Investment for Development

Papers and Power Point Presentations at IFD-Launch Meeting

Paper Presentations

International Investment Rule-Making: Overview, Relevance and Role of Civil Society, Particularly Non-Governmental Organizations: Khalil Hamdani

Benefits and Costs of FDI for Development: An ongoing OECD project:  Hans Christiansen

Mozambique’s experience in attracting beneficial IFD: The case of Mozal aluminium smelter: Leonido Funzamo

International Investment and Environmental issues: the case of Kenya's Kwale mineral sands project : David O Ongo’lo

Can Developing Countries use Foreign Investment to move up the Development Ladder: Suman Bery

Consumer Public Perceptions of Competition Policy and Consumer Protection in South Africa: Diane R Terblanche

Power Point Presentations

Country Reports

Country Reports

Can Developing Countries use Foreign Investment to move up the Development Ladder 

Introduction

Attitudes towards Foreign-Direct Investment

Arguments for FDI

FDI Flows

Determinants of FDI

Policies towards FDI  

Suman Bery & Sanjib Pohit,  National Council of Applied Economic Research, New Delhi-2

www.ncaer.org 

Introduction

In the immediate post-war period, stimulated by the success of the Soviet Union, most developing countries pursued a policy of investment-led growth. The emphasis was on increasing the investment rate and not on the productivity of investment.  To their dismay, many of the developing economies found that higher investment (which represents a sacrifice of current consumption) did not lead to high growth as many were faced with declining investment productivity.  Of late, developing economies have shifted their focus from the absolute level of investment to the productivity of investment.  The most important shift in this regard has been a move to trade liberalisation. In addition, most developing countries now welcome Foreign Direct Investment (FDI) as an important factor which contributes to economic growth through technology transfer and efficiency improvement.

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Attitudes towards Foreign-Direct Investment

Over the years, the developing countries have always felt that their investment needs are far greater than what can be realised through domestic savings. As a result, most of the countries have been open to foreign saving to meet their investment needs. By and large, the developing countries have a clear preference towards official/private debt flows than foreign private capital in the form of FDI. Nationalists wished to build strong home-grown champions and feared FDI would erode sovereignty and culture.  Out of the net long-term resource flows to developing countries, Foreign Direct Investment (FDI) initially constituted only a small portion in comparison to official/private debt flows. (see Table 1). However, the situation has changed drastically in the 1990s: debt flows have virtually stagnated while FDI has increased five-fold from US $ 36 billion in 1991 to US $ 178 billion in 2000. Today, FDI flows contribute more resources to the developing countries than the debt flows.

With the global debt crisis of the 1980s, developing economies realised the dangers of debt finance. One distinct disadvantage of debt finance is that it creates fixed debt-servicing obligations.  During the debt crisis, even when the borrowing agency was a private entity, government had to eventually come to its rescue for maintaining the credibility of the country. The growing volume of FDI, the stagnating volume of debt flows, and the servicing aspect of debt finance—all have contributed to the current policy shift of the developing countries towards FDI. The developing economies have also realised that in case of foreign investment, equity needs to be serviced only if profits are made.  Furthermore, the success stories of export-led growth led by FDI in the Newly Industrialised Economics (NIEs) has showed the developing economies the benefits of FDI.  Today, most countries now welcome FDI.

Arguments for FDI

Growing FDI inflows promise a variety of potential benefits to country recipients. FDI flows can provide a relatively stable source of finance for less developed countries, and they have tended to be considerably less volatile than other types of capital inflows for middle-and high-income countries. There are various channels through which FDI flows are thought to affect recipient countries. Notable among them are the following:

1.  FDI inflows tend to raise domestic fixed capital formation in the developing countries. While the link between capital inflows and investment may have weakened during the 1990s, this is probably due to shifts within FDI, toward mergers and acquisitions instead of “greenfield” investments (i.e., a firm started from scratch).[1]

2.  Multinational corporations tend to pay higher wages than domestic enterprises and can offer valuable training opportunities to workers.

3.  FDI promotes technology spillovers as multinational corporations incorporate new technologies in their subsidiaries. As new technologies are generally developed and adapted by firms in industrial countries, FDI may be the most efficient way for developing economies to gain access to them. In addition, this knowledge may become more widely available in the country over time, as employees with experience in the techniques used in foreign companies switch to other firms.

