Chapter

3 Foreign Direct Investment in Developing Economies

Author(s):
Claire Liuksila
Published Date:
December 1995
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Author(s)
J. Jegathesan

This paper focuses on the “export-oriented investor” Such an investor has the choice of various locations in any part of the world. Many developing countries are “bending over backwards” to either attract or retain the manufacturer who has an export-oriented project.

Any businessman investing abroad will ask, “If I were going to invest my money, time, and effort in another country, what conditions would I reasonably expect in that country?” Ten factors stand out—these might be called the ten checkpoints or ten commandments for an ideal investment environment. These factors are political stability; economic strength; welcoming attitude; government policies; infrastructure; labor; banking and finance; government bureaucracy; local business environment; and quality of life. The bonus factor would be tax incentives. There must first be a solid foundation under the bonus factor, however, which is the investment environment.

The ten factors, discussed below, should be considered by both concerned investors and governments trying to attract foreign investors.

Political Stability

This factor is essential, because without it there would be political turmoil which could wipe out overnight even the most lucrative investments and endanger the lives of personnel. Many countries and companies have paid a heavy price because they overlooked or ignored this factor.

Economic Strength

Investors would not want to invest in a country where the economic fundamentals are so weak that it is unpredictable what the government will do next to shore up a sagging economy. A country that has sound economic fundamentals is not likely to make drastic or negative changes. The investor is assured of a growing economy, and of increased opportunities for business, as more government development projects and private sector investments put purchasing power in the hands of the people. Increased purchasing power means increased positive multiplier effects on the economy and a source for stability.

Welcoming Attitude

The attitude that the country portrays to a foreign investor when he is in the country is very important. Ministers and top civil servants while on investment missions abroad encourage foreigners to visit their country—both as tourists and investors. However, is this attitude pervasive? Do all government officers, labor leaders, and opposition party politicians feel the same way? What about the people of the country in general? Has past anti-foreign rhetoric of leaders created a sense of fear and hatred of foreigners? Have immigration and customs officers at airports and other entry points been fully briefed to be made aware of the critical role they play in the entire investment promotion effort? Or do officers at entry points see every foreigner as an exploiter, a nuisance, someone who should be “properly harassed,” or as a source of “corrupt pocket money”? These attitudes play an important role in foreign investors’ decision making.

Government Policies

Foreign investors (in fact, all investors) are concerned about government policies that could in one way or another affect business—trade and investment. There are three critical factors that the investor who plans to invest money, time, personnel, and resources in any country should take into account:

Equity guidelines. Simply put, “How much of my business can I own?” This is a critical factor and often the investor’s attitude toward ownership will differ depending on the type of project. For example, if the project is export-oriented and does not depend critically upon the raw materials of the country (especially depleting raw materials), then the foreign investor would insist on a majority or often complete foreign ownership. Another example would be if the project is export-oriented but critically depends upon the raw materials of the country, the investor’s attitude will depend on the availability of neighboring countries that may offer equally or even slightly less favorable investment environments. Thus, developing countries wooing export-oriented manufacturers must be sensitive to the strategic options available to foreign investors, especially in the key issue of ownership.

Employment of expatriates. “Once I know how much I can own, who will look after the project and especially my personal interest in that project?” This is a question that any investor will ask and thus the policy on expatriate employment becomes a critical issue. Thus, governments must be prepared to allow for one or several permanent “foreign posts” in any project where the foreign investor has a degree of equity participation.

Exchange control. This is another vital factor for the investor, even more critical than the first two. “How easy is it to bring my money into the country, and more important, how easy is it to repatriate my profits and also my capital from the country?” The freedom of movement of capital and profit is not nearly enough. The ability of companies to hold foreign exchange external accounts in domestic or foreign banks (that is, of earnings they make in foreign exchange) would be another positive factor, for this would save considerable losses to companies in the exchange risks they have to face.

Another factor that is of concern is that of intercompany accounts. This is especially a concern to multinational organizations with parent companies supplying components to projects in developing countries and buying back sub-assemblies or finished products; or even where companies export directly to buyers on orders received through the parent company. In a world where physical movement of funds is being offset by counterentries, this intercompany accounting system would be a useful incentive to companies that have to deal with “net flows” of funds.

