Foreign direct investment (FDI) flows continue to set new records. In 1999, global inflows reached $865 billion, an increase of 27 per cent over the previous year. FDI flows to developing countries, after stagnating in 1998, seemed set to resume their earlier growth trend. Their value reached $208 billion, an increase of 16 per cent over 1998. The driving force behind the 1999 increase in FDI continued to be cross-border mergers and acquisitions (M&As), accounting for a substantial share of total flows -- a higher share in developed and a lower share in developing countries.

This is the short-term picture. The longterm picture is that FDI is playing a larger and more important role in the world economy. International production -- production under the common governance of transnational corporations (TNCs) -- is growing faster than other economic aggregates. The nature of international production is changing, responding to rapid technological change, intensified competition and economic liberalisation.

Falling transportation and communications costs are allowing TNCs to integrate production and other corporate functions across countries in historically unprecedented ways. Previous World Investment Reports (WlRs) have termed this process "deep integration", which is giving rise to a cohesive global production system, with specialised activities located by TNCs in different countries linked by tight, long-lasting bonds. The system is unevenly spread across industries, countries and TNCs, but it is growing rapidly to span many of the most dynamic activities in the world. If it represents "best practice" in international economic activity -- and this may be so, given the strong economic rationale behind its growth -- then all countries have to come to grips with its dimensions and implications.

The growth of international production remains unabatedInternational production now spans -- in different degrees -- virtually all countries, sectors, industries and economic activities. While it is difficult to quantify its magnitude because of its many facets, broad indicators show its spread. At the end of 1999, the stock of FDI, a broad measure of the capital component of international production, stood at $5 trillion. Sales by foreign affiliates, a broad measure of the revenues generated by international production, reached an estimated $14 trillion in 1999, while their gross product (value added) stood at an estimated $3 trillion. The gross product of all TNC systems together -- that is, including parent firms -- was an estimated $ 8 tri]lion in 1997, comprising roughly a quarter of the world's gross domestic product (GDP).

International production is thus of considerable importance to the world economy. Global sales of foreign affiliates alone were about twice as high as global exports in 1999,compared to almost parity about two decades ago.

Global gross product attributed to foreign affiliates is about one tenth of global GDP, compared to 5 per cent in 1982. The ratio of the stock of FDI to global GDP has risen from 6 per cent to 16 per cent over this period. The ratio of FDI flovs to world gross domestic capita] formation was 14 per cent in 1999; this ratio is significantly higher for manufacturing (22 per cent in 1998). In relation to private capital formation, the share varies (for the countries for which data are available) from 0.4 per cent in Japan to 98 per cent in Djibouti. This share is typically higher in developing countries. Global sales and gross product associated with international production have increased faster than global exports and GDP -- by 3.2 percentage points and 4.1 percentage points, respectively, during the period 1982-1999.

Countries continue to liberalise FDI regimes Given the economic importance of FDI, it is not surprising that all countries today seek to attract it and to make their policies more favourable to investors. Of the 140 changes in FDI laws in 1999, 131 liberalised conditions for foreign investors; over the period 1991-1999, 94 per cent of the 1,035 policy changes favoured investors.

These changes in national FDI laws were complemented by the conclusion of new bilateral investment treaties (BITs), an increasing number between developing countries. The total number of BITs rose from 1,726 at the end of 1998 to 1,856 at the end of 1999. These treaties were often accompanied by double taxation treaties(DTTs), which rose in number to 1,982 at the end of 1999, compared to 1,873 at the end of 1998 @@@@ BITs and DTTs together were concluded at a rate of one every two working days during 1999 -- an impressive rate of treaty-making. At the regional level, an increasing number of agreements are creating more favourable FDI regimes as well.

Thus, during the second half of 1998 and 1999, free trade and investment agreements between Chile and Mexico, and between the members of the European Community and Mexico, expanded and deepened the existing network of agreements. More broadly, investment issues increasingly permeate international economic agreements. For examyle, many of the free trade, association, partnership and cooperation agreements signed by the European Community with third countries also contain FDI provisions.

Enterprises seek to become more international The quest of countries to attract more FDI is matched by the desire of companies to enhance competitiveness by spreading activities over different locations -- to acquire a good portfolio of "locational assets''. Capturing new markets is one important motivation, allowing firms to serve customers better by setting up local facilities.

Typically TNCs engage in the whole range of internal and external transactions internationally: the decision on the tvpe of transaction depends on the nature of a firm's advantages, the capabilities of the overseas firm and conditions in the foreign kcation. Over time, however, as FDI policies have been liberalised, innovation costs have risen and international transaction costs fallen, internalized transactions by TNCs have grown in significance. As a result, the number of firms that have become transnational has risen exponentially over the past three decades. ln the case of 15 developed countries, that number increased from some 7,000 at the end of the 1960s to some 40,000 in the second half of the 1990s.

The number of parent firms worldwide is now in the range of 60,000. These parent firms form a diverse universe that spans all countries and industries, and include a large and growing number of small and medium-sized enterprises. More and more TNCs hail from countries that have only recently begun to undertake international production - witness the growth of TNCs from some developing countries and economies in transition. The ownership of FDI, however, remains highly concentrated in both host and home countries.

The concentration ratio increased even further in recent years in FDI inflows. A mere one hundred (non-financial) parent firms, based mainly in developed countries, account for roughly one-eighth of the total assets of all foreign affiliates. This means that the locationalP žš The quest of countries to attract more FDI is matched by the desire of companies to enhance competitiveness by spreading activities over different locations -- to acquire a good portfolio of "locational assets''. Capturing new markets is one important motivation, allowing firms to serve customers better by setting up local facilities.