Absence of a Comprehensive Institutional Structure

Some countries have no comprehensive institutions for screening and monitoring foreign direct investment. Foreign investors are generally free to invest, with some exceptions that may be adopted from time to time reflecting the country’s development priorities. The basic attitudes of these countries can be described by three characteristics: an essentially favorable disposition toward foreign direct investment; a system where treatment of foreign direct investment has been clear and fairly constant over time, but also flexibly and informally applied; and a set of sectoral priorities for foreign direct investment.

Brazil is the example of a major host country without comprehensive foreign investment legislation and institutional infrastructure for screening foreign investment proposals. No government approval is needed for foreign direct investment unless a foreign investor wants to take advantage of investment incentives (industrial or regional), and no government body evaluates foreign direct investment.¹⁰ A foreign investment must be registered by the Central Bank, which satisfies itself that the basic laws are complied with and that the value of the requested investment is accurately stated.¹¹ Among the benefits of this approach is the greater predictability of the outcome of the approval process for both government and investor compared with the inevitably more ambiguous outcome associated with selective policies. Consequently, the potential costs for an investor considering entry are likely to be low. On the other hand, in the presence of large price distortions resulting from tariffs, subsidies, and limited competition, an “open door” policy, such as that followed by Brazil, may result in the entry of those investments that may not necessarily be economically desirable for the host country.

Decentralized Mechanism

Some countries adopt a decentralized screening process that is dispersed across several government ministries and agencies whose interests could be affected by an investment. Usually, the agencies participating in the screening include ministries of finance, industry, or trade, the central bank, as well as other functional government bodies. This direct involvement of many government bodies and entities can have the advantage of bringing to bear the technical expertise necessary for evaluating proposals for a specific industry. On the other hand, many of the agencies and ministries involved in screening may have little technical knowledge or limited experience with a particular industry. Diffuse units operating autonomously may also have little ability to evaluate overall net benefits of foreign direct investment in light of larger policy objectives. Moreover, each agency involved in screening may be pursuing its own narrow objectives, and these may be inconsistent with each other, and with broader policy objectives.

As a result of these considerations, a decentralized approach is likely to be costly to the foreign investor because the period of negotiation is likely to be longer and the results unpredictable at the outset. The potential investor with only marginal interest may possibly go elsewhere, while other investors, responding to the conflicting demands of approval agencies, may reshape investments in ways that are inconsistent with broad national objectives.

Interministerial Mechanism

In recognition of the potential costs that a diffused decision-making process can impose on foreign direct investors, some host countries have developed interministerial mechanisms to coordinate the foreign investment approval process. Such coordination entails the creation of decision-making structures whose operations cut across the existing functional divisions of government and whose membership comprises representatives of affected government agencies.

Many of the disadvantages associated with diffusion of the decision-making process may be overcome by coordinating bodies. Such entities provide a single focal point for foreign investors in all their dealings relating to a particular venture and avoid, to some extent at least, investors tramping from department to department to secure the necessary approvals. Coordinating mechanisms also can recognize the necessary link through planning, promotion, screening, approval, and monitoring of ventures—they can ensure that what is being planned, for example, is reflected in the screening criteria, and what is being monitored reflects the key considerations that have arisen during the screening and approval process. Finally, coordinating mechanisms can allow a streamlining of decision making by avoiding the need to involve government agencies that are only peripherally concerned with a particular investment decision.

Gaining these advantages may entail serious internal political costs, however, since a participating ministry may feel its influence is diminished if it cooperates fully with a coordinating body. To preserve influence, politically powerful ministries may be tempted to send only low-level people to meetings and later impose their power over the investor administratively.

As a result of such political considerations, the power of a coordinating agency in relation to individual board members can vary greatly from country to country. In some countries, coordinating bodies serve only as a clearinghouse for information, while the real power rests with individual ministries. In other countries, a board may have final decision-making authority and truly serve as a one-stop agency, at least for the major negotiating issues. Coordinating boards may be dominated by one or a few members, or power may be diffused among all members. Whatever the specific span of control and authority of a coordinating agency, its existence in a country indicates that the government is attempting to emphasize foreign investment issues, whether the government’s interest lies in attracting or in controlling foreign investors.

Interministerial bodies may either be permanent or ad hoc in nature. The National Commission on Foreign Investment in Mexico, the Board of Investment in Thailand, and the Malaysian Industrial Development Authority are examples of permanent, interministerial bodies.¹²

Centralized Authority

To overcome some of the costs associated with the operation of coordinating bodies, several countries have centralized the foreign investment decision process in a single government ministry or department or, in a case of a particular sector, have given screening authority to a state enterprise. In Korea, for example, approvals are handled by the Ministry of Finance, in Colombia by the National Planning Department, and in Yugoslavia by the Ministry of Foreign Economic Relations.

