Factors attracting foreign direct investment (FDI) in a country
Tuesday, 13 April 2010
M. Mizanur Rahman
There are many factors that attract FDI for an economy. Over the decades, the nature of these factors has evolved and changed owing to the changing nature of international finance and investment. FDI itself became a global competitive financial and investment market. Therefore in such a global competitive environment the factors that attract FDI tend to remain competitively changing. Taking this into consideration, the factors that contribute best to inward FDI performance are discussed below:
The first important factor that traditionally lures higher FDI is availability of natural resources and raw materials. The vast reserve of natural resources in many countries attracted FDI during the early decades of the twentieth century when public as well as private big companies in the West invested heavily in extractive economies around the world such as mining. However, natural resources are no longer a highly attractive factor now for FDI. Countries completely devoid of natural resources such as Hong Kong, Singapore and Taiwan receive the lion's share of FDI in Asia. Therefore, low FDI inflow into Bangladesh despite having reserve of raw natural resources is not something unexpected.
The second traditional factor is cheap labour. This factor emerged after 1970s following the high economic growth and high labour cost in the USA, Western Europe and Japan. Multinational companies of these countries started to relocate their production bases in Asian, African and South American countries to exploit the lower labour cost in these economies. This resulted in massive FDI inflows and relocation of global Trans-national Corporations (TNCs) in areas like Southeast Asia, and in countries like China and India recently.
However, cheap labour is no longer a strong factor for high FDI inflow. The labour cost in the tried and highly developed economies in the North is among the highest in the world, yet these economies continue to remain the most popular destinations for FDI. Similarly, newly developed economies in Asia such as Hong Kong, Singapore, South Korea and Taiwan also maintain a very high level of labour cost compared to Bangladesh, yet they attract the lion's share of FDI in Asia. This is because labour is no longer valued in terms of cost alone, but it is valued more in terms of real productivity, skill and innovativeness. This fact indicates that as cheap labour cost does not necessarily attract FDI anymore, high labour cost does not necessarily deter it either. So, in Bangladesh the low share in FDI despite cheap labour is not something exceptional.
The third traditional factor is the large domestic market. FDI inflows find their destination in economies where local demand for the product is huge due to heavy absorption capacity because of advanced industrialization, and a huge consumer market because of high per capita income and purchasing power. An example of this factor is the heavy concentration of FDI inflows in the triad economies namely the USA, the Europe Union and Japan. During 1998-2000 the triad accounted for three-quarters of total global FDI inflows, and 85 per cent of outflows. During the same period its inward FDI stocks and outward FDI stocks remained 59 per cent and 78 per cent respectively. The developed countries' share even surged further in 2004 when they accounted for over 90 per cent of total outward FDI. This is obviously due to the fact that the triad economy is home to nearly 65,000 TNCs, which further maintain about 850,000 subsidiaries worldwide.
In terms of population size Bangladesh's share is huge. However, large population size does not necessarily indicate large economic market for FDI. Low per capita income indicates low purchasing power which means less consumption. Therefore, though Bangladesh has a huge population size, its domestic consumer market is considerably small. In contrast, the developed countries in the North and the Asian Tigers have huge domestic market. Due to high income, the purchasing power of the people as well as the rate of consumption in these countries is also very high. This certainly indicates the business profitability of the foreign investment in these countries.
Fourth, policy liberalisation is the key to attract FDI today. Policy liberalization includes among others, ease entry and exit (starting and closing a business), appropriate standard of treatment and dispute settlement, reduction of tariff barriers, and transparent regulatory framework. The transparent regulatory framework is highly associated with good support.
Fifth, rapid technical progress or change is inevitable for attracting FDI. New transport, faster delivery service, latest communication and information technology allow firms to spread and operate international investment and business more efficiently and smoothly. Investors usually come with latest technologies for operation, so the host countries must have the ability to provide the complementary human capital, infrastructure, supplies and institutions to operate technologies efficiently and flexibly.
Sixth, low transaction cost is a factor of paramount importance for FDI inflows. Transaction cost can include a wide range of costs such as interest rate, fund transfer, royalties and fees, tariffs, permission and registration, and bribery. Low transaction cost in these fields invites higher FDI.
Seventh, image building and good support ensure market predictability and stability, non-discriminatory standard treatment, competitive business environment and friendly political support. A country with a reputable image of investment friendly welcoming environment consisting of all the factors is able to attract higher FDI.
Eighth, new managerial and organisational techniques put emphasis on careful targeting of core competent sectors in which a country desires to attract FDI.
Finally, political stability of a country is a major factor that helps in predictability of business environment on a long term basis. Political stability guarantees stable FDI regimes, low risk and steady return for investment.
In addition to the above mentioned indicators some other indicators like dealing with licences, registering properties, laws of protecting investors, payment of taxes, trading across nations and enforcement of legal contracts etc., are also important factors for attracting FDI. These are the yardsticks related to policy liberalisation, transaction cost, new managerial techniques and image building environment of a destination economy. The easier and smoother the environment is in a country in these indicators the higher the FDI in that country. Besides, political environment of the host or destination country is also an important factor for FDI inflow. Usually, political stability together with high business environment attracts high FDI. Similarly political instability may deter high FDI regardless of high or low business environment. Bangladesh on an average performs lower in above mentioned indicators compared to developed countries hence FDI inflow is reducing. Therefore, to increase FDI inflow in Bangladesh the above mentioned factors have to be considered.
