Fdireg1 module 1 by Ceddet

TOWARD THE NEXT GENERATION OF IPAS

1ST EDITION

MODULE 1

FDI AND THE IPA: DEFINITION, FUNCTION, STRATEGY DEVELOPMENT AND ORGANIZATIONAL SERVICES

Toward the Next Generation of IPAs. 1st Edition

Module 1

Course author Inter-American Development Bank (IDB) (www.iadb.org), through its Integration and Trade Sector (INT). Course coordinator Inter-American Development Bank (IDB) (www.iadb.org), through its Integration and Trade Sector (INT), the Institute for the Integration of Latin America and the Caribbean (INTAL) (www.iadb.org/en/intal) and the Inter-American Institute for Economic and Social Development (INDES) (www.indes.org). Module author Dr. Ashraf A. Mahate Pedagogical and editorial coordination The Inter-American Institute for Economic and Social Development (INDES) (www.indes.org) in collaboration with CEDDET Foundation (Economic and Technological Development Distance Learning Centre Foundation) (www.ceddet.org).

1st edition Copyright © 2017 Inter-American Development Bank. This work is licensed under a Creative Commons IGO 3.0 Attribution-NonCommercial-NoDerivatives (CC-IGO BY-NC-ND 3.0 IGO) license (http://creativecommons.org/licenses/by-nc-nd/3.0/igo/legalcode) and may be reproduced with attribution to the IDB and for any non-commercial purpose. No derivative work is allowed. Any dispute related to the use of the works of the IDB that cannot be settled amicably shall be submitted to arbitration pursuant to the UNCITRAL rules. The use of the IDB’s name for any purpose other than for attribution, and the use of IDB’s logo shall be subject to a separate written license agreement between the IDB and the user and is not authorized as part of this CC-IGO license. Note that link provided above includes additional terms and conditions of the license. The opinions expressed in this publication are those of the authors and do not necessarily reflect the views of the Inter-American Development Bank, its Board of Directors, or the countries they represent.

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Table of Contents List of Figures .................................................................................................................. 5 List of Boxes .................................................................................................................... 5 Glossary ........................................................................................................................... 6 Module Introduction ....................................................................................................... 7 General Objectives of the Module.................................................................................. 8 Learning-Oriented Questions ......................................................................................... 8 Complementary Materials .............................................................................................. 9 UNIT I. INTRODUCTION TO FDI .....................................................................................10 Learning Objectives ...................................................................................................... 10 I.1. Introduction to FDI .................................................................................................. 10 I.2. Definition of FDI ....................................................................................................... 12 I.3. How Is FDI Carried Out ............................................................................................. 13 I.4. Benefits of FDI .......................................................................................................... 15 I.5. Disadvantages of FDI ............................................................................................... 17 I.6. Measuring FDI ......................................................................................................... 18 I.7. Trends in FDI ............................................................................................................ 20 SYNTHESIS OF THE UNIT .............................................................................................. 27 Bibliography .................................................................................................................. 28 UNIT II. WHY DOES FDI TAKE PLACE? ......................................................................... 29 Learning Objectives ...................................................................................................... 29 II.1. Theories of Why Firms Conduct FDI ...................................................................... 29 II.2. What Do Firms Look for in a Location? ................................................................. 32 II.3. FDI Ecosystem ........................................................................................................ 35 SYNTHESIS OF THE UNIT .............................................................................................. 38 Bibliography .................................................................................................................. 39 UNIT III. THE ROLE OF AN IPA .......................................................................................41 Learning Objectives .......................................................................................................41 III.1. Principles for Organizing Investment Promotion .................................................41 III.2. Are Investment Promotion Agencies Effective ................................................... 43 3

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III.3. Establishment of an Investment Promotion Agency .......................................... 45 III.4. Governance of IPAs .............................................................................................. 46 III.5. IPAsâ&#x20AC;&#x2122; Instruments, Functions & Techniques ........................................................ 47 III.6. Human Capital and Skills for Effective IPAs ......................................................... 49 III.7. The Rationale for Promoting Investment and Trade .......................................... 50 SYNTHESIS OF THE UNIT .............................................................................................. 53 Bibliography .................................................................................................................. 54 UNIT IV. SPECIAL ECONOMIC ZONES AND FDI ........................................................... 55 Learning Objectives ...................................................................................................... 55 IV.1. Special Economic Zones ........................................................................................ 55 IV.2. Types of Special Economic Zones ........................................................................ 56 IV.3. How Do Special Economic Zones Attract FDI ...................................................... 58 IV.4. Benefits of SEZ to Foreign Investors ................................................................... 60 IV.5. Economic Impact of SEZs ..................................................................................... 61 SYNTHESIS OF THE UNIT .............................................................................................. 64 Bibliography .................................................................................................................. 65 UNIT V. SUSTAINABLE FDI ........................................................................................... 66 Learning Objectives ...................................................................................................... 66 V.1. The Sustainable Development Agenda ................................................................. 66 V.2. The Sustainable Development and the Role of FDI .............................................. 68 V.3. The Sustainable Development FDI Policy Framework ......................................... 70 V.4. The Sustainable Development Investment Attraction ........................................ 73 SYNTHESIS OF THE UNIT .............................................................................................. 77 Bibliography .................................................................................................................. 78

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List of Figures Figure 1. FDI inflows: global and by group of economies, 2005–2016 ......................... 21 Figure 1.1. Regional contribution to global FDI flows, 2015–2016 ............................... 22 Figure 1.2. Estimated FDI inflows: top ten host economies, 2016 ............................... 22 Figure 1.3. Latin America and the Caribbean: FDI 1990-2015 ....................................... 23 Figure 1.4. FDI inflows into LAC by country for 2014 and 2015 .................................... 24 Figure 1.5. FDI inflows into Central America for 2014 and 2015 ................................... 25 Figure 1.6. FDI inflows into the Caribbean for 2014 and 2015 ...................................... 26 Figure 2. The FDI ecosystem ......................................................................................... 36 Figure 3. The broad activities of an IPA ........................................................................ 43 Figure 3.1. IFAC governance framework for public sector organizations .................. 47 Figure 5. Strategic framework for private investment in the SDGs............................ 69 Figure 5.1. Structure and components of UNCTAD’s investment policy framework .......................................................................................................... 72 Figure 5.2. Assessing sustainable FDI ........................................................................... 74 Figure 5.3. Project assessment matrix ......................................................................... 76

List of Boxes Box 1. Coverage of the course ........................................................................................ 7 Box 2. The eclectic paradigm ........................................................................................ 30 Box 3. The structure of IPA functions .......................................................................... 49 Box 3.1. The differences between TPOs and IPAs ........................................................ 51 Box 3.2. Advantages and disadvantages of a merged TPO and IPA entity ................. 51 Box 4. Different variants of special economic zones .................................................. 58 Box 5. The SDGs............................................................................................................. 67 5

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Glossary n BEPS: Base Erosion and Profit Shifting. n BIT: Bilateral Investment Treaty. n BOOT: Build Operate Own and Transfer. n EPZ: Export Processing Zone. n EZ: Enterprise Zones. n FDIR: Framework for Direct Investment Relationships. n FDI: Foreign Direct Investment. n FTZ: Free Trade Zone. n FCZ: Free Commercial Zone. n GDP: Gross Domestic Product. n IIA: International Investment Agreement. n IMF: International Monetary Fund. n IPA: Investment Promotion Agency. n IPFSD: Investment Policy Framework for Sustainable Development. n ISIC: International Standard Industrial Classification. n KPI: Key Performance Indicators. n LAC: Latin American and Caribbean. n MDG: Millennium Development Goals. n OECD: Organisation for Economic Cooperation and Development. n PPP: Public Private Partnership. n REIT: Real Estate Investment Trusts. n SDG: Sustainable Developments Goals. n SEZ: Special Economic Zones. 6

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n TPO: Trade Promotion Organisation. n UN: United Nations. n UNCTAD: United Nations Committee on Trade and Development. n WCO: World Customs Organisation. n WTO: World Trade Organisation.

Module Introduction This is the introductory module on the course and seeks to provide an overview of the world of foreign direct investment (FDI). In doing so, the course seeks to look at five themes which are shown below:

Box 1. Coverage of the course Theme

Why?

For Whom?

By Whom?

Using what?

Coverage

The benefits of FDI to the economy

How do potential investors make the investment decision

What is the institutional structure and functions of IPAs

UNIT

UNIT 1

UNIT 2

UNIT 3

What tools do IPAs offer and what services are provided? Understanding the role of special economic zones. UNIT 3 AND UNIT 4

What is the future? All countries have signed to the sustainable development goals so the future is sustainable investment. UNIT 5

As box 1 illustrates this module seeks to take a holistic approach and look not only at why and how IPAs need to carry out their role but build a foundation for later modules. As such the module covers five main themes, namely why have IPAs; whom do the IPAs serve; how are IPAs structured; what tools do they use and finally what is the future of IPAs.

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General Objectives of the Module The main aim of this module is to provide learners with an overview of the activities of an Investment Promotion Agency (IPA). In doing so the module seeks to explain certain key aspects which are: n What is meant by FDI and why is it important? n The market failure role that IPAs seek to carry out. n How is the investment decision carried out by potential investors? n The role that Special Economic Zones play. n The importance of sustainable FDI. n The role and functions of an IPA. n Whether IPAs and TPOs should be merged.

Learning-Oriented Questions n Question 1.

Do IPAs have a productive role in the country in attracting FDI? Even if they have a productive role can a country/region justify their existence based on the return on investment? n Question 2.

Can one generalize the factors that foreign investors look for in a country/region prior to entry and if so what are they? n Question 3.

What is a Special Economic Zone and what role can they play in attracting inward FDI? n Question 4.

What is meant by sustainable investment and should a country/region be pursuing such FDI and if so why? 8

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Complementary Materials n Nelson R. C. (2009). Harnessing Globalization. The Pennsylvania State Univer-

sity Press. n Trnik M. (2010). The Role of Investment Promotion Agencies at Attracting FDI:

The Czech Republic and Slovakia in Comparative Perspective. LAP Lambert Academic Publishing.

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UNIT I INTRODUCTION TO FDI

Learning Objectives The learning outcomes for this unit are as follows: n To understand what is meant by FDI and how it is carried out in the modern

context. n To analyze the impact of FDI on the local economies. n To be able to appreciate how FDI is measured by agencies such as the

UNCTAD, World Bank etc. n To have an awareness of the recent global and regional trends in FDI.

