World Bank Document

9 Direct and portfolio investment
Throughout most of the twentieth century, direct nology and management, both of which can
investment has been an important source of capi- increase the productivity of the capital. In addital,
technology, and expertise for countries in the tion, like portfolio investment, direct investment
process of development. In the early years of the shares in both the risks and rewards of each particcentury,
foreign investors built railroads and elec- ular project. The financial value of direct investtric
power systems and invested in plantations and ment therefore normally understates its overall
mines to produce for export markets. Later, direct benefits to the recipient country.
investment in manufacturing industries and ser- Direct investment and other types of foreign
vices became more common. Portfolio investment, capital are not necessarily substitutes; indeed, they
in contrast, is a relatively new phenomenon that often complement each other. For example, only
has only assumed significance with the growth of about 60 percent of the external finance for the
large public companies in developing countries Latin American subsidiaries of American compaand
the emergence of local stock markets. Direct nies has come from their parent firms. The rest has
investment normally involves an ownership inter- come from commercial banks (both local and forest
and an effective voice in the management of an eign) and trade credit. Roughly three-quarters of
enterprise, while portfolio investment entails a all the borrowing done by those subsidiaries has
share in ownership but no significant influence been in the form of trade credit. Other forms of
over the enterprise's operations. international capital-such as bilateral and multi-
Many developing countries have recently made lateral aid-have also facilitated direct investment
policy reforms that, among other things, give more by helping to create investment opportunities and
scope for private sector activities. They have also by financing essential infrastructure.
become more receptive to foreign direct invest- The bulk of direct investment is done by a relament
as lending by banks has declined. In the light tively small number of large firms. The 380 largest
of these changes, this chapter examines whether transnational corporations had foreign sales of
equity forms of investment can expand to provide about $1,000 billion in 1980, almost $3 billion a
a larger amount of capital to developing countries. firm. They are usually attracted to invest abroad by
It concludes that equity investment is beneficial to a country's natural resources or its favorable ecodeveloping
countries and can be increased, but nomic environment; occasionally they are also
that it is largely a complement to commercial bank attracted by the special inducements offered by
lending, not a substitute for it. Because it is nar- host countries.
rowly concentrated in countries and sectors, its One common motive for a company to underpotential
for expansion is limited. To maximize take foreign investment is a threat to an existing
that potential, developing countries need policies export market. The threat might come either from
that promote trade, plus a stable economic and the actions of a competitor or from measures
political environment that does not discriminate restricting the market to local producers. The only
against foreign investment. For their part, indus- way to avoid the trade barriers is to be inside them.
trial countries can support direct investment in Companies are also keen to invest abroad when
developing countries by liberalizing their own there are clear cost advantages from doing so.
trade and investment policies.
Direct investments in manufacturing and services
are often made by firms with some kind of special
The nature and role of direct investment advantage that is best utilized by maintaining
management control of operations in foreign coun-
Unlike commercial bank lending, direct invest- tries. Such advantages may be a superior product
ment provides finance as part of a package of tech- or production process, or a product that the for-
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