Foreign Direct Investment and the Operations of Multinational Firms.

• Author: Lipsey, Robert E.

Robert E. Lipsey [*]

Foreign direct investment (FDI) flows and the operations of multinational firms have attracted increased research attention in recent years. This is partly because FDI has grown in importance as a form of capital flow and partly because FDI seems a more reliable form of finance for developing countries than portfolio investment or short-term lending in light of the recent Asian experience. Perhaps the most important reason is the emergence of a popular view that multinational firms control much of the world's economy.

In fact, the share of direct investment in the world's capital outflows has grown substantially since the early 1970s to reach about 25 percent in the early 1990s. [1] That share dropped in 1996 and again in 1997, with a surge in portfolio capital and short-term lending. But as portfolio and short-term capital flows declined after the start of the Asian crisis, FDI flows rebounded to 30 percent of the total world capital flows.

Despite this growth in FDI flows, the resulting production is still a small part of the world's total output: about 7 or 8 percent in 1995, compared with about 4.5 percent in 1970. [2] The petroleum sector was the most internationalized in 1970, but the internationalized share fell sharply afterwards, especially in developing countries where important operations were nationalized. Manufacturing is now the most internationalized sector, at over 16 percent of output, but apart from these two sectors, internationalized production remains under 4 percent of the world total.

In the past, FDI flows to individual countries were less volatile than other international capital flows: they changed direction less frequently and the range of fluctuations around their mean was smaller. That characteristic of FDI flows was demonstrated in the Latin American crises of the early 1980s. It was confirmed in the Mexican crisis of 1994, when direct investment inflows quickly regained their previous level, while other forms of capital inflow remained far below their peaks. And the pattern was further confirmed in the Asian crises of 1997, when direct investment inflows into developing Asia as a whole hardly paused in their rapid growth, while portfolio and other forms of investment either dried up or turned negative on net balance. [3]

Over a longer horizon, the economies of East Asian countries have been transformed, and FDI has played an important role in most of the transformations. The industry structure of production and of exports has changed drastically. In 1977 almost two-thirds of East Asian manufactured...