In some situations subsystems are best examined at the single country level, as in the case of the People’s Republic of China (PRC). However, in most instances, federations of states are the most important units of analysis — the EU and the North American Free Trade Agreement (NAFTA) are cases in point. Finally some subsystems are best analysed in terms of geographic regions – examples being Central and South America. Each of these different units of analysis are aggregations of disparate subunits in terms of level of development (Beijing versus Ginghai, Estonia versus Kazakhstan, Paraguay versus Argentina) and in terms of culture, geographical centrality and outside linkages. However, their coherency and distinctiveness lies in the internal convergence in economic and political systems of constituent member states and by the relatively homogeneous responses of these states to the external world system.
Within and between these subsystems of nations, regions and blocs ranges the multinational enterprise. The flow of investment from the home country of these MNEs to their subsidiaries and affiliates abroad, which are owned and controlled either completely (wholly-owned subsidiaries) or in part (equity joint ventures) is FDI. FDI is typically undertaken to expand the capacity of existing foreign operations; to create new (greenfield) capacity; to acquire new subsidiaries or to merge with established foreign enterprises (Davies et al. 1999). Although it is often argued that MNEs are above individual nations and owe their allegiance to none, this view is fallacious – in fact the great majority of MNEs still derive from, and owe primary allegiance to, one key nation state (or two in a tiny minority of cases), even when ultimate control may be shrouded by residence in a tax haven. As most MNEs are from the advanced EU countries, Japan and the USA, it is possible to view MNEs as strongly related to the ‘triad’ of advanced blocs, interpenetrating each other as well as extending into less developed regions. Naturally, there are preferences in the direction of expansion of MNEs, some of which are clearly based on historical, cultural and linguistic ties. Instances of this include investment in Latin America by Spain and Portugal (respectively in Spanish-speaking Argentina and Portuguese-speaking Brazil), by UK firms in the Commonwealth countries and by the US investment into the UK. However, it is evident that a rapid realignment in the traditional flow of FDI is now underway, the scale and direction of which is determined, at least in part, by the rate of economic and political integration within individual regional subsystems. Japanese, and latterly Korean investments in the USA and EU, and the substantial inflow of FDI to the PRC in recent years represent important advanced guards in the reorientation of traditional patterns.
International business
theory has contributed much to our understanding of the cross-border distribution
of business activity. One useful approach is that of Dunning (1993), who proposes
that a firm's propensity to engage in production abroad is determined by the
interplay of ownership specific advantages, locational advantages and gains
from the internalization of activity in the host market. Put simply, ownership
specific advantages, both tangible and intangible, enable the firm to out-compete
domestic producers in the foreign market. However, gains from internalising
these advantages are required, otherwise "arm's length" contract-based means
(such as licensing, franchising, inter-firm alliances and technical service
agreements) will be used to service the foreign market. There must also exist
certain location advantages (location-bound assets that are host country or
region specific) in the target market which, when exploited in conjunction with
ownership and internalization advantages, render FDI more preferable than servicing
that market by exporting from the home or third party countries. Locational
factors thus determine which aspects of a country's immobile assets attract
or retain FDI (Commission, 1998). Some of the factors influencing the location
of economic activity are presented in Table 1. Of course, the precise role of
location factors in a particular investment decision depends greatly upon the
firm in question, its nationality, its industry and its motives for investing
(see Dunning, 1993 for an analysis). Nevertheless, certain generalizations in
the context of regional integration can be made (see Table 1).
Table 1 Some factors influencing the location of economic activity
At the sub-national and/or industry level |
Likely effects of deepening regional integration within subsystem |
|
become increasingly available as access to optimal production locations improves |
|
become increasingly available as access to optimal production location improves |
At the national level (country specific advantage) |
|
|
|
|
decrease, as competitive pressures drive down prices |
|
decrease, as competitive pressures drive down prices |
|
governments retain discretion, especially regarding incentives |
|
increase, at both national and regional levels |
|
slow to change |
|
slow to change; governments retain some discretion to influence |
At the bi- or multi-lateral level |
|
|
harmonise across members, in time |
|
|
|
increasingly determined at the regional level |
|
greater likelihood that regional subsystem will lobby for members as a whole |
|
decrease, when internal tariff and non-tariff barriers to trade are removed and telecommunication industries are liberalized |
|
decrease, particularly between member states |
Source: Adapted from Commission (1998).
It is natural that at the outset of regional integration location advantages will not be evenly distributed across member states of a subsystem. Certain countries will be at a disadvantage as business locations compared to others. The essence of the economic rationale of regional integration is undoubtedly its ability to redirect trade and investment activity within and between subsystems, with the expectation that the location advantage of the entire subsystem is augmented, relative to others, and that discrepancies in locational advantages between member states are equalised. In other words, regional integration reconfigures the distribution of locational advantages across member states of a regional subsystem, such that the realignment of economic activity improves net social welfare for the subsystem as a whole. Overall, regional integration should not be regarded as a location advantage per se; but rather, a process that serves to change key determinants of the investment decision, especially those founded on economic considerations. It follows that national markets and areas whose location advantages are enhanced during regional integration should attract greater inflows of investment relative to those with diminishing locational advantages. Of the latter, certain member states may even witness net investment outflows during the process, as levels of inbound FDI fail to compensate for the outward investment of national firms and the divestment of existent foreign-owned operations.
FDI and Policy Issues in Regional Subsystem Development
In the 1980s, a major concern among developed countries was the international competitiveness industries, firms and individual products. The ‘competitiveness debate’ was wide-ranging, and the most macro level considered was the national economy. At that time, questions related to the national organisation of resources, policy objectives of government, government management of the economy (in terms of domestic production levels, employment, investment, competitiveness, technological capacity, and so on), and the (purported) trade offs in national economic goals, especially the perceived trade off between national competitiveness and social goals (for instance, Scott and Lodge 1985). It is now reasonable to say that the unit of analysis for many purposes must be the region, followed by the country’s place within the region. Of course, national differences in competitiveness are legitimate concerns of governments. Nevertheless, these problems increasingly have to be approached from within a framework in which the region is the global champion securing an appropriate share of world activity on behalf of its members. This regional strategy follows from the increasingly interdependent nature of the world economy. Needless to say, such a strategy must place constraints on the independence of individual government's actions. What is more, certain policy tools may be ineffective or even damaging when interdependency between countries within a subsystem is taken into account. Without coordination, there is always the risk that the strategies of national and regional governments to secure competitiveness may no longer be congruent.
Fears will always be voiced regarding the deleterious effect of inward foreign investment, such as the possible squeezing out of existing domestic firms and the suppression of new indigenous enterprises. MNEs will also always have a strong incentive to manipulate internal transfer prices to their advantage and to the detriment of host governments’ tax yields. Nevertheless, we are now a long way forward from the time when the debate on inward foreign investment was highly polarised between the proponents of foreign investment as an engine of development and the critics who based their arguments on Marxist or ‘dependencia’ analyses. It is clear that a more rounded debate is now taking place and that a substantial shift in attitudes on the part of host countries has taken place in favour of FDI. Inward FDI can inject extra investment capital into a host economy and bring transfers of technical and managerial know-how. It can also stimulate competition among local firms that, together with demonstration effects and technological spillovers, can enhance productivity levels within local industry. Probably of greatest concern, especially to many of the industrial economies, is that foreign firms may generate additional local employment, both directly, in the operations they establish, and indirectly, through the linkages they develop with local firms. Of course, whether or not these potential gains materialise will depend greatly upon the investing firm, its industry and its mode of entry. New ‘greenfield’ entries, for example, may tend to maximise the benefits of FDI compared to foreign acquisitions of local firms, which can simply involve a change in ownership with limited international transfer of resources besides capital. For member states of a regional subsystem, it is also becoming increasingly recognised that MNEs help to foster closer regional integration through their cross-border, "arm's length" trading activities, through their intra-firm transactions between business units in global corporate networks, and through their investment and divestment decisions within and between regional subsystems (UNCTAD, 1998). With the growing recognition of the benefits of attracting inward FDI there is a much more welcoming attitude amongst host governments (Dunning 1991). Competition for investment capital has become rife.
