Lecture (4) FDI in Developing Countries

8/3/2019 Lecture (4) FDI in Developing Countries

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Most developing countries encounter numerouseconomic problems, the most salient of which are

The deterioration in development rates related, to agreat extent, to low income levels thus exerting apassive impact on savings and consequently on

investments rates.

The lack of essential financing potentials aggravatesthe problem of enhancing investment and exportation.

At this point, these countries began to search foralternative sources of finance:


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Most countries turn to that option to bridge the gab offinancing, however, these countries are faced with the

so-called crises of external indebtedness, especially as

this problem aggravates in the form of interest and

installments.

Creditor countries, hence, became the key beneficiary

from the fruits of development rather than developingcountries itself, the matter that adversely affect the

economic development of the said countries.


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Among the different forms of capital flows, academicsand policymakers, talk about foreign direct investment

(FDI) the most.

This is because of several benefits of FDI and its

importance in the world economy vis--vis other forms

of capital flows.

In the past twenty years, FDI has been the dominant

form of capital flow in the global economy, even for

developing countries.


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Here we have three terms : Investment: is the commitment or involvement of a

certain amount of money in commercial transactions

for the achievement of profits within a certain period

time.

Direct: is the straight full or partial participation in

the management and control of these commercial

transactions. Foreign: Means that these commercial transactions

are performed in a foreign territory.


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It is worth mentioning that investment decision

depends on two main points:

First: The motives of the donor country for

investment and the competitive edge of relevant

projects besides the need to find access for new

markets. Second: The points of attraction for investing in

hosting countries are embodied in economic

development, market size, administrative, economic

and political stability, hard and soft infrastructure,transparency, and finally legislations and laws

concerning investment and the incentives

embodied in the same.


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FDI is seen as an important source of capital inflow.

Transfer of technologies is expected because foreign

companies will use technology from their home

country.

It is argued that FDI will lead to employment creation.

Transfer of management skills, to local managers, takes

place when investors set up new plants, acquire

companies or outsource to local subcontractors


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FDI can take the form of eitherGreenfield

investment (also called "mortar and brick"

investment) ormerger and acquisition (M&A)

It depends on whether the investment involves

mainly newly created assets or just a transfer

from local to foreign firms.


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UNCTAD World Investment Report revealed that, for the host country, the benefits of M&As are

lower and the risks of negative effects are greater whencompared to Greenfield investments.

FDI through M&As correspond to a smaller productiveinvestment than Greenfield as the financial resources do notnecessarily go into increasing the capital stock.

FDI through M&As is less likely to transfer new or bettertechnologies than Greenfield investment.

FDI through M&As do not generate employment at the time ofentry into the host economy, and may lead to lay-offs as theacquired firm is restructured.

FDI through M&As can reduce or eliminate competition .


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The direct barriers to FDIFirst, guise colonialism

Although the colonial period ended long time ago, ithas also remained a central factor in Africasskepticism over joining the global economy, reflectinga common sentiment even today.

This was closely complemented by dependency theory,which argued that capitalism in general, and foreigncompanies in particular, were agents ofunderdevelopment and merely continuing colonialism

in another guise.


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Second, perhaps just an importantly, most of Africas anti-

colonial movements were heavily supported by the Soviet

Union and its allies.

This encouraged the popularity of socialism and an

ideological bias against foreign (or, more specifically,

Western) capital.

Many of the current decision-makers (including those

frequently hailed as reformers) have held political positionsfor decades and were trained on the socialist model steeped

in anti-foreign investment ideology.


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Third , economic nationalism

Ideas of economic nationalism affected sentiment towards foreigninvestment, and they continue to influence policy today.

Fourth, On a more practical level, political elites also did not wantto be constrained by foreigners who might control key strategicsectors of the economy or their access to foreign exchange.

Fifth

, there are direct de jurebarriers(legal restrictions) to foreignparticipation in the economy.

