RESTRICTED
WORLD TRADE WT/WGTI/W/16
11December 1997
ORGANIZATION(97-5425)
Original: English Working Group ontheRelationship
between Trade andInvestment
SUBMISSION FROM KOREA
Thefollowing communication, dated 5December 1997, hasbeenreceived fromthePermanent
Mission oftheRepublic ofKorea withtherequest thatitbecirculated toMembers.
_______________
FDI'sEffect onEconomic Development anditsRelationship withTrade
I. INTRODUCTION
1. Worldwide foreign direct investment (FDI) inflows increased approximately seven times in
termsofannualaveragefromUS$49.8billionintheearly1980stoUS$349.2billionin1996.Compared
toanapproximately three-fold increase intheworld trade volume during thesame period, thegrowth
ofFDIinflows issubstantial. Thisisprimarily duetoinvestment liberalization measures taken by
many countries, aswellastotheglobalization ofentrepreneurial activities inareas suchasproduction,
sale,procurement, andR&D.
2. Since the1980s, Korea hasalsobeenliberalizing itsFDIregime byenhancing thetransparency
ofFDI-related procedures andopening more domestic industries toforeign investment. Asaresult,
bothinward andoutward FDIhaveincreased continuously, anditsgrowth ratehasrisen sharply in
recent years. After exceeding US$1 billion in1987, inward FDIshowed adownturn intheearly
1990s duetotheworsening investment environment caused bytheproliferation oflabour strikes, higher
wages andrising landprices. But,in1994, thetrend began toreverse again. Theamount ofinward
FDIreached US$3.2 billion in1996 andattained anevenhigher figure in1997 during thefirstten
months.
Annual Inward FDI
(Unit: US$million)
Year 1987 1990 1993 1995 1996 Jan.-Oct.
1997
Inward FDI 1,063 803 1,044 1,941 3,202 5,843
3. Since thelate1980s, outward FDIhasalsoincreased substantially duetothecurrent
account surplus. Ithaddecreased slightly intheearly 1990s, but,since 1994, ithasshown adrastic
upturn, reaching US$6.2 billion in1996.WT/WGTI/W/16
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Annual Outward FDI
(Unit: US$million)
Year 1987 1990 1993 1995 1996 Jan.-Oct.
1997
Outward FDI 367 1,611 1,876 4,913 6,205 4,829
4. TheWorld Investment Report 1997 published byUNCTAD recognized Korea asoneof
thecountries withahighFDIgrowth. Recognizing FDIasadriving force foreconomic development,
theKorean Government willendeavour topromote it.
5. Thispaper examines theinfluence ofFDIonKorea 'seconomic development andtrade from
the1970s tothe1990s. Through theanalysis ofexisting empirical research thatrelates toKorea 's
experiences, wehopethisexercise willcontribute tothecollective efforts oftheWorking Group towards
adeeper understanding oftheissues involved.
II. EFFECT OFFDIONKOREA 'SECONOMIC DEVELOPMENT
Effects onemployment
6. Itisgenerally accepted thatFDIcreates jobopportunities inthehostcountry, thereby increasing
itsemploymentrate.Inparticular,transnationalcorporationsdirectlygenerateemploymentopportunities
bybuilding factories andhiring workers forproduction andmanagement. According totheempirical
research (1981-1991), Korea 'sinward FDIcreated approximately 24,000 jobs. Thedirect employment
effect inthemanufacturing sector wasmuch larger thanthatintheservice sector: 18,000 jobswere
created inthemanufacturing sector and5,000 jobsintheservice sector.1Thenumber ofjobsdirectly
generated byinward FDIwasequivalent to0.5percentofthetotaldomestic population increase during
thesame period of1981-1991, andtheadded value directly induced byinward FDIamounted to
0.4percentoftheGNP increase. These figures clearly underline thesignificant impact ofFDIon
employment.
7. Moreover, FDIhasindirect employment effects which increase theemployment among related
industries through inter-industry linkages. InthecaseofKorea, theindirect employment effects were
considerable inelectrics, electronics andtransport equipment sectors which traditionally showed indirect
production effects among related industries.