On the other hand, within regional subsystems, countries that previously enjoyed strong locational advantages may experience an erosion of this position relative to other member states as the integration process proceeds. This raises the concern that, as business activity shifts away from their economies (for example, as domestic firms relocate elsewhere within the subsystem and as foreign firms divest or are discouraged from investing) so domestic investment will decline, jobs will be exported and that the capacity to develop new technology (often regarded as the engine of economic growth) will be impeded. A general hollowing-out of an economy may ensue. Because of such concerns, as participation in regional subsystems becomes more prevalent, the advanced developed countries collectively face the prospect of having to reinvent themselves, and do so in an environment in which regional objectives subsume national objectives to an ever-increasing degree. The difficulty for the European Union, and for European integration in particular, is that now there is no clear beacon of best practice for which to aim. The only vestige of comparative methodology to remain is the notion that Europe must strive to emulate the efficiency of the USA. Of course, this reasoning has largely underpinned the idea of European economic integration. This drive for reinvention is exemplified by the rise of North American integration, itself partly a counter-response to the success of integration in Europe. We now observe a trend towards competitive regional economic integration, in which regional integration becomes an instrument for securing increased regional shares of global investment, income and employment (Buckley, Clegg and Forsans, 1999).
It is clear that a symbiotic relationship exists between economic integration and FDI. This, however, has yet to be fully analysed. A new generation of thought is needed, that extends international business theory to the regionalised and globalised economy. A better appreciation is required of the precise role that MNEs play in the allocation and distribution of economic activity across a regional subsystem such as the EU. In the context of Europe, the issue is one of what the EU’s own position should be towards the MNEs that it both hosts and generates. The following sections aim to prove the relevance of the theoretical rubric by analysing the regional subsystems of the European Union, in terms of trends in FDI flows. We are able to discern how the development of the various overlying subsystems of the European economy have driven the progress of FDI within Europe and between Europe and the rest of the world. The patterns of, and motivations for, FDI that we encounter in Europe are accordingly distinctive, yet nevertheless still may illuminate the likely impact of regional integration on FDI flows to and within regional subsystems less advanced than those of Europe.
Empirical Evidence on FDI and the Regional Subsystems of Europe
At the inception of the European Community, in 1957, the share of world trade and the proportion of total trade that occurred between the members were paramount performance indicators. By the 1980s, the EU’s share of world FDI had become the more pressing issue. Understanding European integration is now central to grasping the evolving relationship between investment strategies, FDI flows and the regional subsystems that Europe now comprises.
Three distinctive phases in the economic development of Europe have been found to be integral to FDI flows in the region, namely Mark I, Mark II and Mark III integration (Dunning (1997a, 1997b) Each phase is characterized by the degree of widening and deepening associated with the integration process and its concomitant effect on FDI. As several regional subsystems have now been formed within Europe, investment consists of a three-stage decision making process — the decision to locate (or relocate) within Europe, followed which European regional subsystem to enter, and finally where to locate within that subsystem.
Mark I Integration
The first, Mark I, integration began in 1957 and extended until the mid-1980s. It concerned the establishment of the original Common Market of six European nations and its subsequent enlargements to twelve member States in 1986 (EC12). This phase involved the eradication of internal tariff barriers and quotas affecting intra-area trade in manufactured products, and the establishment of a common external tariff (CET). Only limited attention was paid to the existence of non-tariff barriers (NTBs) that proliferated as tariff barriers were removed and served to segment domestic European markets (Commission, 1998).
Data on the impact of Mark I integration on extra and intra-EC FDI is very patchy. However, a major review by Dunning (1997a) of empirical work provides some insight. In particular, Dunning finds that, in absolute value terms, Mark I integration had a positive influence on both extra-EC and intra-EC FDI. For Germany, the stock of outward investment to the rest of the EC, as a percentage of its total outward investment was 36.4 per cent in 1976 and 39.8 per cent in 1986. The corresponding percentages for UK outward investment was 8.0 per cent in 1962, rising to 21.9 per cent in 1974 and 21.1 per cent in 1984. The Netherlands, on the other hand, exhibited a small decline in the proportion of its total investment flow directed to the EC member states during this period, falling from 50.6 per cent in 1973 to 46.5 per cent in 1979 and 38.4 per cent in 1984 (Dunning, 1997a). For the UK especially, these figures reflect a significant reorientation of investments by MNEs during Mark I integration from the countries of the Commonwealth to the increasingly accessible markets of continental Europe. Among many German and Dutch firms, with less extensive colonial interests and longer membership of the EC, this perspective was already ingrained. Much of the intra-EC investment by EC firms was import-substituting market-seeking FDI between member states, caused by the continued existence of NTBs and the segmentation of national markets within the region. However, and especially for UK firms, a sizeable proportion of investment was made in distribution to enhance trading activities. Indeed, during the period 1958 to 1985 growth in intra-EC trade far outstripped growth in intra-EC FDI (Dunning, 1997a). Mark I integration almost certainly promoted the servicing of EC markets by exporting between member states rather than by stimulating a change in the location of production.
While for most member states the proportion of total outward FDI directed to other member states increased during Mark I integration, MNEs from outside the EC, especially those from the USA and (but to a lesser degree) the European Free Trade Association (EFTA) countries still accounted for the majority of inbound FDI to the EC. Although estimates vary, it is thought that extra-EC FDI flows were around two-thirds of all inbound FDI to the region in the period 1980-84 (Yannopolous, 1992), while others suggest that for the period 1975-83, this stood at 75 per cent (Molle and Morsink, 1991). Whatever the true figure, these estimates nevertheless demonstrate that non-EC firms were quick to locate production to the emerging regional subsystem. Much of this surge was defensive import-substituting FDI; that is, 'tariff-jumping' production relocated within the EC in order to avoid the CET and preserve market shares accumulated previously through exports. In effect, integration enhanced the locational advantages of countries previously served by exports from the US and other non-EC countries (Commission, 1998). Relocating production to Europe also provided non-EC firms with proximity to local markets. This lowered transportation costs and improved the flow of market knowledge and information to and from the consumer. Through direct investment, rather than licensing-out to EC firms, non-EC MNEs retained and defended their market power through the control of brand names, trade marks and other ownership-specific advantages held (Buckley and Casson, 1976).
The realignment of US corporate strategy towards the EC at this time is particularly noteworthy. In 1957, 15.0 per cent of the global stock of US FDI was located in the EC10 countries (as of 1973), which rose to 28.5 per cent in 1972 and 35.0 per cent by 1984 (Dunning, 1997a). Japanese firms responded similarly, though not quite to the same degree. Between 1955 and 1984, the proportion of Japan's global stock of FDI in the same countries fluctuated between 11 per cent and 17 per cent, peaking at 16.6 per cent in 1974 and standing at 12.7 per cent in 1984 (UNCTAD, 1993). For two reasons, US (and other non-EC) MNEs were in a better position to promote Mark I integration, and to benefit from it, compared with native EC firms. Firstly, non-EC firms were not encumbered by entrenched market positions, and so were able to choose the most efficient production locations as they became available. Secondly, non-EC (especially US) MNEs were typically larger than their EC counterparts. Not only were potential gains from corporate integration commensurately greater for non-EC firms, but they were also more able to surmount the transaction costs of the remaining NTBs than were native firms. In addition, US firms in particular enjoyed greater organisational flexibility (Dunning and Robson 1988). Mark I integration therefore allowed non-EC (especially US and Japanese) MNEs to attain scale economies in production at the regional (pan-European) level. Even so, these firms often continued to treat national markets as distinct and separate on account of non-tariff distortions, particularly in marketing and service activities.
