Although China, especially since its recent accession to the World Trade Organization (WTO), is a magnet for FDI in Asia, many smaller countries have learned to compete for their share of investment. Indeed, for the long term, FDI flows to China and to other parts of Asia could well be complementary rather than competitive, according to two Tokyo-based IMF regional experts, Yu Ching Wong and Charles Adams. They told participants in the conference, jointly sponsored by the IMF and the State Bank of Vietnam, that “more FDI for China need not imply less for other countries.” In their view, the more important issue was getting the domestic policy environment right to attract FDI.
Nearly 150 conference participants considered the key role FDI can play in supporting the transition of Cambodia, Lao PDR, and Vietnam to market-oriented economies by fostering management know-how and nurturing dynamic private enterprises. Review of the global and regional experience with FDI provided the backdrop to a more detailed analysis of how the three Mekong Delta countries could attract and sustain higher levels of FDI.
Several broad conclusions emerged, according to Wanda Tseng, Deputy Director of the IMF’s Asia and Pacific Department.
While China will remain a magnet for FDI, it cannot have a comparative advantage in everything. A prosperous China will undoubtedly contribute to opportunities in the region. Some participants, including Nick Freeman of Mekong Capital, said that ultimately China would become a source of FDI for the rest of the region. In this connection, Jiang Xiaojuan of the Chinese Academy of Social Sciences strongly emphasized the benefits of FDI to the Chinese economy.
Policymakers need to recognize that the challenge in the globam economy of today is to build knowledge, not just buildings and machines.—Peter Brimble
On the factors driving FDI, there was a convergence of views. It was generally accepted that FDI cannot flourish without political stability. It was equally clear that the existence of a large and growing domestic market, or an integrated regional market within the framework of a regional association, can be very helpful, but this is not essential because most successful FDI has been in export-oriented sectors, as Jiang pointed out. An open attitude toward global competition and a favorable investment climate are prerequisites, as is a relatively low cost structure, entailing reasonably adequate infrastructure. There is also the need for a transparent and dependable legal framework and a simple investment approval process. In this connection, Chia Siow Yue of Singapore’s Institute for Southeast Asian Studies stressed the role of efficient administration. Singapore, she noted, started out by adopting a partnership approach with regional companies that did not try to extract too much from them and did not impose performance requirements.
There were diverse views, however, on how to maximize the benefits of FDI by enhancing technology transfers and spillovers. Most believed that countries should rely more on current comparative advantage, and that FDI that responds to global market forces holds the most promise, particularly FDI in export sectors. However, a few participants suggested that selective interventions based on anticipated trends in comparative advantage can be effective, but this would require careful industry-specific analysis and broad consultation with the private sector. For example, Hooi Eng Phang, Advisor to the IMF Executive Director for the three Mekong Delta countries, cited Malaysia’s experience in providing special incentives to encourage a shift from manufacturing to services and, more recently, to high-tech sectors.
Limiting tax incentives
On the possible pitfalls of strategies designed to attract FDI, participants debated the relative merits of tax incentives. One view held that because tax incentives for FDI are typical in the region, no country may be able to avoid them. Yet others believed that over the medium term, the region is moving away from relying on these incentives. Meanwhile, if incentives are unavoidable, they can be streamlined and designed to limit the drain they place on the budget and their potential for corruption.
While the specific circumstances of each country differ, there are common elements in the strategy for improving the investment climate, not only for foreign investors but also for the domestic private sector. These include maintaining a stable macroeco-nomic environment aimed at sustained economic growth; strengthening public finances while using public expenditure to build infrastructure and improve labor skills; tackling corruption and strengthening governance; and deepening reforms, especially by pursuing open trade and investment regimes, particularly through the free trade agreement of the Association of South East Asian Nations (ASEAN) and earliest possible accession to the WTO.
Lessons from the region
As FDI can fluctuate with global market conditions, it is important to manage macroeconomic policies prudently and flexibly to deal with external shocks. A key policy in this context is flexible exchange rate management. Peter Brimble of the Bangkok-based consultancy Brooker Group drew applicable lessons from the experience of Thailand and elsewhere in the region. He recommended a shift toward attracting investment in the knowledge economy. “Policymakers need to recognize that the challenge in the global economy of today is to build knowledge, not just buildings and machines,” Brimble stated. He noted that both Singapore and Malaysia have been “very proactive with promotional strategies to attract new players to their respective markets.” Le Dang Doanh of Vietnam’s Ministry of Planning and Investment agreed, saying that, so far, potential investors in Vietnam could not get enough information through the Internet.
What specific steps should the three Mekong Delta countries take? For Vietnam, participants particularly recommended rigorous implementation of its bilateral trade agreement with the United States and active preparations for entry into the WTO as a means to further open market access for investors and to upgrade its legal framework. Equal emphasis was put on improving the business climate by reducing the costs of doing business and leveling the playing field between the private and state sectors. Transparency, predictability, and consistent application of policies are crucial. On a more practical level, they added, simplifying licensing and approval processes would be helpful.
For Cambodia, there is an urgent need to rebuild human capital, basic infrastructure, and the legal framework. Also, to increase budget revenues to help finance economic infrastructure, Cambodia should rationalize its relatively generous investment incentives and broaden its revenue base to avoid higher tax rates—as it has started to do. More generally, continued progress in strengthening the fiscal position and in improving economic management will be essential. Hing Thoraxy of Cambodia’s Council for Development said that, because of limited resources, Cambodia would focus on developing industrial corridors and export processing zones where facilities and infrastructure would be competitive.
For Lao PDR, prudent macroeconomic management is needed to ensure overall stability. With its rich endowment of untapped natural resources and a continuation of its liberal investment policy, Lao PDR is well placed to attract FDI. Streamlining approval procedures is important, and promoting special economic zones may be a pragmatic first step to improving infrastructure for investors. Greater policy transparency, especially through increasing information flows, will be critical in boosting investor confidence.
Freeman observed that one of the initial driving forces for French colonial investment in the Mekong Delta was as a backdoor entry to China. Could the region serve as a conduit to the large Chinese market again? Without directly supplying the answer, he said that ultimately China is likely to become a substantial source of FDI for Indochina. Chinese investors have already taken on a more prominent role in Cambodia and Lao PDR, particularly since 1997, but “it will probably take time,” he said, “for China’s FDI flows into Indochina to gain real momentum”
On a per capita basis, smaller Asian countries have been relatively successful at competing for FDI
1 In U.S. dollars.
Data: IMF, International Financial Statistics; World Economic Outlook database; IMF country reports; and national sources