Economy

FDI is typically considered to be a lagging indicator of the investment environment in that once a given project is decided upon it typically takes some time for the funds to be delivered. Therefore, examining data on FDI outflows in a given year generally does not portray the full picture on investor sentiment in that particular year. Nonetheless, given the magnitude of the financial crisis that emerged in 2007, the impact on FDI outflows is already reflected in the 2008 data.

The capacity and desire of companies to invest has weakened because of:

• reduced access to financial resources
• falling corporate profits
• business perceptions of low returns on investment in a recessionary environment
• heightened risk

In 2008, global FDI outflows declined by 15 per cent from the previous year. The fall in global FDI is expected to be even more pronounced in 2009.

The impact of the crisis on FDI outflows has varied by region and country. Developed countries were hit first and hardest, but the impact has been spreading to developing and transition countries. The United Nations Conference on Trade and Development (UNCTAD)—the organization dealing with trade, investment and development issues for the United Nations—notes that “for developing and transition economies, the worst is yet to come.” ¹

The drop in FDI outflows was larger in the 17 comparator countries than in the rest of the world. The 17 countries, which accounted for 71 per cent of global FDI outflows in 2008, reduced their outward FDI by 18 per cent. The rest of the world reduced their FDI by 7.5 per cent.

The decline in outflows was particularly significant in Finland (–80 per cent), Italy (–75 per cent), and Germany (–60 per cent).

Canadian direct investment abroad increased in 2008. Most of the money flowed to existing foreign subsidiaries in the United States. The finance and insurance industry received 65 per cent of the funds, while the energy sector received 16 per cent. According to Statistics Canada, Canada’s positive investment abroad in 2008 may reflect liquidity issues encountered by Canadian foreign affiliates in the face of the worldwide financial turmoil. ²

The Outward FDI Performance Index captures a country’s relative success in investing globally. If a country’s share of global outward FDI matches its relative share of global GDP, the country’s Outward FDI Performance Index is equal to one. A value greater than one indicates a larger share of outward investment relative to GDP, and a value less than one indicates a smaller share of outward investment relative to GDP. The index is calculated using three-year periods to offset annual fluctuations in the data.

The International Monetary Fund defines foreign direct investment as an investment that allows an investor to have a significant voice in the management of an enterprise operating outside the investor’s own country. The phrase “significant voice” usually means ownership of 10 per cent or more of the ordinary shares or voting power (for an incorporated enterprise) or the equivalent (for an unincorporated enterprise). This may involve either creating an entirely new enterprise—a so-called greenfield investment—or, more typically, changing the ownership of existing enterprises, via mergers and acquisitions. Other types of financial transactions between related enterprises, such as reinvesting the earnings of the FDI enterprise, are also defined as FDI.

FDI is becoming a key driver of global growth. FDI is growing rapidly around the world, outpacing growth in production and in international trade. Since 1990, GDP has increased by an average of 5.5 per cent per year, and exports by 8.7 per cent. Meanwhile, the flow of FDI worldwide has grown by 13 per cent per year.

FDI outflows open access to foreign markets and promote deeper integration into global supply chains, making an economy’s firms more efficient and competitive. Capital-exporting countries receive repatriated profits, intellectual property royalties, and similar payments.

Traditional international trade theory saw FDI as “trade substitution,” a way to avoid tariff barriers, such as by setting up branch plants. The new paradigm—that of “integrative trade”—recognizes that outward FDI promotes trade by developing new exporting (and importing) opportunities. Specifically, FDI tends to increase exports of goods and services from the capital exporting country. For this reason, most developed countries actively promote outward FDI by providing information and technical assistance, risk insurance or guarantees, and loans to multinationals, as well as by participating as co-investors.

To understand the benefits of outward FDI and integrating into global supply chains:

Christopher Beckman and Glen Hodgson, “Making Connections: The New World of Integrative Trade and Canada,” in Performance and Potential 2005–06—The World and Canada: Trends Reshaping Our Future, Ottawa: The Conference Board of Canada, 2005.