Examples Ethiopia legally excludes foreigners from the financialsector, and Tanzania only allowed foreign bank entry since the

early 1990s,Ghana still bars foreigners from certain trading andservices sectors.

Sixth, Many countries have legal requirements for (or have givenofficials wide discretionary powers to add) performance

requirements, such as local employment, local partnership orlocal in uts.


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Indirect barriers typically include bureaucratic

and other informal impediments to foreign

investment, such as ambiguous regulatory

approval, delays in customs clearance, visas for

expatriate workers, or weaknesses in the legal

system.


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African countries, like most other developing countries

have taken various initiatives to attract FDI.

These initiatives include incentives, signing of

investment treaties and investment promotionactivities.


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Financial Incentives

Grants Loan and loan guarantees

Rules-based incentives Modifying rules on workers rights

Modifying environmental standards

Greater protection for intellectual property rights

(CUTS, 2001)


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Incentives are only a part of what governments offer to attractforeign investors to their countries for investment.

Increasingly countries have entered into investment treaties,both bilateral investment treaties and multilateral onesbecausethey include the following:

Fair and equitable treatment for foreign investors in terms ofapplications for investment approval and setting up their

businesses.

Specific provisions on compensation for expropriation andnon-commercial losses.

Dispute or conflict settlement mechanism.


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Most countries have established investment promotion agencieswhose main purpose is to attract FDI and to look after foreign firmsonce they have set operations.

Investment promotion agencies usually fulfill a dual role :

By acting as a one stop for investors to deal with regulatory andadministrative requirements.

By changing or modifying investor perception of the country by

attending and organizing investor fairs and by distributingmaterials.

Investment promotion covers a range of activities, includinginvestment generation, investment facilitation, aftercare services,and policy advocacy to enhance the competitiveness of a

location.


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Governments should also try and create an enabling

environment.

The term enabling environment has been coined to

include legal, political, social and economic factors that

make a country an attractive destination for investment.

These include:

1- Stability

It is pointed out that social and political stability of acountry plays a very important role in determining whether

investors will consider investing in a country.

Countries experiencing civil unrest and political upheaval

are unlikely to be considered as investment destinations.


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3- Macroeconomic policies

Within the context of a stable and transparent economic

and regulatory environment, the main determinants ofinvestors decisions are broad macroeconomic factors

such as the size and growth of the market and the costs

of production.

Governments should thereforeput in place sound

macroeconomic policies that will help the country

achieve development objectives as well as helping thecountry to attract FDI.


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4- Trade policy

The trade regime in a country may encourageenterprises, local and foreign, to invest in developinglocal capabilities.

A highly protected regime or a large regime with very

restrictive laws will put constraints on the entry andexit of local enterprises, discourages technologicalupgrading, and isolate the economy from international

trends.

Liberalizing the trade regime will encourage and bringcompetition in the economy, forcing domestic firms toimprove efficiency.


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Governments should replace burdensome regulations withgood regulations that will support a countrys developmentaims.

This should include maintaining restrictions on capitalflows, maintaining screening procedures and impactassessments prior to establishment for major projects,

restricting investment in key strategic sectors .

requiring firms to follow good standards in the operationalphase.


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1- Developing countries encounter different financial

problems that urge them to search for solutions.

Explain

2- Investment decisions entail critical riskiness and

adventure that oblige investors to think rationally .

Explain this statement and define investment andclarify its types.

3- M&As provoked several criticisms. Explain


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4- Are you with or against the following statements? Justify

your approval or disapproval: A- External borrowing is preferred to FDI.

B-M&A is preferred to Green field investments.

C- Investment promotion agencies usually fulfill a dual role

D- transparency does not help in predictability ofenvironments where investors perform their transactions.

5-Barriers to FDI are varied and different in the developingcountries . Explain and comment.

6- Enabling environment is a decisive factor to attract FDI .Explain this statement and apply it to your country.

7- Precautions when formulating policies to attract FDI arevaried and different. Explain

Lecture (4) FDI in Developing Countries

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Transcript of Lecture (4) FDI in Developing Countries