08 April 2012 Written by  Tesfaye Abate

INVESTMENT IN DEVELOPING COUNTRIES

General

In developing countries, the trend is that both inflows and outflows rose in 2005 although trends varied by regions. According to the study conducted by the UN, inflows into and outflows from Latin America and the Caribbean and West Asia rose in 2005. But, only inflows rose in Africa and East, south and South- East Asia in the same year. West Asia underscored both inward and outward.

Africa

In Africa, rising corporate profits and high commodity prices helped boost inflows in 2005 to $ 31 billion from 17$ billion in 2004. However, the region’s share of global FDI remained at around 3%. The inflows concentrated in mining, in particular oil and gas, although there was also investment in services from the United Kingdom, the United States, South Africa, China, Brazil and India.

With respect to manufacturing, low skill labour, fragmented markets and lack of diversification inhibited FDI in Africa.

South Africa, Egypt, Nigeria, Morocco and Sudan accounted for 66% of the region’s FDI inflows in descending order of value of FDI in 2005. Investment from China and other Asian economies increased particularly in the oil and telecom industries.

FDI inflows into East Africa fell to $ 1.7 billion from $ 1.9 billion in 2004, which represented only 5% of the inflows to Africa. Two factors are pointed out as reasons for the decline in the inflow of FDI in East Africa. These concern the fact that the sub-region is poor in resources, and there is a political instability. As a resul,t the inflow of FDI into Ethiopia, Kenya, Madagascar and Mozambique declined in 2005. On the other hand Uganda attracted more FDI due to its continued macro economic and political stability.

With regard to out flow FDI in 2005, Africa’s share fell by 44% to $ 1.1 billion from $ 1.9 billion. This comprises only 0.1% of the world FDI outflow and only 0.9% of developing countries out flows. In 2005, Nigeria, Liberia, Morocco, the Libyan Arab Jamahiriya, Egypt and South Africa were the top six countries in out ward flow FDI, accounting for 81% the region’s outflows.

Sectorial trends

The trend shows that the FDI inflows to Africa in 2005 were tilted towards primary production, particularly oil. It also shows an increase in service sector, especially in banking. Algeria (55%,) Egypt (37%,) Nigeria (80%) and Sudan (90%) attracted FDI in oil production.

Policy Developments

African countries continued to liberalize their investment environments. Most of the African countries made their environment favourable to investment although some of them made the environment less favourable. In addition, the trend towards privatization continued across Africa. African countries also attempted to change the investment climate. Countries like Egypt, Ghana, Senegal and South Africa have reformed their tax systems, and as a result they often reduced corporate income taxes. In addition, some have ensued operational conditions for TNCs. For instance, Egypt has been facilitating the entry and residence of foreigners.

Further, some countries such as Ghana, and Mali have reformed their admission procedures by introducing one-stop shops, having recognized that an investor-friendly admission phase has a beneficial effect on the subsequent  relationship between the host and the investor. Some other countries also acted to remove some of the key constraints in attracting and benefiting from FDI. South Africa, for instance, has introduced a Skills Support Programme (SSP) to enhance the supply of skilled labour.

Some policy changes have also been made with respect to regulatory framework less favourable to FDI in the extractive industries. For example, the Central African Republic introduced an indefinite suspension of the issuance of new gold and diamond mining permits and banned foreigners from entering mining zones. Zimbabwe continued its indigenization program by requiring all foreign- owned mining companies to sell a 30% stake to local businesses within a 10-year period.

African countries concluded bilateral investment treaties to regulate investment.

India: A Successful Developing Country in Investment

Since 1991, India has opened its doors to foreign investment. Prior to the implementation of the 1991 Indian economic policy, foreign investment was allowed on a case-by-case basis. However, now the Indian Industrial Policy liberalized the internal licensing requirements for business and retained only minimum procedural formalities. The policy removed restrictions on investment and it facilitated easy access to foreign technology and foreign direct investment.

The Industrial policy of 1991 was aimed at avoiding the red tape and corruption in the bureaucracy, and liberating Indian business. The policy has resulted in increasing income and improving the living standards of Indian residents over the last decade.

Labour-The local employment population is another great benefit for investment in India in addition to the liberal investment policy. India is one of “the largest domestic markets in the world and it has a large labour force available at relatively low cost”. India has very educated workers especially in the area of engineering and science. The country welcomes approximately 200,000 new engineers per year. India offers investors higher  potential rate of return than any country in the computer software sector. The people are fluent in the global language English, which offers an advantage for foreign investors in the country.  The Indian labour has a generally favourable attitude towards foreign investment. What is more, foreign investors could employ foreigners since the Indian investment law does not prohibit doing that.

Despite the fact that India offers educated workers, investors faced delays due to Indian workers failure to understand what they are expected to perform. The reason is believed to be that Indian workers are not being onsite. In addition to delays, there are also hidden costs associated with outsourcing jobs to India. As a result, investors have been forced to expend more money and hence, many companies could actively look for places cheaper than India, such as Argentina and Colombia.

Tax treatment- India has also made changes to its tax law with a view to increasing foreign investment. As a result, the rate of import duties for capital goods has been greatly reduced.