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Dr. M. Mizanur Rahman is an economist and researcher
There are many factors that attract FDI for an economy. Over the decades, the nature of these factors has evolved and changed owing to the changing nature of international finance and investment. FDI itself became a global competitive financial and investment market. Therefore in such a global competitive environment the factors that attract FDI tend to remain competitively changing. Taking this into consideration, the factors that contribute best to inward FDI performance are discussed below:
The first important factor that traditionally lures higher FDI is availability of natural resources and raw materials. The vast reserve of natural resources in many countries attracted FDI during the early decades of the twentieth century when public as well as private big companies in the West invested heavily in extractive economies around the world such as mining. However, natural resources are no longer a highly attractive factor now for FDI. Countries completely devoid of natural resources such as Hong Kong, Singapore and Taiwan receive the lion's share of FDI in Asia. Therefore, low FDI inflow into Bangladesh despite having reserve of raw natural resources is not something unexpected.
The second traditional factor is cheap labour. This factor emerged after 1970s following the high economic growth and high labour cost in the USA, Western Europe and Japan. Multinational companies of these countries started to relocate their production bases in Asian, African and South American countries to exploit the lower labour cost in these economies. This resulted in massive FDI inflows and relocation of global Trans-national Corporations (TNCs) in areas like Southeast Asia, and in countries like China and India recently.
However, cheap labour is no longer a strong factor for high FDI inflow. The labour cost in the tried and highly developed economies in the North is among the highest in the world, yet these economies continue to remain the most popular destinations for FDI. Similarly, newly developed economies in Asia such as Hong Kong, Singapore, South Korea and Taiwan also maintain a very high level of labour cost compared to Bangladesh, yet they attract the lion's share of FDI in Asia. This is because labour is no longer valued in terms of cost alone, but it is valued more in terms of real productivity, skill and innovativeness. This fact indicates that as cheap labour cost does not necessarily attract FDI anymore, high labour cost does not necessarily deter it either. So, in Bangladesh the low share in FDI despite cheap labour is not something exceptional.
The third traditional factor is the large domestic market. FDI inflows find their destination in economies where local demand for the product is huge due to heavy absorption capacity because of advanced industrialization, and a huge consumer market because of high per capita income and purchasing power. An example of this factor is the heavy concentration of FDI inflows in the triad economies namely the USA, the Europe Union and Japan. During 1998-2000 the triad accounted for three-quarters of total global FDI inflows, and 85 per cent of outflows. During the same period its inward FDI stocks and outward FDI stocks remained 59 per cent and 78 per cent respectively. The developed countries' share even surged further in 2004 when they accounted for over 90 per cent of total outward FDI. This is obviously due to the fact that the triad economy is home to nearly 65,000 TNCs, which further maintain about 850,000 subsidiaries worldwide.
In terms of population size Bangladesh's share is huge. However, large population size does not necessarily indicate large economic market for FDI. Low per capita income indicates low purchasing power which means less consumption. Therefore, though Bangladesh has a huge population size, its domestic consumer market is considerably small. In contrast, the developed countries in the North and the Asian Tigers have huge domestic market. Due to high income, the purchasing power of the people as well as the rate of consumption in these countries is also very high. This certainly indicates the business profitability of the foreign investment in these countries.
Fourth, policy liberalisation is the key to attract FDI today. Policy liberalization includes among others, ease entry and exit (starting and closing a business), appropriate standard of treatment and dispute settlement, reduction of tariff barriers, and transparent regulatory framework. The transparent regulatory framework is highly associated with good support.
Fifth, rapid technical progress or change is inevitable for attracting FDI. New transport, faster delivery service, latest communication and information technology allow firms to spread and operate international investment and business more efficiently and smoothly. Investors usually come with latest technologies for operation, so the host countries must have the ability to provide the complementary human capital, infrastructure, supplies and institutions to operate technologies efficiently and flexibly.
Sixth, low transaction cost is a factor of paramount importance for FDI inflows. Transaction cost can include a wide range of costs such as interest rate, fund transfer, royalties and fees, tariffs, permission and registration, and bribery. Low transaction cost in these fields invites higher FDI.
Seventh, image building and good support ensure market predictability and stability, non-discriminatory standard treatment, competitive business environment and friendly political support. A country with a reputable image of investment friendly welcoming environment consisting of all the factors is able to attract higher FDI.
Eighth, new managerial and organisational techniques put emphasis on careful targeting of core competent sectors in which a country desires to attract FDI.
Finally, political stability of a country is a major factor that helps in predictability of business environment on a long term basis. Political stability guarantees stable FDI regimes, low risk and steady return for investment.
In addition to the above mentioned indicators some other indicators like dealing with licences, registering properties, laws of protecting investors, payment of taxes, trading across nations and enforcement of legal contracts etc., are also important factors for attracting FDI. These are the yardsticks related to policy liberalisation, transaction cost, new managerial techniques and image building environment of a destination economy. The easier and smoother the environment is in a country in these indicators the higher the FDI in that country. Besides, political environment of the host or destination country is also an important factor for FDI inflow. Usually, political stability together with high business environment attracts high FDI. Similarly political instability may deter high FDI regardless of high or low business environment. Bangladesh on an average performs lower in above mentioned indicators compared to developed countries hence FDI inflow is reducing. Therefore, to increase FDI inflow in Bangladesh the above mentioned factors have to be considered.
................................................
Dr. M. Mizanur Rahman is an economist and researcher