Getting the right kind of FDI

Syed Akhtar Mahmood | Wednesday, 7 December 2022

Bangladesh needs to attract the right kind of foreign direct investment (FDI), not just any FDI. It needs FDI that will help diversify its exports and enable it to gain a foothold in various global value chains. FDI is particularly needed in activities that produce sophisticated, complex products, such as electronics. There is little justification in providing valuable resources - land, infrastructure and skilled manpower - to foreign investors who make the same things that Bangladeshi entrepreneurs are good at.
BANGLADESH SCORES LOW ON PRODUCT COMPLEXITY: In 2020, Bangladesh ranked 93 in the Economic Complexity Index produced by the Harvard University's Growth Lab. Among comparators, Malaysia ranked 24, India 46 and Vietnam 52 (Figure 1).In 1995, Bangladesh ranked higher than Vietnam, 89vs 107.But in the 25 years since then, Bangladesh's rank has declined while Vietnam's has increased significantly.
Vietnam improved its score on the product complexity index by moving from simple products such as garments to complex products such as electronics. In 1995, simple products such as coffee, rice and garments, dominated Vietnam's export basket. By 2020, electronics was pre-dominant.
Bangladesh has failed to make such a transition. In 1995, electronics accounted for less than oneper cent of the export earnings of both Bangladesh and Vietnam. But then the paths diverged. By 2018, more than one-third of Vietnam's export earnings came from electronics. Bangladesh's electronic exports have increased in absolute terms but, as a share of total exports, it is where it was in 1995.
A major reason for this huge difference between the two countries is FDI. Vietnam's breakthrough in electronics was driven by foreign investment. In the late 1980s, both countries had very modest amounts of FDI; annual FDI inflow being less than oneper cent of GDP. From the early 1999s onwards, Vietnam's FDI inflows has almost always exceeded four per cent of its GDP. During the same period, Bangladesh's ratio has never gone above 2 per cent.At end 2021, Bangladesh's FDI stock was $21.6 billion, compared to $192.6 billion for Vietnam. In fact, Bangladesh is an outlier when compared to its aspirational comparators (Figure 2).
THE COMPOSITION OF FDI: There are also issues with the composition of FDI coming to Bangladesh. FDI experts distinguish between three types of FDI: natural-resource seeking FDI, market-seeking FDI and efficiency-seeking FDI. In the first case, investors are attracted by the natural resources of a country and make an investment to explore, extract and/or process the resource. It may sell the crude or processed resource in the same country or export it elsewhere. A good example of this is Chevron's investment in Bangladesh.
In the second case, the foreign investor is primarily targeting the domestic market in the country in which it is investing. An example is the FDI that has come to the power or mobile telecommunication sectors in Bangladesh. Given the huge, and growing size, of Bangladesh's economy and its domestic market, it is natural that many investors interested in Bangladesh would be of the market-seeking variety.
The third type, i.e., efficiency-seeking FDI,is one where the investor seeks to produce in a country in order to sell abroad. Thus, Bangladesh may be viewed as a cost-efficient production base for a variety of factors, such as low labor cost. Hence the term efficiency-seeking.
An analysis of the existing FDI stock in Bangladesh suggests that market-seeking FDI is the dominant form in Bangladesh. So far, a modest amount of FDI has gone into export-oriented industries, and much of that too in the traditional sectors, such as garments & leather goods.Going forward, a key objective of FDI should be to help diversify our exports. We need this to reduce our dependence on garments and gradually shift towards more skill-intensive, complex products.
One of the major developments in recent decades has been the shift towards global value chains,whereby developed country manufacturers of a widerange of products, from automobiles to laptops, are investing in developing country facilities to manufacture parts required for such products. The manufacturing process is being unbundled,and some stages of production with their associated tasks, are being shifted to countries where the required inputs, usually semi-skilled labor but in some cases also skilled labor are available at lower cost.
Thus, the knowledge and know-how residing in the developed country is now increasingly being combined with low-wage labor in the developing countries. The ICT revolution has facilitated this process by substantially reducing the coordination costs of having facilities at a distance. Thanks to ICT, managers in the developed country facility can now communicate with their developing country affiliates faster, more frequently, and with less cost.
Countries that have gained a foothold in global value chainshave seen massive increases in their export earnings. Examples include China, Taiwan, Korea, Thailand, and Vietnam. In the process, they have also acquired valuable skills and knowledge. Their exports have diversified and become more complex. FDI has been at the heart of this.
Bangladesh needs to move to a similar trajectory. This will require a more strategic approach to FDI. Instead of welcoming any FDI that comes our way, we should proactively seek FDI that helps us gain a strong foothold in global value chains. In turn, this will require putting in place processes, practices, systems, and institutions that can help us attract such investment. I turn to some of these issues now.
POLICY AND REGULATORY PREDICTABILITY ARE VERY IMPORTANT FOR FDI: The World Bank recently surveyed more than 2,400 foreign investors for its 2019 Global Investment Competitiveness Report.The respondents operated in 10 middle-income countries: Brazil, China, India, Indonesia, Malaysia, Mexico, Nigeria, Thailand, Turkey, and Vietnam.They were asked to rank the factors that were critically important for their investment decisions.The top three factors were political stability, macro-stability, and legal and regulatory environment.Bangladesh scores reasonably well on the first two dimensions (although there are now some concerns about macro-stability) but needs to work on the third.
