Global Boom, Infrastructural Investment in Emerging Countries, and the Role of Multinational Corporations

Notes present short pieces which are research-based, experience-based, or idea-based. Global Boom, Infrastructural Investment in Emerging Countries, and the Role of Multinational Corporations Rahul Bishnoi Infrastructure deficiencies in emerging countries mean potential investment opportunities. In this note, Rahul Bishnoi examines the nature of opportunities in this sector and discusses the role multinationals can play. Rahul Bishnoi is a member of the faculty in the Banking and Finance Department, Hofstra University, Hempstead, New York, USA. In many emerging countries, an estimated one billion people do not have access to clean water, do not have sufficient sewage treatment, have deficiencies of electricity, roads, airports, and telecommunications. Many countries around the world lack an appropriate infrastructure to enable their economies to grow (Savona, 1995). For multinational corporations (MNCs), infrastructure deficiencies in emerging countries mean potential investment opportunities for companies of all sizes and in all types of industries. Consider the statistics. Though between 1981 and 1994 some emerging countries have been struggling (e.g. the debt crisis in Latin America in the 1980s and the recessionary period in Eastern Europe in the early 1990s), it is estimated that the Gross Domestic Product (GDP) growth for the developing (emerging) world will increase from 2 per cent in 1994 to 5 per cent per year between 1995 and the year 2000. In Asia, considered the fastest growing market, it is estimated that GDP growth will be an approximate 7.7 per cent per year. Compare this statistic with that of the industrialized nations (the developed nations), whose aggregate GDP growth is estimated to expand less than 3 per cent (Economist, 1995). The possible returns for investment projects in emerging markets for MNCs, who have an expertise in an industry and the capital resources, can be considerable. Global Boom The force that is driving infrastructure spending is the liberalization of trade and investment throughout the world. Emerging countries recognize that in order to modernize their economies and compete in the world market, they need to attract foreign direct investment. Foreign direct investment involves the investment of financial capital in a different country from that of its owner, with the intent of controlling the real assets, resulting from the investment of this capital (Shapiro, 1992). If a country does not have a power source that is reliable, the phones do not work, the water dries up, it is impossible that goods can be moved around. This inadequate infrastructure would be detrimental to the ability of a country to attract foreign direct Vol. 25, No. 1, January-March 2000 81 oped world (See Exhibit 2 which shows the difference in foreign direct investments between 1980 and 1994). investment needed for its further development. Exhibit 1 displays the reasons why emerging countries need to spend more on infrastructure. Notice the low-income economies coverage of the five sectors in 1990 is lower than middle-income economies in 1990, and considerably lower than the high-income economies coverage in 1990. All five sectors for the emerging economies need improvement, especially the telecommunications sector. Need for Infrastructural Investment Infrastructure spending is at the heart of growth in the emerging markets. It is estimated that investments in power generation, transportation, telecommunications equipment, etc. are likely to add up to $1 trillion by the end of the decade (Radosevich, 1995). The possibilities are enormous for US, European, and Japanese manufacturers of capital goods, who can mitigate the cyclically of sales in their home market, by increasing sales overseas. For example, US steelmakers anticipate weak domestic sales and are planning on exporting a significant amount of their products. Governments of emerging nations recognize that infrastructure investments are often backed by operating revenues they generate. Therefore, they are giving infrastructure spending projects top priority. In fact, the ever-close integration of national economies has been associated with soaring foreign investment. Stock of foreign-owned assets in developing countries increased more than five-fold between 1980 and 1994 (Economist, 1995). At the end of 1994, the stock of foreign-owned investments topped $580 billion though the amount is still considerably less than the develExhibit 1: Reasons for Emerging Countries' Sector Power-generating Capacity (thousand kilowatts per million persons) Low-income Economies Coverage 1975 1990 41 53 Telecommunications (main lines 3 per thousand persons) Sanitation (percentage of 23 population with access) Paved Roads (kilometres 308 per million persons) Water (percentage of 40 population with access) Source: World Bank. 82 Singapore, considered to have the world's fourth largest forex trading centre, has an extensive infrastructure, and subsequently has been a magnet for foreign investors in the past 15 years (Exhibit 3). By 1994, its stock of foreign direct investment reached $60 billion dollars. Compare Singapore with the excommunist countries that have attracted very little foreign direct investment because of their inadequate infrastructure (Euromoney, 1994). Singapore's success and