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       *Columbia FDI Perspectives*
Perspectives on topical foreign direct investment issues by
the Vale Columbia Center on Sustainable International Investment
No. 122   May 26, 2014
Editor-in-Chief: Karl P. Sauvant ([log in to unmask])
Managing Editor: Shawn Lim ([log in to unmask])
       *The rise of FDI income, and what it means for the balance of
payments of developing countries*
Miguel Pérez Ludeña* <#1463ea6e924f4e1b__edn1>

Multinational enterprises (MNEs) multiplied their profits made in
developing countries by four between 2002 and 2011 (at current prices).[1]
<#1463ea6e924f4e1b__edn2> In Latin America and the Caribbean, they rose
from US$20 billion in 2002 to US$113 billion in 2011. The growth rate has
been even higher in Africa and China, but much lower in developed countries.
[2] <#1463ea6e924f4e1b__edn3> This rise is explained by an increase in FDI
stock in developing economies and the higher average profitability of MNEs.

Companies investing in services and manufactures for the domestic market
have benefited from high growth rates across developing regions, which has
boosted domestic demand for modern goods and services. Companies in the
natural resources sector have enjoyed high commodity prices. Conversely,
MNEs in export-oriented manufacturing saw their profits grow at a much more
modest rate. Overall, high rates of return on existing investments are a
sign of success and will likely lead to more FDI inflows into developing
countries. At the same time, FDI income generated in Latin America is now
almost as large as FDI inflows into Latin America, meaning that the
activities of MNEs can no longer balance a current account deficit as they
did in the 1990s. This has been the case for several years in Latin America
and the Caribbean as a whole, as well as in many other developing economies.
[3] <#1463ea6e924f4e1b__edn4>

FDI is now the largest external liability in developing countries and also
the largest contributor to debits in their income accounts. FDI income is
now higher than portfolio or other investment income and one of the largest
items in the balance of payments as a whole. Between 2008 and 2011, FDI
income originating in Latin America was almost double the surplus in goods
trade. In other words, the profits of MNEs are a major determinant of the
external constraint for the economies of Latin American and other
developing countries, and could play a major role in any potential
balance-of-payments crisis, as loans and portfolio flows have in the past.

However, some characteristics of FDI income will attenuate its negative
impact during a potential crisis. To start with, FDI inflows are much less
volatile than portfolio and other investments and very rarely turn negative
during crises. Second, FDI income expands with economic growth, but
contracts during downturns, producing a counter-cyclical effect on the host
country economy. The same events that could trigger a balance-of-payments
crisis, such as a sudden drop in the price of exports, are likely to reduce
FDI income outflows as well.

In Latin America, mining has generated the largest part of FDI income over
the past decade, but FDI in market-seeking activities may have a larger
impact on the balance of payments, as they do not generate exports that can
compensate for FDI income. This is notably the case in Brazil, where most
FDI income is generated in services and manufacturing for the local market.
On the other hand, FDI income generated in activities for the local market
will fall if the exchange rate depreciates.

Policies for restricting capital outflows normally target portfolio
investments, but given the high level of FDI income, some governments may
need to consider measures to restrict FDI income repatriations as well
during times of crisis. So far, very few countries have done so—and those
that have done so have used informal mechanisms—but more could be done to
impose restrictions in the future. Before doing so, however, governments
have a range of other options, such as trade policy, exchange rate
manipulation or directly raising taxes on the profits MNEs make in their
jurisdictions. But governments’ ability to raise taxes may be limited if
they have granted certain tax advantages to foreign investors. A material
rise in tax rates can also push some MNEs to move their profits abroad, for
example, through transfer pricing.[4] <#1463ea6e924f4e1b__edn5>

The notable rise in FDI income in developing countries has followed—with
some lag—the rise in FDI flows to these economies. This should be a
reminder that FDI is a financial liability that needs to be repaid. It
remains a powerful instrument to change a host country’s production
structure and raise productivity, but not to alleviate external imbalances
over the long term.

* <#1463ea6e924f4e1b__ednref1> Miguel Pérez Ludeña ([log in to unmask])
is an economist at the United Nations Economic Commission for Latin America
and the Caribbean (ECLAC), where he covers FDI in the region. The author is
grateful to Khalil Hamdani, Jose Antonio Ocampo and Padma Mallampally for
their helpful peer reviews. *The views expressed by the author of this
Perspective do not necessarily reflect the opinions of Columbia University
or its partners and supporters. Columbia FDI Perspectives (ISSN 2158-3579)
is a peer-reviewed series.*
[1] <#1463ea6e924f4e1b__ednref2> Profits of foreign affiliates are
accounted in the balance of payments as FDI income; 89% of them are profits
on equity investments, while the remaining 11% are interest income on debt
between fellow enterprises. Of the former, a little less than half are
reinvested in the same affiliate, while the rest is repatriated.
[2] <#1463ea6e924f4e1b__ednref3> For more data and other analysis related
to Latin America, *see* ECLAC, *Foreign Direct Investment in Latin America
and the Caribbean 2012* (Santiago: ECLAC, 2013).
[3] <#1463ea6e924f4e1b__ednref4> FDI income credit (profits that national
companies make abroad) has also grown across the developing world, but in
Latin America, it still amounts to only 14% of the debit and is
concentrated in a handful of countries.
[4] <#1463ea6e924f4e1b__ednref5> *See* OECD Centre for Tax Policy and
Administration, “Base erosion and profit shifting,”

       *The material in this Perspective may be reprinted if accompanied by
the following acknowledgment: “Miguel Pérez Ludeña, ‘**The rise of FDI
income, and what it means for the balance of payments of developing
countries**,’ Columbia FDI Perspectives, No. 122, May 26, 2014. Reprinted
with permission from the Columbia Center on Sustainable Investment
( <>).” A copy should
kindly be sent to the Columbia Center on Sustainable Investment at
[log in to unmask] <[log in to unmask]>.*
For further information, including information regarding submission to the
*Perspectives*, please contact: Columbia Center on Sustainable Investment,
Shawn Lim, [log in to unmask] or [log in to unmask]

The Columbia Center on Sustainable Investment (CCSI), a joint center of
Columbia Law School and the Earth Institute at Columbia University, is a
leading applied research center and forum dedicated to the study, practice
and discussion of sustainable international investment. Our mission is to
develop and disseminate practical approaches and solutions, as well as to
analyze topical policy-oriented issues, in order to maximize the impact of
international investment for sustainable development. The Center undertakes
its mission through interdisciplinary research, advisory projects,
multi-stakeholder dialogue, educational programs, and the development of
resources and tools. For more information, visit us at

*Most recent Columbia FDI Perspectives*

   - No. 121, Karl P. Sauvant and Victor Z. Chen, “China needs to
   complement its “going-out” policy with a “going-in” strategy,” May 12, 2014.
   - No. 120, Jeremy Caddel and Nathan M. Jensen, “Which host country
   government actors are most involved in disputes with foreign investors?”
   April 28, 2014.
   - No. 119, Rainer Geiger, “The Transatlantic Trade and Investment
   Partnership: A critical perspective,” April 14, 2014.
   - No. 118, Peter Nunnenkamp, Wan-Hsin Liu and Frank Bickenbach,
   “Regional concentration of FDI involves trade-offs in post-reform India,”
   March 31, 2014.
   - No. 117, Rudolf Adlung, “Multilateral investment disciplines: Don’t
   forget the GATS!” March 17, 2014.

*All previous FDI Perspectives are available at *
*. *

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