A Better Investment Climate

and
Foreign Direct Investment

Uri Dadush, Director, Development Prospects Group and

International Trade Department, The World Bank
and
Carlos A. Primo Braga, Senior Adviser, International Trade
Department, The World Bank

OECD Global Forum for International Investment

Rio de Janeiro, Brazil
October 2005
Key Messages
y FDI has been an important source of international finance in
developing countries. It has evolved in terms of sectoral
distribution and market-seeking has become its main
motivation.

y Investment climate is particularly important to attract market-

seeking FDI, especially in the services sector. It is also
crucial for the association between FDI and domestic
investment.

y Although investment climate —therefore risks factors— in

the developing world improved over the years, significant
inadequacies remain in terms of “bureaucratic cholesterol,”
finance and infrastructure.
FDI has been a stable source of international
finance in developing countries
Capital flows to developing countries
$ billion
200
FDI

150

Capital market flows

100

Official flows
50

0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

-50
FDI flows to developing countries hit a record
high in 2004 …

$ billion %
200 FDI 4.0

180 3.5
160
3.0
140
2.5
120 FDI–GDP
100 2.0

80
1.5
60 …but the recovery was modest in
proportion to the GDP growth in 1.0
40
developing countries 0.5
20

0 0.0
1990 1992 1994 1996 1998 2000 2002 2004
 Recovery was significant in Latin America
and Eastern European countries…
100 $ billion
90 Latin America

80
70
60 East Asia and Pacific

50
40
30
20 Europe Central Asia
10
0
90

91

92

93

94

95

96

97

98

99

00

01

02

03

04
19

19

19

19

19

19

19

19

19

19

20

20

20

20

20
…mainly in Brazil, Mexico and Russia

35 $ billion

30
Brazil
25
20
15 Mexico

10
Russia
5
0
94

95

96

97

98

99

00

01

02

03

04
19

19

20

20
19
19

19

19

20

20

20
 FDI flows have shifted towards services
sector
Share in total FDI Stock in 2002
70 percent
Manufacturing
60 Services
Primary
50

40

30

20

10

0
Developing AFRICA LAC ECA ASIA
Countries

Source: Global Development Finance 2004

Market-seeking activity has become the
main driver of FDI

y Primary Sector: Resource-seeking investment

y Manufacturing Sector:
– Efficiency-seeking: Consumer electronics in China
– Market-seeking: Auto industry in China (tariff-jumping)

y Services Sector:
– Market-seeking: Retail, infrastructure and financial
services (almost 20 % of total FDI flows)
– Efficiency-seeking: IT and business services
(e.g. Call centers) – (small share in total FDI)
 Important Determinants of FDI: Investors’
Perspective
y Political and economic stability

y Market size and prospects for growth

y Predictable rules for investment and a sound legal framework

y Availability of infrastructure

y Stability of the tax system is important, but tax incentives not

critical in investment decisions

y Productivity of labor rather than wages per se

* Based on Capital Markets Consultative Group Survey, IMF and World Bank (2005)
Market size by itself is not decisive

60 $ billion
China
50

40

30 Partly, due to higher risk and “red tape”

in India
20

10 India

0
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
 Improved investment climate is
associated with higher FDI…
percent
7

4
FDI-GDP Ratio
3

0
High Middle Low
Policy Performance
 … and with higher FDI in Services
percent
70

60

50

Services FDI 40
as a share of
30
total FDI
20

10

0
High Middle Low
Policy Performance
 Improvement in investment climate in
developing countries
ICRG index

70
1995 1999 2004
Less Risky 60
50
40
30
20
10
0
Economic Risk Financial Risk Political Risk
Rating Rating Rating
 Investment Climate in Brazil also
improved after a setback in 1999
ICRG index Middle Income Average (2004)
80
Less Risky 70
60
50
40
30
20
10
0
Economic Risk Financial Risk Political Risk
Rating Rating Rating

1995 1999 2004

Poor infrastructure is prevalent problem
among developing countries
Number of days per year with the problem

Poor Middle
Countries Income
Power outages/surges from public grid 92 9
Insufficient water supply 28 10

Unavailable mainline telephone service 12 6

Transport failures 5 1
 Improving trade logistics (ports, customs, transport) is an
important agenda

Average number of days to clear customs for sea cargo

Developed

East Asia and

Pacific
Latin America
and Caribbean

Africa

South Asia

0 2 4 6 8 10 12

And development assistance is key to this agenda

in poor countries

Source: International Exhibition Logistics Associates, based on a sample of countries

in each region (http://www.icla.org)
 Bureaucracy and law & order remain a problem

Opening Up A business
# of Time (days) Cost (%GNI per capita)
Procedures
Brazil 17 152 12
Developing Countries 10 53 67
High Income OECD 7 28 8
Enforcing A Contract
# of Time (days) Cost (% of debt)
Procedures
Brazil 25.0 566.0 15.5
Developing Countries 34.0 419.2 40.9
High Income OECD 21.5 276.6 11.4
World Bank’s Role in Promoting FDI

y Monitoring and helping to improve investment climate

in developing countries.

y MIGA provides investment guarantees against certain

non-commercial risks (i.e., political risk insurance) to
eligible foreign investors for qualified investments in
developing member countries.

y Dialogue/research/cooperation with OECD, IMF,

UNCTAD, WTO, regional banks and other relevant
organizations.
 Concluding Remarks: Prospects for FDI
y FDI flows to developing countries are expected to continue their recovery
in 2005 and 2006

y China is still the top investment destination among developing countries.

However the growth of FDI to China is slowing down reflecting increasing
competition in the country and uncertainty about its currency.

y Brazil will also remain a major FDI destination although the “productivity”
of these investments could be significantly improved by addressing the
cost of doing business in the country.

y Other Asian countries (Malaysia, Thailand and Vietnam) as well as EU

accession countries are also expected to receive higher levels of FDI in
the medium term.

y Limited prospects for Africa reflecting growth potential, concerns about

infrastructure, political risks, and labor productivity. This said South-South
FDI flows are growing in the region.
 World Bank Sources on Business Climate:

y The Doing Business Database provides objective measures of business regulations

and their enforcement in more than 150 economies.

y Investment Climate Surveys: Investment climate data in 58 countries, based on

surveys of more than 28,000 firms. The surveys provide indicators of firm
productivity and performance and cover management's perceptions of the severity of
obstacles to operation and growth of the business

y Investment Climate Assessments are comprehensive country reports that draw upon
the results of Investment Climate Surveys and other available diagnostic tools.
Currently available for 24 countries.

y World Bank, 2005, World Development Report -- A Better Investment Climate for
Everyone (Washington, DC: The World Bank).

y Contact -- Carlos A. Primo Braga: cbraga@worldbank.org

y Thanks!