Effects ontechnology advancement
8. Technology development basically occurs intwoways: technology transfer andtechnology
diffusion. Awell-known mechanism oftechnology transfer isajointventure. Jointventures between
transnational corporations andlocalcompanies often include licensing agreements andmanagement,
marketing, andtechnical service contracts withtheforeign partner. Theeffect oftechnology transfer
dependsonthequalityofthetransferredtechnology.Technologydiffusionisthedeliveryoftechnologies
from foreign affiliates tolocalcompanies. Although technology diffusion canbelengthy process, it
contributes tospreading important technological know-how inallsectors oftheeconomy.
1Study conducted bytheKorea Development Bank andtheMinistry ofFinance, 1993WT/WGTI/W/16
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9. Some studies haveaddressed Korea 'sexperience withtechnology development caused byFDI.
Asurvey shows thatconsiderable technology transfer wasachieved inKorea through official channels,
suchasdocument exchange between aparent company anditsaffiliate, dispatch ofsupervisors, and
technology training programmes related tohigh-technology organized onaregular oradhocbasis.2
Results ofaStudy ontheLevel ofTechnology Transferred from FDI
Technology from
Developing CountriesTechnology from
Developed CountriesNoAnswer Total
6 24 10 40
10. According tothissurvey, considerable technological development wascaused bythe
technology diffusion effect. Most foreign affiliates formed networks withlocal companies for
procurement ofparts andrawmaterials, andengaged intechnological assistance forlocalpartners.
Inaddition, workers whoweretrained inadvanced technology byforeign affiliates played animportant
roleintechnology diffusion while working inlocalcompanies. According tothesurvey, 27outof
40foreign affiliates indicated thatsome oftheirworkers hadmoved tolocalcompanies.
Results ofStudy ontheFormation ofNetworks between Foreign Invested
Companies andDomestic Companies
Formed Cooperative Links withDomestic
CompaniesExperience withTechnology Assistance for
Linked Companies
Yes No No Total Yes No No Total
23 13 4 40 21 12 7 40
11. R&D projects byforeign affiliates also significantly contribute tothetechnology
development ofhostcountries. According toKorea 'scasestudies, there werevarious types ofR&D
conducted byforeign affiliates, including theoperation oftechnology assistance centres, R&D projects
forming information network withparent company.
Effects oneconomic growth
12. FDIeventually contributes much totheeconomic growth ofhostcountries through theincrease
ofcapital stock, theenhancement ofproductivity intheeconomy asawhole, andthrough technology
transfer. FDIinduces risesinincome, andexpands theproduction capacities byincreasing capital
stock. Theriseinthecapital-labour ratioduetotheincrease ofcapital stock upgrades theindustrial
structure, enhances labour productivity, andeventually brings about economic growth.
13. InKorea 'scase, thecontribution ofloans toeconomic growth wasgreater thanthatofFDI
asloans played amore important roleasameans ofcapital mobilization. Butempirical research shows
thatFDIalsocontributed significantly totheincrease inproductivity.3Astudy, which analysed FDI's
effects onproductivity, showed thatthepercentage ofFDI'scontribution toKorea 'sGDP growth in
themanufacturing sector was19.5percentduring theperiod of1970-1990: 17.0percentwasattributed
2Study conducted byDr.Yoon Jong Wang, Korea Institute forInternational Economic Policy, 1994
3Studies conducted byDr.June Dong Kim, 1996 andbyDr.KiTaek Hong, 1997WT/WGTI/W/16
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totheincrease ofproductivity and2.5percent totheincrease incapital formation.4Therefore,
itcanbesaidthatFDIhascontributed substantially toKorea 'soverall economic growth.