Regarding the geographical concentration of inbound FDI, prior to 1985, around 90 per cent of inbound FDI to the EC, from within and beyond the region, was concentrated in six ‘core’ member states, namely Belgium, Luxembourg, France, Germany, Italy, Netherlands and the United Kingdom. EC firms generally favoured Belgium and France and non-EC firms, Germany and the UK. Both Spain, and, but to a lesser extent Portugal also enjoyed a surge in inward FDI, much of this in advance of their accession in 1986. The geographic distribution of inbound investment to the EC by US MNEs during Mark I integration is especially revealing. Throughout the 1950s, just under 60 per cent of total US manufacturing FDI in Europe was sited in the UK, but from 1960 this share declined steadily to less than 30 per cent by 1976 (Miyake and Thomsen, 1999). While the close cultural links between the two countries will have accounted for the UK's dominant position, and that some erosion of this was probably inevitable, the timing and duration of the downward trend also coincides with the period during which the UK was not a member of the EC. Since its accession in 1973 and full integration a few years later, the UK consolidated its position as the prime location in Europe for US manufacturers, and from 1991 to the present day between 25 and 30 per cent of US manufacturing investment stock in Europe is consistently found in the UK (Miyake and Thomsen, 1999). This pattern serves to illustrate the discouraging effect that non-membership to a proximate regional subsystem (or a delay in membership) can have on inbound FDI to a particular economy from other non-member states.
To sum up the effects of Mark I integration, the evidence is strong that Mark I integration was accompanied by a significant net increase in both intra-EC and extra-EC FDI, with the greater effect on the latter. Nevertheless, in the latter years of Mark I integration Western Europe's share of total inward investment flows declined quite substantially, from 41 per cent of the world's total in 1975 to 31 per cent in 1985 (Dicken, 1998). Much of this decline can be attributed to the growing importance of the USA as an investment location at this time (see Table 2), particularly for Japanese and EC firms that enjoyed enhanced ownership advantages (and so were better able to compete with US firms on equal terms in their domestic economy) and for whom US markets had become more attractive than those in the EC. Not only had appropriate investment levels already been made by EC and non-EC firms in response to the initial, and sometimes once-for-all, effects of Mark I integration, but economic stagnation evident in Europe at the beginning of the 1980s was already acting as an investment disincentive. Other determinants such as market size, market growth and relative factor costs were at least as important, if not more so, than regional integration in shaping patterns of investment inflows to the area at this time.
Mark II Integration
The second phase
of European regional integration, Mark II integration, is reckoned from 1986
or 1987 onwards with the adoption of the Single European Act (SEA) in 1986 and
the initiation of the Single Market Programme (SMP). The importance of this
phase for FDI cannot be underestimated. The deteriorating competitiveness of
Europe compared to that of the USA and Japan in the early 1980s had manifested
itself in the EU as a slowdown in absolute output, high rates of inflation and
unemployment; slow growth in investment and productivity; a lagging behind in
new technologies on which global economic business seemed to be rested; and
the preservation of national (rather than EC-wide) objectives (Cecchini, 1988).
In response, the SEA sought to abolish all remaining tariffs and quotas and
to remove non-tariff barriers (NTBs) to trade and, significantly, to investment.
By now, barriers to investment were understood to limit EU market integration,
especially in many service sectors, the worst cases of which were enshrined
as state monopolies (Clegg and Kamall, 1999). Three hundred or so detailed measures
were contained in the Act, which aimed to create a Single European Market (SEM)
by the end of 1992 and so enable companies to treat the EC as a single domestic
market. These measures included the removal of such things as frontier controls,
national differences in technical regulations, public procurement bias in favour
of domestic producers, and differences in national tax levels and fiscal regimes
(Davies, et al. 1999). This new wave of integration was non-discriminatory,
in that it lowered or eliminated non-tariff barriers to the benefit of non-EC
and EC investors alike. The anticipated effect on industries and firms were
two-fold; a reduction in costs and a heightening of competitive pressures. The
former would accrue due to the elimination of NTBs. In particular, fewer customs
delays, simplification in documentation procedures at national borders, and
promoted access to more efficient production locations (from which to service
larger markets) would permit firms to increase output, generate scale and learning
economies and better exploit their comparative advantage. The latter would lead
to reduced prices and increased efficiencies as more firms from different member
states compete directly in the larger market (Davies, et al., 1999).
In such an environment, the location of production becomes critical, and the
a priori expectation was that production would tend to gravitate towards
areas with a relevant comparative advantage and where production could occur
most cost-effectively. National borders would retain their importance, but would
become more permeable to trade and investment flow (Barrell and Pain, 1999).
Table 2 FDI inflows, by host region and economy, 1984-1997 (US$mn and per cent)
Host region |
1984-1989 |
1990 |
1991 |
1992 |
1993 |
1994 |
1995 |
1996 |
1997 |
(annual average) |
(est.) |
||||||||
World (US$mn) |
115370 |
203812 |
157773 |
175841 |
217559 |
242999 |
331189 |
337550 |
400486 |
Percentage share of world: |
|||||||||
Developing countries |
19.2 |
16.6 |
26.2 |
29.1 |
33.3 |
39.3 |
31.9 |
38.5 |
37.2 |
Developed countries |
80.7 |
83.3 |
72.3 |
68.4 |
63.8 |
58.2 |
63.9 |
57.9 |
58.2 |
EU12 countries |
|||||||||
share of total |
31.3 |
46.1 |
45.2 |
46.9 |
34.7 |
25.7 |
30.2 |
24.3 |
23.8 |
share of developed |
38.8 |
55.3 |
62.5 |
68.5 |
54.3 |
44.1 |
47.4 |
42.0 |
40.9 |
EU15 countries |
|||||||||
share of total |
32.7 |
47.8 |
49.3 |
47.7 |
37.2 |
29.5 |
35.3 |
27.4 |
27.0 |
share of developed |
40.5 |
57.4 |
68.2 |
69.7 |
58.3 |
50.6 |
55.2 |
47.3 |
46.4 |
USA (share of total) |
38.1 |
23.5 |
14.0 |
10.7 |
20.0 |
18.6 |
17.7 |
22.6 |
22.7 |
Japan (share of total) |
0.1 |
0.9 |
1.1 |
1.6 |
0.1 |
0.4 |
0.0 |
0.1 |
0.8 |
Source: Based on data from UNCTAD (1998, 1996).
Table 2 reveals
that throughout Mark II integration the EC12 (and later the EU15) attracted
an increasing proportion of world investment flow (including flows between members
states). This share rose from just under one third in the first half of the
1980s to almost half by 1990, reaching a maximum of 47 per cent in 1992 before
declining gradually throughout the 1990s to just under a quarter of global investment
flow observed by the middle of the decade (UNCTAD, 1998). The high proportion
of investment flow to the developed countries received by the EC highlights
its centrality in the global investment strategy of firms at this time. For
the majority of years since the late 1980s, around half of the annual FDI inflows
to the developed countries were inflows to the EC12 countries, with the exception
of 1992 when this figure exceeded two-thirds (UNCTAD 1998). In absolute value
terms, the period of greatest growth occurred between 1986 and 1990 (the years
immediately following the inception of the SEM), during which time there was
a four fold increase in total inbound FDI to the EU12, from 17bn ecu to 72bn
ecu (see Table 3).
