Countries are adopting new approaches to growth and development based on economic liberalization and recognition that integration into the global economy is an important challenge. In particular, developing countries have increasingly come to see foreign direct investment (FDI) and international trade as a source of economic development, modernisation, income growth and employment.

Foreign Investment

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 the productivity of investment. However, 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. In recent years, many of these countries 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. 

Perceived Benefits of Foreign Investment 

The benefits that foreign investors may bring to host countries, although not guaranteed, may be vital in helping developing countries meet the challenge of integration into the competitive global economy. The major benefits associated with foreign investment include technology transfer, job creation and export development. Poor countries on average are helped by foreign investment in form of money, equipment, machines and factories, as well as infrastructure improvements such as roads and bridges.  

The potential drawbacks include the deterioration of the balance of payments as profits are repatriated, lack of positive linkages with local communities, the environmental impact especially in the extractive and heavy industries, competition in national markets and the risk that host countries, especially small economies, may experience a loss of political sovereignty. Some of the expected benefits may prove elusive, if, for example, the technologies or know-how transferred turn out to be ill-adapted to the host economy. 

Critics argue that foreign investment often leaves poor people vulnerable to the worst forms of corporate abuse. It is claimed that all too often, big business is allowed to trample on peoples’ rights, evicting them from their homes, squeezing them out of business and refusing to allow workers to join unions or make a decent wage. It has also been observed that there is no automatic link between foreign investment and growth. A report by Action Aid (2002) points to the experience of Latin America and the Caribbean in the 1990s compared with the 1970s to argue that “there is no automatic link between increased FDI and (economic) growth.” FDI in the region was 13 times greater in the 1990s than in the previous period, while growth in the region’s gross domestic product was 50 percent lower. The reason was that FDI was concentrated in buying state-owned assets, such as mines or telecommunications companies, rather than creating new industries that provided new jobs and technology. 

Determinants of FDI

On balance, the benefits of FDI exceed the costs. Benefits are, however, not homogeneously distributed across sectors and countries. For maximising the benefits of FDI, policies matter. Many challenges befall the host country authorities to improve economic structures, infrastructure and human capital.

Market Access 

Countries where the state exerts a large degree of control over economic activity and restricts the private sector’s freedom to conduct business are not attractive to potential investors. The regulatory environment must also allow MNCs to compete on an even footing against local companies (foreign firms are often monitored more closely than their local counterparts).

Capital Repatriation. 

Investors focus on the regulations affecting their ability to take invested capital and profits out of the host country. Relevant regulations may consist of tax rates, restrictions or burdensome procedure on taking hard currency out of the country. Typically, local subsidiaries will transfer profits to the parent company through dividends, interest payments, or royalties and/or technical assistance payments. MNCs may also wish to sell some of their holdings of the local company. Countries that restrict these activities have less attractive investment climates. 

Protection of Intellectual Property Rights 

Intellectual property refers to a company’s ownership of the intangible as well as tangible products of its research. These include its manufacturing processes, software, and marketing techniques. A company’s ownership rights are protected through the use of patents, copyrights, trademarks, protection of trade secrets, and other laws covering proprietary technical data. Given that a significant proportion of their assets consists of intangibles, the protection of intellectual property is a high priority for MNCs, in dynamic industries such as computers, telecommunications, and pharmaceuticals, in which technology is a major competitive weapon in the development of new products and markets. For the host countries, the attraction of such industries is of the highest priority, because they offer the highest potential benefits in terms of technology transfer and development of a local high-technology industrial base. To attract investment in these industries, host governments must ensure the effective enforcement of intellectual property rights. 

Some countries are lax in the protection of intellectual property because companies that use proprietary technology illegally may spring up quickly and provide jobs and growth for the host country. In the entertainment industry (through illegally produced videos, movies, and music) and the pharmaceuticals industry (through illegally copied drugs), this practice is widespread and costs the rightful owners of the patents and copyrights hundreds of millions of dollars in lost revenues. Because of the stakes involved, the protection of intellectual property has become a major trade issue between countries. 

Trade Policies 

Since cost is a crucial factor in the competitiveness of exports on international markets, high tariffs make countries unattractive to foreign investors. Similarly, quotas, burdensome licensing or approval procedures, and other nontariff barriers for imports may also raise costs or slow the production cycle and consequently dampen competitiveness and investment.

Licensing procedures also affect the ability to export goods out of the host country. Many countries require exporters to go through several steps before they can ship their products. They may have to get permission from the central bank, clear their goods through customs, or secure other approvals. Fees may also be charged for exporters to obtain the necessary licenses and permits. These requirements may raise costs and delay the appearance of the finished products at the market. Given the intense competition among global producers in numerous industries, higher costs and delays make host countries less competitive and less attractive.

Government Regulation.  

Too much regulation can create distortions that raise costs and cause markets and firms to function less efficiently. For example, many governments have labour laws designed to protect workers’ jobs by making it difficult for firms to dismiss workers despite changing market conditions. Other laws may dictate wage rates for workers (such as the minimum wage law) or may require firms to provide a host of benefits. These laws may raise costs for foreign investors, who often look for competitive edges in labour costs in assessing potential investments. Thus, laws intended to help workers may actually hurt them by discouraging investors from investing their capital and creating jobs. 

Government regulations in other areas also discourage potential investors. Policies may dictate interest rates and/or designate priority sectors where available capital should be invested. Governments may create numerous procedures for getting foreign investments approved or establish other bureaucratic requirements or restrictions that may hamper investors’ ability to move their capital and/or profits into and out of the country quickly. Investors seek flexibility to enable them respond to rapidly changing market conditions. Regulations that hamper firms’ flexibility (such as when governments reserve specific sectors for state-owned enterprises) serve as a deterrent to investment.

Tax Rates and Incentives.  

Excessive tax burdens on investments and profits will discourage MNCs from investing in a prospective host country. The tax burden involves not only tax rates, but the tax treatment of dividends, royalties, remittances, and other transactions between local subsidiaries and their parent companies. To improve their attractiveness relative to competing countries, many countries offer packages of tax and other incentives for foreign investors.  

Political Stability.  

Stable political environments give investors confidence that the “rules of the game,” or laws and regulations governing their investment and the markets in which they operate, will remain basically the same over the long term. When capital is risked in a direct foreign investment, a long-term time horizon is usually required for the investment to generate the expected profits. Investors’ confidence reflects not only their perceptions of the current climate but their expectations about the political as well as economic outlook over the medium and long term.

The attitude of government officials, labour leaders, and private-sector leaders in the host countries also affect perceptions of the host country’s stability and attractiveness. Some countries may espouse a policy of encouraging foreign investment on one level, while at other levels officials may seek to impede such investment through bureaucratic obstructions and other means. Similarly, labour leaders who threaten strikes create a climate of instability that undermines foreign investment. Private-sector leaders may wish to keep MNCs out of their local markets for fear of not being able to compete with them. These groups may take advantage of weak political systems and change the rules of the game in ways that are unfavorable to foreign investors. 

Dr. Francis Chigunta
Development Studies Department
University of Zambia