I.1. Introduction to FDI Foreign Direct Investment (FDI) has a very long history but its importance has gained prominence in the post-Second World War period coinciding with the development of the new corporate firm. Post-war production has meant that firms have sought to exploit economies of scale that necessitate large consumer markets with multiple distribution channels. Also, the growth of modern complex global value chains implies that FDI takes place in a variety of different forms from production to research

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and development. From a corporate viewpoint FDI has allowed firms to invest in foreign countries in order to secure resources; benefit from cost efficiencies; acquire strategic assets so that they do not fall under the control of a competitor; extend the market share of the parent company; acquire technology; have access to particular skills and in some cases financing. Therefore, it is no surprise to see that currently FDI inflows are well over US$1.7 trillion or about 3% of world GDP (OECD, 2016). Governments around the world are seeking to reap the benefits of FDI and have been encouraging inward investment through simplifying their processes and thereby allowing foreign firms to be established more easily, reducing or even waiving taxes, investing in high class infrastructure and relaxing ownership requirements all of which contribute to an investor friendly business climate. Under the traditional Keynesian-type economic model aggregate demand equals the sum of consumption, investment, government expenditure and the net of exports minus imports. Therefore, if economic growth is to take place then at least one of these variables needs to increase. However, countries may not have the ability to change their level of government expenditure due to various reasons such as financing constraints. It may also be the case that private sector consumption cannot change as it is reliant on either borrowing or income. Similarly, the export component is determined by the relative competitiveness of the country to its trading partners. Such a situation implies that countries need to attract FDI in order to increase their aggregate demand and hence the gross domestic product (GDP). Despite the obvious benefits of FDI it is not without its critics both in the investor and recipient countries. Critics argue that FDI seeks to exploit the wage arbitrage between countries by moving jobs abroad from the investor to recipient country. As such FDI seeks to exploit the cheaper labor costs in foreign markets at the expense employment in the home country. Even the recipients find that once a cheaper destination is found than the investment is moved again. In this way FDI is solely motivated by seeking to obtain the lowest labor costs. Recently, this has become an important argument and forced many companies to relocate back to their home country. Then there is the issue of tax privileges that are awarded to foreign investment 11

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at the expense of domestic firms. Critics point out that such benefits displace domestic producers.

I.2. Definition of FDI FDI is an investment that is made in an asset based in a foreign country whereby the investor has an element of control. Two important issues arise from this definition. First, the issue of investment which can be either inorganic through the purchase of an existing company or organic by expanding a business currently owned by the investors or establishing a new operation. Second, the issue of control is very important in that it has to be differentiated from a foreign portfolio investment. In reality control is not a precise science but a matter of judgement. However, in order to obtain a consistent global definition the IMF and UNCTAD refer to control whereby the investing entity owns 10% or more of the ordinary shares or voting power of the overseas operation. It may be the case that 10% may not give the owner sufficient control or even representation on the board of directors. However, 10% ownership is large enough to stop a forced takeover. The following aspects define aspects of control as per the OECD (2008) and the IMF (2009): 1. The ability to obtain representation on the board of directors (in some cases this is possible at ownership levels below the 10% cut-off point). 2. The ability to participate or influence the strategy or policy-making processes. 3. Evidence of significant or material inter-company transactions. 4. History of interchange of managerial personnel. 5. The provision of technical information. 6. The provision of long-term loans at lower than existing market rates. Source (OCED, 2008 and IMF, 2009)

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I.3. How Is FDI Carried Out The entity carrying out the overseas investment can be an incorporated or unincorporated public or private enterprise, a government, a consortium of individuals, or a syndicate of private and/or public entities. The most basic form of FDI is for an entity to establish a foreign presence through a Greenfield project or to purchase a shareholding in a foreign entity. FDI has developed considerably in order to overcome investment impediments in the domestic or host country rules on taxation, capital mobility, and foreign ownership restrictions etc. Some of the new innovations in FDI methods include the following: a) Greenfield investment: This is a direct investment in establishing a new operation be it a start-up or the expansion of existing facilities. Governments tend to focus their efforts on encouraging Greenfield investments as it leads to greater production capacity and jobs in the economy. b) Mergers and acquisitions: This is either a partial or complete purchase of the existing assets from host country owners. c) BOOT projects: This refers to Build Operate Own and Transfer (BOOT) which tends to be signed by governments but can also be with private firms. Under a BOOT project the investing firm can either supply the funds or borrow on its own name, construct the facilities, manage the operations through its own proprietary technical know-how or acquire it from a third party all for a specified period of time. Most BOOT agreements provide the investing entity with a management fee or a percentage of the profits/sales which can be paid either in cash or in kind. At the end of the specified time period the investing entity has to transfer the ownership of the asset to the counterparty.

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d) PPP projects: A Public Private Partnership (PPP) is the coming together through a joint venture or even a special purpose entity between a private sector entity and a government department. The partnership usually requires the private sector entity to provide the financing, technical know-how or manage the project for a period of time. In return the government provides the private sector entity with a fee, share of profits or even a concession. e) Capital in kind: An alternative form of capital is to provide payment or capital in kind which usually takes the form of intangible assets such as research, use of patents, technical expertise, brands, etc. Under such a situation the foreign partner provides the tangible assets which may include raw materials, production facilities, finance and so on. f) Technology-based FDI: Technology-based firms benefit from two aspects: first, they are global from inception and as such can be housed anywhere in the world; second, technology companies require little in the way of infrastructure unlike conventional firms. However, technology-based firms especially start-ups have very long incubation periods and hence their need for constant financing implies that they cannot carry out FDI at the beginning of their life. However, technology firms may have valuable know-how or licenses that can be capitalized and some of the ways in which this can be done are as follows: n Licensing technology:

Licensing technology allows a firm to capitalize on their knowledge without incurring any of the risks that are present in doing business in the foreign market. The firm receives a royalty fee and the investment can be carried out by the domestic partner or even a third party.

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n Reciprocal arrangements:

A reciprocal arrangement is where each party carries out activities on behalf of the other party. A typical example of such an arrangement is to distribute each partyâ&#x20AC;&#x2122;s products in the otherâ&#x20AC;&#x2122;s market and thus each is able to have an immediate distribution and marketing channel which would otherwise take considerable capital and effort. n Hybrid strategic structures:

The need to access proprietary know-how implies that various types of strategic relationships are developed that cross a number of companies which may be in many countries around the world. Participants in such a partnership benefit from access to proven technology in a short space of time that would otherwise take a long time to develop as well incur considerable capital.

I.4. Benefits of FDI Academic research on FDI studies has identified a number of direct and indirect benefits to the host country. Below are some of the benefits that prior research has identified: 1. Economic growth: This is perhaps the most important direct benefit of FDI and takes the form of an increase in the level of capital formation in the host country which then provides greater employment opportunities and a positive multiplier takes place. Prior research has also found that FDI tends to be attracted to countries that have greater economic growth. Academic research finds considerable support for the FDI and economic growth relationship typical among these studies is Stehrer and Woerz (2009) which finds that a 10% increase in FDI results in a 1.2% increase in economic growth.

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2. Improvement in ease of doing business: Countries seeking to attract FDI are in constant competition with with each other and therefore global rankings such as the World Bank Ease of Doing Business or the World Economic Forumâ&#x20AC;&#x2122;s Global Competitive Index make a huge difference to investor sentiment towards a particular location. Countries in order to attract FDI seek to improve their business environment which also benefits the local industry. 3. Increased international trade: FDI tends to promote exports from the host countries as the new investment seeks to enter neighboring markets. This also allows domestic firms to free ride on the back of FDI-based investment through being local suppliers. Also, FDI-based investment makes local firms aware of global market opportunities that may not have been present previously. 4. Greater employment opportunities: There is sufficient evidence to show that FDI tends to increase employment opportunities which then has a positive multiplier effect on the economy. The greatest employment opportunities take place in Greenfield projects which add to existing production capacity. There is less of an increase in employment with Brownfield projects where there is simply a change in ownership of the asset. 5. Development of human capital resources: FDI-based investment is argued to have a positive impact on the host country labor. There are three ways in which host country labor skills improve: first, FDI investment brings about new technology, processes or even ways of doing things. Over time, labor from FDI-based investment moves into local firms and takes their knowledge with them and it spills over into the domestic firms. Second, as suppliers to FDI-based investment local firms are taught new skills. Third, in order to attract greater FDI countries train their people so they have the latest skills and knowledge.

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6. Tax incentives: In order to attract FDI countries reduce their tax rate and simplify the taxation system. Such improvements also benefit the local firms. 7. Technology transfer: Technology transfer is an important indirect benefit of FDI and takes place either vertical or horizontal. In the case of the former the linkage is from the supplier to the FDI investment and then to the customer through supply chain linkages. The latter takes place at the same level of production through labor knowledge transfer such as witnessing its effectiveness or the need to make a change in order to survive and become more competitive. 8. Increased productivity: According to Earth Institute (2009) FDI investment is found to be 40% more productive than that of the host country. Therefore, encouraging FDI investment forces host country producers to increase their own productivity.

I.5. Disadvantages of FDI FDI is not without its critics who argue that it has the following weaknesses: 1. Loss in domestic investment and employment: Perhaps the strongest attack on FDI is that it takes away investment and employment opportunities from the investing nation. In the host country it is argued to hinder domestic investment as investors feel that they may not be able to compete with larger and more efficient foreign capital.

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2. Political influence: There has been criticism that FDI investment can sometimes be too closely linked to political leaders in the host country and this may cloud their judgements at the expense of domestic firms and citizens. 3. Impact on exchange rates and balance of payments: FDI has sometimes been criticized for having a negative impact on a countryâ&#x20AC;&#x2122;s exchange rate and also balance of payments. This really tends to take place when there is a large level of capital flight out from a country or exceptionally large investments are made into the host nation. For many countries FDI tends not to impact the exchange or the balance of payments. 4. Loss in ownership of assets: Some critics feel that any form of FDI is a loss in the national assets of the country. This is more important a point if the assets are strategic assets or limited natural resources. 5. BEPS and tax avoidance: Base Erosion and Profit Shifting (BEPS) is the ability of multinational corporations to artificially move their profits from one country tax jurisdiction to another with the sole aim of reducing its tax obligation. The secondary tax jurisdiction is selected on the basis of more favorable rates or the ability to exploit mismatches in avoidance of double taxation treaties. The end result of BEPS is that tax is not being paid in the country where the main economic activity is carried out but in a second and possibly third jurisdiction which has the lowest tax rates.