Table 3 Intra and extra-EU12 FDI, 1983-1993 (mn ecu and per cent)
Host region |
1984 |
1985 |
1986 |
1987 |
1988 |
1989 |
1990 |
1991 |
1992 |
1993 |
Total inbound EU12 FDI |
10365 |
11660 |
17568 |
25335 |
40458 |
62428 |
72048 |
55837 |
60924 |
51873 |
Percentage of inbound FDI originating from: |
||||||||||
Intra-EU12 |
40.6 |
51.0 |
59.5 |
48.7 |
55.2 |
55.2 |
54.5 |
62.5 |
63.0 |
59.5 |
Extra-EU12 |
59.4 |
49.0 |
40.5 |
51.3 |
44.8 |
44.8 |
45.5 |
37.5 |
37.0 |
40.5 |
Percentage of total extra-EU FDI originating from: |
||||||||||
EFTA |
27 |
32 |
46 |
30 |
47 |
30 |
34 |
33 |
18 |
17 |
US |
48 |
31 |
37 |
18 |
14 |
35 |
28 |
26 |
52 |
43 |
Japan |
6 |
13 |
7 |
12 |
14 |
16 |
17 |
8 |
8 |
8 |
Others |
19 |
24 |
10 |
40 |
25 |
19 |
21 |
33 |
23 |
32 |
Ratio intra-EU12/outbound EU12 FDI |
0.24 |
0.39 |
0.48 |
0.40 |
0.70 |
1.04 |
1.91 |
1.31 |
2.16 |
1.41 |
Source: Based on data from the Commission (1995)
Although the EC sustained its share of global annual FDI flows over this period, it is important to note, however, that there was a slowdown in the annual inflow of investment in absolute value terms over the final three years of Mark II integration (see Table 3). The recessions experienced by several of the larger member states in the early 1990s had rendered them less attractive to inward market seeking investors, while economic downturn in the major home countries outside of the EC caused their MNEs to scale down or delay their investment intentions. In addition, by this time many firms had already realized their EC investment ambitions and fears that the CET would impede extra-EC trade had proved largely unfounded. These factors combined to dilute the locational advantages of the EC as an investment location and impact negatively upon the value of inbound market-seeking investment to the region. Nevertheless, even after normalising for differences in the growth of GDP between the EC member states and the rest of the world, it is evident that the EC still attracted a disproportionately large amount of global investment activity during Mark II integration (Dunning 1997b).
For the most part, the success of the EC in the mid-1980s in revitalising a flagging share of world FDI can be attributed to the SMP. Let us consider first the impact of the SMP on extra-EC FDI. Table 3 provides a percentage breakdown of the total extra-EU FDI by home country. It demonstrates that, during early Mark II integration, the US and Japan contributed comparatively little (less than 20 per cent from 1987-88) and the EFTA countries comparatively more extra-EC FDI to the EU12. The main period of Japanese FDI in the EC took place between 1987 and 1990, reaching a peak of 17 per cent of all extra-EC FDI inflows in 1990 before tailing off to less than 10 per cent by 1993. In contrast to most Japanese firms, because of extensive past import-substituting FDI to the EC US affiliates had become well established in the EC and did not respond to the SMP to quite the same degree as those from Japan. Nevertheless, the contribution of US firms grew during the second half of Mark II integration, especially from 1989 onwards, such that by 1992 over half of the inflow of FDI from outside the member states originated from the USA. A similar trend is also revealed in Table 4, which shows the percentage of the USA’s global FDI directed to the EC12 countries. By the early 1990s nearly half of the total non-domestic assets of US multinationals was concentrated in the EC (Commission 1996).
Table 4 Geographical breakdown of FDI flows of leading investing countries, 1986-1997 (million ecus and per cent)
1986 |
1987 |
1988 |
1989 |
1990 |
1991 |
1992 |
1993 |
1994 |
1995 |
1996 |
1997 |
||
Germany |
Total world FDI |
8504 |
6951 |
9365 |
11365 |
16434 |
16239 |
14378 |
13853 |
14488 |
28066 |
22239 |
26222 |
Percentage to: |
|||||||||||||
EU15 |
69.0 |
72.3 |
59.1 |
61.4 |
47.9 |
43.5 |
|||||||
EU12 |
36.9 |
24.2 |
36.3 |
60.3 |
67.3 |
69.9 |
64.0 |
66.4 |
55.1 |
55.7 |
34.4 |
40.7 |
|
EMU |
51.9 |
58.9 |
39.9 |
38.3 |
34.4 |
32.9 |
|||||||
EU non-EMU |
17.1 |
13.4 |
19.2 |
23.1 |
13.5 |
10.6 |
|||||||
CEE5 |
5.7 |
8.1 |
9.3 |
7.3 |
10.2 |
7.9 |
|||||||
France |
Total world FDI |
5333 |
7550 |
10816 |
16408 |
21204 |
16583 |
14519 |
10393 |
19321 |
14393 |
22889 |
29757 |
Percentage to: |
|||||||||||||
EU15 |
81.9 |
57.8 |
53.5 |
62.6 |
51.1 |
52.4 |
|||||||
EU12 |
33.8 |
53.9 |
63.4 |
62.2 |
67.6 |
53.0 |
80.0 |
55.3 |
52.8 |
63.4 |
48.6 |
52.6 |
|
EMU |
71.8 |
47.8 |
48.1 |
53.8 |
43.7 |
31.9 |
|||||||
EU non-EMU |
10.1 |
10.1 |
5.4 |
8.9 |
7.4 |
20.5 |
|||||||
CEE5 |
1.5 |
2.1 |
0.7 |
6.4 |
2.3 |
1.8 |
|||||||
UK |
Total world FDI |
10742 |
16766 |
19000 |
18439 |
2639 |
4760 |
6868 |
9124 |
7724 |
16621 |
6742 |
na |
Percentage to: |
|||||||||||||
EU15 |
92.7 |
48.5 |
65.9 |
30.2 |
134.9 |
na |
|||||||
EU12 |
8.8 |
0.2 |
22.6 |
19.6 |
85.1 |
34.2 |
86.9 |
53.4 |
58.4 |
26.7 |
129.7 |
na |
|
EMU |
83.3 |
44.1 |
57.5 |
24.8 |
131.7 |
na |
|||||||
EU non-EMU |
9.3 |
4.4 |
8.4 |
5.4 |
3.4 |
na |
|||||||
CEE5 |
1.8 |
1.7 |
5.0 |
0.4 |
4.0 |
na |
|||||||
USA |
Total world FDI |
8797 |
9820 |
3850 |
22608 |
6873 |
12851 |
20301 |
35106 |
41331 |
34282 |
20861 |
50734 |
Percentage to: |
|||||||||||||
EU15 |
45.1 |
56.8 |
53.5 |
64.2 |
51.0 |
52.3 |
|||||||
EU12 |
18.2 |
18.4 |
65.2 |
73.2 |
-67.1 |
67.3 |
42.5 |
48.8 |
50.9 |
63.7 |
49.4 |
51.1 |
|
EMU |
na |
na |
31.8 |
22.5 |
25.1 |
20.9 |
|||||||
EU non-EMU |
na |
na |
21.7 |
17.3 |
25.9 |
31.4 |
|||||||
CEE5 |
na |
na |
na |
na |
na |
na |
|||||||
Notes: data excludes reinvested earnings; 1997 data are estimates. |
|||||||||||||
Source: calculated from Commission (1995, 1999) |
Much of the investment in the EC by non-EC firms was market-seeking investment for defensive import-substituting purposes (Balasubramanyam and Greenaway 1991). These firms responded to the threat of diminution of their relative competitive positions (that it, their ownership-specific advantages) by adopting a physical presence in the region. The incentive for defensive FDI was greatest for Japanese firms, as in general they were someway short of their desired capital stock at the inception of the SMP, primarily because they were relative latecomers to the area, certainly compared to US and EFTA firms (Clegg and Scott-Green, 1999). By moving production to the EC, non-EU firms responded to the perceived trade diversion effects of the customs union. For several reasons, it was likely that the SMP programme would hinder exporting to the area from a non-member state. Although the removal of physical barriers and the reduction in technical barriers in the EC had the equivalent effect to that of an internal tariff barrier reduction, to the advantage of all firms servicing EC markets through exports, cost benefits were anticipated to be greater for firms engaged in intra-EC trade than those exporting to EC markets from a non-member state. Firms lacking production facilities in the EC would also be disadvantaged by changes in external trade policy (such as voluntary export restraints, local content requirements, anti-dumping rules and other import restrictions). While the trade diversionary effects of the CET are often grossly overstated (the ‘tariff wall’ hypothesis), together with the issue of ‘tariff-jumping’, the importance to firms of being an insider in the EC were not. With insider status came the ability to participate in the evolution of the rules of the EC, particularly in regard to the development of product standards and the formulation of directives.
