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UNCTAD VIRTUAL INSTITUTE
TRAINING PACKAGE ON ECONOMIC AND LEGAL ASPECTS OF
INTERNATIONAL INVESTMENT AGREEMENTS (IIAs)
Module 2
POLICY ASPECTS OF FDI IN DEVELOPING COUNTRIES
Theme 1
National FDI Policies in a New Setting
Kampala, 10-14 November 2008
Zbigniew Zimny
UNCTAD consultant
Objectives of FDI policies
• Attracting FDI
• Maximizing benefits from FDI
• Minimizing negative effects and
addressing concerns related to FDI
The distinction between the first two objectives
is sometimes blurred. E.g., attracting “better”
types of FDI (export-oriented FDI, greenfield
FDI, FDI in R&D) equals increasing benefits
from FDI (e.g., Intel in Costa Rica)
Many policies matter for FDI:
general and core FDI policies
• General economic policies
– monetary and fiscal policies
– trade and exchange rate policies
– technology policy
– education, labour market and health policies
– privatization policy
– environmental policy
– policy vis a vis SMEs… to name a few
Focus here on core FDI policies,
although general economic
policies are no less and
sometimes more important. The
dominant trend has been to
establish enabling frameworks for
FDI, address some concerns and
benefit from FDI
MAIN ELEMENTS OF AN ENABLING FDI FRAMEWORK
Liberalization of FDI policy
LIBERALIZATION OF OTHER INTERNATIONAL
ECONOMIC TRANSACTIONS, notably trade
Restrictions Standards of protection
FDI PROMOTION, incentives, EPZs
and treatment
•Entry and REDUCING
establishment •Protection against •Fair and equitable
BUILDING
nationalization, treatment
•Ownership and
control (e.g., joint expropriation and •Transfer of funds
ventures) regulatory takings abroad
•National treatment •Transparency,
•Operational •Investor-State stability and
restrictions (e.g., dispute settlement predictability
expatriates,
performance •Recourse to •Policy coherence
requirements) international means
for the settlement of
•Privatization investment disputes
with FDI
(services, mining)
Market supervision: competition policy,
monopoly regulation, prudential
supervision of banks, etc.
LEGAL FRAMEWORK: investment codes, mining codes and contracts
Attracting FDI
• Reducing obstacles to FDI by removing restrictions on
admission and establishment as well as operations of
foreign affiliates
• Improving standards of treatment of foreign investors
• Protecting foreign investors: provisions for
compensation in the event of nationalization and
expropriation, dispute settlement and guarantees on
transfer of funds
• Promoting FDI inflows through enhancing a country’s
image, investment generating activities, investment
facilitation services, locational incentives, EPZ, etc.
Liberalization and enabling
frameworks are not enough!
• Opening up has not, in many cases, led to
the magnitude of inflows that countries
expected (were expectations too high?), es
• Even if FDI inflows rose, the development
benefits were below expectations
• Policies are crucial to ensure more benefits
• Policies that induce upgrading of local
capabilities (and address economic base of a
country) are key! But they take time.
How far liberalization of FDI in developing
countries has gone?
Very far in greenfield manufacturing (+
incentives competition), quite far in mining (with
exceptions such as China and CODELCO in Chile),
not so far in infrastructure services. In oil SOEs
continue to dominate, but some cooperate with
TNCs through service and other agreements. FDI
liberalization has been predominantly unilateral
Services: electricity and telecom most restrictive
Restrictiveness of FDI policy of 50 developing countries in service
industries, 2004 (1=FDI banned; 0=no restrictions)
Construction
Hotels & Rest.
Education
Distribution
Tourist agency
Business
Roads
Trans. Int. maritime
Trans. Dom.
Finance
Telecom mobile
International air
Domestic air
Rail
Telecom fixed
Electricity
0 0.1 0.2 0.3 0.4 0.5 0.6
Especially in Asia and Africa (power)
Developing countries: restrictiveness of FDI policy in infrastructure, by
regions and industry, 2004 (1=FDI banned; 0=no restrictions)
0.8
0.7
0.6
ASIA
0.5
AFRICA
0.4
LATIN AMERICA
0.3
TRANSITION
0.2
0.1
0
All Telecom Transport Power
Oil: mostly closed to FDI
• TNCs from developed countries have full FDI access to countries with
6% of world’s known oil reserves, mainly in Europe and North America.
