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Foreign Direct Investment: What shapes and what shakes?
Jamaluddin Ahmed
3/18/2006
Foreign investment can take two forms. Foreign equity investors can simply buy a stake in an enterprise or take direct interest in its management. The first, an indirect form of investment, is called foreign portfolio investment. Foreign Direct Investment (FDI) involves more than just buying a share or security. It is the amount of financing provided by a foreign owner who also is directly involved in the management of the enterprise. For statistical purpose, the IMF defines foreign investment as FDI when the investor holds 10 percent or more of the equity in an enterprise. As a rule of thumb, this is usually enough to give the investor a say in the management of the enterprise. With the portfolio investment, the enterprise benefits from the finance and a sharing of risk. FDI can bring additional benefits to improve investment productivity by involvement in management, access to technology and access to marketing and market links.
Foreign Direct Investment (FDI) is regarded as one of the most important factors for the development process of developing countries. Basically, it is regarded important in providing additional capital to these countries where capital resources are scarce and labour plentiful. Such inflow of foreign capital brings about an increase in labour productivity and helps increase real wages. The theoretical approach explaining this kind of phenomenon was suggested by MacDougall (1960). The basic idea of this theory is similar to that of a few other economists who try to explain why foreign direct investment is taking place, using theory of capital movement, resulting from the difference in inter-country interest rates. Among those pioneer economists are, for example, Ohlin (1967) and Nurkse (1972). These theories are based on competitive markets assumptions. On the other hand, new theories of international investment try to explain the phenomenon in the context of the theory of the firm, mostly in the terms of oloigopolistic advantage of overseas investors or firms from investing countries. Hymer's (1960) "specific advantage hypothesis" can be regarded as a starting point. In this theory, Hymer believes that the primary objective for firms to have overseas investment is to control foreign operations due to imperfect market power in the home market. This imperfect market power arises because of the firm's ownership-specific advantages such as better or superior technology, better entrepreneurship, etc.
Caves (1971) explain FDI in a similar way. Using his industrial economic approach, he argues that FDI in industries characterised by certain market structures in both home and host countries. He defines FDI as horizontal and vertical. Horizontal FDI usually occurs in industries where product differentiation and oligopolistic power exist while vertical FDI occurs mainly because the firm wants to secure its raw materials or intermediate products for its own operation in the home market. Veroon's (1966) product life cycle is also popularly used to explain such phenomenon. Veroon's theory is basically a technology oriented, and a dynamic model of FDI. Veroon believes that technological development usually starts in developed countries where there are large domestic markets and high-income elasticity. When a firm or a country starts developing its own technology, it will use such technology in its production process and later export the products to other countries. As the technology becomes standardised, the originator of technology will find it less and less profitable. Thus, it forces the country that develops the technology to shift its resources into the development of new technologies. Dunning's electric model (1982) could be regarded as the most comprehensive theory explaining FDI phenomenon. The theory explained that a firm will engage in FDI if three conditions, namely, the ownership specific advantage, the internationalisation-incentive advantage, and the location-specific advantage are simultaneously satisfied.
Early in twentieth century, a large part of the world's infrastructure was developed through FDI, including electric power in Brazil and telecommunication in Spain, Persian Gulf's oil fields, India's tea plantation, and Malaysian rubber plantation. British firms invested in consumer goods manufacturing abroad from an early date. German Chemical Companies were expanding outside before World War-1 as were US auto manufacturers. The UK domination in FDI was apparent up to World War-II as the USA became the engine of capitalist development. Escalating commodity prices in the 1970 s had two effects on FDI. First, high prices encouraged increased FDI in extractive sectors, particularly in oil and gas. This benefited countries such as Congo, Equador, Indonesia, and Nigeria, which saw sharp increases in FDI in the early 1970s. Second, the balance of payment surpluses of commodity exporting countries created an abundant source of investible capital. This money was recycled to developing countries through a large scale sovereign lending by commercial banks. Added to this, many developing countries in this period encouraged inward-oriented approaches, often expresseldy aimed at delinking from global economy and FDI fell sharply and continued to stagnate into the first half of 1980s.