competitive edge in acquiring foreign direct investment as a country can be attributed to a number of factors. The main ingredient to its success is its level of infrastructure. Those MNCs who are interested in performing business in Singapore will discover that Singapore's infrastructure is well-developed, efficient, and costeffective, which consequently reduces the risk of conducting business there. This explains why Singapore has the fourth largest foreign exchange market in the world (Euromoney, 1994). Lastly, to win the intense competition for infrastructure business, MNCs need both the experience and reputation in order to successfully negotiate and acquire business contracts. GMO International won a contract to build a Hong Kong Airport, because the company understood the particular problems of that specific airport, and was able to communicate its expertise through its experience and reputation. Another important factor in winning a contract is to provide not only technical expertise but total project service. The most important service being financing, Need to Spend More on Infrastructure Annual Percentage Increase Middle-income Economies Coverage Annual Percentage Increase High-income Economies Coverage 1975 1990 1990 1.6 175 37 34.7 2100 6 3.2 33 81 5.6 442 42 3.8 44 68 2.7 95 396 1.6 1150 1335 0.9 10106 62 2.7 54 74 2 95 Vikalpa Exhibit 2: Foreign Direct Investment ($bn) 1980 1994 Developed Countries Developing Countries Source: UNCTD. in order to raise funds for the projects, providing financial services is a major advantage for US MNCs because the US has the world's "largest and deepest" capital markets. In fact, Merrill Lynch is involved with financing the Three Gorges Dam Project (Savona, 1995). A recent survey by Ernst & Young revealed that 74 per cent of 1,000 US, European, and Japanese MNCs have cited inadequate infrastructure as a top barrier for investing in emerging countries. Simply stated, Exhibit 3: Inward Foreign "Countries that do not have adequate infrastructure will not take part in the economic boom" (Savona, 1995). The potential for MNCs investing in emerging markets could be substantial, especially if their own domestic economies have little or no growth. The possibility that the economic boom could be offset by a world recession is highly unlikely Previous world-wide economic expansions and contractions have often acted in lockstep. The current world economic boom though is likely to prove durable, Direct Investment ($bn) 1994 1980 Sirgapo re 10 20 30 Source: UNCTD. Vol. 25, No. I, January-March 2000 83 because economic business cycles seem to be more independent of one another. US, Europe, and Japan, for instance, have followed out of the recessions at different times. The US slid out of the recession in the summer of 1990, but the economies of Europe and Japan did not enter a recessionary period until mid1992, a year after the US economy was on the upswing (Richman, 1995). Studies by the World Bank have shown that the amount that is invested in infrastructure is influenced by the rapidity with which the economy and per capita income is growing. This is especially true in Asia, which has an estimated 65 per cent of the biggest international projects. It is projected that Asia will spend between $500 billion to $1 trillion in infrastructure development by the year 2000 (Lii, 1996). China, with its 1.2 billion of the world's population, is one of the world's fastest growing economies, but its infrastructure has been compared to pre-World War II America (Lii, 1996). For these reasons, China has been the centre of infrastructure building. Consider Shanghai, the symbol of new China, whose urban transformation has created modern tower blocks, expressways, high-tech parks, workers' housing developments, and new corporate headquarters. The city is described as "Rich, Big, Modern, and Flashy." Shanghai is the showcase of China's economic revolution. Subsequently, some experts have predicted that Shanghai could overtake Hong Kong as the new economic hub of China. For these reasons, 28 of the world's top MNCs have set up offices in Shanghai (Buruma, 1996). Two projects that are currently being undertaken by the US MNCs in China are the AES Corporation of Alexandria, Va, which is working on a $1.5 billion upgrade on the Yancheng Power Plant and AT&T, which has a $150 million contract to provide gateway switches to the telecommunications authority in South China (Savona, 1995). Investment in China and in other developing nations has many potential risks. There are business risks and economic/financial risks that MNCs need to be aware of before investing in a foreign investment project. For example, China has had a considerable amount of political uncertainty, involving Chinese nationalism, and economic risks, involving its state bureaucracy. Another potential risk that MNCs need to be aware of are exchange rate and credit risks. Credit risks have been profound in markets of Latin America. In fact, many international investors are skeptical about investing in certain economies, like Mexico, especially after the peso crisis. 