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Sizing Up Foreign Direct Investment, Part II: Lions and Sparrows

Is it true that only “fat cats” receive FDI at the cost of smaller countries?

October 31, 2002

Is it true that only "fat cats" receive FDI at the cost of smaller countries?

Foreign Direct investment (FDI) attracts a surprising amount of criticism. When famous economists like Joe Stiglitz point to a problem, most people listen. He argues that "despite the sizeable increase in FDI to developing countries in the past decade, most of that investment goes to only a few countries. The majority of countries benefit only marginally…"

The critics seem to believe that, because most FDI flows to a few countries, it must reflect a flaw in markets. Why, otherwise, don't private investors put their money into a larger number of countries?

This criticism brings us to the saga of lions and sparrows. The lions, as you can imagine, are China, Brazil and Mexico.

Together, those three countries accounted for over half of all FDI in the developing world between 1970 and 2000. The sparrows include countries such as Grenada, Nicaragua and Equatorial Guinea.

Of course, how much FDI goes to a particular country depends largely on two things: whether foreign investors find conditions there attractive or not — and the size of the country.

Some countries are lion-sized — such as China and Brazil. Others are sparrow-sized. An example is Barbados. And some are in between. It would be absurd to expect Barbados (a sparrow) to “consume” or "eat up" as much FDI in raw dollar figures as China or Brazil (two big lions).

Whatever distinguished economists think about "excessive concentration," what matters to the people of the developing world is obtaining enough FDI to make a difference. And the amount that is "enough" depends on the size of the economy.

To see just how much this matters, let's switch the focus away from the sheer number of dollars. Instead, let's look at FDI in relation to the size of the economy (their GDP). Who tops the list?

The answer is … Lesotho.

Surprise! Lesotho, a small country in southern Africa, has a very small economy. Its total production is worth less than one billion U.S. dollars (out of a world GDP of well over 30 trillion dollars).

Yet, the contribution of foreign investors to the economy is clearly very substantial. Foreign direct investment totaled 21.8% of GDP during the years 1997-2000.

And just what amazing things does Lesotho produce that attracts foreign investment? It produces rather boring things like clothing, footwear and other light manufactures —mainstay industrial products for a newly developing country.

The table below shows all developing and transition countries that attracted foreign direct investment to the tune of 4 % of their GDP or more:

 Net FDI as a percentage of GDP (1997-2000)
The 20%+ Club: 3 countries
1 Lesotho 21.8
2 St. Vincent and the Grenadines 21.2
3 Angola 20.4
The 10%-20% club: 9 countries
4 St. Kitts and Nevis 17.1
5 Azerbaijan 16.2
6 Trinidad and Tobago 11.8
7 Grenada 11.3
8 Vanuatu 10.5
9 Nicaragua 10.5
10 Panama 10.4
11 Bolivia 10.4
12 St. Lucia 10.3
The 7%-10% club: 7 countries
13 Seychelles 9.3
14 Chile 8.0
15 Equatorial Guinea 8.0
16 Estonia 7.7
17 Guyana 7.5
18 Czech Republic 7.4
19 Armenia 7.2
The 5%-7% club: 13 countries
20 Kazakhstan 6.9
21 Latvia 6.5
22 Bulgaria 6.1
23 Zambia 5.9
24 Vietnam 5.8
25 Dominica 5.5
26 Eritrea 5.5
27 Moldova 5.4
28 Sao Tome and Principe 5.4
29 Georgia 5.3
30 Jamaica 5.3
31 Mozambique 52
32 Lithuania 5.1
The 4%-5% club: 17 countries
33 Dominican Republic 4.9
34 Cambodia 4.9
35 Croatia 4.8
36 Solomon Islands 4.7
37 Lao PDR 4.6
38 Argentina 4.5
39 Poland 4.5
40 Venezuela, RB 4.5
41 Jordan 4.4
42 Brazil 4.3
43 Bahamas, The 4.3
44 Turkmenistan 4.3
45 China 4.3
46 Thailand 4.2
47 Hungary 4.2
48 Ecuador 4.0
49 Slovak Republic 4.0
Concept and copyright:

Of the top 20 countries in the table, seven are relatively small economies which depend mainly on mineral exports. Mineral exports require massive investments, which are often beyond the financial and technical capacity of local companies.

The big mineral export countries are Angola (20.4%), Azerbaijan (16.2%), Trinidad and Tabago (11.8%), Bolivia (10.4%), Equatorial Guinea (8.0%), Guyana (7.5%), — and Kazakhstan (6.9%).

Another six of the top 20 countries are small island-states which attract tourism-related investors. These are very small economies — with a GDP of somewhere between $ 200 and 600 million.

Construction of a few new hotels can easily represent a sizeable proportion of total GDP. These countries are St. Kitts and Nevis (17.1%), Trinidad and Tobago (11.8%), Grenada (11.3%), St. Lucia (10.3%) and Seychelles (9.3%).

Of the others, two — Estonia and the Czech Republic — are transition countries that pursued successful foreign investment policies. Chile, with a GDP of over $70 billion, is the only sizeable economy among top FDI recipients, with the highest FDI inflows in relation to its size.

This ranking is a reflection of good economic policies pursued over many years. While mining plays a major part in the picture, foreigners have been investing in a variety of Chilean sectors as well.

Even more amazingly, on a relative basis, the two presumed lions — Brazil and China — barely make the list. They rank 42nd and 45th, respectively.

What do we learn from all this? Looking at direct investment flows in relation to economic size conveys a message of hope.

By continuing to drum home the message that only a handful of countries attract the lion's share of FDI, eminent economists and international institutions are sending out a discouraging message.

Under these circumstances, the peoples of all the other developing and transition countries are bound to ask: Is it worth trying to attract foreign businesses, when they are likely to wind up in China, Brazil or Mexico anyway?

In reality, the peoples of the smaller countries have every reason to make efforts at attracting foreign investors. Indeed, the smaller you are, the easier it is to attract a level of FDI which is meaningful to your economy.

Messages from Joseph Stiglitz and others who keep focusing on dollar amounts should not be allowed to discourage the leaders of small countries. In this case, "small is truly beautiful" — at least for those who are making an effort at attracting investors.