The IFC survey (1997) rated FDI flows of 12 countries dividing the period into segments, 1970-79, 1980-89, and 1990-96. It revealed interesting findings. Resulting from government policy and international environment Brazil was ranked number one during 1970-79 and second in 1980-89 period. Nigeria was the third highest recipient of FDI during 1970-79 but for 1980-89 it was rated in the 10th positions However, in 1990-96 it had no place among the top 12 countries. Malaysia was the 4th largest FDI recipient during 1970-79 and retained the position during 1980-89 and graduated to 3rd position in the 1990-96 period. Indonesia was the 5th largest FDI recipient during 1970-9 and 11th in 1980-89 and graduated to the 5th in 1990-96. Greece was the 6th largest FDI recipient in 1970-9 and 7th in 1980-9 and had no position in 1990-96 among top 12 countries. South Africa ranked 7th during 1970-9 but vanished from the list of top 12 countries in 1980-9 and 1990-6 periods. Similarly Iran and Algeria scored 8th and 12th position in 1970-9 but had no position in during the 1980-96s. Egypt scored 9th position in 1970-9 and graduated to 5th in 1980-9 and no position in 1990-96 while Equador scored 10th position in 1970-9 but no position among top 12 FDI recipients in 1980-96. Thailand graduated from 11th position in 1970-9 to 8th position in 1980-9 and 6th position in 1990-96. China scored no position in 1970-9 but gained 3rd position in 1980-9 and finally the took the first position in 1990-96. This was possible for the change in its economic policy since 1979. Surprisingly, China's FDI rapidly caught up with its size and rate of economic growth. By contrast, the next largest developing country, India, remains way down the list, with FDI of only at 0.6 percent of GNP, against China's 4.8 percent. This reflects India's, like its nearest neighbour Bangladesh, relatively slow progress in restructuring growth and orienting its policies to encourage FDI.
For attracting FDI developing countries should keep in mind that with the opening of central and eastern European communist countries FDI is getting diverted from other developing countries. Inflow of FDI also depends on the system of running a government. For example, Algeria and Iran occupied position among the top 12 FDI recipient countries but the wave of Islamic revolution changed the situation after 1980s. Similarly, the rise of radical Islamic fundamentalism in some countries like Afghanistan and Pakistan and Turkey have witnessed the decrease of FDI flow. Foreign Investment Advisory Services (FIAS) of USAID study (1990) identified Mediterranean basin as a vulnerable investment area where hundreds of West European, North American and Japanese companies having knowledge of those countries with rise of radical Islamic Fundamentalism, do not consider the Mediterranean basin as prospective investment sites and exclude them as too risky to include in their corporate business strategy.
In Bangladesh, the present unfavourable law and order situation, spread of rampant corruption within the government, bureaucratic tangles towards deregulation and liberalisation, all combined, have damaged the FDI friendly environment. Examples are easily available from the daily newspapers and electronic medias. Over and above, deteriorating law and order situation, Islamic fundamentalists sharing power with the current government, widespread interference of special house in every government decision where the major consideration is bribe, are considered to be contributory reasons for reduced inflow of foreign investment in Bangladesh now. One can imagine the gravity of the situation when one observes that the BoI Chairman convened a press conference in the recent time by hiring identified criminals for his protection. This indicates that the BoI Chairman has no confidence in the ability of government police forces to ensure his security. Despite the widespread proof of his unethical activities published in the several national dailies, the BoI Chairman was given two years extension being influenced by the special house. The BoI Chairman should recognise the fact that just creating figures in the creative manner has kept his job, perhaps, couldn't improve FDI. Blaming Bangladesh Bank or any other organisation including opposition parties cannot be an excuse for the reduced inflow of FDI. The fault lies elsewhere, to my mind, within the government itself including BoI and other relevant GoB agencies connected with processing of FDI inflow into Bangladesh. Time has come for the professionals and experts to open their mouth about FDI, boldly exposing the reasons for the pitiable foreign loan dependence syndrome of the economy of Bangladesh. If BoI reporting to Prime Minister's Office and the Bangladesh Bank report to Finance Ministry can not agree on FDI calculation methodology, then the question remains how the international credit rating agencies shall rate Bangladesh in terms of reliability of FDI figures. The way things are going we should wait for worse days in terms FDI. The Chairman of BOI is not the recognised authority to dictate the methodologies to figure out FDI inflow; rather he should follow accepted international practices.
The writer -- an FCA and PhD -- is the Vice President of The Institute of Chartered Accountants of Bangladesh, Treasurer of Bangladesh Economic Association and Partner of Hoda Vasi Chowdhury & Co, an affiliated Firm of Deloitte Touche Tohmatsu
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