They can also invest in countries that own an additional 11% of
reserves through joint ventures or production-sharing agreements. The
rest of the world is closed to FDI by TNCs
• West Asia, which hold some 65% of the world’s proven reserves of oil
and where the production is, by far, the world’s cheapest, has remained
closed to FDI since the nationalizations of the 1970s. During the 1990s,
countries of the region, to varying degrees, began to enter agreements
with TNCs to get access to capital, advanced technology and managerial
expertise.
• African oil producing countries as well as Indonesia have relied heavily
on TNCs in their oil industry through production-sharing agreements
(initiated in Indonesia), accompanied often by joint ventures or other
types of capital participation
• In LA the richest and most profitable oil deposits have remained in the
hands of SOEs, which, however, often concluded agreements with
TNCs.
KEEPING TNCs OUT OF CERTAIN SERVICES
SECTORS, NOTABLY INFRASTRUCTURE, OIL
AND IN SOME COUNTRIES MINING, IS A
MAJOR WAY OF ADDRESSING ADRESSING
CONCERNS RELATED TO FDI
Addressing specific concerns: examples
BoP problems (PRs, trade restrictions, safeguards)
Anticompetitive practices (competition laws)
Transfer pricing (DTTs, low taxes, laws)
Crowding out (restrictions, SME development, etc.)
Environmental degradation (impact assessments,
taxes, incentives, environmental regulations, etc.)
Socio-cultural effects (restrictions, PRs, etc.)
Too limited ToT (PRs, linkage promotion, local
capabilities)
Excessive use of incentives/race to the top (int’l
cooperation)
Benefiting more
QUICK, TEMPTING, NOT ALWAYS EFFECTIVE, AND COSTLY
MEASURES
– mandatory measures: performance requirements
– encouraging TNCs to act in desired ways: incentives
which may be tied to performance requirements
SLOW, COSTLY, LONG-TERM BUT EFFECTIVE MEASURES
WITH EXTERNALITIES FOR DOMESTIC FIRMS
– strengthening own capabilities: local suppliers,
infrastructure, skills, technological capabilities, etc.
FREE ACCESS TO LARGE INTERNATIONAL MARKETS,
THROUGH REGIONAL INTEGRATION CAN BE HELPFUL
Let’s discuss performance requirements and incentives
Performance requirements: types
• Local content
• export performance
• domestic equity or joint ventures
• technology transfer
• employment of nationals
They can be mandatory (condition of entry) or
voluntary (a condition to get an incentive)
Performance requirements: rationale
• To counterbalance TNCs export restrictions on
foreign affiliates
• Lack of awareness of local potential or
unwillingness to use local resources
• to counterbalance the anti-export bias of
import-substitution trade regime
• to offset or pre-empt RBPs
• to secure rents (e.g. in natural resources)
PRs: trends in use...
• Declining incidence, more so in developed
than in developing countries
• Developed countries use strategic policies,
rules of origin, anti-dumping measures and
locational and behavioural incentives to
influence TNCs behaviour
• Large developing and CEE countries use
them, though less frequently than before:
shift to requirements linked to incentives
…cntnd…trends
• WTO rules prohibit TRIMs, esp. local content,
trade balancing and export controls
• Other reasons: risk of deterring FDI;
competition for FDI>shift from sticks to carrots;
doubts about effectiveness; problems with
enforcement;can adversely effect other
countries.
Are PRs effective? What do studies say?
• Can be effective, esp. local content and
export PRs, employment, training and
joint venture requirements, when local
capabilities are high and the supply
response dynamic
• Imposed considerable cost on countries,
suggesting inefficient results
• Countries with strong attractions for FDI
can impose more stringent requirements
without putting investors off
Incentives: types
• Financial: outright grants or loans at
concessional rates
• Fiscal: tax holidays or reduced tax rates
• Regulatory concessions: exemptions
from labour or environmental laws in
EPZs
• Locational to attract new FDI to a
country or a site within a country
• Behavioural to undertake training, R&D,
exports or local sourcing
Why incentives are used?
