What will digitisation mean for FDI?

A dramatic shift is under way in patterns of FDI: advances in technology are reshaping its very location, nature and scale as part of a new digital economy. And those patterns of change could be accelerated by the impact of the coronavirus. The results are forcing companies and countries – especially developing economies – to re-evaluate what kind of FDI to seek and how to address the digital economy.

The digital economy was defined by Unctad in 2017 as “the application of internet-based digital technologies to the production and trade of goods and services”. These technologies – including blockchain, 3D printing, the Internet of Things, 5G mobile broadband, cloud computing, automation and robotics, and AI and data analytics – are driving the so-called Fourth Industrial Revolution.

Meanwhile, internet platforms such as search engines, online payments, e-commerce and digital media providers make transactions easy.

Estimates of the value of the digital economy range from 4.5% to 15.5% of world GDP, but there is consensus that that share is rapidly growing. Unctad estimated in 2019 that the global value of e-commerce in 2017 reached $29,000bn, or 36% of world GDP. Digitally deliverable service exports totalled $2900bn worldwide, or 50% of global services exports, Unctad reported.  

At the same time, traditional manufacturing and service multinationals are increasingly using ICT to rethink the way they operate internationally and streamline their operations, as are SMEs and a new generation of ‘born global’ companies.

Push and pull

Bruno Casella, an economist with Unctad in Geneva who helped write its reports on the digital economy, notes that digital technologies facilitate the management and coordination of disparate value chains. 

“They are a way to manage complexity. Traditionally, one of the main reasons to do FDI is that the transaction costs of dealing with third parties abroad is too high or the risks are too high, so you want strict controls,” he says. “But digitisation can have the effect of reducing transaction costs because there is more transparency and higher control. So one of the main reasons to internalise your operations [through FDI] is not there, and there is less financial risk in outsourcing.”

Not only is there a possibility that traditional multinational companies may decide to outsource production to third parties instead of undertaking FDI, some may choose to adopt robotics or other technologies to manufacture at home and export the finished product. The higher labour costs of domestic production may be offset by the limited use of human labour in a robotic world, especially in industries such as automotives and electronics.

For this reason, Mr Casella believes digital technologies may enhance opportunities in offshoring production, but robotics may work in the opposite direction and encourage reshoring.

Scaling down

Lorraine Eden, a management professor at Texas A&M University, agrees. Even clothing – the epitome of a low-cost labour FDI choice – could be affected. Ms Eden expects FDI to continue for manufacturing of basic clothing and mass-market goods. However, she foresees digitisation enabling the growth of ‘micro-manufacturing’: small-scale manufacturing and short production runs closer to home, aided by 3D printing.

While 3D could have a big impact, it is not yet a driver of changing investment patterns, according to Jacob Dencik, economic research leader at IBM’s Institute for Business Value in Brussels. The companies that are reshaping their business models around 3D are mainly in niche areas.

Mr Casella notes that digital multinationals can operate abroad with much less presence than traditional business, presenting an asset-light footprint that traditional services companies are likely to adopt.

Indeed, Mr Dencik adds, the impact of digital disruption is being seen in fewer job-intensive investments. The decline in investment was especially sharp in production and shared services centres, where automation and new technologies have taken hold. 

However, while global FDI as measured by jobs created fell by 5% in 2017, the number of FDI projects rose by 10% to record levels, suggesting a shift toward smaller scale projects. FDI in the digital sector is on the rise, including software, data centres and R&D, Mr Dencik reports. In 2017 this type of FDI ranked highest in number of projects and third in number of jobs created.

Mr Dencik stresses that the use of digital technologies is not the same as automation. “Digitisation is not a substitution for work. Sometimes it complements work,” he notes. “We should take a more nuanced approach.”

Cost changes

Services are also susceptible to being offshored, including some aspects of professional services. “Low- and medium-value services can be offshored, but value-added or sensitive services will be mostly retained at home,” predicts Mr Casella. “In the short term, some services will be offshored if it can be done remotely and cheaper. But in the medium term – about 10 years – some services may be done by machines and could be reshored again.”

Automating some activities will reshape the services sector, according to Mr Dencik, depending on how a company views customer engagement. Companies can use chatbots or other technologies, but some may shift the staff freed up from routine tasks to improving customer service and performing higher value activities.

If digitisation offers opportunities for corporations, for emerging and less-developed countries it presents enormous challenges and risks. Experts agree that countries that rely on low-cost labour as a competitive advantage will lose out. Instead, they will need an intense focus on creating digital infrastructure, improving education and skills development.

The coronavirus pandemic accentuates the threat to all countries that host parts of multinational enterprises' supply chains, especially China. Companies have woken up to the risks of having all their eggs in one basket. Describing the pandemic as a “black swan event”, Ms Eden said many multinational companies are considering bringing work home, seeking back-up suppliers and exploring digitisation. “The Covid-19 outbreak will potentially accelerate existing trends of decoupling and reshoring driven by the desire... to make supply chains more resilient,” Unctad said in a March 8 report. 

“We are currently looking through a glass, darkly,” says Ms Eden. “We know on the other side it will be different, but we don’t know how.”

This article first appeared in the April-June edition of fDi Magazine.