I.6. Measuring FDI The basis of measuring FDI are the IMF's Balance of Payments and International Investment Position Manual (BPM6) and the OECDâ&#x20AC;&#x2122;s Benchmark Definition of Foreign

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Direct Investment (BDM4). Three types of FDI stocks or flows can be identified based on the definition of FDI as discussed in section 1.2. It is important to appreciate that there is no reason for the actual management structures that exist between the investing entity and the recipient to bear any resemblance to the investment. Due to the complex nature of management structures and cross border investments BPM6 uses the Framework for Direct Investment Relationships (FDIR) to identify direct investment relationships. Under the FDIR direct investment consists of five component parts which are: equity, debt, dividends, reinvested earnings and interest income. These component parts can be reorganized into three different types of direct investment statistics as shown below: 1. Direct investment positions (stocks): This is a measure of the stock of FDI carried out over a certain period of time segregated by host country or investing nation and also by the sector using the International Standard Industrial Classification (ISIC). This measure includes the following: a. Equity. b. Debt (intercompany loans). 2. Direct investment income flows: This provides the net inward and outward investment flow for a certain period of time for a country. This measure includes the following: a. Dividends and distributed branch profits. b. Reinvested earnings. c. Income on debt (interest). 3. Direct investment financial flows: This provides information on the earnings by direct investors and of the direct investment enterprises. This measure includes the following:

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a. Equity. b. Reinvestment of earnings. c. Debt. Both BPM6 and BDM 4 recommend that aggregate FDI data which appears in the country’s balance of payments and international investment position accounts is shown using the accounting system of assets and liability to make it consistent with other macroeconomic statistics. Therefore, an example of an asset is when the reporting country has carried out an equity investment in a foreign affiliate because the reporting country has a claim. Similarly, a liability is where the reverse of this situation takes place as the foreign country has a claim against the reporting nation. However, when FDI data is calculated based on a partner country or sector then BDM4 and BMP6 suggest using a directional approach whereby all direct investment flows are reported based on their movement with respect to the reporting country i.e. outward or inward. Almost all countries’ central bank, statistical office or the appropriate ministry compiles the balance of payment statistics according to BMP6. This data is published by various sources such as the World Bank FDI data based on each country’s reported balance of payment statistics, or the United Nations Conference on Trade and Development (UNCTAD) which also publishes data on FDI flows and stocks within its World Investment Report.

I.7. Trens in FDI Statistics produced by UNCTAD (2017) show that global FDI has experienced a mixed picture over the last decade. There was a period of growth until the International Financial Crisis in 2007 recovering slightly from 2010 onwards. However, the weak global economic performance and very low levels of growth in international trade

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have dampened FDI flows. Figure 1 illustrates the FDI inflows at the global and regional level. It is clear from figure 1 that developing countries have experienced the sharpest decline in FDI inflows as from 2015 and the least in developed economies.

Figure 1. FDI inflows: global and by group of economies, 2005â&#x20AC;&#x201C;2016

Figure 1.1 illustrates the regional FDI inflows in 2016 compared to 2015 which shows a drop of 13% or US$225 billion. Europe experienced the greatest decline at 29% followed by developing countries in Asia and Oceania at 22% and Latin America and the Caribbean with 19%. Interestingly, transition economies experienced an increase in FDI inflows of 38% as did North America and other developed nations at 6% and 139% respectively.

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Figure 1.1. Regional contribution to global FDI flows, 2015â&#x20AC;&#x201C;2016

Figure 1.2 lists the top ten host nations for FDI of which the largest recipient of FDI inflows was the USA followed by the UK, China and Hong Kong. Interestingly, these four destinations account for 52% of all global FDI inflows. In fact, the top ten destinations account for 70% of global FDI inflows. Figure 1.2. Estimated FDI inflows: top ten host economies, 2016

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Over the last twenty-five years the Latin American and Caribbean (LAC) region has experienced two periods of an increase and one decline in FDI. The periods of increase were from 1990 to 1999 and then 2003 to 2011 while the decline took place between 1999 and 2003. Overall, FDI inflows into LAC have tended to be around 3.5% of regional however the distribution is not equal and with 2.5% of GDP for Mexico and 10% for both Chile and Panama. Also, the volume of FDI is not equal and heavyweight economies such as Brazil account for 42% of all FDI inflows into the LAC region. Figure 1.3 illustrates the FDI inflows for the LAC countries for 2014 and 2015. The main source of FDI inflows into the LAC region is the United States accounting for 26% however in the case of some LAC countries such as Mexico the United States is an important investing nation accounting for 52% of the investment inflows. Other important investing nations into the LAC region are the Netherlands at 16% and Spain with 12%.

Figure 1.3. Latin America and the Caribbean: FDI 1990-2015

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Brazil is not only the largest economy in the LAC region but the greatest recipient of FDI inflows with US$96,895 billion in 2015 compared to US$ 75,075 billion in 2014. Way behind Brazil come Chile, Colombia and Argentina. Figure 1.4. FDI inflows into LAC by Country for 2014 and 2015

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The Central American region experienced an increase of 6% in FDI inflows with Panama being the most important accounting for 43% of the sub-regional figure. Other significant sub-regional recipients are Costa Rica at 26%, Honduras at 10% and Guatemala with 10%. Interestingly, four countries account for about 90% of the sub-regional FDI inflows. Figure 1.5. FDI inflows into Central America for 2014 and 2015

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The Dominican Republic is the largest recipient of FDI inflows within the Caribbean sub-region at 39% of the total followed by Trinidad and Tobago at 20% and Jamaica at 13%. These three countries account for three quarters of all the FDI inflows into the sub-region. Figure 1.6. FDI inflows into the Caribbean for 2014 and 2015

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SYNTHESIS OF THE UNIT FDI is the process by which investment by a resident in one country is made in an asset that is located in another nation. However, to differentiate investment from temporary equity holdings the OECD (2008) implies that it should have an element of control which is viewed as a shareholding of at least 10%. FDI can be carried out in a number of ways however the two most common are Greenfield projects or mergers and acquisitions. Greenfield projects are new operations or expansion to existing establishments. Countries tend to favor such type of FDI because it creates the greatest level of capital formation and employment opportunities. The second most common form of FDI is mergers and acquisitions which implies the process of acquiring either a partial or total shareholding in an existing enterprise. FDI attraction is actively promoted by governments due to its benefits which include increasing the economic growth of the host nation, providing employment opportunities, increasing productivity, ability to acquire technology, human capital development, increased exports and greater tax revenue. However, FDI is not without its critics who point out that it can be extremely fickle especially if it seeks to exploit labor wage arbitrage, leads to a loss in the control of assets, displaces domestic businesses, can be too closely associated with current political leaders and is open to abuse especially if the investor seeks to reduce its tax liabilities through base erosion techniques.

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Bibliography n Economic Commission for Latin America and the Caribbean – ECLAC (2016).

Foreign Direct Investment in Latin America and the Caribbean, 2016 (LC/G.2680-P). n IMF (2009). Balance of Payments and International Investment Position Man-

ual. Sixth edition (BPM6). IMF. n OECD (2016). FDI in Figures. OECD. n OECD (2008). OECD Benchmark Definition of Foreign Direct Investment.

Fourth edition. OECD. n Stehrer, Robert and Woerz, Julia (2009). “Attract FDI! A Universal Golden

Rule? Empirical Evidence for OECD and Selected Non-OECD Countries”. European Journal of Development Research, Vol. 21, No.1, pp. 95-111. n UNCTAD (2017). Global Investment Trends Monitor. UNCTAD n UN (2016). Foreign Direct Investment in Latin America and the Caribbean. UN/

ECLAC

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UNIT II WHY DOES FDI TAKE PLACE?

Learning Objectives The learning outcomes for this unit are as follows: n Role of multinational companies and other investors and how they deter-

mine locations for investment. n Government and business ecosystem surrounding FDI.

II.1. Theories of Why Firms Conduct FDI One of the earliest theories seeking to explain why firms establish overseas operations was by Vernon (1966) who argued that as the firmâ&#x20AC;&#x2122;s product life cycle determines its decision to establish an overseas presence. As the product becomes mature in the home market it needs to go overseas to maintain demand. In a later study Vernon (1979) argued that firms go overseas in order to benefit from cost differentials. Hymer (1976) claimed that firms establish overseas operations to capitalize from firm and market-based factors. In the case of the former aspects such as the need to benefit from economies of scale, reduction in risk through diversification, knowledge accumulation and so on are relevant while for the latter some type of monopolistic power due to ownership of a particular technique is important. Therefore, overseas

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presence takes place in order to exploit the firm’s knowledge or the possibility to generate significant returns that justify the expansion. Aliber (1970) argued that firms expand overseas not because of their products but because of the need to manage exchange rate risk through holding assets in different currencies. In a later study Aliber (1983) argued that firms carry out overseas investment due to relative market price of assets. One of the landmark studies that examined why firms expand overseas was by Dunning (1977 and 1988) who argued that prior studies sought to answer very different questions, namely why firms go abroad and which locations they select. Dunning (1977 and 1988) or the “eclectic paradigm” identified three key factors for FDI to take place, namely ownership, location and internalization advantages. Therefore, the first factor is that a firm needs to have ownership advantages that outweigh the cost of exporting. Second, a particular country is selected due to its locational benefits. These can include access to regional markets, low cost labor or finance, modern infrastructure, transportation and communications costs and linkages as well as ability to take advantage of any international agreements that the country has signed. Third, the internalization advantage holds true when the benefits to an overseas presence outweigh a transactional relationship such as selling or licensing the rights. Under the Dunning (1977 and 1988) model FDI only takes place when all three are present as shown in box 2. Box 2. The eclectic paradigm Categories of Benefits Ownership

Location

Internationalization

Forms of

Licensing

Yes

Market Entry

Export

Yes

FDI

Yes

Source: Dunning (1981)

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More recent studies on FDI (Francis et al, 2009) argue that a firmsâ&#x20AC;&#x2122; decision in selecting a location is based on the institutional factors such as the quality of government institutions and regulations. There is sufficient evidence to support a direct relationship between the quality of government institutions and the level of FDI (see Meon and Sekkat, 2004). The rationale for this is that FDI positively values government institutions that increase the firmâ&#x20AC;&#x2122;s productivity, bring transparency and clarity to foreign investors and allow them to incorporate good planning. The opposite is also true whereby government institutions that are corrupt reduce the transparency and increase the firmâ&#x20AC;&#x2122;s costs and are negatively thought of by foreign investors (Wei, 2000). What is apparent from the discussion above is that for a firm to carry out any form of FDI the opportunity identified by the firm must have an international condition in the absence of which the foreign investment cannot take place. Once this has been established then one can use the Dunning (1977, 1983 and 1993) model to arrive at four classifications of FDI motivations which are as follows: 1. Resource seeking: the firm seeks to acquire a specific resource that is not available or not possible to control in the investing country. Typical examples of resource seeking FDI include natural resources, access to technology, etc. 2. Market seeking: FDI is carried out to exploit the potential of overseas markets. Typical examples include being closer to customers, discourage potential competitors from entering the market, etc. 3. Efficiency seeking: FDI is carried out to take advantage of lower production costs either due to differences in market prices as a result of factor endowments between the countries or the ability to exploit economies of scale and scope. 4. Strategic asset seeking: FDI is carried out to obtain access to particular knowledge or competences that are not available within the firm or in the investing country.

