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Determining FDI Potential: Are National Policies and Incentives Sufficient?

Foreign direct investment (FDI) is increasingly becoming a preferred form of capital flows to developing countries in recent years, as compared to other forms of capital flows. 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 hope for 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: • • • • FDI allows transfer of capital and technology, which is not possible through financial investment in goods and services. FDI also promotes competition in the domestic input market Profits generated by FDI contribute to the corporate revenue in the host country Operation of new ventures by FDI leads to employee learning in the host country who learn how to manage and operate the businesses. This contributes to human capital development of the host country. • Profits generated by FDI contribute to tax revenues in the host country

FDI is different from other major types of external private capital flows in that it is motivated largely by the investor’s long-term prospects for making profits in production activities that they directly control. Foreign bank lending and portfolio investment, in contrast, are not invested in activities controlled by banks or portfolio investors, and are often 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) claim that the importance of FDI also lies in the fact that it not only a means of transferring technology and skills and managerial practices, but also of accessing international marketing networks. The greater the supply and distribution links between foreign affiliates

FDI has also proved to be resilient during financial crises. which now have an estimated $3. According to a recent UNCTAD report: on World Investment: • • • • Foreign affiliates of some 64. while the ratio is about one-for–one between FDI and domestic investment. and the stronger the capabilities of domestic firms to learn from the presence and competition from foreign firms. FDI is the largest source of external finance for developing countries. Mallampally and Sauvant (1999) also assert that the increase in direct investment flows has laid the foundation for a marked expansion of international production by TNCs. Developing countries’ inward stock of FDI in 2000 amounted to about one-third of their GDP .and domestic firms. Loungani and Razin (2001) point out that such investment was remarkably stable in East Asian countries during the global financial crises of 1997-98 in contrast to portfolio equity and debt flows. There is virtually little or no impact or relationship between portfolio inflows and investment. UNCTAD.000 2 . compared to just 10 percent 10 percent in 1980. Similarly. which were subject to large reversals during the same period. One-third of global trade is intra-firm trade. in its recent World Investment Report. enhance exports and contribute to the long-term economic development of the world’s developing countries. asserts that FDI has the potential to generate employment.000 transnational corporations (TNCs) generate 53 million jobs. raise productivity.4 trillion invested in about 449. the more likely it is that the qualities/attributes of FDI that enhance productivity and competition will spread. transfer foreign skills and technology. Recent evidence A comprehensive study by Bosworth and Collins (1999) on the effects of capital inflows on domestic investment for 58 developing countries during 1978-1995 covering nearly all of Asia and Latin America as well as most of Africa finds that an increase of one dollar in capital flows is associated with about 50 cents increase in domestic investment.

income tax exemption for 15 years for the experts of foreign enterprises. Standard dispute settlement procedures are followed in case there is any dispute with the government or with any private party. Like other developing countries. Despite the best tax reliefs and other incentives compared to neighbouring countries. with the major sectors attracting FDI being oil. exemption from duty for importing machinery and spare parts for 100 per cent export-oriented units. Bangladesh seems to offer perhaps the most liberal FDI regime in South Asia. option for foreign firms or joint ventures not to sell their shares through public issues. followed by chemical industries and cotton and textile industries. As a member of World Intellectual Property Organisation (WIPO) and World Association of Investment Promotion Agencies (WAIPA) the country further safeguards the interest of foreign investment. among others. To understand these issues. and protection from expropriation by the state under Foreign Investment Promotion and Protection Act of 1980. full repatriation of profit and dividend by the foreign companies. protection from double taxation. If the foreign investors feel that their rights have been violated. a countries’ FDI potential may still be low. it is necessary to look into the national policies and incentives for FDI in Bangladesh. However. or it may be an under-performer. include: tax holiday for 5 to 7 years. Bangladesh has also adopted a number of policies and provided generous incentives to attract foreign direct investment (FDI) into the country In According to experts. recent trends in global FDI flows lead one to conclude that national policy guidelines and incentives are not the main determinants of FDI. they can file writs with the High Courts. National Policies and Incentives for FDI in Bangaldesh The second half of the 1990s witnessed a surge of FDI inflows in Bangladesh. However. gas and power. Bangladesh is also a signatory of the Multilateral Investment Guarantee Agency insuring investors against political risk. USA. Malaysia and UK dominate the FDI scenario in Bangladesh. the inflow of FDI compared to neighbouring developing countries is below expectations.foreign affiliates. let us look into 3 . The value of sales by these foreign affiliates has increased more rapidly than that of foreign trade (world exports). To understand why this is so. eligibility for full working capital loans from the local banks on banker-client relationship. These.

