International Finance [CFI4102]

B.Com Finance

Foreign Direct Investment

Prepared by

Edson Mbedzi
 What is FDI?
• Definition
– Investment into basic capital in a foreign country.
– Long-term loans joint with yields and decision power.
– Reinvested earnings.

– 10% or more share on equity (OECD, 2012).

 Investors has long-term interest and control about their investment.

 Forms of FDIs
1. By category
• Greenfield investment (starts from the bare ground)
– High inflow of FDI; new production capacity – investment and
employment effects.

• Brownfield investment (existing company)

– Unlike greenfield – investor buys existing real estate; quicker spillover
effects.
2. By entry strategy
• New subsidiary
• High inflow of FDI involving establishing new plants and operations.

• Mergers & acquisitions

– Relatively high inflow of FDI, but no new production facilities; higher
spillover effect; Investment mainly on better technology and higher
productivity efficiency.

• Joint ventures
– Easier penetration for foreign investor; higher spillover effect.
 Foreign Direct lnvestment Theories
Theory Type Analysis of Theory Application
Market • Firms seek market opportunities and decision to invest both industrialized and
imperfection overseas is a strategy to capitalize on certain developing countries
Theory (Hymer, capabilities not shared by competitors.
1970).
• MNEs owe their existence due to market imperfections.
• MNEs are a substitute for a market as a method of
organising institutional exchange.
• No considerable competitive advantage against the
local competitors.
International  Specific attractions abroad compared with resource Target sector:
Production Theory implications and advantages at home – locational • Agriculture
(Dunning and •
advantage. Manufacturing
Fayerweather,
 Extensive use of host country linkages (labour, • Textiles
1980)
suppliers, clients). • Pharmaceutical
 Less concerned with host country risk. • Telecomms
 Concurs with classical FDI theory.
Internalization  Follow an incremental strategy (internal integration). Target Sector:
theory (Buckley  Concerns expanding direct operations of a firm and  Oil
and Casson, 1982)
bringing under common ownership and control the  Agriculture
activities conducted by intermediate markets that link the  Construction
firm to clients and suppliers.  Manufacturing
 Less use of host country linkages.
 More concerned about host country risk.
 China’s FDI Strategies in Africa
Entry Mode
CSOEs (1970s onwards)
 China National Petroleum
Corporation (Shin, 2007)
 Chinese Agri-Farming Group
(Zweig & Jianhai, 2005)
Objective Outcomes
CPOEs (MNCs) 1990s onwards
• Chinese Datong Group
(Senegal)
• Wenzhou Hazan (Nigeria)
Objective Outcomes
Strategic Motivation Target Sector
Geopolitical interest of Chinese  Oil
government (Alden, 2005).  Agriculture
 Resource seeking approach.  Construction
Thus it is an internalization theory
oriented approach
 Secure China oil needs expected to reach 563 tonnes in
2020
 Acquire land for production to feed increasing population
 Build infrastructure to provide link to the natural
resources projects in host countries.
 Use Chinese labour and increase remittances home.
Economic and profit maximization of • Agriculture
firms (Lin, 2010). • Manufacturing
 Market seeking approach  Textiles
 Efficiency seeking approach  Pharmaceutical
Thus it is an international production
theory oriented approach
 Profits
 Increase shareholder value
 Critics of Foreign Direct lnvestment Theory
• Create natural monopolies as
MNCs are more profitably than
local competitors.
• Monopolistic advantage comes
from:
–Superior knowledge.
–Economies of scale – through
horizontal or vertical FDI.
• Creates business linkages
provided benefits outweigh
crowding out effects of
competition.
• Regional & local mandate of
MNC subsidiary matter.
• Limited local business linkages
• Limited knowledge
transmissions.
 Benefits & Costs of FDI to Host Countries
The Benefit Concept
• Net addition of inputs and outputs of foreign firms add to the domestic
market output.
• Results in increased competitiveness of the local market, thus reducing the
level of underdevelopment.
• Business linkages effects.

