The developed world still accounts for 90 percent of global outward FDI flows, but direct investment originating in the South is growing rapidly—rising from $14 billion in 1991 to $83 billion in 2004. The annual outward FDI growth from emerging market economies averaged 27 percent between 1999 and 2004, compared with the developed world’s roughly 11 percent growth rate. According to the United Nations Conference on Trade and Development’s World Investment Report (2005), the total outward FDI from emerging market economies exceeded $1 trillion in 2004, representing 11 percent of the cumulative global stock. The sources have changed over time; Asia has seen a steady and consistent rise in FDI outflows, while the share from Latin America and the Caribbean has fallen. South-North investment has also increased, as multinationals in emerging markets have looked to acquire strategic assets in developed markets.

Four of the five economies with the largest FDI stock are in Asia (Singapore, Hong Kong, China and Taiwan).

The growth of South-South FDI flows has two key consequences. First, emerging countries are becoming more integrated with one another as a result of the activities of Southern multinational corporations (MNCs). Second, these markets are benefiting from improved access to beneficial sources of investment. Data suggests that South-South capital flows are less volatile than North-South flows.

A confluence of factors has led to the increase in South-South FDI. These include reduced capital controls, increased wealth in the emerging world, trade liberalization and regional integration. The World Bank identifies three objectives driving outward FDI from the South: access to resources, access to markets and access to strategic assets.

The desire to secure energy and commodity supplies is behind many investments by MNCs from the South. China and India, in particular, have been competing to gain access to energy resources elsewhere in the developing world, as could be seen in the competition to acquire PetroKazakhstan, bought by China National Petroleum Corporation for $4.18 billion in 2005.

The desire to gain access to markets is also a powerful driver. In many cases, domestic markets have become saturated, so to continue to grow, Southern MNCs have to acquire access to other opportunities. Telco providers and IT companies from the South have leveraged their low-cost structures to tap into demand abroad. Their familiarity with social and cultural factors provides a comparative operating advantage over companies from the developed world. This leads naturally to an intraregional bias of South-South flows, reflecting an underlying competitive advantage that MNCs from the South have over their competitors from the North: the ability to operate effectively in a similar economic environment.

In certain cases, emerging market governments have created incentives for outward FDI via investment insurance, preferential loans or tax breaks. China and Malaysia both offer programs of this nature.

Unlike the motivation for North-South investment, seeking efficiencies has generally been less of a goal. However, this is changing as developing-country MNCs grapple with the need to maintain competitiveness in the face of rising competition from cheaper labor economies, or to offset disadvantageous economic developments such as currency appreciation. These factors drive some of the Korean and Taiwanese investments in China.

Foreign But Familiar
MNCs from the South enjoy a number of advantages when operating in other emerging market economies. These include generally lower cost structures, familiarity with difficulties that are often particular to emerging markets gained from experience operating in their home markets, and their production of items designed for the lower-income markets. Southern MNCs have also tended to invest close to home in markets where there are shared ethnic or cultural ties. But some multinational corporations are beginning to invest further afield: Companies in Latin America and Asia have invested in Africa, and Asia and Latin America are also swapping investment capital.

In terms of sectors, South-South FDI flows have been dominated by infrastructure and extractive industries. Southern MNCs have also been expanding in the telecom sector, with Mexican, Russian and Egyptian companies acquiring assets abroad.

TOP VIEW Historically, foreign direct investment has flowed from North to South. But that direction is changing. Emerging market multinationals of the South are investing in other Southern economies, many of which share similar challenges and opportunities. Some Southern multinationals are also reversing the historical flow of FDI, investing in the North in their quest to capture coveted skills, brands and production facilities.

There are a number of reasons why the extractive sector has led the process. First, state-owned oil companies in emerging market economies have access to reserves that can provide a natural source of long-term comparative advantage. There has also been a stimulus to acquire access to supplies of energy and other raw materials to fuel rapid economic growth and industrialization in markets like China and India, which are net importers of oil. This has created a need to look abroad to secure resource access.