4.  In the 1980s and the 1990s,  a large portion of growth in trade is accounted by the intra-firm trade of the multinational enterprises. If  trade is to be the engine of growth,  the role of FDI cannot be overlooked.

5.  Export-oriented FDI could play an important role in the process of export-led industrialisation  in the developing countries. Affiliates of multinational enterprises have marketing channels in place, possess experience and expertise in the many complex facets of product development and international marketing, and are well placed  to take advantage of inter-country differences in the cost of production. The successful examples, which are often cited, are the newly industrialising economies.[2]

6.  Finally, foreign investment could increase competition in the host-country industry, and hence force local firms to become more productive by adopting more efficient methods or by investing in human and/or physical capital.

FDI Flows

The developing countries have by and large been minor players in global growth in attracting private external capital, particularly foreign direct investment (FDI). As Table 2 indicates, while FDI inflows to developed economies increased from US $ 137 billion in 1989 to US $ 1005 billion in 2000, in the same period flows to developing economies increased from US $ 60 billion to US $ 240 billion.

Chart 1 shows the top 10 recipients of FDI flows among the developing economies for the year 2000.  As the chart shows, maximum FDI flows went to Hong Kong in that year, followed by China.  Among the East European economies, only Poland figures in the top 10 category. None of the African countries figures in the list.

Reflecting recent policy shifts by the developing countries towards FDI, the share of FDI in developing countries’ GDP has jumped from less than 1 % in 1991 to about 2.5 % in 2000 (Table 3). However, the flows remain concentrated. The top 10 developing-country recipients of FDI accounted for 74% of total FDI flows to the developing world in 2000.[3]

Determinants of FDI

There is a large body of literature dealing with the determinants of FDI. What we shall do here is to draw upon some selected studies in an effort to identify what appear to be the main factors influencing FDI inflows.[4] One study worth noting is UNCTC (1992), which surveys the cross-section, time series, and survey evidence on both outward and inward FDI, sourcing by multinational firms, offshore assembly and export subsidiary operations, bargaining between government and multinational firms, tax and related incentives and political risk. Some of the principal conclusions of this UCNTC study relating to developing countries are as follows.  First, even if a production process is capital or R&D intensive, there might be a part of the process that can be carried on advantageously in a developing country. Second, regarding locational advantages, the most important factors motivating import-substituting production are market size and tariff protection. By contrast, wages and other costs appear to be important factors for inward FDI to produce for the export market. Third, tax and other financial incentives may be important after the decision by a multinational firm to invest abroad has been made, in which case incentives might determine which country will in fact be selected for investment purposes. Fourth, though offshore production and export-oriented production may not generate significant FDI inflows, there may nonetheless be positive employment and foreign exchange benefits in host countries.  The study also calls attention to the impressive unilateral efforts of many developing countries in recent years to deregulate their economies and to reduce or remove tariffs and other trade barriers in order to shift resources from import-competing to export sectors.

Bajo-Rubio and Sosvilla-rivero (1994) is an econometric study of the determinants of FDI in Spain for the period 1964-1989.[5] They found that flows of inward FDI for Spain depended mostly on macroeconomic variables. But they also found that tariff reductions and accession to the European Community  were important to some extent as well.

Lucas (1993) analyses the determinants of FDI inflows into countries in East and SouthEast Asia.[6] Among his findings worth noting are: (1) FDI inflows depend more on wages than on cost of capital; (2) FDI inflows are more responsive to aggregate demand in export markets than in host country markets; and (3) political stability is an important determinant of inflows.

As a general matter, incentives designed to encourage FDI inflows do not appear to matter very much, although once it is decided to engage in FDI, the presence of incentives may affect the magnitude and geographic location of the FDI.[7]

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Policies towards FDI

Today, developing countries compete against each other for FDI by offering a range of tax and financial incentives. But what is more effective is to establish a favourable climate for investment. There has been a significant improvement in the 1990s regarding host government regulations governing FDI. Licensing requirements were abolished, coverage of sectors for FDI were expanded, restrictions limiting the share of ownership by foreign investors were eased, laws on the protection of intellectual property were strengthened, rules governing trade and foreign exchange transactions were liberalised and finally tax systems and other laws were made more neutral between domestic and foreign investors (European Round Table of Industrialist 2000; UNCTAD 1999).

