The role of FDI2018-11-03T16:05:57+00:00

The role of FDI

In our framework, FDI is seen primarily as a source of capabilities. In fact, for poor countries with little prior history of manufacturing, FDI can be the main source of productive capabilities, including production techniques in new industries and management practices in existing firms.[1]

An FDI strategy must be structured around the objectives of attracting the best possible kinds of foreign investment, and maximizing the domestic economic returns generated by it. The most beneficial FDI will be in industries that offer more scope for further diversification and quality improvements[2] and are not too complex given existing capabilities. Capability transfer will be enhanced by increased contact between foreign and domestic producers, which can take place either through buyer-supplier relationships, social networks, or experience working in the same firm.

Guiding Principles for FDI

  • FDI should be promoted only as a means of furthering domestic economic objectives.
  • Key is to transfer capabilities from foreigners to domestic workers and managers.
  • Countries should aim to attract efficiency-seeking investment, but;
  • Market-seeking or resource-seeking investment can be beneficial under certain circumstances.
  • Improving economic fundamentals will ensure greater benefits from FDI through increased absorptive capacity

Key Policies:

  • Creating well-functioning Investment Promotion Agencies (IPAs), aiming to attract foreign investors and ensuring they can operate smoothly.
  • Creating well-functioning Local Content Units (LCUs), responsible for suggesting potential local suppliers to foreign firms and helping domestic firms meet higher quality standards.
  • Financing entrepreneurs with experience in foreign firms.

Sutton’s Principles of IPA Design

  • Establishing ‘one stop shop’ operations.
  • Creating an organizational culture focused on helping foreign firms.
  • Assigning each important company to one contact person at the IPA.
  • Organizing monthly meetings where progress is checked and action points are identified.
  • Periodically checking in with foreign firms, rather than waiting for problems to arise.

 

Sutton’s Principles of LCU Design:

  • The relationship-building function and the training function should each be embodied in a different ‘sub-unit’.
  • Focus on the largest firms.
  • The LCU should be put under a government ministry with authority over an adequate number of policy areas.
  • Head of the LCU should be a senior appointment, politically ‘neutral’, well-connected, and trusted and respected by the business community.
  • Small, highly skilled group of staff members operating over a long time frame.

 

There is no clear guidance on how much FDI is optimal in a development strategy. In Asia, the use of FDI varied from minimal in the case of South Korea (with FDI inflows at an average of 0.1% of GDP between 1980-1989) to extensive in Malaysia (at 3.1%)[3]. More important than the absolute amount of inbound FDI is the way in which foreign investors engage with the host economy, the capabilities they are required to transfer locally, and the amount of power they are allowed to wield over the recipient country. It is appropriate to expect the behaviour of foreign investors to be consistent with the development strategy of the recipient country. At the same time, foreign investors must feel like they are welcome.[4]

[1] See Dercon, Lippolis and Peel (2018) –  “What should be the role of FDI in African Development Strategies?” Background Paper for Programme on Rethinking African Paths to Industrial Development. Blavatnik School of Government and Centre for the Study of African Economies, University of Oxford

[2] For a more detailed treatment of sectoral selection, see Dercon, Lippolis and Peel (2018) – “How do the goods a country produces affect its growth?” Background Paper for Programme on Rethinking African Paths to Industrial Development. Blavatnik School of Government and Centre for the Study of African Economies, University of Oxford

[3]See Kohli (2009) – “Nationalist versus Dependent Capitalist Development: Alternate Pathways of Asia and Latin America in a Globalized World”. Studies in Comparative International Development (44) pp. 386-410

[4] For more details on this and other points, see Dercon et al. (2018) – “What should be the role of FDI in African development strategies?”

Chinese investment in Africa

Accounts of Chinese investment in Africa tend to be polarized. On the one hand, the Western media frequently portrays the Chinese as ‘resource-grabbers’ hungry for resources but giving no consideration to human right or environmental standards. On the other hand, advocates of Chinese investment see it as a boon of industrialization in Africa.

In reality, the new Chinese presence offers a mixed picture, demonstrating the importance of local conditions as a determinant of the impact of FDI. Research by the Johns Hopkins SAIS China-Africa Center shows that Chinese investment in Africa is relatively diversified, with significant shares in construction, manufacturing and agriculture, as well as mining and oil extraction[1].

However, even the manufacturing investment is not necessarily transformative. In countries such as Ghana, Madagascar and Nigeria, most investment just seeks to take advantage of uncompetitive markets, and there is little transfer of capabilities to locals. Backward and forward linkages also fail to materialize. The evidence suggests that this is due to the dearth of local capabilities and the low educational levels of most local workers, which in combination lead to low ‘absorptive capacity’, together with cultural and linguistic differences.

Ethiopia is the only African economy where efficiency-seeking Chinese investment has taken hold. Chinese firms have invested in Ethiopia with a view to exporting, principally in the textiles, garments, and leather and leather products sectors, but also in other industries such as automobiles and bone china[2]. Key to Ethiopia’s success in attracting efficiency-seeking investment is cheap labour, improving infrastructure, cheap electricity, political and economic stability, and the government’s commitment to an FDI-led industrialization strategy.

[1] For a review of this literature, see Dercon, Lippolis and Peel (2018) – “What Should be the Role of FDI in African Development Strategies?”, Background Paper for Programme on Rethinking African Paths to Industrial Development. Blavatnik School of Government and Centre for the Study of African Economies, University of Oxford

[2] World Bank (2012) – Chinese FDI in Ethiopia: A World Bank Survey, Washington, DC: World Bank

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