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JEON Young-Jae

Boosting FDI Competitiveness during a Recession

JEON Young-Jae

Jan. 16, 2009

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Korea's ability to sustain a recovery in foreign direct investment (FDI) will be severely tested this year as the global financial crisis constricts worldwide business activity. In 2008, inbound FDI in Korea rose 11.3% over 2007 to US$11.71 billion, ending a three-year skid. The increase defied an estimated 10% global FDI reduction stemming from recession in industrialized nations, but with global FDI in 2009 expected to suffer a second consecutive year of negative growth, deteriorating prospects should be no surprise. Thus, the government will need a multi-prong strategy to both attract new FDI and to keep international companies from softening or ending their foothold in Korea.

World economic growth is forecast to be less than 1% this year, even lower than the 1.5% growth experienced in 2001 during the collapse of the IT bubble. An 1 percentage point decrease in global economic growth will likely result in an 11.12 percentage point drop in world FDI, while an 1 percentage point drop in world stock prices will likely result in a 0.64 percentage point drop in FDI. With world GDP growth expected to fall 1.4 percentage points in 2009, world FDI will likely drop 15.6 percentage points.

For Korea, the crisis is especially ill-timed. Between 2005 and 2007, global inward FDI rose 36.9% on yearly average, but FDI to Korea dropped 32.8%. Consequently, Korea's share in total global FDI fell to 0.14% in 2007 from 1.25% in 2004. The rebound in 2008 with the seating of a new business-friendly administration saw notable FDI inflows in the service sector (up 10.2% year-on-year), centering on financial services and logistic industries. The administration along with regional governments obviously hoped to build on the upward momentum with various incentives but they must now temper expectations for a repeat performance in 2009.

To be sure, even if the global economy were not in recession, upward traction in inbound FDI would be no guarantee. Korea still remains well behind other countries in its ability to attract FDI. Policies and systems are not very attractive to potential foreign investors. Higher production costs (i.e. wages and land prices), small market size, and lack of proprietary technology act as barriers. Just eliminating these obstacles or the simple provision of incentives is unlikely to make much headway in engineering a much better environment. FDI strategy may need to change from a quantity-oriented approach to a quality-oriented approach, from an in discriminative approach to strategically customized attraction.

The simplest answer is to refocus on quality. FDI policy will need to consider both Korea' s unique characteristics, and the future contribution of any potential FDI to the economy, and then focus on the industries, companies, and countries with the most potential. In addition, strengthening connections between the FDI and free trade agreements and forming a network that vitalizes two-way FDI will also be critical.

Strategically, the area that Korea would most want to see FDI is the service sector, where inflow affect on job creation and industrial competitiveness would be high. Investment in the non-manufacturing sector will contribute to the formation of fixed capital formation and economic growth. To boost service sector FDI, regulations and restrictions must be eased drastically. A more competition-friendly environment for companies will be needed, along with deregulation to boost investment and to ease entry of companies.

In addition, the government should seek R&D-oriented FDI. Advanced techniques and knowledge from global companies can spill over to and benefit the local economy, creating synergy effects when combined with domestic research capabilities. Advanced companies are promoting the globalization of R&D along with the formation of global production networks. The global R&D centers that Korea should attract can function as "centers of excellence" that can help provide the innovation capability that Korea lacks, while upgrading Korea's industrial structure.

FDI in itself will not be enough to enjoy maximum benefits from external players. Much more thorough follow-up will be needed to prevent existing foreign investors from withdrawing their investments, while continuing to spur additional investments. This is because there is a high risk that the global financial crisis and evaporating earnings will force multinational companies to pull up stakes and withdraw.

The need to boost FDI takes on a special urgency, considering that Korean companies will tend to defer investments themselves until the global economy normalizes. FDI, of course, can act as a bridge to increase domestic demand and secure long-term growth engines. To do so effectively, it will be crucial for policymakers to astutely identify what foreign investors need and why.

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