Effects oncompetition promotion
14. Korea regards inward FDIasanimportant factor inincreasing domestic market competitiveness
whichwillultimatelyhelptoimproveKorea'srelativelyinefficienteconomicstructurethathasweakened
thecompetitiveness ofKorean firms. Itistheexpectation oftheKorean Government thatinward FDI
willhavepositive effects ontheadjustment ofKorea 'seconomic structure andwillsteadily increase
theefficiency ofKorea 'seconomy byinducing specialization oflocal companies, alleviating the
concentration ofeconomic power, andfacilitating theexitoflesscompetitive companies frommarkets.
III. EFFECT OFFDIONKOREA 'STRADE
Relationship between FDIandtrade
15. Generally speaking, market-seeking FDIreplaces theexports ofthehome country, having a
negative effect onitsbalance oftrade, while reducing imports ofthehostcountry, thushaving apositive
effect onitsbalance ofpayments. Ontheother hand, FDIinaparticular hostcountry attracts imports
from thehome country, including capital goods, equipment, expertise inengineering andtechnical
services etc.,andthushasapositive effect onthebalance ofpayments ofthehome country, anda
negative impact onthebalance ofpayments ofthehostcountry.
16. However, inthecaseofefficiency-seeking FDI,thelinkage between FDIandtradeisrelatively
more complex. Agrowing proportion ofinternational trade nowtakes place within multinational
corporations intheformoftransactions between affiliates andparent companies. Inthenewsystem
ofintegrated international production, different partsoftheproduction process arespread alloverthe
globe. Itcould therefore beargued thatsuch anincrease inintra-firm trade makes FDImore
trade-supporting.
17. Thecomplexity ofinteractions between trade andFDImakes itmore difficult tomake a
conclusive judgement ontherelationship between FDIandthebalance oftrade. According toasurvey
included intheSecretariat 'snote(WT/WGTI/W/7), empirical research conducted inthepasthasnot
produced consistent results astowhether FDIhaspositive ornegative effects onahome country 's
trade balance. However, thesurvey suggests thatFDIhasapositive effect onthetrade balance of
hostcountries.
Effect ofFDIonKorea 'strade balance
(a) Effect ofoutward FDIonKorea 'strade balance
18. According tothestudies ontheeffect ofKorea 'soutward FDIonthebalance oftrade, the
neteffect ofoutward FDIontrade flows hasbeenpositive. Themainreasons werethatoutward FDI
wasstrongly export-supporting andtheimport inducement effect plustheexport substitution effect
didnotexceed theexport inducement effect.5Astudy estimated thatthecombined foreign direct
4Study conducted byDr.KiTaek Hong, 1997
5Studies conducted byDr.JuneDong KimandDr.InSooKang, 1995; byDr.JaeWon Yoo, 1995; and
byDr.Byung KiHa,1997WT/WGTI/W/16
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investment of241Korean firms improved thebalance oftradebyUS$220 million in1995.6Theexport
inducement effect wasUS$950 million (US$620 million bytheexport ofcapital goods and
US$330 million bytheexport ofcomponents), while theexport substitution effect wasUS$130 million.
These figures indicate thatKorea 'soutward FDIwasstillattheinitial stage andthatKorean firms
tended toprocure capital goods andcomponents from thedomestic market. Inthecaseofimports,
outward FDIresulted inaUS$600 million increase. Outofthisincrease, thedirect import inducement
effect wasUS$390 million, while indirect import inducement effect (extra demand forimports by
increased domestic product) wasUS$210 million.
19. However, asthelocalization oftheexisting overseas affiliate inthehostcountry progresses
inthelongterm, theexport inducement effect willdecline andtheimport inducement effect will
increase. Thisprocess canmake theneteffect ofoutward FDIontradeflowbecome neutral ornegative.
Another recent study shows thattheimport inducement effect hasincreased significantly, mainly due
toKorea 'soutward FDIinthedeveloping countries, which hasincreased import oflightindustry
products.7According tothisstudy, imports induced byKorea 'soutward FDIinthedeveloping countries
were 12times aslarge asimports generated byoutward FDIinthedeveloped countries in1995.
(b) Effect ofinward FDIonKorea 'strade balance
20. According tothestudies, theneteffect ofinward FDIontrade flowhasbeenpositive since
themid-1980s, asinward FDIbegan toincrease exports while showing aneutral impact onimports.