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II.2. What Do Firms Look for in a Location? Firms looking to carry out FDI tend to consider a number of different factors when selecting a particular location which can be categorized into five groups, namely market, operational, financial, signatory to international agreements and employee lifestyle factors which are explained below: 1. Market factors: These factors seek to tap into the consumer markets that are available in the: a) Host country market: some FDI is motivated specifically to target the host country market because it may be sufficiently large to warrant an investment. b) Regional market: more commonly FDI seeks to tap into not only the host country market but also that within the region. c) Market accessible through trade agreements and customs unions: in some cases FDI is attracted to the fact that trade agreements and customs unions create large markets that make an investment viable. 2. Operational factors: FDI tends to be motivated to establish in locations that allow for a reduction in costs and an increase in efficiency through: a) Availability of skilled and relatively low-priced workforce. Any business needs to be assured that it has access to an ample supply of labor while also being able to retain them into the long run. b) Regulation is important but there has to be a fine balance so that it is not excessively burdensome on businesses in terms of costs or the number of days and steps required to obtain approvals or permits. More importantly, the regulatory environment needs to be transparent and carried out within a reasonable period of time. c) Labor rules are an important consideration for any new or expanding investment as it can add considerable costs to the business. 32

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d) Air and sea connectivity reduce the cost and time taken to transport goods to market. This is important also when it comes to bringing raw materials. New investment often seeks to identify locations that have good air connectivity for regional offices so that staff can travel efficiently. e) Access to suppliers may be an important consideration where the FDI needs to source inputs closer to its investment in the foreign country. Ideally, new investment seeks to identify local suppliers. f) Business environment can greatly impact the operations of the FDI through not only delays and costs but also missed opportunities. The more businessfriendly a location the greater the likelihood that FDI will flow to it. 3. Financial factors: Financial factors increase the cost of doing business in a particular location. The reverse is also true and positive financial factors can actually reduce financial costs. Typical financial factors include: a) Real estate: not only does a company look for suitable real estate but the relative price is extremely important as it can add to the operating costs. b) Tax structure: All companies prefer low tax structures but more important is the fact that they look for systems which are simple to implement and transparent. c) Infrastructure: FDI positively values infrastructure especially in key areas such as transport, roads, ports, airports and ICT. High class and modern infrastructure can substantially reduce the firm’s costs. Some countries have extended this concept and provide FDI with “plug and play” facilities. In other words, they actually build the infrastructure that FDI would want to use such as warehousing, offices etc. This substantially reduces the set up costs as well as the financial risk for FDI as they can simply rent the facilities and expand as their business grows.

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d) Incentives: An incentive should never be the driving point as far as a location selection is concerned. However, firms actively seek incentives from federal or regional government authorities in order to establish a presence. 4. International or bilateral agreements: Companies can actively take advantage of the international agreements that a country has signed. Typical examples of international agreements that FDI tends to positively value are as follows: a) Membership of the WTO: the important aspect is that member countries of the WTO share a common platform to reduce tariffs and resolve disputes. b) Trade agreements: allow companies that comply with terms of the trade agreement to benefit from tariff-free access into other markets. c) Bilateral Investment Treaty/Investment Guarantee Treaties: A BIT is an agreement between two countries that sets up â&#x20AC;&#x153;rules of the roadâ&#x20AC;? for foreign investment in each otherâ&#x20AC;&#x2122;s countries. These agreements provide foreign investors an equitable access to investment opportunities in the counterparty country. They also provide protection from expropriation and a neutral dispute settlement system. d) Avoidance of Double Taxation Agreement: these agreements avoid a company from having to pay tax twice, i.e. in the home and host country for the same income. As tax needs to be paid only once on the income it can make investments more financially viable and attractive. 5. Employee lifestyle: Firms need to ensure that they are able to attract and retain the best talent be it from the home or the host country for the investment to be financially viable and attractive. Therefore, FDI also takes into account the employee quality of lifestyle. Typical factors that are taken into account are:

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a) Cost of living: The cost of living in the host country is important as it impacts the remuneration that needs to be paid. More importantly, it’s the change in the cost of living or the inflation rate that is important for a company. Rapid and increasing inflation makes it difficult for a company to plan. b) Quality-of-life issues: the quality of life that a firm’s employees will experience is important selecting a location. FDI needs to ensure that a location works well for the business as well as the employees’ families. c) Low crime: FDI needs to ensure that its employees, their families and corporate assets are safe in the location. Increased risk of safety negatively impacts on the selection of a location. d) Quality of higher educational institutions: The availability and quality of higher education is important as it will help to provide training, certifications, and qualifications to the firm’s current and future workforce. e) Quality of pre-university education and healthcare: FDI is acutely aware that they will not be able to attract or retain employees if a particular location does not have an adequate supply of quality schools and healthcare services. Both schools and healthcare are important factors when it comes to the quality of life of a particular location. f) Recreational and leisure facilities: families actively look for locations that have a variety of good quality recreational and leisure facilities which can range from shopping malls, to libraries, cultural and sports facilities.

II.3. FDI Ecosystem The FDI ecosystem system has seven component parts each of which play an important role in attracting, retaining and expanding the investment. The starting point for any FDI is the core group which consists of the ministry and/or federal authority that is tasked with attracting FDI. The normal practice is that the ministry or federal authority establishes an IPA that promotes, facilitates and carries out post-investment services to any FDI. There is no reason to assume that FDI cannot take place in

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the absence of the core group however its relevance is the national strategy, framework and support that it provides investors. In most cases any incentives financial or otherwise tend to be provided by the core group. The second component of the FDI ecosystem are the influencers who work on behalf of the investor. Various surveys show that the influencers play an important role in selecting a particular location. The second component of the FDI ecosystem are the influencers (e.g. advisers such as lawyers, location experts etc.) who work on behalf of the investor. Various surveys show that the influencers play an important role in selecting a particular location on behalf of the investors. The influencers themselves use various measures and rankings which refer to the locational benefits such as the quality and presence of ports, airports, special economic zones or free zones, incubators and accelerators, clusters and universities as well as technology parks. The infrastructure as discussed in section 2.2 is important for a company when selecting a particular location. Therefore, the infrastructure authorities or agencies need to provide the facilities and services that are demanded by investors.

Figure 2. The FDI ecosystem

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FDI enters a country for the domestic demand but also for the regional demand, therefore the customers and the customers of the customers are important. Similarly, FDI also needs to be connected to suppliers and indirectly to the suppliers of the suppliers. This connectivity need not be in the country of the investment, however there needs to be effective connectivity to global supply chains if the suppliers are outside the location of investment. As the FDI becomes more established it will need support to grow and expand which is provided by local, regional and national chambers of commerce, business groups and associations, and professional advisers. Similarly, the investment at some point will seek to export and hence the support from the export promotion agency, export and import bank and export credit insurance agency all become relevant. Also, exporting requires the availability of trade finance which includes pre-shipment finance. With the growth of the FDI it may also require additional equity investors, bank debt and financial market instruments such as bonds. Therefore, at later stages of the development of the FDI these institutions can play an important role.

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SYNTHESIS OF THE UNIT This unit has examined the decision-making process of a foreign investor starting with the most important theory, namely Dunningâ&#x20AC;&#x2122;s eclectic paradigmâ&#x20AC;&#x2122; which argues that firms expand overseas if organizational, locational and internationalization benefits are greater than the costs. If these costs are higher then firms will export, license etc. The decision to establish in a particular location is dependent on five factors, namely market, operational, financial, signatory to international agreements and employee lifestyle factors. There is no golden rule as regards the relative weights that can be assigned to each of these five factors and each foreign investor has its own priorities. Various surveys carried out each year show the changing relevance and weights of each of these five factors. Finally, the FDI ecosystem is divided into seven component parts each of which play an important role in attracting, retaining and expanding the investment. The seven components of the FDI ecosystem are the core group which includes the investment promotion agency; the influencers such as site selection agents; the infrastructure authorities such as ports; the support groups such as chambers of commerce; tied parties which include the customers and suppliers; government bodies such as export promotion agencies and finally the providers of finance.

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Bibliography n Aliber, R. Z. (1970). "A theory of direct foreign investment", in C. P. Kindle-

berger (ed.), pp. 17-34, The International Firm. Cambridge, Mass.: MIT Press. n Aliber, R. Z. (1983). "Money, multinationals, and sovereigns", in C. P. Kindle-

berger and Autretsch, David B., (eds.), pp. 245-259. The Multinational Corporation in the 1980s. Cambridge: The MIT Press. n Dunning, J. H. (1977). Trade, Location of Economic Activity and the Multina-

tional Enterprise; a Search for an Eclectic Approach. London: MacMillan. n Dunning, J. H. (1979). “Explaining Changing Patterns of International Pro-

duction; in Defence of the Eclectic Theory”. Oxford Bulletin of Economics and Statistics, 41. n Dunning, J. H. (1980). “Toward an eclectic theory of international produc-

tion: some empirical tests”. Journal of International Business Studies, 11 (1), pp. 9-31. n Dunning, J. H. (1981). “Explaining the International Direct Investment Posi-

tion of Countries; Toward a Dynamic or Developmental Approach”. Weltwirtschaftliches Archive. Band 117, Heft 1. n Dunning, J. H. (1981). International production and the multinational enter-

prise. London: Allen and Unwin. n Dunning, J. H. (1988). Explaining International production. Unwin Hyman. n Dunning, J. H. (1992). Multinational enterprises and the global economy. Wo-

kingham, UK and Reading, Mass.: Addison-Wesley Publishing Company. n Dunning, J. H. (1993). The globalization of business. London and New York:

Routledge.

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n Dunning, J. H. (1993). Multinational Enterprises and the Global Economy. Wo-

kingham, England: Addison-Wesley. n Francis, J., Zheng, C., & Mukherji, A. (2009). “An institutional perspective on

foreign direct investment: A multi-level framework.” Management International Review, 49 (5), pp. 565-583. n Hymer, S. H. (1976). The International Operations of National Firms: A Study

of Direct Foreign Investment. Cambridge, Mass: MIT Press n Mahate A. A. (2017). “Developing an Effective FDI Ecosystem”, Working Pa-

per. n Méon P. and Sekkat, K. (2004), "Does the Quality of Institutions Limit the

MENA's”. n “Integration in the World Economy?" The World Economy, 27, pp. 1475-1498. n Vernon, R. (1966). “International Investment and International Trade in the

Product Cycle.” Quarterly Journal of Economics, 80, pp. 190-207. n Vernon, R. (1979). “The product cycle hypothesis in a new international en-

vironment.” Oxford Bulletin of Economics and Statistics, 41, pp. 255-267. n Wei, S. J. (2000). “How taxing is corruption on internal investors?” The Re-

view of Economics and Statistics, 82 (1), pp. 1-11.