Against this backdrop, many developing countries are yet to attract FDI in a big way. High transactions costs in the form of corruption, unnecessary regulatory requirements, lack of transparent administrative regulations and insufficient protection of physical and intellectual property rights still impede FDI (Hoekman and Saggi, 1999).[8] A recent study found that corruption (as measured by the extent of irregular, additional payments in connection with business transactions) in 53 countries that host FDI significantly reduced FDI inflows; a one-standard-deviation increase in the corruption index was associated with a 33% fall in FDI (Wei, 2000).[9] Another study examining the impact of transparency on FDI found that for 52 industrial and developing countries over the period 1991-95, a one percent increase in the index of the level of transparency  (index varied from from 8.5 to 38 for the 52 countries) was associated with an average of 40% increase in FDI inflows (Drabek and Payne 2000).[10]

Recent analyses using macroeconomic data suggest that FDI can have a positive impact on growth, particularly when the receiving country has a highly educated workforce, allowing it to exploit FDI spillovers.[11] In a similar vein, other studies have found that FDI spillovers are greatest in richer countries, while in poor countries the technologies being used are often less attuned to the needs of the economy, limiting the benefits from technological spillovers.[12] The evidence on spillovers between foreign-owned and domestic-owned firms is less clear-cut. While studies find that sectors with a higher degree of foreign ownership exhibit faster productivity growth, firm-level data provide little evidence of spillovers.[13]

                   Source: World Bank, "Global Development Finance," Table 2.2 (pp.38)        

Table 2. FDI Inflows by Host Region and Economy (Billions of dollars)

Source: UNCTAD, 2001, “World Investment Report”.

Table 3. Ratio of FDI Inflows to GDP (percent)

Source: World Bank, 2001, “Global Development finance.”

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[1] The share of mergers and acquisitions in the FDI flows rose from 28% in 1995 to 36% in 1999 (World Bank, 2001, “Global Development Finance”, pp. 43).

[2] Wu, Yanri, 1999, “Foreign direct Investment and Economic Growth in China”,Edgar Elgar Publishing, Inc.  (USA)

[3]Source: World Bank, “World Development Indicators”.

[4] United Nations Centre on Transational Corporations (UNCTC), 1992, “The Determinants of Foreign Direct Investment: A Survey of the Evidence,” New York: United Nations

[5] Bajo-Rubio, Oscar and Simon Sosvilla-rivero, 1994, “An Econometric Analysis of Foreign Direct Investment in spain,” Southern Economic Journal, vol. 61, pp. 104-120.

[6] Lucas, Robert E.B, 1993, “On the Determinants of Direct Foreign Investment: Evidence from East and South-East Asia,” World Development, 21, pp. 391-406.

[7] Brown, Drusilla, Alan V. Deardorff and Robert M. Stern, 1995, “A Free Trade Agreement between Tunisia and the European Union: Effects on Tunisian Trade and Foreign Direct Investment,”    mimeo, University of Michigan.

[8] Hoekman, Bernard, and Kemal Saggi, 1999, “Multilateral Disciplines for Investment-Related Policies”, In Palao Guerrieri and H.e. Sharer, ed. Global Regionalism and Economic Convergence in Europe and East-Asia: The Need for Global Governance Regimes. Rome: Institute for International Affaires 

[9] Wei, Shang-Jin, 2000, “Local Corruption and Global Capital Flows”, Brookings Papers on Economic Activity, vol. 2, pp. 303-46.  

[10] Drabek, Zdenek and Warren Payne, 2000, “The Impact of Transparency on Foreign Direct Investment”, World Trade Organisation, Geneva, and Economic Consulting Services, Washington D.C. Processed. 

[11]Borensztein, Eduardo, Jose De Gregorio, and  Jong-Wha Lee, 1998, “How does Foreign Direct Investment Affect Growth?”, Journal of International Economics, vol 45 (June), pp. 115-35

[12]Blomström, Magnus, Robert  Lipsey, and Mario Zejan, 1994, “What Explains Developing Country Growth,” NBER Working Paper No. 4132 (Cambridge: National Bureau of Economic Research).

[13]Aitken, Brian, and Ann Harrison, 1999, “Do Domestic Firms Benefit from Direct Foreign Investment?” American Economic Review, vol. 89 (June), pp.  605-18.

 Blomström, Magnus, 1986, “Foreign Investment and Productive Efficiency,” Journal of Industrial Economics, vol. 35 (September), pp. 97-110.

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