A big problem is regulatory uncertainty. A 2018 IFC survey of businesses in Bangladesh found regulatory uncertainty to be a big problem (Figure 3).Most respondents were local businesses, but foreign investors may have similar opinions. Two out of three respondents feel that many laws in Bangladesh are inconsistent with each other.More than half feel that regulatory officials use a lot of discretion in dealing with businesses, and that it is difficult to find information on rules and regulations.Almost 50 per cent say that adverse policy or regulatory changes often make cost and revenue streams uncertain.
Several actions may be taken to reduce regulatory uncertainty. These actions will benefit all investors but will be particularly relevant for foreign investors who are most put off by regulatory uncertainty. One such action is to gradually introduce and require the use of Regulatory Impact Assessment (RIA) for all major regulatory interventions. Such assessments typically look at the costs and benefits of introducing new regulations- the costs and benefits to government as well as those to be regulated. Such assessments may be overseen by a technical oversight body, such as an RIA Unit in the PMO or the Ministry of Law and Parliamentary Affairs. Such bodies may also provide quality control as well as training.
It will also be useful to establish a systematic approach for the review and overhaul of existing laws, acts, rules, and statutory regulatory orders (SROs), and identify areas of redundancy, conflicting areas, jurisdictional overlaps, and regulatory gaps. The Government mayconsult with businesses and relevant professionals and identify a few clusters of related laws and regulations. It may start by subjecting these to such a review, followed by a roll-out of the review process to other important laws and regulations impacting the private sector.
The government may also consider establishing a "Notice and Comments" system which will include publication of a regulatory calendar at the beginning of a fiscal year indicating all upcoming laws for the year, and a structured mechanism to solicit comments on draft laws and regulations. In line with the Government's Digital Bangladesh agenda, such a system may be technology-based.
The government may also introduce a system to automatically publish all new laws, regulatory amendments, and SROs on a dedicated website within a week of their enforcement. Since the access to information is most problematic for regulatory orders, which are also often a major source of regulatory discretion, the government may initially focus this exercise on SROs.
IT IS IMPORTANT TO LOOK AFTER EXISTING FOREIGN INVESTORS: A significant part of FDI inflows in a country often comes from foreign investors who are already in the country. This typically happens through reinvestment of a part of their earnings. In Bangladesh, since the mid-1990s, about 40 per cent of FDI has been reinvestments by existing investors. This ratio could be on the higher side (the global average is about 30 per cent) because FDI from new investors has not grown as much as we would like. Investors have told me that such reinvestment could be higher if there is greater policy and regulatory predictability.
Foreign investors already in Bangladesh are importantfor one other reason. Prospective investors often talk to those who are already in a country. If such investors have a negative experience to share, that will discourage others from considering investing in the country.
It is thus important to have in place an investor grievance system. A grievance mechanism helps an investment promotion agency identify issues being faced by existing investors and take corrective actions, which often means bringing other government agencies to the table. Many countries have set up such systems to help resolve investor problems in a timely fashion. By doing so, these have helped retain investment that could have been withdrawn. For example, in Georgia in 2015, such a system helped retain $343million worth of FDI which was at risk of being withdrawn. This happened due to timely action by a government agency called Business Ombudsman, which is tasked with identifying and helping to resolve investor grievances. One of the most effective of such agencies is the Office of the Foreign Investment Ombudsman in South Korea, established in 1999.
Bangladesh government often addresses problems faced by individual investors when it is made aware of the same. But we need to move away from such ad-hoc resolution of problems and adopt a more systematic approach.
KEEP TRACK OF INVESTORS WHO HAVE SHOWN INTEREST IN BANGLADESH: Efficient investment promotion agencies around the world do one thing very well. They keep track of investors who have shown some interest in their country. The interest may have been expressed in an investors' meeting or an investor road show. Alternatively, it may have been articulated in direct meetings with the government. Whatever the nature of the initial engagement, such agencies work hard to ensure that the initial investor interest issustained and, one day, turns into actual investment.
They do this through investor tracking systems whereby the initial leads are systematically tracked. Such systems monitor how far an investor has moved along its journey - from initial interest in a country to start of operations. A good investment promotion agency has a clear idea of the bridges that investors need to cross till their investment project is commissioned and operations commence. The tracking system monitors at which bridge an investor currently is and whether it is finding problems crossing the bridge.
The proactive investor agency then takes corrective actions, by itself or in collaboration with other government agencies, to help the investor move forward. It is important to note that many investors silently withdraw their plans in the face of problems. An investment agency may never come to know about such cases in the absence of a tracking system.The absence of such a system has been an Achilles Heel for us.
To conclude, Bangladesh needs to take a more strategic view of foreign investor attraction, i.e., a clear-headed approach to decidingwhy FDI is needed and what kind of FDI will best help the country achieve its developmental goals. Once that is clear, government should keep track of the problems and issues being faced by both existing and prospective foreign investors and resolve these expeditiously. It should do so proactively, rather than waiting passively for investors to come and complain. And it should institutionalise the processesand not rely too much on ad-hoc, case-by-case treatment of problems.
Finally, it should enhance the predictability and clarity of its regulatory regime. Investors dread uncertainty. They do not mind, if you say "No". What they hate most are the words "May be".

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