the reasons for investment from the investors’ point of view. oil and gas and mineral processing projects) often have to compete for capital funds with similar projects proposed elsewhere to investors. liberalization of policies related to FDI. etc. [shorten these theories] A transactional theory of MNE (Multinational Enterprises) has been forwarded by Caves (1981). Horizontal multi-plant firms 4 . come after consideration of the factors mentioned earlier. Proponents of non-resource-based projects seek the lowest cost/highest return location for their investments. FDI Story From The Other Side: Why Foreign Firms Look Abroad [change and shorten] There are various theories explaining the behaviour of multinational corporations (MNCs) in investing abroad. incentive packages. as well as what determines the FDI potential of a country. Economic Determinants of FDI From an economic perspective. investment treaties with other countries for promotion and protection of investment. A summary of some of those theories may be forwarded to explain the behaviour of MNCs.the economic determinants of FDI. Projects that depend on a resource (e. Market-oriented determinants for FDI inflows from the host country’s perspective generally refer to the market size and marketability of the field products for which FDI is sought.g. technology-created or innovationcreated assets and physical infrastructure. MNEs—which are essentially multi-plant firms—can be grouped into three broad categories: 1. low-cost skilled/unskilled labour. determinants of FDI can be grouped into resource-oriented and market-oriented determinants. Other economic factors such as liberal industrial policy reforms. The resource-oriented determinants include availability of raw materials. According to him.

Suppose a processing firm needs information about future prices and available raw materials for its production plans. a bank may grow a “special relationship” with its customers in a country. Diversified MNE Multinational firms can be divided into a third category—the diversified MNE. it is put up with costs not faced by the local firm. Thus it goes multinational.). Vertical multi-plant firms 3. Due to long-term relationship with its client or some other special facilities it provides. etc. When an outside firm operates in a country. In such a case. Such intangible asset may be in the form of a special skill—technology. the local firm’s way of doing things. Vertical Integration An MNE can exist in vertical integration as well. The producers of that raw material may withhold that information. The presence of multinationals in the services sector such as banking or advertising is also explained by the transactional theory. culture. the processing firm stands to gain by vertical integration. Economic conditions are generally uncorrelated 5 . such as familiarity with the environment (including language. Therefore. which lowers the costs of transactions. know-how—or it may be in the form of a trade mark. sources of raw materials.2. etc. since foreign investment is a “risky activity”. According to Caves. An explanation for this behaviour is found in some peculiar characteristic which an MNE possesses—some “intangible asset”—unique to the firm. an MNE could diversify its risks by investing across countries. or special skill in marketing a product. Diversified MNEs Horizontal Integration—the “Intangible Asset” Theory It has been empirically observed that plants in different countries under common control of an MNE tend to have greater profitability through lower costs than if they operate under different managements. the successful foreign firm must have certain transactional advantages which offset the costs and place it over local competitors. It can use these techniques in other countries to derive similar advantages.

government’s policy changes. availability of patent/trade-mark. etc. Therefore.across countries. could have a downward effect on investments in a country. Once a company has decided to look abroad. tariffs. such as import quotas. adverse economic conditions.. royalties. The company sends a team to investigate the “setting” abroad. the next step begins: investigation. but if investments were spread among countries. etc. etc. such losses could be wholly or partially offset by gains in another country. Diversification among products also tends to reduce risks in a similar manner. 4) Existence of investment guarantee agreement with US 5) Government assurances regarding remittance of profits and repatriation of capital 6) Tax rates which effect the proposed enterprise 7) Trade agreements with other countries 8) Availability of auxiliary industries 9) Extent and elements of competition 10) Extent of market 11) Availability of domestic raw materials and spare parts These are the issues on which a company tries to make information available. Investment in LDCs offers a strong case for an MNE to diversify its interest among different products in view of the restriction posed by many LDCs on repatriation of profits. But a little reflection will reveal that to gather all the information is an extremely difficult time 6 . A partial listing from the “Foreign Investments Checklist” for US business abroad includes the following: FOREIGN INVESTMENT CHECKLIST: Some Factors For Consideration By US Business In Exploring Investment Abroad 1) The general political atmosphere 2) Attitude of the foreign government towards foreign investment 3) Administrative practices affecting the prospects in investment.