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UNIT III THE ROLE OF AN IPA

Learning Objectives The learning outcomes of this unit are as follows: n The role of the IPA in the process. n Structure, mission, goals and capabilities of IPAs. Investment and trade pro-

motion under the same umbrella: pros and cons. n The role of complementary advisor institutions for the IPA (public/private

advisory board; foreign successful business/philanthropic leaders as part of the board, etc.). n Strengthening the staff of the IPA and the importance of qualified HR. n The importance of appropriate public/corporate governance practices.

III.1. Principles for Organizing Investment Promotion Unit 1 discussed the benefits of FDI and therefore itâ&#x20AC;&#x2122;s no surprise to see that inward investment promotion is carried out by almost all governments in addition to or in coordination with regional and in some cases city-based authorities. The question is

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why should inward investment promotion be carried? From a government perspective it brings about economies of scale in that the provision of information to potential investors on the host country can be carried out by a single entity or at least leading it. This avoids overlaps and gaps between different government agencies. More often than not the case is that a clear message seldom exists and where it does it tends to overlap with other government agencies. More importantly, a single body can competitively position the country as opposed to different ministries trying to do the same. Furthermore, companies have a single point of contact that is able to provide correct information. A survey by the University of Oxford showed that 83% of executives tasked with selecting where to invest state tend to consult the countryâ&#x20AC;&#x2122;s IPA as a first point of call. The IPA can also assist the foreign investor to deal with the maze of bureaucracy that normally exists when establishing a business. The single agency can also offer more tailor-made portfolio of financial and non-financial incentives to foreign investors. After the investment has been done the IPA can carry out aftercare services so that it continues to be retained and even expanded over time. Figure 3 illustrates the broad categories of activities carried out by IPAs.

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Figure 3. The broad activities of an IPA

It is sometimes argued that information regarding a particular location or country can be obtained from the internet through an effective website. However, this ignores the important, that a central body needs to be in place to ensure that the information on the website is current and relevant. In the post-social media environment IPAs also play an important role of ensuring that investors globally are continuously made aware of the country and its investment benefits.

III.2. Are Investment Promotion Agencies Effective It is difficult to judge the effectiveness of an IPA, however prior studies have adopted two different approaches. The first is to examine the services that they offer and the

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vacuum that would be created in their absence. The second is to evaluate the financial return of IPAs based on either their return on investment or impact to the economy. Taking the first approach, IPAs play an important role in informing potential investors of the country's advantages as an investment location and converting this as investment. Second, IPAs facilitate new investment through the various huddles of obtaining permissions and licenses in the absence of which it would most likely get frustrated and seek another location. Third, IPAs work with the existing investors and to help them increase their investment in the country. Fourth, to lobby to national authorities on behalf of strategic foreign investment to obtain financial and non-financial incentives. Fifth, to be an advocate on behalf of foreign investors when it comes to national policy development.

The pecuniary approach finds that IPAs generally lead to positive and substantial financial returns for governments. Wells and Wint (2000) report that a 10% increase in the investment promotion spend of an IPA leads to a 2.5% rise in FDI. Harding and Javorcik (2011) show that every US$1 spent on investment promotion leads to an increase of US$189 in FDI inflows. These studies argue that despite the widespread use of the internet there is considerable information asymmetry from the foreign investors and the extent of support required in carrying out investment in a country. Interestingly, the prior literature does not find a uniform performance across IPAs and those that select a few targeted sectors can have up to twice as much in FDI compared to those that are generalist and seeking to attract all types of investment (see Charlton and Davis, 2006). Another area that leads to greater FDI is the professional handling of enquiries (see Harding and Javorcik, 2012). On the other extreme, IPAs that are focused developing incentives and negotiation concessions are the least successful. This result indicates that IPAs have a particular area where the greatest benefit can be derived which is provision of information, investment conversion, investment facilitation, after-investment care and advocacy. It appears any activity outside this leads to a substantially lower return.

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III.3. Establishment of an Investment Promotion Agency The discussion in section 3.1 and 3.2 shows that there are considerable benefits to be achieved in establishing an IPA. The evidence shows that the organizational and institutional structure of the IPA impact its performance and therefore they need to be designed based on the desired outcomes. This is important at the point of establishment as well as at regular intervals when institutional reviews take place. The factors of importance include: n Establishing a clear legal status for the IPA: the IPA must exist as a legal en-

tity usually established through a government law with well specified mandate that ensures there is no duplication with another body. n A clear line of reporting: the IPA should have a clear reporting structure

which can in some cases be to the President, the Prime Minister, Minister or even the head of an authority. The reporting structure ensures that there is oversight of the IPA and it is accountable as well as focused on achieving its objectives. n Institutional relationship: there are essentially two formats that are

adopted, namely autonomous or tied. In the case of the former the IPA is given a budget and is relatively independent. The tied relationship implies that the IPA is financially dependent on the reporting authority for all financial decisions and has little flexibility to move within. The evidence supports an autonomous relationship as it has the flexibility and speed to move with market demands, however in such a system there have to be clear targets that need to be achieved. n Private sector linkages: by its very nature the IPA needs to have direct and

close relations with the private sector so it is aware of the issues and challenges that it faces along with the opportunities. Successful IPAs have a constant dialogue with the private sector so that it can provide quality information to potential investors while being an advocate. 45

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n Governance structure: it is clear from prior research that IPAs with a proper

system of governance allow them to achieve its goals and objectives. n KPIs: an IPA needs to have a clear set of outcomes that are measurable. The

rationale behind KPIs is to boost the performance of the IPA in line with its mandate. The KPIs also make the IPA accountable for any lack of performance in achieving its targets. n Quality of human capital and skill development: almost all IPAs are classified

as public sector institutions, however the nature of their activities implies that they need to have a private sector approach. Therefore, they need to recruit staff that are able work within such a system. n Overseas presence: a large number of IPAs have overseas offices that pro-

mote the country and its opportunities in target countries. There is no clear formula as to how many offices that an IPA should have overseas and some have as many as 227 while others have none whatsoever. What is apparent is that some level of overseas presence is important in order to regularly interact with potential investors in the target country.

III.4. Governance of IPAs The idea of governance in public sector organizations is relatively new and arose from its use in the private sector. Generally speaking, governance refers to the processes and structures through which organizations are directed, controlled and held to account. As such it is the relationship between the management of the entity and its stakeholders. A good system of corporate governance allows the management to follow objectives that are consistent with the interests of its stakeholders while allowing them to be monitored so that the organization uses its resources more efficiently. The broad nature of governance and the diversity in public sector organizations both within a country and internationally makes the concept of a â&#x20AC;&#x153;one-size-fitsallâ&#x20AC;? approach impossible. Nevertheless, an IPA is faced with the situation of satisfying 46

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a diverse and complex collection of political, economic as well as social objectives. This implies it needs to transact its affairs with a high level of transparency and accountability. The International Federation of Accounts has produced a framework for good governance in public sector bodies which is illustrated in figure 3.1. Figure 3.1. IFAC governance framework for public sector organizations

From a practical view point all the aspects of the IFAC (2014) framework help to develop a good IPA. An additional step that effective IPAs take is to form a supervisory committee or board with representatives from the public and private sectors. The aim of the supervisory committee is to oversee the activities of the IPA as well as to advise it of its future direction.

III.5. IPAsâ&#x20AC;&#x2122; Instruments, Functions & Techniques IPAs all across the world are very diverse whereby in some countries they have a very limited role of only supplying information whilst in others they carry out a diverse range of activities including registering businesses and being responsible for one or

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more special economic zones. Despite the diversity of IPAs the following activities are common to all: n Provision of information: potential investors need to have information re-

garding opportunities, approvals processes, labor laws, issues relating to finance and tax, and so on. n Investor facilitation: the actual process of assisting the investor to carry out

the investment and register the company as well as obtain all the necessary approvals. n Post-investment aftercare: once the investment has been made the IPA

needs to provide regular support for its expansion. n Advocacy: the IPA needs to lobby the case of foreign investors in the coun-

try so as to make the location more attractive and efficient for potential FDI. These four functions of the IPA are discussed in greater detail in the later modules that will be undertaken. In this section we put these functions into context and show how they are arrived at. The starting point for all IPAâ&#x20AC;&#x2122;s activities are the national and regional strategies and policy documents which feed into the vision and mission of the entity itself. This gives rise to the support and core functions and then the activities as shown in box 3.

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Box 3. The structure of IPA functions National Strategies and Policies Regional Strategies and Policies

IPA's Vision, Mission, Targets

Supervision Committee

Functions of the IPA Support Functions

Management / HR/ Finance/ IT

Core Functions

Research/Strategy (Information &

Planning/

and

In- Branding)/Investment

vestment Attrac- Facilitation/Post tion

vestment

InAfter-

care/Advocacy

KPI Measurement and Reporting Source: Mahate (2017)

III.6. Human Capital and Skills for Effective IPAs It is often said that the assets of an organization are its people and this is especially true for an IPA which seeks to attract inward investment. The manner in which the staff of the IPA interact with potential investors will ultimately play a major role in whether the investment takes place or not. As such the employees need to be dynamic energetic but at the same be able to speak and understand the language of business. The reason for this is that more often than not the IPA staff will be interacting with the investors or their representatives whose interest will largely be financial. At the same time IPAs need to interact with all levels of the organization so that it

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may be the case that initial information is obtained by a junior member of staff but during the conversion stage the interaction may be with the CEO. In order to have an appropriate level of interaction some IPAs recruit senior staff or even former diplomats who are well versed in transacting at the higher levels of business. Even for junior staff it is important that they receive regular and continuous training to ensure that they upgrade their skills and knowledge. In some cases IPAs allocate a mentor who is a senior member of staff who provides regular advice and support. Other internal systems of training include mechanisms for sharing experiences on success and failure stories. In this way all staff learn about and share knowledge. Of course training programs such as this one are also vital for the development of all IPA staff.

III.7. The Rationale for Promoting Investment and Trade Just as countries promote inward invest they also encourage and support exports from their countries through the intervention of Trade Promotion Organizations (TPOs). Countries have understood the positive spillover effects from exporting in terms of employment, trade balance, exchange reserves, technology know-how and increase in productivity. One of the reasons as to why FDI takes place is to penetrate regional markets and therefore exports are important. One approach that about 55% of global IPAs have adopted is to have a merged entity which provides support for inward investment as well as for exporting. The rationale for an IPA and TPO merged entity is that there are economies of scale in operation as well as seeking to ensure that domestic and inward investment is export-oriented. The more successful is FDI, which can take place through exports, the greater the likelihood of further investment in the country. Although there are synergies from combined IPA and IPO entities they do offer challenges which are illustrated in box 3.1.