The Cost Concept

1. Adverse effects on competition
2. Adverse effects on the balance of payments:
 After the initial capital inflow there is normally a subsequent outflow
of earnings.
 Foreign subsidiaries could import a substantial number of inputs.
3. National sovereignty and autonomy
 Some host governments worry that FDI is accompanied by some loss
of economic independence resulting in the host country’s economy
being controlled by a foreign corporation.
Determinants of the flow of FDI
 Investment Incentives – problems

• Prisoner Dilemma

– incentives cause competition among governments.

• can result in unintended policy formulations.

– Multinational enterprises sometimes have bigger economic

size and power than some governments or nations.

– Monopoly – strong industry associations but dominated by

new big firms.
Benefits of FDI to a Country
 The Direction of FDI so far…

• Historically, most FDI has been directed at the developed

nations of the world as firms based in advanced countries
invested in other markets.

– The US has been the favorite target for FDI inflows for a
long time – good market and high levels of income.

• While developed nations still account for the largest share of

FDI inflows, FDI into developing nations has increased.

– Most recent inflows into developing nations have been

targeted at the emerging economies of South, East, and
Southeast Asia
 FDI growth trend in LDCs
FDI Inflows to LDCs

12
10.9

10 9.7
8.7
Billions of dollars

8
7.1
6.6
6.0
6
4.9
3.8 4.1
4

1.9 2.1
1.6 1.6 1.7
2
1.1

0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: UNCTAD, FDI database

 …but global share is very small
LDC Share of World FDI

1600

1400

1200
Millions of dollars

1000
World
800
LDCs
600

400

200

Source: UNCTAD, FDI database

 …and the distribution is uneven
• High concentration
in a few LDCs Sudan

FDIGuinea
Equatorial inflows, top 10 LDCs, 2004-2005 a
• Bulk of FDI is aimed (Millions of dollars)
Congo, Democratic Republic of
at resource
extraction, esp. in Chad
Africa
Bangladesh
• But in Asia, some 2005
United Republic of Tanzania
FDI is in services 2004
(telecom, electricity) Cambodia

Myanmar

Zambia

Uganda

0.0 0.5 1.0 1.5 2.0 2.5

Source: UNCTAD, FDI database

Contributions of MNCs to Developing Countries Output
 FDI in Zimbabwe Recently
• Statistics available from the Zimbabwe Ministry of Finance show that
FDI, which averaged 14-20% of GDP from 1980-2000, has declined
remarkably in the last ten years to the current 1.1% of GDP (2011).

• Foreign investment inflows were US$125 million for 2011 and this is
less than 1% of the US$17 billion into the SADC region, placing
Zimbabwe among the least attractive investment destinations in the
region

• In 2011, Zimbabwe attracted the largest greenfield investment in

Africa. This is mainly due to a $4 billion investment from the Essar
Group. (However this deal is still to be concluded)( World investment
report 2012)

• The People’s Republic of China has placed more than half a billion
dollars in FDI into Zimbabwe in the past four years, and has lined up
projects valued at more than $10 billion(e.g. Tianze — a tobacco
contracting, procurement, processing and exporting business)
 Policy Developments on FDI

Improving investment climate in many LDCs

 More transparent and liberalized FDI legal frameworks.

 Bilateral, regional and multilateral agreements.

 National and sub-national IPAs.

 Zimbabwe has one investment promotion agency, while

South Africa has 10 IPAs (one national agency and 9
provincial ones)
 Prospects for inward FDI in LDCs

• Picture is cautiously bright due to high natural resources

demand.

• However, appropriate policies and institutions are needed:

 to attract non-oil FDI .

 to solve underlying problems that LDCs face, including:

 governance related issues,
 Corruption and,
 Stability
 Good Governance in Investment Promotion

for Ease of Doing Business

Ghana 67
Singapore 1
Haiti 139
USA 4
Mauritania 148
UK 10
Madagascar 149
Thailand 18
Namibia 98
UAE 23
Botswana 56 Afghanistan 162
Zambia 83
Ethiopia 125
Sierra Leone 168
Uganda 132
South Africa 41
Zimbabwe 170
Source: World Bank Report, 2014
 Ease of Doing Business in Zimbabwe
The first table lists the overall "Ease of Doing Business" rank (out of
189 economies) and the rankings by each topic