By the late 1980s and early 1990s, however, much of the investment by non-EC firms in the region, especially by US firms, was increasingly for offensive import-substituting purposes (Buigues and Jacquemin 1994; Clegg 1995). This strategy reflected the relative attractiveness to non-EC firms of the single market vis-à-vis other investment opportunities worldwide at this time. The SEM had generated new market opportunities and improved market access, most evident in sectors where entry barriers had previously been substantial (such as banking, insurance and in the public utilities) or where policy favoured local firms (such as the public procurement of construction services). However, certain non-EC firms, most notably Japanese automobile manufacturers, continued to invest for genuinely defensive import-substituting purposes throughout the 1980s, and many Japanese suppliers to these manufacturers followed their principal customers to Europe, again for market-seeking motives.
As Table 3 illustrates, Mark II integration was characterised by a general waning in the share of extra-EC FDI from the US and EFTA, as intra-EC FDI flows surged. Taking 1984 as the starting point, the first year for which official comparative data were available, intra-EC FDI rose from 41 per cent to 55 per cent during 1984-90, and then to over 60 per cent in 1991-93 (Commission, 1995). Indeed, the level of intra-EC FDI as a proportion of total FDI inflows to the EC more than doubled between the mid-1980s and the early 1990s (Dunning 1997a). Since 1985, foreign investment flows between member states has exceeded inbound investment from outside the EC for every year except one, 1987. The dramatic redirection of investment strategy towards member states by EC firms during this phase of integration is strikingly illustrated by examining the ratio of intra-EC12 FDI to outbound EC12 FDI (made by firms from member states to the rest of the world) (see Table 3). Between 1984 and 1988, this ratio was less than one, indicating that in each of these years member state firms invested more equity outside of the region than within; over four times more so in 1984. However, this ratio increases from 1985 onwards, reaching approximate parity in 1989 and rises each year until 1992, by which time the flow of investment by member state firms to EU12 markets was more than twice that of investment to non-member states.
Differences by home
country can be observed in the degree to which firms realigned their investment
activity at this time. Table 4 shows the share of global FDI flow invested in
the EC12 countries by German, France and UK firms between 1986 and 1992. These
data exclude reinvested earnings and therefore represent new investments by
MNEs. Although there is considerable variance in the data, reflecting the lumpiness
in FDI flows for any given year, it is nevertheless clear that at the outset
of Mark II integration French and German firms were directing a greater proportion
(around a third) of their FDI to member states than were their British counterparts.
This share rose steadily to reach two-thirds by 1990. Although UK firms were
making substantial new investments overseas, the bulk of this was beyond the
EC12 countries. In 1990 and again in 1992, UK firms did commit over four-fifths
of their FDI activity to the EC12, but in both years this was a share of a much-reduced
value of global FDI. In 1990 there was a dramatic downturn in the value of UK
FDI when reinvested earnings are removed from investment data. Poor performance
of the British economy at this time may have discouraged firms from exploring
non-domestic business opportunities. For France and Germany, however, the outward
flow of FDI continued more or less unabated, and by 1992 over 80 per cent and
64 per cent of this respectively was directed to other member states. A significant
proportion of this was aimed at Austria, Finland and Sweden in advance of their
accession in 1995.
Table 5 Cross-Border merger and
acquisition sales and purchases (millions of dollars)
sales from |
purchases by |
||||||||||||||||||
Economy |
1988 |
1989 |
1990 |
1991 |
1992 |
1993 |
1994 |
1995 |
1988 |
1989 |
1990 |
1991 |
1992 |
1993 |
1994 |
1995 |
|||
All countries |
112544 |
123042 |
115371 |
49730 |
75382 |
67281 |
108732 |
134629 |
112544 |
123042 |
115371 |
49730 |
75382 |
67281 |
108732 |
134629 |
|||
of which: |
|||||||||||||||||||
European Union |
29513 |
47107 |
43056 |
23984 |
42626 |
27134 |
38627 |
48604 |
64167 |
61286 |
65224 |
31756 |
30932 |
34658 |
51895 |
60953 |
|||
as a percentage of EU total: |
|||||||||||||||||||
Austria |
1 |
0 |
0 |
1 |
0 |
1 |
1 |
1 |
0 |
0 |
0 |
0 |
1 |
0 |
0 |
0 |
|||
Belgium |
1 |
3 |
2 |
5 |
1 |
1 |
2 |
3 |
1 |
3 |
0 |
0 |
3 |
1 |
2 |
6 |
|||
Denmark |
0 |
0 |
1 |
0 |
1 |
2 |
5 |
0 |
0 |
1 |
1 |
1 |
3 |
1 |
0 |
1 |
|||
Finland |
0 |
0 |
0 |
2 |
0 |
2 |
0 |
0 |
1 |
2 |
2 |
1 |
0 |
1 |
1 |
2 |
|||
France |
14 |
12 |
10 |
11 |
16 |
14 |
23 |
22 |
17 |
31 |
26 |
36 |
29 |
17 |
12 |
13 |
|||
Germany |
5 |
10 |
14 |
11 |
12 |
6 |
15 |
11 |
4 |
12 |
11 |
15 |
13 |
9 |
16 |
25 |
|||
Greece |
0 |
1 |
0 |
1 |
2 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
2 |
0 |
0 |
|||
Ireland |
2 |
0 |
1 |
1 |
1 |
5 |
0 |
0 |
2 |
2 |
1 |
2 |
1 |
2 |
4 |
2 |
|||
Italy |
11 |
4 |
9 |
5 |
7 |
10 |
8 |
5 |
2 |
3 |
6 |
7 |
20 |
2 |
2 |
5 |
|||
Luxembourg |
0 |
0 |
0 |
0 |
0 |
1 |
0 |
0 |
0 |
0 |
1 |
3 |
2 |
5 |
1 |
1 |
|||
Netherlands |
7 |
5 |
3 |
6 |
12 |
16 |
3 |
5 |
3 |
6 |
4 |
12 |
5 |
14 |
5 |
9 |
|||
Portugal |
0 |
1 |
1 |
0 |
1 |
1 |
1 |
0 |
0 |
0 |
0 |
1 |
1 |
0 |
0 |
0 |
|||
Spain |
3 |
4 |
9 |
14 |
8 |
4 |
7 |
2 |
0 |
0 |
3 |
1 |
2 |
1 |
1 |
2 |
|||
Sweden |
1 |
2 |
3 |
4 |
4 |
12 |
6 |
2 |
3 |
3 |
14 |
3 |
2 |
5 |
2 |
5 |
|||
United Kingdom |
55 |
58 |
47 |
38 |
35 |
26 |
28 |
48 |
66 |
36 |
31 |
19 |
20 |
41 |
52 |
30 |
|||
Source: calculated from WTO (1996) |
Two studies undertaken for the European Commission indicate that the growth in both intra and extra-EU FDI surpassed levels that would have occurred if the SMP had not taken place (Commission 1998). However, the investment flow data presented above suggests that EC-specific factors, such as the SMP, have probably had a considerably greater impact on intra-EC FDI than on extra-EC FDI. In contrast to the motives for extra-EU investors, the growth in intra-EU FDI probably resulted from the positive impact of the SMP on market size, income levels and enhanced opportunities for economic activity to be restructured across the EU, rather than from the direct effect of the SMP itself (Dunning 1997b). In order to benefit from these positive impacts it was imperative for EU national firms especially to restructure existing market-oriented operations. For EU firms, efficiency-seeking considerations eclipsed market-seeking motives at this time. EU firms needed to secure footholds in other EU countries and establish a market position in order to be prepared for the intensification of competition that the SEM was expected to initiate (especially in highly fragmented markets), and to take advantage of scale economies generated by treating member states as a single market (Nunnenkamp, et al. 1994). Of course, non-EU firms already active in the region were similarly affected, but to a lesser degree, as many had already optimized their investments at the time of entry to meet the demands of the SEM.
