Introduction: Costs of private foreign investment to a host country have been identified long ago. These costs may originate from concessions offered by the host country. They may have adverse effects on domestic savings. They may lead to deterioration in the terms of trade and problems of balance of payments adjustment. The government of a host country may provide special facilities to encourage foreign investment. These special facilities cost the government as they are provided free of charge.
Concessions: The government may undertake additional public services. It extends financial assistance or subsidizes inputs used by foreign enterprises. These are costs that absorb government resources that could have been used in other sectors of the economy. Tax concessions may also have to be given, but these may have to be extended to domestic investment as the government may not be able to discriminate. The government may not favor only the foreign investors; it may not afford to exclude the domestic investors for political and administrative reasons.
Several developing countries compete among themselves in offering inducements to attract foreign capital. Each country may offer more by way of inducements than is necessary. Whether there is inducement or not, the investments may be of a type that would go to one or another country depending on its endowment. But, the foreign enterprise may approach, one country or another and secure extra concessions. If receiving countries do not have a collective agreement regarding maximum concessions, they will be exposed to the cost of encouraging foreign investment.
Domestic Savings: If the inducement is successful, the foreign investment is expected to have an income effect that leads to higher level of domestic savings. This effect may be reduced if foreign investment reduces profit in domestic in its domestic industries. The resultant reduction in domestic savings is taken to be another indirect cost of foreign investment. But, this cost is not of much practical result as it would require that foreign investment be highly competitive with domestic investment. In poor countries, it is probable that foreign investment will complement domestic investment and this will induce high income and profits in other industries. However, if this complementarity is not achieved, the cost to the economy is obvious.
Terms of Trade: The inflow of capital may lead to an increase in the rate of development of a country. This growth may occur without any change in the terms of trade. In this case, the country’s growth of real income will depend only on its growth of output. However, if the terms of trade deteriorate the rise in income will be less than that in output. The worsening terms of trade may be taken as another cost of the foreign investment.
Whether the terms of trade will turn against the recipient country depends on various changes at home and abroad. These changes could be in the supply of and demand for exports, import-substitutes, and domestic commodities. A rising demand for imports on the side of domestic consumption may be controlled by import restriction. If private direct investment in the export sector leads to a rise in supply of exports, the inflow of private capital would diminish as export prices fell. The reduction in the flow of capital is a cost to the receiving country.
Balance-of-Payments: There are costs related to the balance of payments adjustments. When foreign debt has to be serviced, it creates pressure on the balance of payments. If the foreign exchange required to service the debt becomes larger than the amount of foreign exchange supplied by new foreign investment, then a net outflow of capital occurs. This leads to reallocation of resources in order to expand exports or replace imports. This forces the country to suffer internal or external controls or experience currency depreciation. These adverse effects of balance of payments adjustment are considered the indirect costs of foreign investment.
External and Internal Measures: External measures such as import quotas, tariffs and foreign exchange restrictions may suppress the demand for imports. But, these measures negatively affect productivity and efficiency, if these imports are needed to raise efficiency in production. Internal measures such as higher taxation and tight credit lead to the cost of reduced consumption and investment. Also, the alternative to currency devaluation may cause the country to incur cost in the form of deterioration of terms of trade. To avoid or minimize these indirect costs, the role of the foreign private investment must be related to the debt-servicing capacity of the host country. This depends on the country’s development program to create large export surplus. These require all domestic industries to operate together rather than simply depend on foreign investment alone.
The direct and indirect costs of private foreign investment should not lead recipient countries to discourage investment from abroad. There is a general tendency of poor countries to overestimate the costs and discount the benefits. However, within the context of a development program and careful appraisal of the prospective benefits and costs of foreign investment, policies may be designed to secure beneficial inflow of private foreign capital. Studies suggest some of the principles that could be used as inputs to these policies. Some of these are presented below:
1. The attraction of private foreign investment now depends less on fiscal action and more on other conditions and measures that guarantee protection of the investment. They also provide wider opportunities for the investor.
2. It is necessary to dispel the investor’s concern over the possibilities of discriminatory legislation, exchange controls, and the threat of expropriation.
3. Investment guarantees may be utilized more effectively to remove investor’s fear of administrative risks. Through unilateral or bilateral agreements governments should offer assurance to reduce the possibility of expropriation or blocking of investor’s rights.
4. Both government and foreign investor could agree to use international institutions for conciliation or arbitration in case of investment disputes arising between the two parties.
5. In addition to assurances against risk and measures for investment disputes, multilateral investment insurance program may be used as a guarantee.
These guarantees may help in removing risk to foreign investment, the attraction of foreign capital depends more on positive inducements. These include greater opportunities for profit making in the capital-receiving country. The private foreign investor’s major concern is whether his costs are covered and profits are earned. Many developing countries offer special tax concessions, but these measures are not enough unless the investment yields profit. It is necessary to raise an investor’s profit expectations. These may include building a country’s infrastructure and provision of skilled labor.