Glen Hodgson and Roland Paris, The Benefits of Foreign Direct Investment: How Investment in Both Directions Drives Our Economy, Ottawa: The Conference Board of Canada, March 2006.

Research Update: Can SMEs Fit into Global Supply Chains?, Ottawa: The Conference Board of Canada, 2007.

Canadian SMEs and Globalization: Success Factors and Challenges, Ottawa: The Conference Board of Canada, 2008.

Canada ranked in the bottom group—a “D” grade in the 1990s and 2000s. The key to understanding Canada’s “D” grade is to compare how its outward FDI performance stacks up against that of its competitors. Canada’s share of global outward FDI fell from a high of 11 per cent in 1983 to 4.5 per cent in 2008. Yet its share of world outward FDI in 2008 was still 2.3 times its share of world GDP, which means it was playing a larger role in outward FDI than its economic size would warrant.

So why does Canada not earn an “A” on this indicator? The answer is simple: Other countries are doing relatively better. Denmark—the top performer in 2008—accounted for only 0.3 per cent of global GDP but 1.6 per cent of global outward FDI.

The U.S. earns a “D” on the Outward FDI Performance Index. Why? Because the U.S. accounted for 21 per cent of world GDP in 2008 and only 16 per cent of global outward FDI.

For more on long-term FDI trends:

Trends in Foreign Direct Investment and Mergers and Acquisitions: International and Canadian Performance and Implications, Ottawa: The Conference Board of Canada, 2008.

For more on the role of foreign affiliate sales that are enabled by outward investment:

Canada’s “Missing” Trade With Asia, Ottawa: The Conference Board of Canada, 2008.

The geographic pattern of Canada’s stock of foreign investment in other countries has changed over the past two decades. While the U.S. remains the most important single destination for Canadian outward FDI, its share declined from 66 per cent in 1987 to 49 per cent in 2008.

Europe’s share increased from 17 per cent of Canadian outward FDI stock in 1987 to 24 per cent in 2008. The U.K. is the second most attractive location for Canadian FDI.

Barbados is the third-largest destination for Canadian FDI, mostly in financial services.

Canada is still not taking enough advantage of opportunities outside traditional North American and European countries. For example, Canada’s stock of FDI in China represents less than 0.6 per cent of its overall FDI abroad.

For more on Canada’s limited engagement and weak growth in regional and global supply chains:

Stuck in Neutral: Canada’s Engagement in Regional and Global Supply Chains, Ottawa: The Conference Board of Canada, 2008.

Canada’s outward FDI in 2008 was mostly oriented to services, particularly the finance and insurance industry. In 2008, 50 per cent of the total FDI stock Canada held in foreign countries was concentrated in this industry—a large increase from 1983 when the share was 15 per cent.

The energy and minerals industry accounts for the second-largest amount of Canadian outward FDI. Over the past quarter century, Canada’s share of total outward FDI in this industry has dropped, from 34 per cent in 1983 to 23 per cent in 2008.

Outward FDI is sometimes accused of causing job losses by shifting investment offshore.

However, with trade liberalization and the rise of global supply chains, FDI has increasingly become a much sought-after means of generating wealth and stimulating trade—in both directions. Canadians should be not only attracting more FDI into Canada but also doing more to facilitate growing outflows of FDI. In other words, international opinion has shifted significantly; the perceived benefits of FDI are now seen as far outweighing its drawbacks. This is fundamentally changing the way we look at trade and investment, as well as the relationships between them. Indeed, in future we should perhaps speak less in terms of “international trade and investment”—and more about “international investment and trade.”

¹ UNCTAD, “Global FDI in Decline Due to the Financial Crisis, and a Further Drop Expected,” UNCTAD Investment Brief, Number 1, 2009.

² Statistics Canada, Canada’s Balance of International Payments, Fourth Quarter 2008, Catalogue no. 67-001-X.

See discussions on other indicators
Income Per Capita	Unemployment Rate
GDP Growth	Employment Growth
Labour Productivity Growth	Inward FDI Performance Index
Inflation	Outward FDI Performance Index