84 Foreign direct investment is an issue for many of the recipient governments, because of their fear of loss of sovereignty, especially in a high-technology industry, which are often state-owned and controlled. To reduce political uncertainty, many governments in emerging countries are privatizing sectors of their infrastructure industries. For MNCs, privatizing of state-run business means that they can form more effective joint ventures because privatization shifts control away from the state bureaucrats to business executives. This, in effect, increases the guarantee that an MNC will get returns, since government monopolies are viewed as stumbling blocks to infrastructure development (Savona, 1995). Therefore, countries that have state-controlled industries will receive less foreign direct investment. It comes as no surprise that infrastructure-related privatization in developing countries has increased from $431 million in 1988 to $6.5 billion in 1992, according to the World Bank. Consequently, the amount of inward foreign direct investment to developing countries has increased over the same period. The estimate of such inflows for 1994 was $80 billion or 39 per cent of the total world foreign direct investment. If the present trend continues, the third world will have exceeded the developed world in the percentage of foreign direct investment in three or four year's time (UNCTAD, 1995). For example, American telecommunication companies in Russia are overhauling the Russian telecommunication system at an estimated cost of $40 billion. Involved in the project are large US firms, like US West, and smaller firms, like Andrew Corporation. Exhibit 4 shows the value of privatization in the developing countries by sector (Savona, 1995). Competition has become so fierce for infrastructure projects in the developed world that many US companies are getting financial help from governmental agencies like Export-Import Bank (EXIM), through loans and grants, in cases where other countries do the same. Support has also come from the White House. Former US secretary of Commerce, Ron Brown, made frequent trips overseas to increase business for US firms. In 1995, during his trip to India, he won $1 billion worth of contracts, which included a $100 million telecommunications project for US West (Savona, 1995). Many infrastructure projects are big and ambitious. In Japan, where land is scarce, a man-made island, Kansia, was built for an airport. The 31-mile tunnel underneath the English Channel, "The Channel," was built to connect England and France, and Vikalpa now there is a proposed project to build tunnels through the Alps, to connect high-speed trains between Northern and Southern Europe. The Three Gorges dam in China, which is part of a $176 billion Yangtze investment plan, includes an airport, railroads, and a nuclear power station (Savona, 1995). 1982 statistics and between developed countries versus developing countries. There was significance found for non-policy variables such as political stability, cultural distance, GDP per capita, and importantly for this paper, infrastructure (Loree and Guisinger, 1995). Case in Point: NYNEX Corporation in Thailand The Department of Commerce had gathered information on investment incentives and performance requirements for two of its Benchmark Surveys (1977 and 1982). The surveys contained data that were compiled from reports of every US organization that had a foreign affiliate. An organization has a foreign affiliate if it has direct or indirect ownership or control of 10 per cent or more of the voting securities of an incorporated foreign business enterprise (Loree and Guisinger, 1995). A specific example of a company that invested in the developing world and was faced with a high degree of political uncertainty was NYNEX. The NYNEX Corporation was looking for investment opportunities outside the US. Nynex's management concentrated on countries that met their international investment criteria — strong economic growth and a propelled need for telephone infrastructure. A country that met the investment criterion was Thailand. Thailand's GDP in 1992 was growing by 10 per cent a year, but the country had only three phone lines per 100 people, while the Thai government wanted ten phone lines per 100 people by the year 2000. In 1992, Nynex was negotiating a 15 per cent stake in a joint venture to build two million phone lines in Thailand, when a political coup broke out. The company decided to move ahead with the project mainly because its majority partner in Thailand, Charoen Pokephand Group (CP), pointed out to Nynex that Thailand had endured several coups in the past two decades, and that economic growth continued each time. That risk paid off for Nynex. Nynex's $470 million investment in Thailand is now worth about $1.2 billion. Subsequently, a year after the initial investment, the partnership went public, had a market capitalization of $8 billion, and is currently one of the "best-heeled" carriers in Asia (Arnst, 1995). Effects of Infrastructure on Foreign Direct Investment Theoretical and empirical research studies have been performed by academics to determine whether or not a country's present infrastructure has an impact on the inflow of foreign direct investment. Loree and Guisinger (1995), studied the effects of policy and non-policy variables on the location of new US direct investment abroad using 1977 and 1982 Benchmark data. The data revealed statistically significant effects for incentives (positive), performance requirements (negative), and host country effective tax rates (negative) with differences between 1977 and Vol. 25, No. 1, January-March 2000 Non-policy variables included purely geographical