January 07, 2020

How home country measures can promote foreign direct investment in poor economies

  • The attraction of much needed foreign direct investment (FDI) is not only dependent on least developed countries (LDCs). Developed partners have the means to promote outward FDI and are well positioned to achieve the goal of boosting FDI in LDCs.

  • In order to be effective, existing and future home country outward FDI measures need to be customised to the needs and realities of LDCs.

  • Monitoring the implementation of these measures is fundamental to ensure that sustainable and responsible FDI flows to LDCs.

Foreign direct investment (FDI) constitutes a dominant part of private capital flows to least developed countries (LDCs). According to the UN Committee for Development Policy (CDP), FDI can lead to tangible and intangible benefits, playing a catalytic role in building and strengthening productive capacity and export growth, including developmental objectives such as technology and skills transfer, employment generation, higher wages and poverty eradication. However, the total share of global FDI flows to LDCs remains very low and is often directed at resource extraction.

Whereas many studies have focused on the measures undertaken by host countries to attract FDI, little research has been conducted on what development partners can do to promote and facilitate more sustainable FDI to LDCs – either directly or indirectly. Here we look at these home country measures and how they can influence the flow of productive foreign investment to poor host economies.

Direct and indirect home country measures

In a paper for the United Nations Office of the High Representative for the Least Developed Countries, Landlocked Developing Countries and Small Island Developing States (UNOHRLLS), and a recent study for the World Trade Forum, we argue that development partners could play a larger role in fostering sustainable foreign investment in LDCs both through direct and indirect measures.

In fact, after reviewing home country measures mainly from OECD and G20 countries – as they represent the vast majority of outward FDI flows – we have detected a number of measures that could be used for such purpose.

Direct support measures for outward FDI in LDCs may include preferential financing programmes (for example grants, loans, financial guarantees, equity participation and private enterprise funds), fiscal incentives, political risk insurance, project-business development and information services, as well as management instruments to promote sustainable and responsible investment by home countries.

These countries may also provide indirect support for outward FDI in LDCs. This could include support towards improving the investment climate, strengthening investment promotion agencies, assisting the private sector in the host county, and perhaps sharing experiences on the negotiation of international investment agreements or approaches to investor-state dispute settlement.

The customisation of measures for LDCs

Although both direct and indirect measures mentioned above are common among OECD and G20 countries, generally they have not been conceived to promote or facilitate sustainable and responsible foreign investment in LDCs. For that reason, we believe that the customisation of such measures for LDCs should be explored.

In the area of direct support, since current information and knowledge gaps with respect to available opportunities in host LDCs are significant, we recommend that development factors be included as part of the eligibility requirement for measures such as information services, financial programmes and fiscal incentives.

In addition, the need for political risk insurance is more acute in LDCs. The conditions and costs of such insurance to foster inward FDI should thus be made more accommodating to the needs and contexts of fragile countries.

Direct support measures can also be designed conditional upon investor compliance with certain criteria of sustainable and responsible investment such as technology transfer, climate protection, and respect for human rights. UN Principles for Responsible Investment – which provide a global standard for investing along environmental, social and corporate governance factors, could serve as guidelines.  Effective mechanisms to monitor the implementation of these conditional measures should also be considered.

Several recommendations can be put forward regarding measures that provide indirect support to FDI in LDCs. Development partners can help in the design of effective and efficient schemes and policy frameworks in LDCs to attract sustainable FDI; improve transparency by disseminating information about existing and potential investment opportunities in LDCs through online platforms; strengthen host country investment promotion agencies as one-stop-shops for inward FDI; and promote learning from peers of best practices on smart regulation that encourages investment and safeguards the national interest.

Key lessons for effective measures that drive investment

Three important lessons can be drawn from our review of home country measures directed at outward FDI if such mechanisms are to effectively promote or facilitate investment in LDCs.

First, measures change rapidly over time and keeping track of their implementation can be difficult at times. They can undergo substantial modifications as well as changes in their name, duration, and the repositories (mostly online platforms) where they are explained. As far as possible, these measures should be made more permanent and changes implemented in a manner that is easy to track. Frequent changes to home country measures – as often happens – can affect investor expectations.

Second, policies directed at or implemented in LDCs should be reported separately from other developing countries or economies in transition. Often home country agencies report on all of these countries as a single group. This practice makes it difficult to find systematic information on measures targeted at LDCs and assess the effectiveness of the resources devoted to this type of support. This can create two distinct problems: misrepresentation of the support provided to these poor economies – for example if statistic or other information includes large developing economies; and underrepresentation of the effective support provided to LDCs with “success stories” that are insufficiently identified and showcased by home countries.

Finally, the implementation of home country measures should avoid costs derived from duplication and enable synergies with existing multilateral, regional, and bilateral initiatives. In the same spirit, if possible, they should also use existing international rules, even if they may require complementary adaptations.

Consideration of the ideas set out in this article by development partners will help LDCs attract much needed private investment and finance for development, not least in their journey towards achieving the Sustainable Development Goals.

 

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Rodrigo Polanco is Senior Researcher and Lecturer at the World Trade Institute, University of Bern.

Keywords
FDI
Credits

Header image: a mushroom centre in Lesotho. EIF is working to improve the ability of smallholders from the country to commercialize and diversify their production of fresh fruit and vegetables, targeting farmer groups, youth, women and individual smallholders who have basic resources and motivation. ©EIF/Simon Hess.