A prosperous recovery for worldwide economies hinges on an uptick in foreign direct investment flows, according to a new report from a United Nations think-tank, which also warns about the risk of protectionism.

As the world continues to grapple with the far-reaching effects of the financial crisis, recent research provides hope for a prosperous recovery that hinges on an eventual uptick in foreign investment. However, the report also cautions against complacency and protectionism derived from stimulus packages — obvious enablers designed to help spur foreign investment.

Conducted by the think-tank United Nations Conference on Trade and Development (UNCTAD), the report, titled Investment Policy Developments in G-20 Countries, reveals that G-20 member countries have responded to the crisis by mostly refraining from taking policy measures that restrict foreign inward and outward investment. According to UNCTAD data released in May, global foreign direct investment (FDI) inflows fell by 54 percent in the first quarter of 2009, compared to the same period last year.

Moreover, large transnational corporations intend to reduce their FDI expenditures in 2009, the organization’s annual World Investment Prospects Survey indicates, with recovery beginning in 2010 and a strong rebound expected in 2011.

Although few new laws and regulations related to the financial crisis could be seen as a deterrent to FDI, the new findings surmise something else: that recent policy developments (occurring between October 2008 and June 2009) promote and facilitate FDI in an effort to enhance the clarity and stability of investment frameworks, according to the study.

Among key findings that appear to corroborate this claim:

• Thirty-nine of the 42 countries surveyed have undertaken 167 policy measures in these areas;
• Forty (24 percent) specifically address foreign investment and 127 (76 percent) are part of the general legal framework that can apply to foreign investments;
• Among the measures specific to foreign investment, eight countries have taken measures concerning the entry of foreign investors (15 measures altogether);
• Five countries have undertaken measures aimed at facilitating investment flows (nine measures), and seven countries have enacted laws and regulations that concern the operation of foreign affiliates (seven measures).

While it’s evident that a substantial number of the policy changes surveyed were in the direction of facilitating foreign investment, the report also comes with pointed caveats surrounding stimulus packages.

It is not uncommon for people and governments during turbulent economic times to turn inward and erect barriers to protect jobs. The study says that protectionist pressures could arise as the crisis spreads to less-affected economic sectors and countries. “[A] new wave of economic nationalism could occur in the aftermath of the crisis, when the exit of the state from bailed-out flagship industries might lead to the protection of ‘national champions’ from foreign takeovers,” according to a UNCTAD statement.

“Indeed, a number of areas exist where caution in terms of protectionist dangers and investment distortions appears warranted,” the report warns.

The success of economic stimulus packages deployed by many countries depends on how and when they are implemented and the discretion left to local governments. These factors could discriminate against foreign investors in a “hidden” way, ultimately manifesting as “smart protectionism,” such as leveraging gaps in international regulations to discriminate against foreign investors and/or products.

“This could include favoring products with high ‘domestic’ content in government procurement — particularly in huge public infrastructure projects, de facto preventing banks from lending for foreign operations, invoking ‘national security’ exceptions that stretch the definition of national security, or moving protectionist barriers to sub-national levels that are outside the scope of the application of international obligations (e.g., in procurement issues),” the report says.

The subsidy-like nature of stimulus packages could also create advantages for domestic sectors and put foreign players at a disadvantage, the report says.

China’s stimulus strategy offers a glimpse of how FDI can give a country’s gross domestic product a shot in the arm. Stoel Rives attorneys Geoff Revelle and Jerry Chaing provide a detailed analysis of how foreign investors and companies could take advantage of China’s $4 trillion RMB stimulus package. While a majority of funding will go directly to Chinese businesses, Revelle and Chaing point out, opportunities for foreign companies emerge in areas such as high-tech products and value-added services.

In fact, there are more than 250 encouraged activities aimed squarely at the industrial manufacturing sector. Among them:

• Development of various agricultural technologies;
• Production of engineering plastics and plastic alloys;
• Development and manufacture of software products; and
• Construction of thermal power stations with power production capacity of 300,000 KW or more.

Some countries have enacted measures aimed specifically at encouraging outward investment by domestic companies, for example by streamlining the approval process, providing financing for their internationalization or providing insurance for exports and outward investments.

According to UNCTAD’s findings, part of the think-tank’s World Investment Prospects Survey series, the investment-related measures reviewed point in a positive direction, including the various state aid or national economic stimulus packages. The organization proposes that foreign direct investment flows should take two years to regain momentum after a sharp drop in 2009.

Resources

Investment Policy Developments in G-20 Countries
United Nations Conference on Trade and Development, July 8, 2009

…Investment Policy Trends in G 20 Countries Paint Comforting Picture but…
United Nations Conference on Trade and Development, July 8, 2009

World Investment Prospects Survey 2009 – 2011
United Nations Conference on Trade and Development, July 22, 2009

Slow Recovery in FDI Expected in 2010; More Substantial Rebound Due in 2011…
United Nations Conference on Trade and Development, July 22, 2009

China Stimulus Package
by Geoff Revelle and Jerry Chiang
Stoel Rives LLP, June 17, 2009