Enhanced accessibility to low-cost production locations across member states as a result of the SMP was expected to allow firms to relocate key stages of production to a limited number of sites from where multiple national markets could be supplied. This would take place according to the comparative advantage of member states or areas – that is, to where it would benefit most from local factor endowments. By reorganizing their activities across intra-regional borders, firms would generate scale economies, increase output and spread risk, resulting in lower costs and a more efficient operating position. Ownership advantages would consequently be bolstered, allowing firms to compete more effectively in the SEM and beyond. When firms were previously obliged to produce inside fragmented national markets, this reorganization took the form of divestment from certain member states and a corresponding investment in others. However, it also involved expansion through mergers and acquisitions. The locational strategies of efficiency-seeking firms would be expected to be less influenced by the size and potential of a particular market and more by its comparative advantage arising from its factor costs, technological, transport and communication infrastructure. For this reason, efficiency-seeking firms tended to be more footloose in their value added activities (Dunning, 1993).
It is difficult to ascertain to what extent efficiency seeking activities – as EC firms restructured their European operations following the SMP – contributed to the growth in intra-EC FDI. However, data on European mergers and acquisitions provide some insights (see Table 5). During the 1990s, the EC became the focus of global merger and acquisition activity (WTO 1996). From 1989 onwards, of the global annual sales of assets by mergers and acquisitions over one third consistently involved target firms located in the EC. This figure reached 48 per cent in 1991 and peaked at 56 per cent in 1992 (Table 5). Many mergers and acquisitions of EC firms occurred as firms sought to restructure their operations in order to strengthen their competitive position vis-à-vis US, Japanese and other European firms, to generate greater returns to scale in production and sourcing, and to reposition their business activities on a regional (or pan-European), rather than national level (WTO 1996). Acquisition was the preferred type of FDI entry primarily because it is a time-saving route. This was a very important consideration for firms striving to adopt competitive bases and to diversify rapidly and effectively within the emerging Single Market. A significant, although indeterminate, proportion of acquisitions also took place for strategic purposes. For example, some Japanese firms acquired assets in the EU in industries in which they were comparatively disadvantaged, such as pharmaceuticals, or those that offered complementary technologies or market access (Dunning 1997b).
We turn now to examining the geographic distribution of inbound FDI to the region. The major recipients of total inward investment to the EU in the early 1990s were the UK (with around 23 per cent of the total), followed by France (15 per cent), Belgium/Luxembourg (14 per cent) and Spain (12 per cent). By the end of Mark II integration, an economic hub of the EU had emerged, consisting of northern Italy, northern Spain, southern Germany, central France and south east UK, in which the centralisation of manufacturing and distribution (due to lower transportation costs and proximity to many consumers) was taking place (Dicken, 1998).
The UK consistently received over 40 per cent of all extra-EU FDI inflows between 1986 and 1992 (Commission 1996). On the other hand, the UK was significantly less important as a site for FDI from other member states, absorbing less than 10 per cent of intra-EU FDI flows in 1993. Intra-EU FDI tended to favour Belgium/Luxembourg and France, closely followed by Spain, with the UK in trailing position. Much of the UK’s ability to attract inward investment can be attributed to the closer linguistic, cultural, legal and institutional ties between the UK and the leading investor in Europe, the USA. However, during this period the UK had a programme of deregulation and state sector privatization that was relatively advanced, certainly more so than in other member states. The UK also had (and continues to have) a corporate structure that promotes take-overs (unlike several continental countries) and at times had a comparatively weak currency (which lowered the price of UK assets for firms from countries with stronger currencies). UK firms were, for these reasons, attractive merger and acquisition propositions. Language is also often invoked to explain FDI by Japan in the UK, but many also ascribe importance to the UK’s relatively low real wages and labour market flexibility. Naturally, this means that the UK attracts a certain type of FDI that is seeking relatively low-cost production within the Single Market. It also suggests that the UK’s performance in attracting FDI is only good so long as the EU maintains its world attractiveness and so long as the UK is seen as central to the EU market.
The fact that intra-EU FDI in particular tended to prefer Benelux and France as investment locations may, in part, reflect a trend towards some geographical concentration in distribution and market-seeking activity. A geographic concentration has also been observed in a few technology and information-intensive industries (Dunning 1997b). For example, in the financial services industry (an information-intensive sector) the UK maintained its comparative advantage as an investment location. This was due primarily to the continued, although declining, preference for US and Japanese MNEs to invest in, or acquire institutions in the City of London. A geographical concentration of investment activity has also been observed in the pharmaceutical industry (a technology-intensive sector). In this industry, some 91.3 per cent of the cross-border merger and acquisition activity in the EU between 1989 and 1994 involved the six core EU countries, particularly the UK and France (Dunning 1997b). Some companies are also exhibiting a trend to relocate their headquarters to major financial centres such as Frankfurt, Paris, London and Brussels.
On balance, apart from these instances, there is little evidence of a general increase in the geographical concentration of FDI within the EU following the SMP. In fact, evidence from cross-border mergers and acquisition data indicates that a slight decrease in the geographical concentration of FDI occurred. For example, in technology and information intensive sectors such as electronic components, office and computing machinery, industrial instruments and business services, there was a trend for production to move away from the four largest EU countries, namely France, Germany, Italy and the UK (Dunning 1997b). There was also a modest decentralisation of investment in other sectors. These include auto-components and auto-assembly, with Spain becoming a major new production location for Japanese, EU and US companies and joint ventures, and chemicals, where production moved from Germany and the UK towards the Netherlands and Spain (Dunning 1997b). It would therefore seem that peripheral countries such as Spain and Ireland, and certain regions of the ‘core’ countries, centred on the Benelux countries, did attract greater inward investment following the onset of Mark II integration. Much of this investment has come from other member states. As MNEs of all nationalities restructured their European operations, and moved production to where it could take place most efficiently, the likelihood is strong that this process promoted economic redistribution in the EU and facilitated economic convergence.
Mark III Integration
The third phase of European integration, Mark III integration, began with the Maastricht Treaty, which took effect on 1 November 1993, and is still on-going. In addition to the accession in 1995 of Austria, Finland and Sweden to create the EU15, this phase involves two major initiatives – the introduction of monetary union across eleven member states in 1999, and the planned accession of a number of candidate Central and Eastern European countries (CEE5, see footnote 2). Although a timetable for their accession has yet to be agreed, an interim period is in force, in which some of the benefits of integration have been extended to these countries, through 'Europe Agreements' and through the Central Europe Free Trade Agreement (Agarwal 1999). These provide for free trade (with greater liberalization of trade in goods than in services), liberalization in capital movements and economic aid. Although both the deepening and widening of Mark III integration is certain to affect FDI in Europe, the widening of the EU (for which there are precedents) is more amenable to early analysis.
The rate of growth in global FDI flows accelerated dramatically during the period of Mark III Integration. Over the past five years, the annual worldwide inflows of FDI to host economies has almost doubled, from US$217bn in 1993 to an estimated US$400bn in 1997 (UNCTAD, 1998). As Table 2 reveals, the vast majority of investment flows continues to be made by firms from the developed countries and are directed to other developed economies. However, in recent years this share has receded, as the developing countries attracted a greater proportion of world investment flows; from 29 per cent in 1992 this has risen steadily to around 38 per cent in 1996, with the PRC (12 per cent of worldwide flow) and Brazil (3 per cent) being major beneficiaries in 1996 (UNCTAD, 1998). Nevertheless, the ability of the EU to maintain its preeminent position in global FDI flows remains undiminished. Inflows to the region increased from 55bn ecu in 1993 to an estimated 92bn ecu in 1997 (Commission, 1999). It has been suggested that, as in the mid-1980s, following the announcement of the date of completion of the SEM in 1987, a significant proportion of inbound investment occurred in advance of EMU (UNCTAD, 1998).