MNCs in Korea, Malaysia, Singapore and South Africa have a well-established track record of investing abroad. Companies in others countries, including Chile, Mexico, Brazil, China and India, have emerged as players more recently. Geographically, outward FDI from emerging market economies is now concentrated in Asia. Hong Kong has a higher FDI/Gross Fixed Capital Formation (GFCF) ratio than most developed countries. Taiwan has a higher FDI/GFCF ratio than the United States, Germany and Japan; its FDI mostly flows to China. Chile and Malaysia have ratios higher than Germany and Japan. Four of the five economies with the largest FDI stock are in Asia (Singapore, Hong Kong, China and Taiwan), the other being Brazil. These five economies account for more than 70 percent of the total FDI stock from the South.

Total foreign assets of the top 50 MNCs from the South climbed to $249 billion in 2003 from $195 billion in 2002. The five largest MNCs accounted for almost half of the total assets of the top 50. Hutchison Whampoa of Hong Kong was the largest Southern MNC and alone accounted for 25 percent of the total foreign assets held by the top 50. Asia dominated the top 50 with 39 enterprises. The other 11 companies are from South Africa, 4; Mexico, 4; and Brazil, 3. Singapore and Hong Kong were the most important home economies, with nine and 10, respectively, of the top 50 MNCs ranked by outward FDI. Taiwan had eight.

Southern multinationals have also been acquiring assets in the developed world. This is evident in the recent acquisition of brands and distribution capability, in particular by Chinese producers. Chinese corporations TCL and Lenovo have acquired IBM, RCA and Thompson brands, allowing them to short-circuit the lengthy brand- and loyalty-building process that companies in Japan and Korea had to go through to increase global market share.

Southern MNCs have also invested to gain access to production facilities or, in some cases, complete businesses from production through to distribution capabilities. Mexican cement giant Cemex’s purchase of UK-based RMC Group, another cement manufacturer, in 2005 was one such landmark transaction for a company from the South. Brazilian brewer AmBev’s acquisition of Labatt in Canada and South African brewer SABMiller’s purchase of a number of beer companies in developed markets are other examples of companies acquiring and building global brands. Russian natural gas company Gazprom raised concerns in the UK last spring with its interest in UK gas utility Centrica.

There have also been a number of investments by MNCs in R&D in the North to access technologies and knowledge to strengthen competitiveness and move up the production value chain. Indian IT firms have been active in this, investing in a number of developed markets. Even so, in net terms, the flow is still in the other direction, and India and China have been important beneficiaries of Northern investment in R&D.

Costs and Benefits
The impact of rising outward FDI on home markets in the South will depend on a range of factors, including whether the outward FDI is a substitute for, or complement to, domestic production, and whether the economies can leverage technological and managerial transfers from abroad. When the process is complementary, the home market is likely to gain on the employment front, and there should also be some positive spillover to fiscal performance. The reverse will be true for FDI that substitutes for domestic production. It is still too early to assess fully the implications of the upsurge in outward FDI.

There have been a number of investments in R&D in the North to access technologies to strengthen competitiveness.

Japan’s experience provides some insight, although it is not fully comparable due to the large difference in cost structures between Japan and the emerging markets in which it invests. In most instances, its outward FDI has substituted for domestic production. The so-called hollowing out of Japan’s manufacturing sector began after the first Plaza Accord in 1985, when the yen shot up in value against the dollar, undermining the profitability of domestic manufacturing. Since then, there has been a steady rise in the share of manufacturing produced overseas as a result of Japan shifting lower value-added activities abroad while keeping those with higher value-added and intellectual property content at home. This process has generally been good for corporate profitability and the real purchasing power of Japanese residents, but it has had negative implications for employment and domestic demand. There has been a declining trend in manufacturing employment since the early 1990s, and the share of manufacturing in total employment has dropped sharply. There have also been knock-on effects as the advantages of industrial clustering are lost.

Korea is another case in point. Inflexible labor laws make it particularly attractive for companies there to build new capacity in China rather than at home, and its domestic fixed capital formation grew slowly last year despite a rebound in overall economic growth. As in Japan, the strength of the currency is also an important driver of capital reallocation in Korea.

In Taiwan, the government has adopted what has been called a "go slow, be patient" investment policy toward China. Taiwan enforces quite strict rules on how much a company can invest on the mainland and requires approvals for any investment in advanced or tech-heavy sectors. Even so, it is inevitable that Korean and Taiwanese manufacturing will continue to shift to China, facilitating further progress on cost reduction and boosting South-South flows.

Philip Poole is head of research and chief economist for Global Emerging Markets at HSBC in London.