• To compensate for deficiencies in the
business environment or market failures
• Because other countries use them
• To attract flagship firms to send a signal
about attractive investment climate
• To compensate for other government
interventions such as PRs
• To increase benefits from FDI such as
diffusion of knowledge or upgrading of
skills
Incentives are costly
• Offered to TNCs who would have invested
anyway
• Drain on budgets and unwise use of funds:
wouldn’t it be better to invest in infrastructure or
skills of workforce?
• When incentives expire investors may leave
• Delay the day of reckoning at taxpayer cost
• Expanded use of incentives to attract FDI leads
to bidding wars increasing costs of attracting
investment
Evidence on effectiveness
• Not the main determinant of location decisions
• Where all else is equal, they can tilt the balance
in export-oriented projects
• Have become more significant to attract FDI
• Behavioural incentives more effective: export
subsidies in some EPZs, training and assistance
to local suppliers in some countries
• More likely to be effective if complemented with
other measures aimed at enhancing local skills,
technology and quality of infrastructure
Economists vs. governments
Economists: To attract FDI build genuine
economic advantages and offer stable, low
and transparent tax rates. Incentives should
not be a substitute to building competitive
advantages.
Governments realize that incentives are
costly but in the absence of international
cooperation on locational incentives, each
wishes to retain the right to offer incentives.
As a result, countries are worse off and
TNCs better off.
TNCs = firms that allocate their mobile assets to different
countries and combine them with immobile resources of
countries to make the most efficient use of their
assets/resources
Immobile resources/assets
Mobile assets of TNCs
of host countries
• Natural resources
• Land
• Capital • Labour
• Technology • Skills
• Know-how • Infrastructure (transport, power,
• Skills telecom)
• Innovatory capabilities • Institutions/policies
• Management • Research institutions and innovatory
capabilities
• Brand names • Local enterprises incl. SMEs
• Access to TNC markets (potential suppliers to TNCs)
• Free access to large international
markets
CREDO ON GOOD FDI POLICY
To draw the most dynamic assets of TNCs for export-oriented production
requires that host countries improve the quality of their immobile assets
The most attractive immobile assets for such production are: world-class
infrastructure, skilled and productive labour, innovatory capabilities and an
agglomeration of efficient suppliers, competitors, support institutions and
services
Low-cost unskilled labour remains a source of competitive advantages for
countries, and can still attract FDI, but its importance is diminishing
It does not provide a base for sustainable growth, since rising incomes
erode the edge it provides
Natural resources provide a rent as long as resource is in demand
Without establishing downstream industries and upgrading their
technologies, the resources may face eventually stagnant prices and the
risk of substitution
There is no conflict between exploiting static sources of comparative
advantage and developing new ones: existing advantages provide the
means with which new advantages can be developed
A steady evolution from one to another is the basis for sustained growth
and development
A policy framework is needed to facilitate and accelerate this process
Policy coherence: let’s speak with one voice and
act accordingly
• FDI policies implemented by many agencies
• There is no FDI ministry (IPAs do not have
power)
• Coherence is objectively difficult but some
agencies may not understand or sabotage
policy
• Hostility towards foreigners, confusing
immigrants with investors exploited by
political parties
• Genuine policy trade-offs
Conclusion: an integrated approach to policy formulation
• A clear investment strategy and vision
• Knowing own strengths and weaknesses and being
realistic
• Finding policy solutions to constraints
• A vibrant domestic private sector>domestic policy
environment supportive to private investment in general
(also attractive to FDI)
• Integrated approach to investment policy formulation
incorporating harmoniously various policy elements such
as trade policy, labour policy, taxation, monetary policy,
exchange rate policy, immigration and land policy, etc.
FDI promotion has to be integrated, too.
• National FDI policies are increasingly complemented by
international investment agreements
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