According to Aaron (__) decisions to invest are sometimes taken a priori. So it may not be practical. and under-performer . UNCTAD’S FDI Performance Index The United Nations Conference on Trade and Development (UNCTAD). they created the FDI Performance Index by calculating the ratio between each countries' share in global FDI to its share of global GDP.high FDI potential but low FDI performance. consisting of developed countries utilising their potential. consisting of developing countries limited by poverty or instability. the high cost of obtaining information poses a barrier to investment in the LDCs. The company is thus faced with a limitation which forces it to adopt these methods. they constructed the FDI Potential Index. and investigation seeks how to implement the decision. below-potential . as countries in the first and fourth categories are performing to expectations. The second and third categories are most interesting. First. The second category is drawing more than their 7 . Second. These two indices were then used to split countries into one of four categories: • • • • front-runner . conducted analysis to provide truer measures of the performance of the countries in attracting FDI. and executives are directed to go into the country only if the company qualifies in the first three criteria tests. Thirdly. it is logical to assume that the next step would be to take the decision whether or not to invest. the firm will stress on flexibility as a guard against uncertainty. so the willingness of a company to invest will be higher the more easily and readily information is available. preliminary investigation starts at the company’s office. Rigid terms offered by a host country will refrain the firm from investing there. But this is not always so. above-potential .low FDI potential but high FDI performance. on the basis of readily available information. Second.high FDI potential and performance. First. At the end of investigation. since a lot of information will not be covered. using a set of structural variables to assess the potential for countries to attract FDI.low FDI potential and performance. on the grounds such as commitment to hold the market or to protect the initial investment.consuming and costly affair.

a proxy for expected economic growth. Turkey Data source: UNCTAD Regarding Bangladesh. India. Germany. Iran. Table 6 INWARD INVESTMENT PERFORMANCE AND POTENTIAL (1999 . Low FDI Potential Above-potential Includes: Albania. Sri Lanka. an indicator of the sophistication and breadth of local demand (and of several other factors). while the latter group has shortcomings that are preventing their structural FDI from being realised. Papua New Guinea. Qatar. • The rate of GDP growth over the previous 10 years. Foreign Direct Investment (FDI) rose by 72 per cent in 2004 over the previous year’s figure. According to the report. Factors Determining The Inward FDI Potential Index The Inward FDI Potential Index captures several factors (apart from market size) expected to affect an economy´s attractiveness to foreign investors. Honduras. to one. 8 . with the expectation that higher income economies attract relatively more FDI geared to innovative and differentiated products and services.2001) High FDI Low FDI Performance Performance High FDI Potential Front-runners Includes: Canada.potential warrants. China. United States. Nepal. United Kingdom. for the lowest scoring country. to capture openness and competitiveness. New Zealand Below-potential Includes: Australia. Japan. Malaysia. for the highest) of 12 variables (no weights are attached in the absence of a priori reasons to select particular weights): • GDP per capita. the UNCTAD mentions that Bangladesh has reached the 122nd position from 133rd in the World Investment Report (WIR) index of the UNCTAD. Vietnam Under-performers Includes: Bangladesh. • The share of exports in GDP. It is an average of the values (normalized to yield a score between zero. Brazil.

to seize the importance of FDI in the services sector that accounts for some two thirds of world FDI.000 inhabitants. a composite indicator capturing some macroeconomic and other factors that affect the risk perception of investors.000 inhabitants and mobile telephones per 1. competitive 9 . First. to capture local technological capabilities. He explains the best way for companies to gain market entry in Asia by using a formula that identifies opportunities.• • • • • • • • • As an indicator of modern information and communication infrastructure. founder. Next we analyse the external environments of Asian countries (legal and regulatory environment. Country risk. The share of R&D spending in GDP. The variable is measured in such a way that high values indicate less risk. to capture participation in the leading TNC integrated production systems (WIR02). CEO and principal consultant of AsiaBiz Strategy. a broad indicator of the attractiveness and absorptive capacity for FDI. to proxy for the availability of resources for extractive FDI. To share with our corporate readers how we advise clients to enter Asia. because Asia is so heterogeneous and diverse. The share of tertiary students in the population. for the availability of traditional infrastructure. and the investment climate. explores resources and analyses core competences before making a move. The world market share of imports of parts and components for automobiles and electronic products. A formula for determining investment potential in Asia [Modify write-up language] A formula for determining investment potential in Asia is proposed by Lawrence Yeo. The world market share in exports of natural resources. We can identify and assess Asian opportunities using a simple framework that can be easily – yet simultaneously – performed across many Asian countries at once. The share of world FDI inward stock. Commercial energy use per capita. we review the client’s Asia strategic intent and mission. They ask: “Is Asian Country 1’s industry X attractive? How about Asian Country 2’s industry Y?” Such randomised market selection and industry targeting is inadvisable. indicating the availability of highlevel skills. Many of our repeat Fortune 500 and global clients have regularly sought our Asia market entry and marketing strategy advice. The world market share of exports of services. here is a sneak peak inside the mind of an aspiring world-leading Asian consultancy. the average number of telephone lines per 1.