Investing in developing countries abroad

Foreign investors are encouraged by several factors to invest abroad in general and in a developing country in particular. There are also factors that pull investors to invest abroad. These factors may be categorized as pull factors and push factors. Pull factors are factors that attract the investor towards developing countries to invest. Push factors, on the other hand, are unfavourable factors in the home state of the investor that repel the investor from that country. Thus, push factors have the force to push the investor to opt for a favourable condition to invest in. Therefore, the investor will go to abroad to invest. It is worth noting that push factors are the opposite of pull factors.

The following may be the pull factors for investors to invest in a developing country:

1. Market pull factors– Investors need market for their production. Now a days, the world is divided into different economic blocks. For example, there are the common Market of Eastern and Southern Africa (COMESA), European Union (EU) etc. If the product originating from a member country of a block, it may benefit from preferential tax treatment compared to a similar product originating from another region. For example, a product originates from Ethiopia will get a preferential tax treatment in COMESA than a similar product that originated from China because Ethiopia is a member to COMESA while China is not. Thus, if the particular product has a demand in COMESA, Chinese investor may want to invest it in Ethiopia to be a beneficiary of the COMESA.Market pull factors are the most important determinants of FDI especially in host economies. Large Markets that are emerging in developing countries will be more attractive. However, the size of the market depends on the type of the product. Thus, the capacity of the consumers to buy the product is crucial.

2. Resources: An investor needs natural and human resources in a reliable manner to produce or manufacture. Thus, the investor could be attracted by the abundance of natural and human resources available in developing countries. An investor will prefer to invest in a country where natural resources needed for the manufacture of his/her/its produce are available in a large quantity and at a cheaper in price.In addition, an investor will be attracted to invest in a country where skilled, disciplined and cheap labour force is found, other factors being equal.

3. Policy frameworksof a host country also determine the direction of FDI. Liberalized economic policies and privatization policies of a host country attract FDI. Regulations and inducements encouraging FDI and investment treaties (bilateral or multilateral) facilitating FDI are pull factors.

4. Political and economic stability:Investors are investing with a view to gaining profit which would be realized through time. Thus, to gain profit, the political and economic stability of a country are essential. Therefore, investors will be attracted to invest in a country where there is political and economic stability.

5. Existence of relevant clusters:- The nature of investment requires the existence of some inputs from other enterprises. A group of enterprises feeding each other within put are known as a cluster. For example, a textile factory needs an enterprise that spins cotton and produces raw material to produce clothes. An investor will be attracted to invest in a country where inputs are available for him/her/it to produce.

6. Growth: An investor wants to invest in a country where there is a demand for the product because this may reduce cost to transport the product to such country by producing it in the country. This definitely will increase the profit from the investment. Investing in the country where there is demand for the product will also enable the investor to adapt the product to local needs and taste. The point here is that the foreign investor prefers to invest in the country if customers of a given product grow in number, the other factors being same.

Lax Environmental Laws–Developed states require investors to ensure that their investment does not affect the environment negatively. For example, they may require investors to reduce their carbon emission to a specified level. In short, the investment law of developed states is very strict in protecting their environment. On the other hand, developing countries have less strict laws in this regard. Consequently, investors would invest in developing countries to reduce additional costs due to strict environmental law.

Push factors that repel FDI in developing countries include:

1)      Market push factors- Developing countries have limited home market that may not expand as required by investors. Thus, this is a push factor since the investor may wish to go out to find market.

2)      Increases in production costs are also driving factors. Increase in production costs may be the result of rapid economic expansion, or scarcity of resources or inputs. Increase in labour costs is a crucial factor that pushes investors. In addition, inflationary pressures also are pushing factors.

3)      Home country business conditions-may be the cause for the investor to opt for international investment. For example, if the competition in the home country is stiff, the investor may need to move into a foreign market.

MOTIVATION AND STRATEGIES

Market-Seeking– FDI is the most common type of strategy for TNCs in their places of internationalization. This was confirmed by a study conducted by UNCTAD as the most significant motive for FDI. Particularly NTCs in developing countries invest to open or secure markets since the resources, like oil gas, are available in their home countries.

Efficiency-seeking–FDI is an important motive. In Asia FDI investments in electrical and electronic products, garments and IT services are made based on the principle of efficiency seeking. They mostly consider efficiency to mean low-cost labour but for Indians it means “primarily the synergies to be gained through the international integration of production and service activities, rather than “low cost inputs”.

Efficiency seeking investments depend on the nature of the product and the particular type of global production network in which it is located. The two main types of networks are:

I. Buyer driven– Large buyers control branding, marketing and access to markets and strive to organize, coordinate and control the value chain in industries such as agro-industries, garments, furniture & toys.

II. Product driven– Key companies own crucial technologies and other firms in the net work, especially supplies e.g. Electronic & automobiles. Industry clusters are also an important aspect of product-driven global production networks.

C. Resource- seeking:-is of moderate significance. FDI may be made to secure material resources abroad, e.g. China, India, Turkey.

- Due to competition, TNCs are extracting resources in countries beset with civil wars, ethnic unrest or other difficult conditions e.g. China National Petroleum Corporation (CNPC), ONGC and Patronas (Malaysia’s national oil company), are heavily involved in oil exploration and production in the Sudan where a number of conflicts are  raging.

Last modified on Friday, 07 February 2014 14:00