Thisresult corresponds tothatoftheSecretariat 'ssurvey.8
21. Intheearly1980s, theimport inducement effect wassignificant, asforeign affiliates procured
rawmaterials, capital goods andequipment from home countries. Buttheimport substitution effect
progressively increased asaresult ofthelocalization offoreign affiliates, countervailing theimport
inducement effect noted above. Inaddition, theexport share offoreign affiliates 'totalsalesincreased
from thatofthemid-1980s, which ledtoKorea 'strade surplus.
Inward FDI-induced Exports andImports
(Unit: US$million, %)
Year 1980 1987 1991 Annual Increase Rate
(1980-1991)
Exports 869(5.0) 3,290 (7.0) 4,781 (6.7) 18.8
Imports 1,805 (8.1) 3,134 (7.6) 4,484 (5.5) 10.5
Trade Balance -936 156 297
Note: Thenumbers inbrackets indicate theshare ofexports andimports induced byFDIasapercentage
oftotalexports andimports.
6Study conducted byDr.Byung KiHa,1997
7Study conducted bytheSamsung Economic Research Institute, 1996
8Studies conducted bytheKorea Development Bank andtheMinistry ofFinance, 1993; bytheKorea Credit
Evaluation Bank, 1987WT/WGTI/W/16
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IV. CONCLUSION
Summary
22. Inward FDIhashadapositive effect onKorea 'seconomic development inmany respects,
including employment, technology development, andeconomic growth, particularly through thetransfer
ofadvanced technology andincrease inproductivity. Inward FDI,which hasbeenincreasing sharply
inrecentyears,isexpectedtopromotethecompetitivenessofthedomesticmarket,enhancetheefficiency
offirms, andimprove Korea 'soverall economic structure.
23. Regarding theeffect ofFDIontrade, FDIhasbeentrade-supporting rather thantrade-replacing
inKorea. Theexport inducement effect waslarger thantheimport inducement effect. Outward FDI
hasalsocontributed totheimprovement ofthetrade balance.
Implications
24. Korea 'spastexperience withFDIvindicates thebenefits ofFDI. Itseems tosupport thecall
forcountries toimplement policies thatpromote FDI. Similarly totrade, FDIisnowplaying an
important roleintheefficient allocation ofworld resources. Aswasrecognized inUNCTAD 's1992
World Investment Report, FDIserves astheengine ofgrowth. According tothe1997World Investment
Report, liberalization ofFDIregimes hasbeenunder waythroughout theworld. Lastyearalone,
98liberalizing changes weremade intheregulatory FDIframeworks in65countries. Thenetwork
ofbilateral investment treaties isalsoexpanding constantly. Thenumber ofbilateral investment treaties
(BITs) dramatically increased during the1990s. AsofJanuary 1997, atotalof1,330 suchtreaties
havebeensigned around theworld, involving 162countries. Compared withlessthan400BITs at
thebeginning ofthisdecade, thisisanimpressive increase.
25. Despite theriseofadense network ofbilateral investment treaties, theneedforamultilateral
regime forinvestment isgrowing. Current rulesatthebilateral levelhavedifferent geographical scopes
andsignificant differences intheirsubstantive coverage, specific content, approach andlegalnature.
Inorder toencourage investment flows andtocreate aclearer, fairer, andmore favourable investment
environmentforenterprisesconfrontedwiththechallengesofglobalization,acomprehensivemultilateral
ruleoninvestment isdesirable.
26. Astheestablishment oftheWTO regime hasincreased, thelevel ofglobal welfare, the
multilateral investment regime, which would guarantee thefreemovement ofcapital, technology, and
knowledge, willcontribute toboththeeconomic development ofevery country andthepromotion of
global welfare. Inthisrespect, theKorean Government believes thatitisimportant fortheWorking
Group toexamine both thenecessity andeffects ofthemultilateral agreement oninvestment.
Deliberations onthismatter inother international fora,suchasUNCTAD, APEC andOECD, should
alsobereferenced, asappropriate.