These inducements to foreign investment may be costly. They involve costs to the governments of developing countries in terms of revenue forgone. They also incur costs of equity and administrative costs. They may offer excessive concessions in their efforts to attract foreign investment. If these countries compete in offering concessions, they are likely to “over-concede.” These concessions may attract the “speculative foreign investor” who takes advantage of the concessions and leave as soon as they are withdrawn. If the benefits of foreign investment are “realized early” for the host country, there is no reason for extending the concessions beyond this short period.
Developing countries are mainly interested in having foreign investors to contribute to their industry rather than to agriculture
and mining in which they have great potential. In most cases, the size of the market has remained small to attract foreign investors in industry. However, as development proceeds successfully, domestic markets may widen to attract investment for industrial expansion. Markets could be widened through the establishment of a “customs union or free trade area” among countries in a region. These have great potential in attracting foreign investment to the development of manufacturing industry.
These regional preferential arrangements give preferences to the exports of manufactures from neighboring countries. Such arrangements attract foreign investment, inducing transfer of production facilities from developed countries. These facilities convert labor and raw materials into productive inputs of production at lower costs.
In encouraging foreign investment a developing country “does not seek foreign capital indiscriminately.” Its objective is to secure foreign investment that supports programs and activities from which a recipient country derives maximum economic benefits. To this end, a country may design policies such as preferential incentives that will attract private capital that has the “catalytic effect” of mobilizing additional efforts.
It is important that policies affecting the allocation of foreign capital be based on the awareness of the “external economies” that can be realized from different patterns of investment. For example, an investment on industrial enterprise may be accompanied by building houses, roads, power, water and other utilities that could also be used by people in the neighborhood. In addition to the direct increase in income, it is also important to look to the more indirect possibilities of widening investment opportunities that lead to social and cultural transformation.
Joint Venture: Emphasis should be given to a partnership arrangement between domestic and foreign enterprises. A joint venture that involves collaboration between private foreign capital and local private or public capital may be a necessary instrument that protects foreign investment. It helps to integrate foreign investment within a development program of the recipient country. The joint venture stimulates domestic management and investment. It also reduces the transfer burden and balance-of-payment difficulties. This is an arrangement that secures a mix of foreign capital, management and technology.
It may be necessary to inspect the inputs that come as a package of foreign direct investment. It is useful to secure those inputs that are more appropriate and less costly to meet the needs of the recipient country. The problem for the host country is to evaluate benefits and costs of alternative arrangements for “importing capabilities” of foreign investors. These arrangements range from total ownership by foreign investor to joint venture in which foreign investor has majority share, or joint venture in which the local private or public investor has majority share.
There may be other requirements for disinvestment over time. Through the dilution of foreign equity, the host country may insist at the outset on a joint venture. It may also establish a limited time for foreign equity participation. Also, the host country may exclude foreign equity altogether. It may seek the managerial and technical knowledge through other contractual arrangements. These arrangements may allow the transfer of technical and managerial skills without being tied to equity capital. Licensing agreements, technical services agreements, engineering and construction contracts, management contracts, and production agreements provide benefits to developing countries. These arrangements provide the needed foreign knowledge at lower cost than must be paid when the knowledge comes with equity capital.
These approaches to foreign investment are causing both the foreign investor and the recipient country to consider the benefits and costs of foreign investment in a different perspective. This approach is effective when activities are reserved for public ownership or for majority ownership by nationals in line with a development program of a developing country. But, this approach does not exclude the need for seeking technical skills or managerial services from abroad. If the technical and managerial components of direct “private” foreign investment can be secured without a controlling equity, then the recipient country may benefit from this arrangement. It also benefits from foreign “public” sources of capital in the form of financial aid.
From the above presentation one could identify four economic actors. These are: local public ownership; local private ownership; private foreign enterprise; and public sources of capital or foreign aid. The policy-makers of developing countries should seriously consider the optimal combination of these economic actors. This helps to maximize the use of local and external resources in the respective economic sectors of the developing countries.
Conclusion: The policy-makers in developing countries, including Ethiopia, should realize in advance that they are exposed to the adverse effects of competitive concessions to foreign investment. They should also recognize that foreign assistance does not and should not replace domestic efforts in the process of economic development. Foreign assistance fits only to a small portion of the economy. With foreign assistance comes domination of policies by the powers to be. Concessions may have adverse effect on domestic savings. The maximization of profit is the sole objective of foreign investors. Hence, the governments of developing countries should insist at the outset to have a joint venture between domestic and foreign private investments. In this arrangement the national investor, private or public, should engage with a foreign private investor, with a majority share in the joint venture.
The governments of developing countries should find ways and means of maintaining positive terms of trade and balance-of-payments. These require proficient professionals in foreign trade, foreign exchange management, and in handling of import and export efforts. Enhancing domestic production, for example, reduces the need for food imports. Export of commodities depends on external market identification, for which diplomatic missions should be seriously responsible. The government should also be careful in providing special facilities to attract foreign investment.
Thank you.
The Ethiopian Herald July 21, 2019
BY GETACHEW MINAS