Product sales nature: this is defined as the dependency of sales of products/services in the specific industry on the changes in the business environment. and so on). and so on. Asia strategy review. pricing trends. and so on) and the internal environment of the client (key success factors. Let’s take Singapore for example. And finally we formulate the appropriate Asia strategy. business environment. market profitability. Concentration of companies within the same industry: high competitive intensity translates to lesser profit shared among players. We can use a rating scale from 1 to 5 where 1 means very unattractive and 5 means very attractive. To help assess the attractiveness of various Asian markets and industries. B is explore resources and capabilities to determine the best strategies. market segmentation. market share. The model takes into account ratings for: • • GDP output Market growth rate over the past five years: growth is the most important assessment factor and it takes precedence over size and other factors when considering industry attractiveness. value/distribution analysis. It is based on the historic growth of each industry for the past five years. hence lowering attractiveness of the industry. we further modify the GE-McKinsey Portfolio Analysis. In turn. entry barriers. marketing or branding audit. Market attractiveness Market attractiveness has replaced market growth as the main factor of industry attractiveness. • • 10 .environment. B and C: • • • A is identify and assess Asia opportunities. many factors can affect market attractiveness. Three-part formula The strategy formula has three parts: A. competitiveness intensity. and C is analyse core competences to determine modes of entry into the Asian market. This is followed by strategy implementation. such as market size.

business/ commercial/professional. are: • High attractiveness: wholesale and retail. publishing and printing. A recent issue of The Asian Development Outlook. FDI to Bangladesh averaged $7 million annually from 1990-1996. substitution strategy. we look at our clients’ market strength. Mid attractiveness: food. in order of descending attraction. Low attractiveness: wearing apparel. IT and e-commerce. free-riding strategy and strategic alliance strategy or some combination of these. primarily due to foreign investment in Bangladesh’s energy sector. FDI situation Bangladesh According to an UNCTAD report. and hotels and restaurants.• Government support: the Singapore government plays an active role in supporting Singapore’s business. but increased to an annual average of $196. In 2002 new FDI again dropped to $52 milli0on. transport. logistics and communication. beverages and tobacco. Here. therefore government support is a crucial factor for evaluating industry attractiveness. our analysis shows that Singapore’s industries. electronic products and components. In order to attract the huge amount of foreign direct investment pouring into the region. In 2001. however. economies should move away from restrictive investment regimes and alow wholly owned subsidiaries to operate.6 billion in 2000.8 million from 1997-2000. footwear and leather. representing a growth of 15. new FDI dropped 72% (to $78 million) from the previous year. • • Market conditions Also. For small and medium-sized enterprise clients. we will look at Asian market conditions and likely Asian competitors’ countermoves and recommend using a ‘niching’ strategy. The Asian Development Bank also points out that foreign firms are attracted to commercially profitable and politically stable environments.1 billion in 2002. and that offering incentives is often less effective at attracting investment.2 percent per year. 11 . states that FDI in developing Asia grew from $694 million in 1970 to $ 138. construction and engineering. and other services. before declining to $ 90. other manufacturing sectors and financial services. But in 2003 the FDI jumped to $120 million.

Imperatives for Bangladesh Despite the overall poor investment environment. pharmaceuticals and cement industries have experienced significant quality and capacity expansion.2. while share of service and industry has increased to 50 percent and 25 percent respectively. Bangladesh achieved notable success in some fields during the past years. until the FY2002.5 percent. very often sent trsde delegations abroad to explore trsde opportunities as wel as highlightopportunities for investing in Bangladesh. Sectoral composition of the economy also marked some positive changes. difficulty in attracting foreign investment also results from Bangladesh's image as an impoverished and undeveloped country subject to frequent and devastating natural disasters. The situation is much better than what it had been in the 1980s when GDP growth rate hardly exceeded the population growth rate. Turkey. Share of agriculture now declined to around 25 percent. Taiwan China. To a lesser extent. Success of Bangladesh is quite remarkable in select social and economic sectors. Here a distinction has to be made regarding factors and situations which are outside the direct control of the government and those over which it can exercise direct control and 12 . 3. Hence per capita income was increasing at a rate of more than 3 percent a year. A number of foreign business delegations have visited Bangladesh to explore trade and investment opportunities. and policy instability—for example—decisions taken by previous governments being overturned when a new government comes to power). inadequate commercial laws and courts. and Korea. whereas population growth rate declined to 1. Textile and some other manufacturing sectors registered modest success. Malaysia. What is the story from the other side? How do foreigners see inveetment prospects I Bandladesh? A survey of recent reports on the issue including a recent Investment Climate Statement on Bangaldesh by the Bureau of Economic and Business Affairs of the US Government found the following: foreigners often find that ministries request unnecessary licenses and permissions. Investment has increased to 22-23 percent of GDP. Some of Bangladesh’s textile sector units are using state of the art technology and are capable of competing in the global market. Bangladesh needs to adopt urgent plans for the short-run and the medium – term. The country’s industrial and To be competitive in international markets. Bangladesh’s literacy rate has increased to more than 60 percent during the past decade. and to upgrade its potential in the foreign investors’ eyes. labour militancy. including from India. Added to these difficulties are such problems as corruption. Dependence on foreign aid declined significantly.Bangladesh has. Likewise. France. growth rate of GDP exceeded 5 percent. Inflation rate is very low. poor infrastructure. Overall macroeconomic balance had been sustainable in the last decade. By the end of the last decade. inconsistent respect for contract sanctity. Private investment marked a faster growth than public investment.