Up to 1995, the EU15 countries continued to attract over a third (35.3 per cent) of world investment flows (eclipsing the most important single host nation for FDI, the US, by almost 20 percentage points), and this has declined only modestly to an estimated 27 per cent in 1997 (UNCTAD, 1998). It is clear that the surge in investments to the developing countries has primarily been at the expense of the non-EU developed economies. A reticence to invest in the ailing economies of Asia may help to explain in part the dominance of the EU in global investment patterns, although the strong economic recovery currently taking place in the EU and the strengthening of macro-economic indicators prior to EMU probably contributed significantly to this performance as well.
Three leading interconnected and overlying regional subsystems can now be recognized in Europe. The first and most obvious consists of the fifteen member states of the European Union (EU15), which itself has grown from the smaller EU12 subsystem.
Table 6 Intra-EU15 and Extra-EU15 FDI flows, 1993-1997 (million ecu and per
cent)
1993 |
1994 |
1995 |
1996 |
1997 |
|
Total inbound FDI to EU |
55893 |
57735 |
80344 |
69962 |
92577 |
Percentage of |
|||||
Intra-EU15 |
61.5 |
62.5 |
53.7 |
59.3 |
61.1 |
Extra-EU15 |
38.5 |
37.8 |
46.3 |
40.6 |
38.9 |
Source: Commission (1999)
As Table 6 shows, the proportion of inbound FDI to the EU made by member states during this phase of integration has remained more or less constant at around 60 per cent, the figure achieved during the latter years of Mark II integration. German and French companies in particular have repositioned themselves in Europe, especially in the advanced member states (Agarwal, 1999) (see Table 6). Outbound investment from these countries rose dramatically since the mid-1990s, and, of this, over half was consistently directed to other EU15 countries (although a slight decrease in this is observed in 1996 and 1997 for both countries). The majority of this intra-EU FDI has taken the form of cross-border mergers and acquisitions – now the prime method of foreign market entry in the EU (Dunning 1997a, 1997b). Intra-EU mergers and acquisitions have tripled in value terms since 1996 (Miyake and Thomsen, 1999). Within the EU, most acquired firms have been located in the UK (with total asset sales valued at US$118.9bn between 1994 and 1997), followed by France (US$37.1bn) and Germany (US$33.2bn) (UNCTAD, 1998). At the same time, of the global annual purchases of assets through mergers and acquisitions, around half have been made by acquiring firms from the EU. Most of these EU cross-border purchases were made by British (US$26bn in 1997), French (US$12bn) and German firms (US$10bn) (UNCTAD, 1998). By the mid-1990s, just under half of the total purchases made by EU firms were to acquire firms in other member states (WTO 1996). These figures reflect a continuation in the strategies adopted during Mark II integration; that is, the need to quickly strengthen competitive positions and to generate greater economies of scale. However, over this period there has also been a rise in nationally confined mergers and acquisitions in Europe. It is likely therefore that many pan-European mergers and acquisitions are as much driven by strategic issues and imperatives as by regional integration per se (Miyake and Thomsen, 1999).
The second regional subsystem in Europe consists of the EU countries that have been accepted into EMU. These 'Eurozone' economies constitute a subsystem superjacent to the EU15 countries in so far that monetary union is likely to have a non-trivial although as yet indeterminate effect on both intra-EU and extra-EU FDI. For example, it is argued that the introduction of EMU will lead to greater price transparency and lower transaction costs, which in turn may facilitate and accelerate capital flows to members and promote the cross-border merger and acquisition of firms located there (UNCTAD, 1998; Miyake and Thomsen, 1999). Exchange rate stability and macroeconomic stability (for example, in respect to inflation and interest rates) may also attract extra-EU FDI to the Eurozone countries that might otherwise have been destined for non-EMU countries in the EU, such as the UK. To what extent investors to the EU will prefer the Eurozone countries to non-members is difficult to ascertain. The a priori expectation is that this will only occur if exchange rate volatility has a significant deterrent effect on trade, which would encourage both EU and non-EU firms to substitute local production for exporting; that is, as a defensive market-seeking stratagem. However, empirical studies, though limited in number, show no such effect (Miyake and Thomsen, 1999). Cross-border merger and acquisition activity involving the UK, for example, is still at very high levels. In 1997, by which time the reluctance of the British government to participate in the first wave of monetary union had been enunciated, foreign firms acquired an estimated US$51bn of the assets of UK firms (UNCTAD, 1998). This constituted almost 21 per cent of global merger and acquisition activity in that year, and was only surpassed by the USA, in which $58bn of assets were sold to foreign acquirers. Furthermore, as Table 6 reveals, if anything, non-EMU countries in the EU actually attracted a greater share of outbound FDI, certainly from two leading investing nations, the USA and France, in the two years preceding EMU. There seems little doubt that other factors currently hold greater sway over patterns of inbound-EU FDI than membership of EMU, though it is too early to tell whether or not this will continue to be the case.
The third subsystem in Europe consists of five Central and Eastern European countries. The recognition that these countries can be regarded as a discrete subsystem arises from the notion that policy-led initiatives adopted by governments are not necessarily prerequisites for regional integration. Economic integration can also take place independently of such initiatives, through transactions and events that promote greater interdependence and cohesion among economies (UNCTAD, 1998). In the case of the CEE countries, this has not occurred formally, but rather as an outcome of the adoption of similar policies and laws across the region in order to fulfill the terms of membership of the EU as set out in the various Europe Agreements (Agarwal, 1999). This has encouraged a degree of economic convergence and harmonization in policy, both between the CEE5 countries themselves, and between the CEE5 and the EU. Any preconception, however misguided, on the part of potential investors (especially those unfamiliar with the region) that individual CEE5 countries possess equivalent location advantages as a consequence of, for example, geographic proximity to both the EU and former Soviet markets, or potential membership of the EU merely reinforces the view that the CEE5 countries effectively constitute a regional subsystem.
German and but to a lesser extent Austrian firms are the dominant investors by far in the CEE5 countries. In each year since 1992, over 5 per cent of total German FDI flows were directed to the CEE5 countries, and in 1996 this figure reached just over 10 per cent (see Table 6). This commitment to CEE5 markets out-strips that by the other two leading European investing nations, the UK and France. Clearly geographic proximity has a strong positive effect here (Agarwal, 1999). Germany has common borders with Poland and the Czech Republic and Austria with the Czech Republic, Hungary, Slovakia and Slovenia. Historically, Germany and Austria were large trading partners of the CEE countries, prior to 1939 and the cultural barriers between them are consequently low. German and Austrian firms consequently experience lower transaction costs and were therefore natural investors after the removal of artificial barriers to capital mobility that had been created by the former political systems of the CEE countries. In recent years, the growth prospects of the CEE countries have improved considerably, and with an improving investment climate, greater inflow of market-seeking FDI will have been promoted, despite the fact that transition-related recession remains a problem in several of these countries. The CEE5 countries also benefit from preferential access to EU markets, and from assistance from the EU in respect to investment promotion, economic and technical aid, as well as scientific, industrial and monetary cooperation, at the institutional level. These policies will promote market-seeking and efficiency seeking FDI. However, on balance, investment to the CEE is still relatively low and irregular. Obstacles to investment continue to prevail, particularly in the legal and regulatory frameworks and the lack of experience in implementing FDI facilitation measures. Moreover, as much of the FDI to these countries is privatization-based, there is a certain degree of lumpiness in inflows, subject to the availability of suitable local companies to acquire.
Although it is difficult to capture the direction and scale of effect in econometric or other analyses, the evidence is strong that the three phases of regional integration in Europe has generally bolstered intra-subsystem and extra-subsystem FDI. A summary of the principal effects of regional economic integration on FDI, as evidenced by patterns of FDI within and to the European regional subsystems, is provided in Table 7.
Table 7 The effects of regional economic integration on FDI
Macroeconomic effect of integration |
Strategic responses of MNEs |
Likely net FDI effect |
|
to replace exports with extra-regional FDI (defensive market seeking investment) |
increased investment in regionally-based foreign affiliates |
|
to adjust existing investments in the region in order to reflect intra-regional trade (reorganization investment) |
for the region as a whole, gains in FDI for some countries, losses for others |
|
to increase value-adding activities within the region |
increased FDI from within and beyond region as MNEs increase production in regionally-based foreign affiliates |
|
to initiate offensive market-seeking investment |
both intra-regional and extra-regional FDI replace exports |
Source: Adapted from Commission (1998).