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Box 3.1. The differences between TPOs and IPAs

The UNCTAD (2013) report details the advantages and disadvantages between a merged TOPO and IPA entity which are illustrated in box 3.2.

Box 3.2. Advantages and disadvantages of a merged TPO and IPA Entity Advantages

Disadvantages

Better policy coherence in investment and Often different objectives and core activitrade issues

ties. Risk of fragmented responsibilities and loss of focus in the agency

Shared support services (IT, human re- Human resources, accounting, legal sersources, accounting, legal services, public

vices, public relations, research and analy-

relations, research and analysis), shared of- sis, shared office accommodation. fice accommodation

Possible problems in coordinating investment and trade promotion activities and

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Advantages

Disadvantages managing staff with different mind-sets. Risk of increased bureaucracy

Knowledge-sharing, to benefit strategy de- Different time frames, with generally a velopment

longer time perspective in investment promotion

Potentially more continuity in service deliv- Often different clients and contact points in ery. A single point of contact in govern- companies ment, e.g. for export oriented investors Potential synergies in overseas promotion, Largely different skills requirements for especially country branding

staff

Common ground for policy advocacy in the

Risk of less attention being paid to invest-

area of national competitiveness

ment promotion and FDI-related policy issues

Source: ITC (2014)

The real deciding factor as to whether a country should have a merged or separate TPO and IPA entity is whether it meets its medium- and long-term goals. For instance, small countries will never become market-seeking destinations due to their size so one option is for them to opt for being efficiency-seeking destinations. If a country is to focus on being an efficiency-seeking destination then the ultimate market for the products and services produced with be international markets. In such a situation a merged entity makes more sense as not only can it assist FDI to enter the country but assist it to become outward looking. The fact that 45% of IPAs are not merged entities shows that there are practical benefits for keeping IPAs and TPOs separate entities each specializing in its own core functions.

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SYNTHESIS OF THE UNIT This unit has sought to examine the role of an IPA. Prior research shows that IPAs are an effective tool in attracting inward investment and for every US$1 spend the inflows generated are US$189. Potential investors tend to talk to the IPA in the first instance and their role for the provision of information is dispensable despite the advantages in technology and the internet. This unit has also shown that there is no single correct answer as to what an IPA should look like or the functions that its needs. What we do know is that all IPAs perform four key functions, namely the provision of information to potential investors, investment facilitation, post-investment aftercare and advocacy. Each one of these functions can be carried out to different degrees whereby some IPAs when providing information also deal with the external image building of the country. Prior research has shown that certain factors are important in creating effective IPAs such as a law or decree, etc. Also, effective IPAs have established governance structures including a supervision committee. Finally, there is a debate as to whether IPAs and TPOs should be merged. The empirical evidence shows that 55% of IPAs are merged with TPOs and the remaining ones are single activity entities. The real answer to this issue depends on the medium- and long-term goals of the country.

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Bibliography n Charlton, A. and Davis, N. (2006). “Does Investment Promotion Work?” Lon-

don School of Economics, Working Paper. n Enderwick, P. (2005). “Attracting ‘desirable’ FDI: theory and evidence.”

Transnational Corporations, 14 (2), pp. 93–119. n Harding, T., Javorcik, B. S. (2011). “Roll out the red carpet and they will come:

Investment promotion and FDI inflows.” The Economic Journal, 121 (557), pp. 1445–1476. n Harding, T. and Javorcik, B. S. (2012). Investment Promotion and FDI Inflows:

Quality Matters. CESifo Economic Studies. n IFAC (2014). International Framework: Good Governance in the Public Sector.

International Federation of Accountants. n ITC (2014). Trade Promotion Organizations and Investment Promotion Agen-

cies: are they merging? International Trade Center. n Mahate, A. A. (2017). “Developing an Effective FDI Ecosystem”, Working Pa-

per. n UNCTAD (2013). Optimizing government services: A Case for Joint Investment

and Trade Promotion? UNCTAD. n UNCTAD (2014). Skills and foreign direct investment promotion: What Can an

Investment Promotion Agency Do? UNCTAD. n Wells, L. T. and A. G. Wint (2000). “Marketing a country: promotion as a tool

for attracting foreign investment”. FIAS Occasional Paper, No. 13. Washington, D.C.: Foreign Investment Advisory Service.

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UNIT IV SPECIAL ECONOMIC ZONES AND FDI

Learning Objectives This unit seeks to achieve the following learning outcomes: n Understand what is meant by a special economic zone and the different sub-

categories. n To appreciate the importance of Special Economic Zones in attracting FDI. n To be aware of the successes of Special Economic Zones from other coun-

tries and the benefits they bring to governments along with the costs.

IV.1. Special Economic Zones Special Economic Zones (SEZs) have a very long history dating back to the first one in Gibraltar in 1704 followed by Singapore in 1819 and Hong Kong in 1848. These early SEZs were simply entry points for foreign merchants to have a point from which they could trade. The modern definition of a SEZ relates to the Revised Kyoto Convention of the World Customs Organization (WCO) within Annex D as â&#x20AC;&#x153;part of the territory of a Contracting Party where any goods introduced are generally regarded, insofar as import duties and taxes are concerned, as being outside the Customs territory . . . and not subject to the usual Customs controlâ&#x20AC;?. Therefore, a SEZ can be considered as 55

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territory belonging to the country but whose imports are not subject to the usual customs duties and tariffs. SEZs tend to have the following aspects that seek ensure that the non-customs payment area does not seep into the land which is: n A geographically delimited area which tends to be physically secured. n A single system of administration. n Has the ability to receive benefits that are limited to only companies within

the area (fenced-in). n Usually a separate customs system with not only duty-free benefits but also

streamlined procedures. Countries usually seek to attract FDI into the SEZ through offering various inducements which may include the following: tax holidays for a certain number of years; ability to carry out trading with minimal requirements; exemption from quota and customs procedures; light labor regulations and low capital requirements for business set as well as the ability to fully own the firm. Ironically SEZs are not so special any longer and three out of every four countries has such as facility. Current estimates indicate that there are 4,300 SEZs with new ones being added each year. Not all the SEZs use the same name and for instance in Japan they are referred to as a Special Strategic Zone.

IV.2. Types of Special Economic Zones The growth of SEZs has also led to various derivations either in terms of their focus or the benefits provided to investors so as to reach a wider or more niche group of FDI. Some of the common examples of the different types of SEZs are as follows1:

This is based on a list provided by the World Bank (2008) and is not intended to be exhaustive as countries are developing new variants all the time.

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n Free Trade Zones (FTZ): they can also be known as Free Trade Area (FTA) or

Free Commercial Zone (FCZ). These SEZs are a customs-bounded area that offer investors logistics facilities including warehousing, storage, distribution etc. for the primary purpose of re-exporting. Modern FTZs offer plug and play facilities so that investors can use ready constructed facilities rather than investing their own capital in building them. n Export Processing Zones (EPZ): this is essentially an industrial area that pro-

vides particular incentives and offers facilities aimed at encouraging manufacturing primarily for export. Although, the traditional EPZs are aimed specifically for export some do allow non-export oriented manufacturing firms. n Enterprise Zones (EZ): these are sometimes called urban enterprise zones

or revitalization zones. The aim of this SEZ is to rejuvenate old and/or derelict areas through generous tax incentives and financial grants. Interestingly, this type of FDI is focused at rebuilding communities to meet the needs of the modern world. n Freeports: this is a broad extension of the SEZ and not only do they cover a

larger area but also a diverse range of activities from tourism to retail with a broad spectrum of incentives. Freeports allow people to live within the area and permit free movement. n Single factory EPZ: this is a rather odd category as the incentive is provided

regardless of the location and that to a single firm. The rationale for these SEZs is to encourage strategic firms to investment in the country and it is assumed that they will bring positive benefits with them.

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Box 4. Different variants of special economic zones Type

Objective

Size

EPZ (hybrid)

Export manufacturing

<100 hectares

EPZ (single Unit/free enterprise) EPZ (traditional)

Export manufacturing

No minimum

Countrywide

Export manufacturing

<100 hectares

None

Free port/SEZ

Integrated development Support trade

>1000 hectares

None

<50 hectares

Port of entry

Urban revitalization

<50 hectares

Urban/rural

FTZ

Urban enterprise zone

Typical Location None

Typical Activities Manufacturing, processing Manufacturing, processing Manufacturing, processing Multi-use

EntrepĂ´ts and trade related Multi-use

Markets Export, domestic Mostly export Mostly export Internal, domestic, export Domestic, re-export Domestic

Source: World Bank (2008)

IV.3. How do Special Economic Zones Attract FDI Although each country may have its own reasons for establishing a SEZ the main objectives tend to be as follows: n SEZs allow a country to attract export-oriented firms from abroad and en-

courage domestic firms to be outward looking. n They allow a country to maintain two very different systems, one within the

SEZ which is open and pro-trade while a domestic one that may have protective barriers. n SEZs have shown to create employment opportunities through liberal oper-

ating rules. In particular, SEZs have been extremely successful in providing employment to females and estimates show that 60% to 70% of the labor globally in SEZs is female.

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n SEZs can be used as creative policy labs whereby new ideas and approaches

can be tested and refined before being implemented across the mainland. n One hurdle that FDI faces in many countries is the inability to have 100% own-

ership of the asset. SEZs through their relaxed laws allow for complete ownership and hence they are very successful in attracting FDI. n Allows financially constraint countries to focus their infrastructure develop-

ment in a concentrated area where it will derive the greatest benefit. SEZs tend to offer two options to investors, namely the ability for them to construct their own purpose-built facilities either through purchasing the land or leasing it. Alternatively, investors can simply rent already constructed facilities. Some of the more modern SEZs combine the ability of investors to construct their own purpose-built facilities using finance provided by Real Estate Investment Trusts (REITs). In this model the land and the facilities are specified by the investor, built and paid by the REIT and under agreement from the SEZ. Such a model allows the industrialist to partner with overseas financiers and the SEZ. Some SEZs have sought to become specialized or niche players through focusing on one or two areas of activities. The rationale here is to increase the competitiveness of firms within the SEZ through agglomeration or cluster based benefits. From the viewpoint of the SEZ it can construct infrastructure that meets the particular needs of the industry. In the case of a Freeport the aim is not to become export-oriented but an area with light regulation that allows for diversified economic growth that could possibly spillover into the mainland. Due to their diversified nature freeports tend to be substantially larger than SEZs (as shown in Figure 4). One of the benefits of a Freeport is that they allow goods to be imported without being subject to any customs duties. The imports can be sold within the Freeport on retail or wholesale basis. The goods can also be transferred to the mainland, however a custom duty will normally be payable.