for expediting port services. Container handling costs around $600 as against $150 to $300 in neighbouring ports. a mentionable initiave is that the Ministry of Science and Information & 13 . So far as Information and Communication Technology (ICT) is concerned. Besides. But due to inefficient management. Besides. specifically port infrastructure and ICT Developing infrastructure Developing the infrastructure particularly Chittagong port is an utmost priority for developing FDI potential in Bangladesh. Despite huge demand. the government should take immediate initiatives to develop those sectors directly under its control. the Bangladesh Government has decided to allow private sector participation in the port sector. the Government may opt for leasing of equipment for port handling and leasing of floating crafts from the private sector. While indices such as increase in the GDP per capita. share of exports in GDP and increasing the share of FDI in the services sector are not under direct control of the government. notably. and hartals make it one of the costliest ports in Asia. having borders with India and Mynmar and with close proximity with land-locked countries—Nepal and Bhutan. they can hardly handle more than 10 TEUs per hour.It may be mentioned here that as a measure to make the port more efficient. although each of the cranes has a capacity of handling 30 TEUs (Twenty Equivalent Units) of containers per hour. Regarding road infrastructure. such as developing the infrastructure. Bangladesh Railway currently accounts for less than 15 percent of container trans-shipment in the Dhaka-Chittagong Economic Corridor (DCEC). the country is at an emerging stage and lacks behind other Asian countries in comparison. time-consuming custom procedures. Bangladesh is located at the centre of the South Asia Regional Economic Co-operation (SASEC) countries. 2006 to make cargo handling more efficient. absence of skilled operators and modern vessels. However. Bangladesh Railway too is incapable of carrying and delivering the container cargoes efficiently and timely due to poor capacity. and can only be influenced indirectly by it. the number of export containers has not increased at a pace matching the rate of increase in the number of feeder vessels. However. although there has been a rapid expansion of road network. including Chittagong Port. there is hardly any significant trans-shipment through road transport because it cannot handle container lorries due to capacity constraint. they are being used up to only a third of their capacity According to port officials. and lack of operational efficiency. problems like outdated machinery. Four gantry cranes were commissioned at the port on January 30. {Mention example of SINGAPORE] Chittagong port is commercially important to Bangladesh as it handles nearly 85 percent of the country’s exports and imports. to bring them in the capital market and thus make them efficient for handling growing volumes of cargo. Similarly. The port is heavily congested and ship turnaround time needs 4 to 5 days compared to 1 to 2 days in Singapore and Bangkok. In keeping with thesituation. Additionally. Port users have recommended privatization as well as corporatization of maritime ports of Bangladesh. the Government initiated measures such as import of gantry cranes.initiative. which provides potential sub-regional linkages to northeastern states of India as well as Nepal and Bhutan. inadequate storage space.

Under this program. in cooperation with the public/private sector. it is important for Bangladesh to look beyond offering lucrative incentive packages and also inculcate the criterion leading to increasing its FDI potential within a short time. Conclusion From the above it may be concluded that to attract FDI in a meaningfully large way . The objective of the program is to impart basic training for skill development. 14 . graduates/ fresh graduates/post graduates in ICT subjects will be imparted training for 6-months as internees in different IT organizations/companies for acquiring practical experience and hands on training. has taken program to produce quality professionals and skilled manpower in ICT. National ICT Task Force decided to introduce ICT Internship Award Programme in the country.Communication Technology.