FDI and Policy Implications for Regional Subsystem Development
We find that membership
(or potential membership) of a subsystem does enhance the locational advantages
of a nation. However, membership is not sufficient to achieve this. For
example, Greece acceded to the EC in 1981, but has traditionally received very
little inward FDI; between 0.9 to 1.3 per cent of the total annual inbound FDI
to the EU from 1986 to 1997 (UNCTAD, 1998). Italy too is a comparatively unattractive
country for inward investors. Similarly, Bulgaria and Romania have yet to attract
a significant proportion of FDI, even though they are also signatories to Europe
Agreements. These cases demonstrate the enduring importance of location advantages
as determinants in investment decisions (such as market size, institutional
environment and societal issues), irrespective of the degree to which a particular
host economy is embedded in any regional integration process. Furthermore, this
is not necessarily a matter of national market size; Germany, for example, has
historically received a disproportionately low proportion of total inward FDI
to the EU, averaging 8 per cent during the period 1990-93, despite having the
largest domestic economy in the region. When combined with the continued propensity
for German firms to undertake outward FDI, especially in the latter half of
this decade (see Table 4), a net withdrawal of FDI from Germany is observed
throughout Mark II and III integration (see Table 8). Most commentators attribute
this anomaly to the fact that much European FDI, both intra-EU and from the
USA, has been in the form of acquisition. As German firms have proven difficult
to acquire, this has significantly depressed the value of FDI to Germany. However,
other factors, such as language barriers (to non-EU firms), stringent national
regulations, a relatively inflexible labour force, high wage and non-wage related
employment costs and a comparatively high corporate tax regimes have also been
put forward as contributing to Germany’s relative unattractiveness as a business
location.
Table 8 FDI flows in and out of Germany, 1983-96, DM million
1983-6 (a) |
2488 |
14958 |
-12470 |
|||
1987-90(a) |
5635 |
26458 |
-20823 |
|||
1991 |
6785 |
39276 |
-32492 |
|||
1992 |
4158 |
30499 |
-26341 |
|||
1993 |
2944 |
25344 |
-22400 |
|||
1994 |
1118 |
27032 |
-25914 |
|||
1995 |
12914 |
49998 |
-37084 |
|||
1996 |
-4865 |
41824 |
-46689 |
Notes: (a) annual average. Source: Agarwal (1999).
Although popular, the argument that Germany – and other European economies – are disadvantaged because their locational advantages have been diluted as a result of regional integration is myopic. It overlooks the positive factors under-pinning the decision of national firms to invest outside their domestic economy, but within the subsystem. In particular, there is the desire to exploit technological and financial strengths (and other ownership-specific advantages), to purchase new strategic assets, to service new markets or relocate production to areas and sectors where investment was restricted because barriers to capital inflows were previously high (Barrell and Pain, 1999). Home countries can benefit also from the increase in tax yields from repatriated royalties and profits, especially over the medium to long term (Agarwal, 1999). It is well established that, in principle, investment outflows can confer a net benefit on home country levels of investment and production, especially in the long run. FDI enables firms to compete more effectively and increase their foreign market share (Dunning, 1993).
Nevertheless, regional integration does weaken the ability of individual member states to unilaterally attract FDI on the basis of country-specific locational advantages alone, or to negotiate with MNEs on the basis of such advantages (UNCTAD, 1998). In the EU, as integration deepens, fiscal regimes and the degree of market liberalization will inevitably converge across member states. So too, in time, will factor input costs. In this environment, intra-regional competition (at the sub-national as well as the national level) for inward investment regarded as having net benefits for the local economy is less likely to be founded upon such market considerations, but rather upon business facilitation aspects in which the national government retains at least an element of autonomy in policy-making. Examples include promotional efforts, provision of non-fiscal incentives, reduction in bureaucratic impediments, improvements in administrative efficiency, the provision of amenities and attractions to expatriate employees, and so on (UNCTAD 1998). Within the subsystem, access to the regional market supercedes access to particular national markets as an important FDI determinant. For a member state to attract FDI in tradeable goods and services, it must provide good access to the region-wide market, in respect to a harmonization in policies, physical accessibility (that is, geographic centrality), and strong transportation and telecommunication infrastructure. Member state governments have little or no discretion or powers to intervene in certain of these areas (market growth or geographic proximity to major markets) while in other areas individual government decisions had been handed over to the region. Active region-level policy is needed to ensure that the benefits of integration are shared throughout the region, and that 'beggar my neighbour' attitudes towards investment incentives do not erode any gains from investment that might accrue.
Conclusions
European integration was, from the 1950s to the early 1980s, conceived in practice as an outgrowth of trade, notwithstanding the promising early vision of the free movement of all factors of production. Trade was seen as the prime engine of European integration, largely because of the existence of a solid body of trade theory that demonstrated the benefits of customs union and free trade. There was no comparable framework within which the gains (and losses) from FDI could be demonstrated. The ability of the European Commission to grasp the importance of FDI had been long in coming. By the mid-1980s, FDI had been acknowledged as central to EU prosperity in the world economy. The role of FDI as a key factor binding the EU regional subsystem to the world system was becoming recognized.
Investigating the impact of regional integration on inbound FDI is problematic; establishing the counterfactual – that is, the level and patterns of investment that would have occurred without the integration process – is difficult to achieve. Nevertheless, as this paper shows, in Europe the SMP (despite the controversies over the magnitudes of the internal benefits) does appear to have resulted in considerable benefits in terms of increased FDI. This applies to investment flows from outside the EU (although trade protectionism has played a part) and also to intra-EU FDI, much of which, in the absence of the SMP, may have either gone elsewhere in the world or stayed in the domestic economy of member states. To the extent that domestic investment has been replaced by intra-EU FDI the objective of European integration will have been served. Nevertheless, it is evident that while intra-EU FDI has intensified, there was a decline in levels of inbound EU FDI since its peak in 1990. This may be attributable to indirect factors, such as the recessionary phase of the business cycle. However, such a decline in inflows from outside the EU should be expected as the announcement effects of the SMP wane, and as alternative investment opportunities in the world are targeted by non-EU firms. Such influences would appear to have been short-lived, however; in the second half of this decade a resurgence in inbound FDI to the EU, in both value terms and as a share of total global flows, surely reconfirms the position of the EU as the dominant regional subsystem host for international production.
Foreign direct investment in Europe is now a policy target, and both an instrument and an indicator of market integration and macroeconomic development. With the accession of lower-income members to the EU, FDI has become perhaps the leading means of effecting economic upgrading and European integration. The power of FDI is that it promises a route to achieve key policy goals without significant government expenditure. All that is required is the adequate resourcing of key policies, such as competition policy and, in the former monopolised industries, the refinement of industry-specific regulation. Foreign direct investment will remain central to Europe’s continued growth as a regional force. What is more, the intensity of intra-EU FDI discussed in this paper raises the real prospect of European MNEs that owe more to being European than of any particular EU nationality. It may be no coincidence that the move towards a single currency within Economic and Monetary Union (EMU) will create a swathe of MNEs with a common yardstick currency, and thereby reinforce an element of common ‘regionality’, rather than nationality.
FDI and regional subsystem development are heavily inter-dependent. But it is not sufficient to study these two phenomena alone. As we have seen, other factors beyond the regional integration process shape FDI flows, both within and between subsystems. Issues of culture and geography, as well as macro-economic factors in a regional subsystem contribute to the shares of FDI it receives from its constituent member states and from outside. The nature of its interdependencies with other regional subsystems also has an important part to play. Nevertheless, we have presented a partial test of a new idea – that the global economy is, in fact, a system of interrelated regional subsystems. In the examplar subsystem – the European Union – foreign direct investment is both a key instrument and a key measure of system integration.
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