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We Cannot Afford To Spurn the Emerging Investors

Author: Matthew J. Slaughter, Adjunct Senior Fellow for Business and Globalization
January 3, 2010
Financial Times

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Last month China's Geely settled commercial terms to buy the Sweden-based Volvo division from Ford of the US. If this deal receives government approval, it will become the latest in a series of acquisitions reshaping the global automobile industry. Over the past year, Beijing Automotive (BAIC) has bought platforms and technologies from General Motors' Saab unit, Sichuan Tengzhong has proposed a purchase of the GM Hummer division and Ford has sold Jaguar and Land Rover to Tata of India.

Taken together, these transactions demonstrate two significant facts about international investment that carry two cautionary lessons for leaders in business and government. The first fact is the rise of foreign direct investment from developing into developed countries. For generations, FDI flowed overwhelmingly between rich countries. But recent years have seen surging FDI outflows from multinationals based in developing countries. FDI arising from the four "Bric" nations (Brazil, Russia, India and China), Indonesia and South Africa averaged about $10bn a year in the decade to 2003 but had climbed to $121bn by 2008.

Two forces are driving this secular rise. One is sustained, rapid economic growth in developing countries. This has fostered new world-class companies that are now expanding abroad to serve larger and richer markets. The other force is the continuing pattern of global imbalances. Several developed countries remain in chronic current-account deficit, most notably the US. Offsetting current-account-surplus countries now include several developing countries such as China and oil exporters. Some of the asset purchases of these new surplus countries are taking the form of FDI.

The second fact is that M&A activity, not greenfield investment, is by far the predominant method by which multinationals undertake FDI. In the past decade, M&A transactions have accounted for about 75 per cent of global FDI inflows. The share is even higher in many advanced economies. The benefits of FDI via M&A can include quick presence in new markets, immediate cost-reducing synergies and ready access to technologies and managerial talent.

The Geely transaction thus underscores that global FDI today arises increasingly from new sources and overwhelmingly via M&A transactions. For leaders of companies based in developed countries, the lesson is simple - to beware and prepare. Strategic planning for engagement with emerging economies can no longer be confined to opportunities for revenue growth or cost reduction. It now must include something far more challenging: greater competition, even at the most basic level of competition for existence.

Geely demonstrates how quickly this competitive threat can arise. Born in 1986 as a refrigerator manufacturer, it began producing cars in 1998 and first appeared at the Detroit auto show in 2006. Its sales have exploded from 200 in 1998 to a projected 250,000 in 2009. Until recently, it was laughable to think that emerging-market companies could challenge world-class businesses in advanced-technology, mature industries such as automobiles. No longer. Executives in all sectors should today be asking themselves which companies could be their Geely, BAIC, Sichuan Tengzhong and Tata.

For leaders of advanced countries, the lesson is to prepare to resist protectionist calls against acquisitions of their domestic companies by emerging-market multinationals. Unfortunately, many governments were raising new barriers to foreign acquisitions even before the financial crisis and recession. Calls to further protect domestic companies and jobs have grown only louder amid the slow recovery and rising unemployment.

Politicians need to remember the many well-documented benefits of inward FDI: a stable capital inflow, and new companies that tend to create high-paying jobs that involve lots of research and development, capital investment and exporting. Accordingly, to remain attractive locations for developing-country multinationals, leaders should maintain transparent and fair policies for reviewing foreign acquisitions.

Greater FDI can help repair global capital markets and national economies. Geely's deal with Ford is an example of this, with lessons for many.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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