Some countries, to take advantage of available technical expertise in a single industry and to optimize organizational learning with regard to that industry, have delegated the screening of foreign investment proposals in that industry to specialized government agencies or state-owned enterprises. In Indonesia, for example, foreign petroleum firms have dealt primarily with Pertamina, the national oil company. By contrast, in the Philippines, such negotiations are the province of the Ministry of Energy. In this way, the costs of negotiating and of interministerial conflict are likely to be reduced, while organizational learning is enhanced. However, while obtaining these benefits, certain costs are incurred. By delegating authority to state-owned enterprises and other agencies that possess knowledge of the industry, many of the same shortcomings of diffuse decision making may be experienced; larger policy issues such as the net national benefit of investment and the spillover of negotiations on other investors will likely be ignored.

Delegation of Centralized Decision Making

The entry control function, regardless of the form it takes (diffused ministerial approach, single authority, interministerial bodies), is carried out in almost all cases by the central government authorities only. However, some exceptions to this general practice hold for fully export-oriented projects. Export-oriented firms can locate their plants in any of a number of countries that offer cheap production resources. In most cases, they need only inexpensive labor, sufficient infrastructure, and good transportation and communication facilities. Given this common perception, the competition for these “footloose” investors is usually quite intense. Fearful of losing the battle for such investors, a number of countries have delegated powers to approve investments in export projects to authorities separate from the central investment agency. The goal is to create an organization that can act quickly and decisively, thereby increasing the attractiveness of the country to such investors.

Accordingly, in some countries potential investors for export plants have had the option of investing in export-processing zones. Not only do these zones offer infrastructure, but they generally are run by an organization that is fully vested with authority to reach agreements quickly with foreign investors. In the Philippines, for example, a firm producing wholly for export may choose to negotiate with either the Board of Investment or the Export Processing Zone Authority, or both, depending upon where it seeks to locate and what incentives it seeks to enjoy. In Sri Lanka, the Greater Colombo Economic Commission Authority is the sole agency for approving any investment in the export-processing zones. Indonesia is currently considering the establishment of four export-processing zones and the creation of an Export Processing Zone Authority that will be relatively autonomous from the Capital Investment Coordinating Board of Indonesia.

Sometimes, the authority for specific functional issues, such as taxation and investment incentives, may be delegated to regional governments. In Brazil, for example, investment located in one of the less developed regions (North-East and the Amazon) can apply to regional agencies for specific regional ventures.

The Role of Centralized Investment Authorities

The main issue in selecting the most appropriate organizational form for investment screening is the extent to which decision making within the government can and should be centralized. The most important point to remember in this context is that there is no need to centralize investment decision making if there are liberal and automatic investment policies—there is no need for a central authority if, in fact, there are few decisions to be made. The example of Brazil discussed above is a case in point, as is the practice in almost all OECD countries.

Centralized investment authorities are useful to cut through a myriad of regulations. If there are relatively few regulations, or if decisions are based on transparent criteria, the role of an investment authority is much less apparent. Moreover, it needs to be remembered that central investment authorities can serve to block foreign investments just as easily as they can facilitate them. Some of the countries that have been the most active in restricting foreign investment have done so through the mechanism of an intransigent central investment authority. Such authorities, therefore, are not inherently facilitators of investment and, if that is the intent, their activities will have to be carefully monitored by the political authorities.

A second point to be borne in mind when evaluating the feasibility of establishing a true centralized investment decision-making authority is that the various parts of government that normally participate in these decisions will yield authority to a central body only reluctantly. It is for this reason that true one-stop shops are quite rare. They are found almost exclusively in small countries. Most countries that claim to have a central investment authority in fact have a coordinating agency with limited decision-making power. These bodies sometimes have difficulty in cutting through the investment regulations that were the reason for their establishment in the first place.

Rather than establishing a compromise investment authority, it may be more productive to work on the investment policies, making them more transparent and less restrictive. In that way, the need for a central agency can be reduced, and a more decentralized mechanism might suffice.

Organizing for Investment Promotion

The main task of a centralized investment authority may be investment promotion rather than investment screening. Investment promotion is an activity that demands a central focus to present the country to the foreign investment community. It is not an activity that can be easily decentralized either bureaucratically or geographically.