Change in
Topics DB 2014 Rank DB 2013 Rank
Rank
Starting a Business    150 148 -2
Dealing with Construction Permits    170 173 3
Getting Electricity    157 158 1
Registering Property    93 87 -6
Getting Credit    109 105 -4
Protecting Investors    128 127 -1
Paying Taxes    142 135 -7
Trading Across Borders    167 168 1
Enforcing Contracts    118 112 -6
Resolving Insolvency    156 168 12
FDI Competitiveness
Growing emphasis on sustainable development.
New Investment Promotion strategies with Economic restructuring insights

Present position New Position Necessary Actions

1. Broad-based Focused & prioritised • Refocus the activities eligible for

investment investment promotion
promotion
2. Sector-based Sector and Merit-
Incentives based Incentives
promotion.
• Prioritise: Incentives must vary,
depending on the importance of
the activity.
• Different incentives between new
and reinvestment projects.
• Reduce blanket basic tax
incentives.
• Provide additional incentives
based on projects’ merits to
encourage competitiveness
enhancement activities such as
R&D, environmental protection,
community engagement etc.
New Investment Promotion strategies with Economic restructuring insights

Present position New Position Necessary Actions

3. Zone-based Promote New • Abolish zone-based incentives.

Incentives Regional Clusters • Promote new industrial clusters in
each region or border area to create
new investment concentration.
4. Tax Tax Incentive and • Focus on facilitation through non-
Incentive – Facilitation – tax incentives and one stop service
oriented Oriented promotion • Improve investment rules and
promotion regulations, reduce barriers to
create better investment
environment.
• Promote and coordinate human
resources development to support
industrial sectors.
• Integrate supports from various
government agencies as a package.
New Investment Promotion strategies with Economic restructuring insights

Present position New Position Necessary Actions

5. Promote Promote both • Promote overseas investment

inbound inbound & outbound more actively in order to increase
investment investment the competitiveness of the
country’s businesses.
6. Evaluation by Evaluation by • Set clear Key Performance
applications Outcomes Indicators to measure benefits
and cost-effectiveness of
investment promotion.
Zimbabwe investment promotion institutional
framework
Ministry of Finance &
Economic
Development

ZIA Board
of Regional IPAs
Directors

COMESA Regional SADC Investment

ZIA Head Office
Investment Agency Framework Policy

ZIA Provincial ZIA Overseas

Offices Offices Embassy
Bulawayo Consules
 Tools for promoting investment in
Zimbabwe
1. Website Advertising as a tool to promote investment.

2. Local Government Authority Liaison.

3. Investment Promotion Tours.

4. Bilateral Investment Agreements

 Recent Development in Zimbabwe Investment Policy
Period Investment Responsible Ministry Main Policy Focus
Promotion Agency
1980- Zimtrade Ministry of Industry and To promote mainly international
1992 Commerce trade along with investment
promotion activities.
1993- Zimbabwe Investment Ministry of Finance To promote both foreign and local
2000 Centre (ZIC) investment
2001- Zimbabwe Export Ministry of Industry and Promote investment with a focus
2005 Processing Zone Commerce on export oriented investment
Authority (ZEPZA) promotion activities.
2006- Zimbabwe Investment Ministry of Industry and Merger of ZIC and ZEPZA to
2009 Authority Commerce create one investment promotion
agency.
2009- Zimbabwe Investment Ministry of Regional Promote investment with
2013 Authority Integration and emphasis on regional integration
economic Development and economic development.
2013- Zimbabwe Investment Ministry of Finance and Promote targeted investment by
current Authority Economic development identifying specific investment
projects needs in line with the
national economic plan of the
country.
 Areas of concern by investors

Public sector service standards:

“We need a long term change in civil service culture”

Access to information:
“Information can be obtained when one seeks it, but the
public sector is not proactive in providing it”

Dispute resolution:
“The law courts take forever”

Policy dialogue:
“Government at the top level does not understand the day-
to-day problems of the private sector”

* Quotes from foreign investors operating in LDCs

 UNCTAD Programme on Good Governance
in Investment Promotion

• Predictability • Accountability
• Clear policies and a legal Performance standards and
framework for monitoring, as well as
investment, as well as impartial grievance
predictable rules and procedures
regulations

• Transparency • Participation
Timely and accessible Continuous dialogue with
information disclosure and stakeholders that feeds into
openness to the media policy making
Investment Guides for LDCs
END