Infrastructure

Once the investor is satisfied with the first four factors, his next concern is the infrastructure—the availability, reliability, and cost that will affect directly his manufacturing costs.

The word “infrastructure” here covers: industrial land; communications between the industrial area and key markets; availability and reliability of power and water supplies; and telecommunications facilities. Critical to all of these factors would be their operational costs, and how competitive these costs are.

Labor

Often, it is assumed that companies from developed countries invest in developing countries merely because of cheap labor. This is true only to a certain extent. If cheapness per se was the criterion, many of the relatively low-population/higher-labor-cost developing countries of the Far East would have lost out to the high-population/low-wage countries of India, Indonesia, Africa, etc.

There are critical factors over and above the issues of availability of workers and costs. These include education standards of the population, trainability of workers, work ethics, harmony of the labor environment, influence of politics and political parties on the labor movement or labor unions, availability of professional and technical personnel among locals, and productivity levels that can be achieved due to work culture.

Banking and Finance

Other considerations for investors will be whether all the instruments required for modern international trade and investment are available; whether there are sufficient banks with international connections to conduct competitive international business; and what is the cost of funds and how difficult is it to get access to these funds? Foreign banks can play an invaluable role as confidence boosters and also assist investment promotion efforts in their home environments, spurred by their own interests of business and profits.

Government Bureaucracy

This could be the biggest “burden” in any investment environment. It does not matter how efficient the government thinks its investment machinery is; what is critical is the perception of businessmen, especially those already in the country. Do businessmen feel that they have the support of government officials in their efforts to set up and operate efficient business units, or do they feel that they have to “fight” the government to get projects off the ground? Are investments being made in spite of government or because of government support?

Local Business Environment

This covers many factors, including the availability of local lawyers, secretarial service, accountants, architects and building contractors, local consultants, etc.—all required both before and during the life of a project. Also, there is the question of the availability of ancillary and supporting industries, their quality, and their cost.

Another question would be the availability of suitable joint-venture partners, and whether there are lists of potential partners that the investor can choose from or conversely choose to ignore if he has his own contacts. Finally, investors need to know if local businessmen are investing in their own country. A satisfied foreign investor, operating an efficient, growing enterprise and re-investing in that country is the best testimony to the country’s “investor-friendly” environment.

Quality of Life

This last factor is taken for granted by many people living in developing countries who are used to whatever their environment has to offer. What the local population accepts as normal and what long-staying expatriates accept as part of their lives in a foreign country can be a “culture shock” for the expatriate staff of the new investor. If a foreign investor wishes to persuade his “top” officials to run the new operation, the “quality of life” aspect is critical.

Conclusion

The ten checkpoints constitute an investment environment that encompasses safety, cost, convenience, and other factors. These factors are, of course, over and above the critical factors of the economics of the project itself.

One should not forget incentives. The incentives factor will come into play to determine how much profit the investor gets to keep. Where the ten checkpoints and other economic factors will determine whether the project will make profits, two issues—ownership and incentives—will determine how much profit the investor retains and how much he has to share with the government and local partners.

Thus, all newly emerging developing nations (NEDNs) that seek to attract foreign investors must be sensitive to the dynamics of the world investment environment. Today, when investors talk in terms of the world becoming a “global village” for manufacturing enterprises—where robotization and automation may tend to vitiate the cost advantage that newly emerging developing nations may offer—the competitor of the NEDN is not only the neighboring country or even a country in the same continent, it is the world—the world is the competitive arena.

In addition to the ten checkpoints, there are four additional factors that dictate business decisions for companies seeking new investment opportunities. These are cost, convenience, capability, and concessions.

Cost. What is the cost of doing business in this country? These include every factor that goes to make the cost of the product and those that increase costs unnecessarily. These also include the social and other costs that companies and individuals must bear.

Convenience. How easy is it to do business in this country (convenience of business, living, banking, travel, communications, etc.)?

Capability. What is the capability of the infrastructure to sustain project needs, the capability of workers to meet productivity needs, the capability of the government machinery to respond to competitive needs?

Concessions. What concessions or incentives exist for establishment, exports, etc.? These include tax holidays, export incentives, concessional funding, and other cost-reducing or profit-sparing incentives.

If these factors are in place, companies investing in a foreign country will be more likely to succeed, and countries will more likely be able to lay the groundwork for attracting and retaining such companies in their environment.

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