Investment promotion consists of three main activities:

• country image building;

• investment generation; and

• service to investors.

A complete investment promotion program will contain all three elements, but the main focus will be given to one of them at different stages in the life of the program. At an early stage, priority may be given to servicing existing foreign investors so that they will be happy and can serve as ambassadors for the country. As the program develops, greater attention will be given to country image building, assuming that the reality is consistent with the image that is being projected. Finally, the focus should shift to targeted investment generating activities.

The organization that carries out the investment promotion program can be in the government, in the private sector (although supported by the government), or in between the two as a quasi-government organization. The most successful promotion organizations have been of the latter type, with links to government, but with freedom particularly in hiring and setting salaries to attract the kinds of aggressive marketing people who are usually found in the private sector.

Combining Promotion and Screening

It is difficult to combine a vigorous screening organization with an aggressive promotion function. One or the other of these functions will dominate. If it is screening, the promotion function will most likely be neglected. On the other hand, if promotion dominates, the screening function is unlikely to be independent—promoters are unlikely to be willing to see the fruits of their efforts rejected by the screening process.

Screening and promotion have been successfully combined in a single central investment authority when liberal investment rules are in effect. In that case, foreign firms are relatively free to establish, and screening is carried out mainly to determine eligibility for investment incentives. Targets for investment promotion, however, are in a sense pre-screened, being selected for the contribution they can make to the development of the country. The promotion function dominates the investment organization, but screening criteria are taken into account in selecting targets for promotion.

Countries approaching investment promotion in this way generally are considered to have investment authorities that are one-stop shops. They provide a wide range of services to investors and grant incentives, as well as carrying out investment promotion. Good examples of such institutions are the Industrial Development Authority of Ireland and the Economic Development Board of Singapore. These organizations flourish in countries with liberal policies toward foreign investment. They would be difficult to conceive in more restrictive environments.

Summary

Policies and institutions required to manage foreign direct investment (FDI) in the context of developing countries is the subject of Mr. Weigel’s paper. In most developing countries, policies mean objectives of joint ventures, and institutions mean investment authorities. The form of institution is influenced by the policies pursued.

Both policies and institutions should be consistent with the goals to be achieved from FDI. For example, if export promotion is the main economic objective, then FDI policies should be directed to achieving this goal. Likewise, institutions and objectives ought to be consistent.

Comments

I offer the following comments on Mr. Weigel’s paper.

Mr. Weigel has rightly emphasized the point that developing countries should first determine clearly whether they need FDI or not and, if they do, then what purposes are these investments going to serve (that is, objectives). Clear objectives will determine appropriate policies and institutions. Among the major contributions of FDI to the economies of developing countries are foreign exchange earnings, foreign market outlets, and transfer of technology and employment. Developing countries with their different levels of development and resources do associate one or more of these objectives with their FDI policy. Thus, we can say that FDI is needed in one way or another unless a country takes a stand against FDI from an ideological point of view.

In the long-term interests of the host country, a foreign investor should be obliged to structure a joint venture vehicle in which he and a local partner or partners share and run the business. In this regard, I differ with Mr. Weigel, who does not see a strong need for imposing a joint venture policy on foreign investors, if my reading of his conclusions is correct. The percentage of foreign shares in the joint venture may differ from sector to sector, but the various aspects of the joint venture, such as management, the financial structure, and operations, should be left to the share-holders concerned.

The requirement of having a joint venture between foreign and local investors should not be left to the discretion of the foreign investor. Government policy should lend support to local firms in this regard, since local firms are in most cases in a weaker position compared with their foreign counterparts. The latter, in many cases, have the foreign exchange, the know-how, the managerial skills, and foreign market outlets. Therefore, from a practical point of view, a foreign partner may not find himself in need of a local partner. In such an environment, a government policy to enforce joint ventures as a mode of operation for FDI may be necessary. Such a policy will balance the bargaining power in favor of local firms and create a stronger long-term foundation for business activities.

For joint ventures between local and foreign firms to be beneficial to the economy, it is essential that the local partner have a minimum structure of business corporations operating in the same field as his foreign counterpart. Often, foreign companies not interested in transferring technology or managerial skills look for power centers in the host countries with which to form their joint ventures. These power centers act as agents and are not usually interested in developing local institutions to work hand in hand with foreign firms and learn the skills of running a business successfully. This attitude may find large acceptance among the foreign investors who do not have a long-term perspective. The host country agent with his short-term interest and lack of institutional setup is unable to provide genuine and professional services to the foreign firms. Thus, his position in the partnership will depend on his role as a manipulator of the public system and as a user and initiator of corrupt practices as a means of achieving unlawful personal ends.