advantages (mineral deposits, land mass, etc.), and all variables that are not considered subject to governmental manipulation. More specifically, non-policy variables in the analysis of US foreign direct investment flows included the measures of political stability, cultural distance, infrastructure levels, GDP per capita, and wage rates (Loree and Guisinger, 1995). For this paper, only the effects of infrastructure levels on US foreign direct investment flows will be discussed. Table 1 shows the countries used in the analysis. Table 1: Countries Used in the Analysis Developed Countries Developing Countries Australia Luxembourg Argentina Liberia Austria Belgium Canada Denmark France Germany Netherlands New Zealand Norway Portugal South Africa Spain Bahamas Bermuda Brazil Chile Colombia Ecuador Libya Malaysia Mexico Nigeria Panama Peru Greece Ireland Italy Japan Sweden Switzerland Turkey United Kingdom Egypt Hong Kong India Indonesia Iran Israel Philippines Singapore South Korea Taiwan Thailand Venezuela Source: Loree and Guisinger, 1995. Previous studies of foreign direct investment flows had used different proxies for the measurement of infrastructure within a country, including GNP per capita, the ratio of commerce, transport, and communication to GDP and the change in the percentage of GNP devoted to transportation. While these indirect 85 measures were deemed useful, Loree and Guisinger developed an indicator for infrastructure. The measures for the indicator are shown in Table 2. Table 2: Infrastructure Factor Analysis Countn/ Characteristics Circulation of daily newspapers Number of televisions Number of television stations Number of radios Kilometres of paved highways Civil air traffic-passenger kilometres flown Number of airports with runways > 1220 metres Number of usable airports Square kilometres of land area Permanent surfaced runways Kilometres of paved highways per capita Kilometers of paved, gravel, and unimproved highways GNP growth Number of daily newspapers World Atlas* rating of international and domestic telephone service ____________________________________________ Source: Loree and Guisinger, 1995. ""The World Atlas is a software program that combines information from governmental, United Nations, and industry sources for each country. Though the data combined information on country geographical size and/or market, emphasis was placed on collecting data on countries' communication and telecommunication infrastructure. The results of the study concluded that communication and transportation infrastructure variables have a significant influence on foreign direct investment levels. Therefore, the amount of infrastructure existing in a country does influence the flow of US Direct investment Loree and Guisinger had concluded their study, by stating that policy variables like tax incentives were important to governments because they could be altered more quickly than non-policy determinants like market size and infrastructure. But a dollar spent on incentives does not have a higher return in the form of increased foreign investment for a country than a dollar spent on infrastructure (Loree and Guisinger, 1995). Foreign direct investment is attracted to areas with efficient infrastructure except when the natural resource base is very large. In the manufacturing industry, countries that have to compete in the world markets increasingly require excellent transportation, power sources, and communication. The importance of infrastructure is significant for governments aiming to obtain long-term employment generation needed for long-term economic growth (Lall, 1995). Conclusion Both empirical research and present day examples of countries like Singapore demonstrate the importance of having an adequate infrastructure for increasing the inflow of foreign direct investment. For developing countries, having an adequate infrastructure is paramount if they want to increase the amount of foreign direct investment that is flowing into their countries, which should ensuingly increase their economic growth. Consequently, the increase in infrastructure privatization explicitly shows that many developing countries are aware of this fact. For US MNCs, the return for infrastructure investment projects in the emerging countries could be substantial, as long as they account for the business and financial risks that accommodate such projects. Exhibit 4: Infrastructure Privatization in Developing Courntries HSeries1 Series2 SeriesS Series4 SeriesS 86 Source: World Bank. Vikalpa References Arnst, Catherine (1995). "Nynex's Excellent Adventure in Thailand," Business Week, September 18, p 102. Buruma, Ian (1996). "The 21st Century Starts Here," The New York Times Magazine, February 18, p 3. Lii, Jane H (1996). "Boom-at-a-Glance," New York Times Magazine, February 18, pp 26-27. Loree David W and Guisinger, Stephen E (1995). "Policy and Non-Policy Determinants of US Equity Foreign Direct Investment," Journal of International Business Studies, Second Quarter, pp 281-299. Economist, (1995). "Financial Indicators," December 16, p 97. Radosevich, Lynda (1995). "Third Wave/Third World," Forbes, December 4, pp 64-65. Economist, (1995). "Emerging-market Indicators: Investing Abroad," December 23, p 126. Richman, Louis S (1995). "Global Growth is on a Tear," Fortune, March 20, pp 109-114. Enromoney (1994). 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