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IV.4. Benefits of SEZ to Foreign Investors Perhaps one of the most important benefit to foreign investors of a SEZ is that it is a liberal environment that is focused on attracting investment and hence businessfriendly. Other benefits to investors of a SEZ include the following: n Many SEZs have now removed the distortions between foreign and domes-

tic investment within the area and both receive the same privileges. n Modern SEZs allow for commercial and professional services to be carried

out within the SEZs and not just manufacturing. n The secure nature of the SEZs implies that operating costs are lower in

terms of reduced insurance, security, and even overhead costs. n Most SEZs allow for a broad range of business structures from sole owner

to limited liability companies. More importantly, the ownership structure can be direct from investor to investment within the SEZs or through a maze of indirect ownerships or even a trust. n There are usually very low or no capital requirements to establish a firm

within a SEZ. n Most SEZs do not state the percentage of output that needs to be exported

or even the value add that must be carried out within the area. n Modern SEZs offer plug and play facilities thereby reducing the cost of the

investment. In some cases the SEZs partner with REITs so that dedicated facilities can be built without a large investment by the industrialist. Also, the SEZs provide all the necessary utilities such as telecommunications, water/ sewerage, power etc. within the SEZs. n Some countriesâ&#x20AC;&#x2122; firms receive financial benefits for being within a SEZ and

carrying out exports.

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n In order to attract FDI into SEZs the authorities provide generous incentives

such as tax-free holidays, exemption from domestic labor regulations, etc.

IV.5. Economic Impact of SEZs SEZs have shown to have one-time as well as continuous benefits some of which include the following: Direct employment creation and income generation: The most important economic benefit of SEZs is their ability to generate employment both directly and indirectly. Estimates show that SEZs have to date provided about 70 million jobs globally or about 0.25% of the national average. In some countries such as the United Arab Emirates SEZs have a far greater proportion of employment, about 40%. More importantly, each direct job within a SEZ leads to between half to four indirect jobs depending on the level of domestic linkages and the development. It is generally agreed that SEZs have been extremely successful in employment creation especially for low or semi-skilled labor who would otherwise have few if any opportunities. Export growth and export diversification: An important goal of SEZs is their ability to increase exports from a country and the global estimates show that 40% of all exports originate from a SEZ. The African average is that half of all exports are from a SEZ. Some individual countries such as Bangladesh and Philippines have three quarters of their exports from SEZs. These figures show the success of SEZs in developing exports and export-oriented firms. Foreign exchange earnings: SEZs have been successful in attracting FDI and assist a country with its foreign exchange earnings. Estimates of foreign exchange earnings due to a SEZ are difficult to calculate but estimates show that for some countries such as Philippines and Bangladesh it can be more than half the countryâ&#x20AC;&#x2122;s total foreign exchange earnings. 61

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Industrial upgrading and technology transfer: One important role of a SEZ is their ability to bring in new technology, processes and upskill the domestic labor. By and large the bulk of the activities in SEZs have been light manufacturing, assembly and apparel related. Nevertheless, even in these low level jobs there has been evidence of skill upgrading. In the case of the specialized SEZs such as the technology parks in India they have been extremely important developing a whole software industry. Foreign direct investment: The success of SEZs in attracting FDI is evidenced by the fact that there are over 4,500 in existence at present both across the developing and developed world. Most IPAs do not provide FDI on the basis of SEZ and non-SEZ, therefore it is difficult to estimate the actual amount of FDI attracted. However, it can be argued that by examining the importance of export revenues one can establish the success of SEZs in attracting FDI. Government revenues: The government revenue from SEZs is difficult to estimate as it largely depends on the financial incentives that are provided by EPZs compared to the benefits that arise. The typical sources of revenue for a government from a SEZ include the following: n Corporate income tax: this takes place if no tax holiday is provided or for

the period after such a period lapses. n Personal income tax: this is obtained on direct and indirect employment af-

ter any personal income tax allowance. In some countries the low level of salaries may imply that only a small proportion of the workers in a SEZ are subject to personal income tax. n Permit fees and service charges: all SEZs charge a fee for establishment and

annual fees for being in the area in return for which they receive various services. In fact, in some cases such as the United Arab Emirates the permit 62

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and services charges are the largest component of government revenue from a SEZ. In the case where the SEZs is owned and managed by a private sector operator they will be subject to corporate taxation or even a concession fee. n Rental or sales fees: some SEZs sell plots of land or rent plug and play facili-

ties for which they earn a revenue. n Import duties and taxes: although there are no such charges for products

brought into the SEZ the government receives the duties if they are transferred to the mainland. n Utility and concession fees: governments tend to provide the utilities within

a SEZ for which they earn a revenue. In the case that the utilities are offered by a private sector operator the government charges a concession fee. Invariably SEZs also incur a cost for the government the typical ones being as follows: n Costs of operating the SEZ: in the case where the government authority op-

erates the SEZ there is an operating cost which covers aspects such as the salaries of staff etc. n Initial investment: in most cases the government incurs an investment cost

of establishing the SEZ. Even if the SEZ is established by a private operator there are set up costs in terms of design, approval, setting out tenders etc. that need to be borne by the government. One also has indirect costs of which the most important is the loss in customs duties that would be generated in the absence of a SEZ. Also, there is the opportunity cost in terms of the other projects that a government cannot pursue due to the SEZ or the investment that takes within the area instead of the mainland.

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SYNTHESIS OF THE UNIT The modern definition of a SEZ is based on the Revised Kyoto Convention of the World Customs Organization (WCO) within Annex D as, â&#x20AC;&#x153;part of the territory of a Contracting Party where any goods introduced are generally regarded, insofar as import duties and taxes are concerned, as being outside the Customs territory . . . and not subject to the usual Customs controlâ&#x20AC;?. Therefore, a SEZ can be considered as territory belonging to the country but whose imports are not subject to the usual customs duties and tariffs. The success of SEZ has led to the development of different variants, the most common are: hybrid export processing zone; single unit or free enterprise export processing zone; the traditional export processing zone; free port; free trade zone and an urban enterprise zone. Each of the different SEZs seeks to achieve a different set of goals and attract different types of investors. Typically, SEZs offer two options to investors, namely the ability for them to construct their own purposebuilt facilities, either through purchasing the land or leasing it. Alternatively, investors can simply rent already constructed facilities. Some of the more modern SEZs combine the ability of investors to construct their own purpose-built facilities using finance provided by Real Estate Investment Trusts (REITs). Perhaps one of the most important benefits to foreign investors of a SEZ is that it is a liberal environment that is focused on attracting investment and hence it is business-friendly. The most important economic contribution of SEZs is their ability to generate employment opportunities especially for low or semi-skilled labor as well as increasing exports.

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Bibliography n ADB (2016). Asian Development Bank. The Role of Special Economic Zones in

Improving Effectiveness of GMS Economic Corridors, Asian Development Bank. n Bell T.W. (2016). “Special Economic Zones in the United States: From Colo-

nial Charters, to Foreign-Trade Zones, Toward USSEZs”. Buffalo Law Review, Vol. 64, No. 5. Available at SSRN: https://ssrn.com/abstract=2743774 or http://dx.doi.org/10.2139/ssrn.2743774 n UNDP (2015). Comparative Study on Special Economic Zones in Africa and

China, UNDP. n World Bank (2008). “Zone Definition”, Special Economic Zone: Performance,

Lessons Learned, and Implication for Zone Development. Washington DC: World Bank, pp. 9–11.

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UNIT V SUSTAINABLE FDI

Learning Objectives This unit seeks to achieve the following learning outcomes: n To understand what is meant by the Sustainable Developments Goals. n To appreciate the importance of sustainable FDI. n To be able to develop and apply a sustainable development framework for

FDI.

V.1. The Sustainable Development Agenda September 2015 marked a landmark point in the United Nations (UN) history as the General Assembly formally approved a set of 17 global goals with 169 targets which were officially known as â&#x20AC;&#x153;Transforming Our World: the 2030 Agenda for Sustainable Developmentâ&#x20AC;? but are commonly referred to as simply the Sustainable Development Goals (SDGs). Like all plans the initial list was extremely ambitious but through a number of rounds of discussions and interactions with stakeholders they were reduced to seventeen. The SDGs sought to build on the work that was started with the Millennium Development Goals (MDGs) as well as to learn from its failures. At the same time, the SDGs sought to be bring about collective responsibility through ensuring

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that all countries would need to contribute to their success and not just developing nations. More importantly, all countries would be judged equally without any regional or local contextualization of targets and goals. One lesson learnt from the MDGs was that setting targets for just one group of countries leads not only to an unequitable situation as well as distrust of the agencies setting the goals. Therefore, the SDGs are applicable to all countries as a result of which they have become fundamental to every countryâ&#x20AC;&#x2122;s planning cycle and as such have developed a system of global partnerships. As such they are a platform by which all stakeholders can be brought together for the common good of all the worldâ&#x20AC;&#x2122;s people. Another lesson that has been learnt from the MDGs is that for goals to be achieved there needs to be regular reporting. Therefore, the UN has already started the process of making public annual reports regarding the performance of each of the 193 participating countries. Also, countries are motivated to achieve the SDGs because they realize that it brings benefits to their people through a higher quality of living. At the same time the SDGs bring about tangible economic benefits which include economic growth, inflows of foreign direct investment, trade and the attraction of human capital. Box 5 illustrates the SDGs. Box 5. The SDGs 1. No Poverty

7. Affordable clean energy

2. Zero Hunger

8. Decent Work and Economic Growth 13. 14. Climate Ac- Life Below tion Water

3. Good Health and Well-being 9. Industry, Innovation and Infrastructure 15. Life on Land

4. Quality Education 10. Reduce Inequalities

16. Peace, Justice and Strong Institutions

Source: https://sustainabledevelopment.un.org/?menu=1300

5. Gender Equality

6. Clean Water and Sanitation 11. 12. Sustainable Responsible Cities and ConsumpCommunition and Proties duction 17. Partnerships for the Goals

