Determining FDI Potential:Are National Policies and Incentives Sufficient?
Md. Ghulam MurtazaForeign direct investment (FDI) is increasingly becoming a preferred form of capitalflows to developing countries in recent years, as compared to other forms of capitalflows. The reasons for this are not hard to seek. In the context of the gloom and despair of the heavy debt burden plaguing these countries, FDI promises to be the bright ray of hopefor harnessing capital flows to the country’s economic development without the pangs of capital repayment with interest. In this context Feldstein and Razin (2000) and Sodka(forthcoming) note that the gains to host countries can take several other forms:
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FDI allows transfer of capital and technology, which is not possible throughfinancial investment in goods and services.
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FDI also promotes competition in the domestic input market
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Profits generated by FDI contribute to the corporate revenue in the host country
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Operation of new ventures by FDI leads to employee learning in the host countrywho learn how to manage and operate the businesses. This contributes to humancapital development of the host country.
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Profits generated by FDI contribute to tax revenues in the host countryFDI is different from other major types of external private capital flows in that it ismotivated largely by the investor’s long-term prospects for making profits in productionactivities that they directly control. Foreign bank lending and portfolio investment, incontrast, are not invested in activities controlled by banks or portfolio investors, and areoften motivated by short-term profit considerations that can be influenced by a variety of factors—for example, interest rates—and are prone to sudden reversals (capital outflows)if any/some of these factors turn unfavourable. Mallampally and Sauvant (1999) claimthat the importance of FDI also lies in the fact that it not only a means of transferringtechnology and skills and managerial practices, but also of accessing international
marketing networks. The greater the supply and distribution links between foreignaffiliates and domestic firms, and the stronger the capabilities of domestic firms to learnfrom the presence and competition from foreign firms, the more likely it is that thequalities/attributes of FDI that enhance productivity and competition will spread.
Recent evidence
A comprehensive study by Bosworth and Collins (1999) on the effects of capital inflowson domestic investment for 58 developing countries during 1978-1995 covering nearly allof Asia and Latin America as well as most of Africa finds that an increase of one dollar incapital flows is associated with about 50 cents increase in domestic investment, while theratio is about one-for–one between FDI and domestic investment. There is virtually littleor no impact or relationship between portfolio inflows and investment.FDI has also proved to be resilient during financial crises. Loungani and Razin (2001) point out that such investment was remarkably stable in East Asian countries during theglobal financial crises of 1997-98 in contrast to portfolio equity and debt flows, whichwere subject to large reversals during the same period.UNCTAD, in its recent World Investment Report, asserts that FDI has the potential togenerate employment, raise productivity, transfer foreign skills and technology, enhanceexports and contribute to the long-term economic development of the world’s developingcountries. According to a recent UNCTAD report: on World Investment:
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Foreign affiliates of some 64,000 transnational corporations (TNCs) generate 53million jobs.
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FDI is the largest source of external finance for developing countries.
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Developing countries’ inward stock of FDI in 2000 amounted to about one-thirdof their GDP , compared to just 10 percent 10 percent in 1980.
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One-third of global trade is intra-firm trade.Similarly, Mallampally and Sauvant (1999) also assert that the increase in directinvestment flows has laid the foundation for a marked expansion of international production by TNCs, which now have an estimated $3.4 trillion invested in about2
449,000 foreign affiliates. The value of sales by these foreign affiliates has increasedmore rapidly than that of foreign trade (world exports).
National Policies and Incentives for FDI in Bangaldesh
The second half of the 1990s witnessed a surge of FDI inflows in Bangladesh, with themajor sectors attracting FDI being oil, gas and power, followed by chemical industriesand cotton and textile industries. USA, Malaysia and UK dominate the FDI scenario inBangladesh. However, the inflow of FDI compared to neighbouring developing countriesis below expectations. To understand why this is so, it is necessary to look into thenational policies and incentives for FDI in Bangladesh.Like other developing countries, Bangladesh has also adopted a number of policies and provided generous incentives to attract foreign direct investment (FDI) into the country InAccording to experts, Bangladesh seems to offer perhaps the most liberal FDI regime inSouth Asia. These, among others, include: tax holiday for 5 to 7 years, income taxexemption for 15 years for the experts of foreign enterprises, protection from doubletaxation, exemption from duty for importing machinery and spare parts for 100 per centexport-oriented units, full repatriation of profit and dividend by the foreign companies,eligibility for full working capital loans from the local banks on banker-clientrelationship, option for foreign firms or joint ventures not to sell their shares through public issues, and protection from expropriation by the state under Foreign InvestmentPromotion and Protection Act of 1980. Bangladesh is also a signatory of the MultilateralInvestment Guarantee Agency insuring investors against political risk. As a member of World Intellectual Property Organisation (WIPO) and World Association of InvestmentPromotion Agencies (WAIPA) the country further safeguards the interest of foreigninvestment. Standard dispute settlement procedures are followed in case there is anydispute with the government or with any private party. If the foreign investors feel thattheir rights have been violated, they can file writs with the High Courts.However, recent trends in global FDI flows lead one to conclude that national policyguidelines and incentives are not the main determinants of FDI. Despite the best taxreliefs and other incentives compared to neighbouring countries, a countries’ FDI potential may still be low, or it may be an under-performer. To understand these issues,3
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