Local professional firms, especially medium-sized and small ones, are not in a strong position to attract large international corporations. Therefore, government incentives to attract foreign direct investment should be linked to the promotion and development of joint ventures between professionally established local firms and foreign investors.

Many developing countries suffer from the lack of balance between their foreign exchange earnings and foreign exchange expenditures. At the heart of the matter lies the excess of consumption over production. In many cases, the government share in total consumption is the largest and the least efficient. Excessive government spending steered by the forces of corruption and financed through deficit financing contributes much to the shortage of foreign exchange in many developing countries. A successful FDI policy is not only a matter of whether a joint venture is required but, more important, whether a healthy business environment exists that would maximize the economic return from FDI for the benefit of the host economy. Red tape, bureaucracy, corruption, administrative problems, import licenses, and employment of skilled foreign labor could easily handicap the business and minimize its return. What FDI needs is not to be freed from joint venture obligations with a local partner but rather to be freed from:

• political uncertainty;

• uncertainty embodied in the lack of clear and sustained application of the law in general and commercial law in particular; and

• major shocks in fiscal and monetary policy.

Institutions needed to deal with foreign direct investment are mainly affected by the inefficiency of the government management system. In a system where corruption and an absence of accountability are dominant, any organizational structure will not work efficiently. Whether a centralized or decentralized form is adopted, the forces of corruption will be able to twist any system to their own ends. Thus, if the institutional structure to deal with FDI policy is to succeed, a minimum level of efficiency and accountability in the government management system must be accomplished.

In countries of the Gulf Cooperation Council (GCC), or those countries whose foreign exchange earnings and/or employment requirements are not compelling needs in the short run, joint ventures whereby the local firm enjoys a high level of sharing and participation are especially important. What these countries need most are efficient business institutions (corporations) able to absorb foreign skill and the technological capability necessary to create and run a business in a profitable and economically productive manner. This environment is one in which entrepreneurial skills and ability are born, and this is what an economy with a liberal economic strategy needs most.

In summary, Mr. Weigel has concluded his excellent presentation of the various aspects of the two thorny problems of foreign direct investment—joint ventures and the investment authority—by recommending less emphasis on the policy of joint ventures by the host countries and an investment authority whose main concern is promotion of foreign direct investment rather than screening and control.

The liberalization of policies and procedures for foreign investment is accepted almost as a general rule by the majority of developing and developed countries. The winds of liberalism have swept over more areas on the economic and political map than has foreign direct investment, which is undoubtedly a move in the right direction. Nevertheless, liberalizing foreign direct investment should not, in my opinion, mean leaving the issue of the linkages between the foreign and local business institutions to the sole discretion of foreign investors or even to both parties. This would be the norm in the more advanced economies where there is some degree of compatibility and comparability between the two parties—the foreign and local investors—or where the host country is well advanced in the institutional, technological, and managerial aspects of investment, and all that is needed is the flow of financial assets to promote local production for local consumption or export. Developing countries, in many cases, have overlooked the importance of the long-term institutional, technological, and managerial benefits in the host country’s long-term development and have concentrated on the short-term returns embodied in increasing production or employment directly. These objectives in a short-run framework would be achieved naturally by the foreign investors having a free hand in the mode of operation. Domesticating and institutionalizing the forces that lead to higher levels of production and employment in the long term is a much different and more difficult task. Liberalizing foreign direct investment in developing countries should be encouraged and directed so as to enhance the long-term benefits to the host country and the foreign investors.

A clear and well-defined government objective coupled with a liberal and market-oriented policy toward foreign direct investment through joint ventures between well-established institutions of the host country’s private sector and those of the foreign investor is, in my opinion, the optimum policy. Though Mr. Weigel and I may differ on the need for joint ventures as a matter of policy we are not far apart on many other issues.

On the institutional side, I do think that a centralized approach in the form of an investment authority entrusted with all the powers to apply the strategy and to issue policies and procedures is a more efficient vehicle than any other. To ensure the success of the investment authority, it should be given all the ingredients in terms of either organization or by-laws that allow it to operate along the lines of the private market institutions. In this way, the authority can understand the problems facing private investors and can offer logical and efficient solutions.

Moreover, the general levels of discipline, accountability, and morality in the public system, as well as in the whole society, have a good deal of bearing on the working of whatever institutional structure is chosen to manage foreign direct investment. Thus, a means of improving the performance of FDI could be found in some areas that may seem at the outset to have no relationship to the issue.