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V.2. The Sustainable Development and the Role of FDI The success of the SDGs depends on the required level of investment which is estimated to be between US$5 to US$7 trillion per year. Of this, about US$3.3 to US$4.5 trillion is in just the developing countries largely for infrastructure projects such as roads, rail networks, ports, power stations both conventional and renewal energy, water and sanitation, health, education and agriculture. If one assumes the current levels of global FDI as stated in Unit 1 of this module at US$1.7 trillion this leaves a shortfall of US$1.6 to US$2.8 trillion per year. Unfortunately, the bulk of the investment burden will fall on developing countries. The huge investment requirements imply that all governments will rely more on private sector investment if they are to realize the SDGs. Current estimates show that only a tiny proportion of private sector investments are in sectors or areas related to the SDGs and for developing countries it is even lower. If the SDGs are to be achieved by 2030 then private sector investment in sustainable projects needs to become more significant. This also raises sensitivities as many of the SDGs areas are related to public service. Therefore, governments need to find the fine balance between attracting private sector investment in SDG related projects while protecting public interests through effective governance systems and regulation. In essence this involves making investment in sustainable projects attractive to private sector investors but at the same time accessible and affordable to their people. UNCTAD (2014) proposes a Strategic Framework for private sector investment in sustainable projects while seeking to deal with the main policy challenges and options related to the following: a) The first step is to have a national framework or policy that stimulates action to attract FDI but also sets the guiding principles, targets, etc. b) The second step is the practical task of attracting FDI into sustainable projects. Some of the problems that exist with sustainable projects are the need for

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innovative financing solutions, ability to tackle market failures through a private sector arrangement, a lack of information and in some cases transparency on environmental issues which exist because so little is known about it. c) The third step is to channel the funds into investments in SDG sectors. The channeling of funds is made more difficult in the case of sustainable projects because of the mismatch between the required returns and the risks. Furthermore, there is an acute lack of information, investor inexperience in this area and the lack of effective packaging and promotion of projects. d) The fourth step is to achieve the goals of maximizing the impact of FDI into sustainable projects while minimizing risks involved. One of the main challenges in increasing the impact of sustainable FDI is the weak absorptive capacity of the country. This is illustrated in figure 5 below. Figure 5. Strategic framework for private investment in the SDGs

UNCTAD (2014) Action Plan for Private Investment in the SDGs argues for a rethinking of the manner in which private investment is sought especially for sustainable projects through the following:

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n Designing a new generation of investment promotion and facilitation tools

that better meet the challenges of sustainable investment. n The development of a new portfolio of SDG oriented incentives that are able

to deal with the mismatch between returns and risks as well as the issues related to the market failure aspects of some sustainable projects. n Setting up of regional SDG investment compacts to pursue projects collec-

tively or at least share knowledge and expertise. n Developing new types of partnership for SDG projects that go beyond the

simple ability to obtain a concession. n Encouraging financial innovation for sustainable projects to bring new in-

vestors. n Creating awareness programs to change the investor mindset regarding

sustainable projects.

V.3. The Sustainable Development FDI Policy Framework UNCTAD (2015) developed the Investment Policy Framework for Sustainable Development (IPFSD) to assist governments to develop effective investment policy especially in relation to their International Investment Agreements (IIAs) so as to attract FDI for sustainable projects. The IPFSD seeks to maintain a balance between the rights of each party while also seeking to make the investment attractive. Therefore, IPFSD intends to: n Encourage a new type of IIAs that seek to pursue a wider developmental

agenda. n Support and advice in developing national and international investment pol-

icies.

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IPFSD identifies eleven main core principles which can be used for developing good sustainable investment policy. Interestingly, the IPFSD also offers clause-by-clause advice on how to negotiate IIAs in the post-SDG environment. The eleven core principles of the IPFSD are as follows: 1. Investment for sustainable development. 2. Policy coherence. 3. Public governance and institutions. 4. Dynamic policy-making. 5. Balanced rights and obligations. 6. Right to regulate. 7. Openness to investment. 8. Investment protection and treatment. 9. Investment promotion and facilitation. 10. Corporate governance and responsibility. 11. International cooperation.

In addition to the core principles the IPFSD also lists three investment policy guidelines that connect the eleven core principles to formulate national policy. The aim of the guidelines are to ensure that there is a coherent development strategy that furthers the sustainable goals and maximizes the impact of the investment. The IPFSD national investment policy guidelines are as follows: n Strategic: any investment policy should be broad and have a roadmap for

economic growth and sustainable development. n Normative: the role of governments is to be the regulator and set the rules

so as to promote investment focused on SDGs. n Administrative: ensuring effective implementation of its policy, rules and

regulations, the country can ensure continued relevance and effectiveness of investment policies.

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The IPFSD also embodies the challenges faced by countries and therefore proposes that the investment policy needs to be addressed at the following three levels: n Strategic: managing the relationship between IIAs and other international

agreements so that there is complete coherence between the IIAs and SDGs. n Designing provisions for sustainable development: ensuring the rights of in-

vestors and the country along with effective investment promotion and attraction. n Building multilateral consensus on investment policy: this seeks to deal with

the challenges that arise from overlaps and inconsistencies in the IIAs. The IPFSD suggests a clause-by-clause approach of how the IPFSD's Core Principles can be translated into provisions of an IIA by selecting from these explicit policy options list that best meet their needs. In doing so it seeks to make the provisions of the IIA more sustainable development-friendly while balancing the rights of investors. Figure 5.1 illustrates the structure and components of UNCTADâ&#x20AC;&#x2122;s investment policy framework.

Figure 5.1. Structure and components of UNCTADâ&#x20AC;&#x2122;s investment policy framework

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V.4. The Sustainable Development Investment Attraction Although there has been considerable discussion of sustainable FDI in the post SDG period we are nevertheless without a single universally accepted definition. The various definitions of sustainable FDI refer to it as foreign investment that assists a country to achieve its SDGs and therefore have social, economic and environmental objectives. Other definitions refer to sustainable FDI as that which produces a return sufficient to maintain effective corporate engagement in the host country without damaging its interests while making a positive contribution to the long-term development goals. The interest in sustainable FDI is not only due to the SDGs but also some of the foreign investment that has in the past taken place at the expense of social and environmental goals. The wider the definition of sustainable FDI the greater the emphasis on a broader concept of social development. For some countries this has involved focusing on developing skills of its people through attracting FDI at the higher levels of the value chain. This also allows the country to develop a knowledge-based economy. For other countries the focus has been to attract investment that has a lowcarbon footprint and is environmentally sustainable. Yet another approach has been to develop the economy through attracting FDI in into key infrastructure projects such as ICT, energy, roads, public transport, water, etc. One thing is certainly clear from the IPFSDâ&#x20AC;&#x201D;that a country needs to have a national sustainable FDI strategy that is holistic in developing the economy while meeting the objectives of the SDGs. Therefore, a countryâ&#x20AC;&#x2122;s sustainable FDI strategy needs to develop an action plan as how to attract FDI for: n Increasing the productive capacity of the country. n Developing linkages. n Upgrading the domestic capital. n Human capital development.

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n Acquisition of technology & know-how. n Building infrastructure.

These aspects need to be reviewed annually to ensure that they are supporting the countryâ&#x20AC;&#x2122;s SDG targets. Figure 5.2 illustrates one possible manner in which sustainable FDI can be assessed. Figure 5.2. Assessing sustainable FDI

The IPFSD suggests that in assessing an inward investment the following measures can be used: n Economic value added. n Value added. n Contribution to gross fixed capital formation. n Export generation. n Total fiscal revenues. n Job creation.

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n Number of jobs created (directly and indirectly). n Wagesâ&#x20AC;&#x201D;household income generated. n Types of jobs generated. n Sustainable development. n Labor impact especially of the economically disadvantaged groups. n Social impact especially the number of families lifted out of poverty. n Environmental impact in particular GHG emissions, energy and water con-

sumption, treatment of hazardous materials, enterprise development in eco-sectors etc. n Development impact and technology dissemination. Source: UNCTAD 2015

The list of metrics suggested by UNCTAD (2015) can be formalized into an assessment matrix that provides a score as shown in figure 5.3. The idea is that each of the four factors in figure 5.3 are listed, i.e. governance, economic, environment and social. Then for each factor the sub-issues are listed and a system of weights is developed based on importance. Therefore, the top five sub-issues have a weighting of three, the next five a weight of two and the rest one. Once the weights have been assigned, and it is important to note that there is no reason for them not to change with each project or over time, the country can assess the project and arrive at a single score. The single score allows the country to decide between different and sometimes competing projects. More importantly, it allows the country to provide a tailor-made portfolio of incentives in order to attract the most desired projects that are assumed to assist it to achieve the SDGs. The same matric can also assist a country in selecting sectors to target for sustainable FDI.

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Figure 5.3. Project assessment matrix

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SYNTHESIS OF THE UNIT Since 2015, all 193 members of the United Nations are committed to achieving the SDGs. In order to achieve the SDGs globally an investment of between US$5 trillion to US$7 trillion is required while world FDI is US$1.7 trillion. This leaves a huge short of between US$1.6 to US$2.8 trillion per year. This implies that countries need to change their traditional FDI strategy and need to be more innovative in order to attract sustainable FDI. The UNCTAD (2014) proposes a four step framework for sustainable FDI which starts with leadership and guiding principles, followed by mobilizing the funds, channeling the investments and increasing the impact of FDI. UNCTAD (2015) developed the Investment Policy Framework for Sustainable Development (IPFSD) to assist governments to develop effective investment policy especially in relation to their International Investment Agreement. IPFSD identifies eleven main core principles and three investment policy guidelines that connect to formulate national policy. One thing is certainly clear from the IPFSDâ&#x20AC;&#x201D;that a country needs to have a national sustainable FDI strategy that is holistic in developing the economy while meeting the objectives of the SDGs. One manner of developing a holistic approach is to use the metric suggested by UNCTAD (2015) and construct them into an assessment matrix that provides a single score. The single score allows the country to decide between different and sometimes competing projects. More importantly, it allows the country to provide a tailor-made portfolio of incentives in order to attract the most desired projects that are assumed to assist it to achieve the SDGs.

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Bibliography n Bhatkal, T., Samman, E. and Stuart, E. (2015). “Leave no one behind: the real

bottom billion”. Briefing. London: ODI. n ESCAP (2016). Sustainable FDI: Attracting FDI in support of SDGs. United Na-

tions Economic and Social Commission for Asia and the Pacific. n SDSN (2015). Getting Started with the Sustainable Development Goals, Sus-

tainable Development Solutions Network (SDSN). n SDSN (2016). SDG Index and Dashboard: A Global Report, Bertelsmann

Stiftung and Sustainable Development Solutions Network (SDSN). n United Nations (2014). The Road to Dignity by 2030: Ending Poverty, Trans-

forming All Lives and Protecting the Planet. United Nations: New York. n United Nations (2015). Resolution adopted by the General Assembly on 25

September 2015. n United Nations (2015). The Millennium Development Goals Report 2015. New

York: United Nations. n UN DESA—UN Department of Economics and Social Affairs (2013). World

Economic and Social Survey: Sustainable Development Challenges. New York: UN DESA. n UNCTAD (2014). World Investment Report. UNCTAD. n UNCTAD (2015). Investment Policy Framework for Sustainable Development.

UNCTAD.