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Foreign investment, its role in economic development

The following is an overview of foreign direct investment (FDI) as understood and commonly practiced by the international business community. Most Zimbabweans have a very limited understanding of what it is. The subject of foreign investment has many facets and structures.

One must make a distinction between FDI and foreign indirect investments (FIIs). FIIs involve corporations, financial institutions and private investors buying stakes or positions in foreign companies that trade on a foreign stock exchange. In general, this form of foreign investment is less favourable, as the domestic company can easily sell off their investment very quickly, sometimes within days of the purchase. This type of investment is also sometimes referred to as a foreign portfolio investment (FPI). Indirect investments include not only equity instruments such as stocks, but also debt instruments such as bonds.

One must be cognisant of the fact that it is corporate entities not governments that engage in FDI activities and as such, the primary business of a foreign investor is to make money or realise return on investment. As a rule, FDI does not create an economy, but augments a host nation’s economy.

Some of the key features an investor looks for in a host country include strategic location, access to rapidly expanding markets, highly developed physical infrastructure, stable and reliable regulatory infrastructure, skilled man power, low labour costs, low tax rates, political stability, a high level of if not unrestricted financial autonomy and access to capital, open economy, etc.

The reader would do well to have read the previous article titled Government, the People and the Economy.

FDI is a key component in global economic integration. It is an investment made by a resident enterprise or direct investor into the enterprise that resides in another country. This often involves establishing operations or acquiring tangible assets including stakes in other businesses. This is not just a transfer of ownership as it usually involves the transfer of factors complimentary to capital, including management, technology and organisational skills.

The main objective of FDI is to establish lasting interest. This implies the existence of a long term rapport between the direct investor and the direct investment enterprise along with a significant degree of influence over the management of the enterprise.

FDIs are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies.

According to the Organisation of Economic Co-operation and Development (OECD), an ownership of 10% of voting power by a foreign investor is evidence of such a relationship.

There are two types of FDI:

Greenfield investment: This is a form of FDI where a parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up. In addition to building new facilities, most parent companies also create long-term jobs in the foreign country by hiring new employees.

Brownfield investment: Also known as cross-border merger and acquisition. The purchasing of an existing production or business facility by companies or enterprises for the purpose of starting a new product or service. This type of investment does not involve the new construction of plant operation facilities.

From a strategic view point, there are loosely four types o f FDIs:

1) Horizontal FDI: This occurs when a company carries out the same activities abroad as at home;

2a) Vertical FDI: This occurs when different stages of the production chain are added abroad;

2b) Forward Vertical FDI: This is when the FDI takes the firm nearer to the market;

3) Backward Vertical FDI; This occurs when international integration moves back towards raw materials; and
4) Conglomerate FDI: A conglomerate type of foreign direct investment is one where a company or individual makes a foreign investment in a business that is unrelated to its existing business in its home country. Since this type of investment involves entering an industry the investor has no previous experience in, it often takes the form of a joint venture with a foreign company already operating in the industry.

Once a firm undertakes FDI, it becomes a multi-national enterprise (MNE) or corporation.

We shall now focus on the specific benefits of FDI inflows into a country and the policies a country can pursue to maximise the benefits of FDI.

In practice, many countries take a pragmatic stance towards FDI through specific policies. These policies vary from nation to nation, often with mixed results.

The Pragmatic approach to FDI

Nations often pursue policies designed to maximise national benefit and minimise costs for the host country, the receiver of FDI.

The main benefits of inward FDI include:

a) Resource-transfer effects: FDI can contribute positively to the host economy by supplying the capital, technology and management resources that would either wise not be available thereby boosting the country’s economic growth rate;

b) Employment effects: The positive effects can be both direct and indirect;

Direct effects occur when an MNE employs a number of the host country’s citizens.

Indirect benefits occur when the employees of the MNE start spending money locally. Additionally jobs are created among local suppliers as a result of the MNE’s operations;

c) Balance of payment effects: There are two ways in which FDI can help a country run a current account surplus.
First, if the FDI is a substitute for imports of goods and services, and secondly, the host country becomes a foreign subsidiary to export goods and services to other countries; and

d) Effects on competition and economic growth: When FDIs take the form of a greenfield investment,(i.e. to establish a new operation in a foreign country), the number of competitors in the market increases, thereby giving consumers more choice and increasing the level of competition.

The theory is that the increasing level of competition within the national market would help spur innovation and drive down prices, thus creating the conditions for greater economic growth.

Making FDIs work

Host countries often adopt policies that are crafted to both restrict and encourage inward FDI.

Governments may offer incentives to foreign firms to invest in their countries.

Such incentives may include tax breaks, low interest loans, grants, subsidies or state spending on infrastructure.

Furthermore, host counties can often employ a variety of controls to restrict FDI in order to maximise its potential benefits while limiting its costs.

The two most common policies include ownership restraints and performance requirements.

One of the main reasons behind ownership restraints is the idea that local owners can help to maximise the resources transfer and employment benefits of FDI for the host country. This can be in the form of prohibiting most FDIs but making allowance for joint ventures between local companies and foreign MNEs if the latter have valuable technologies.

Performance requirements are constraints placed upon the local subsidiaries of the MNE to control its behaviour.
Many countries often implement performance requirement policies to suit the country’s needs. Common performance requirement policies include a requirement on product content, technology transfer and local participation in top management.

The dangers

The employment benefits that MNEs provide may not last forever. There is no guarantee that the MNE will remain for a prolonged period in a country they invested in;

If thing were to go south the investors may choose to pull out causing harm to the local economy;

Furthermore, being over dependent on MNEs may lead to a loss of sovereignty;

The MNE may gain the upper hand when it comes to making deals with the host country’s government, leading to an exploitative relationship that may not be apparent in the early stages; and

Harms include environmental damage and human rights violations.

Other types of foreign investment

There are two additional types of foreign investments to be considered: commercial loans and official flows. Commercial loans are typically in the form of bank loans that are issued by a domestic bank to businesses in foreign countries or the governments of those countries.

An official flow is a general term that refers to different forms of developmental assistance that developed or developing nations are given by a domestic country.

Commercial loans, up until the 1980s, were the largest source of foreign investment throughout developing countries and emerging markets. Following this period, commercial loan investments plateaued, and direct investments and portfolio investments increased significantly around the globe.

In an increasingly interconnected world, the process of globalisation has presented an economic challenge for developing countries. It is in this context that FDIs have been accorded great importance as a driver of economic growth. Although some countries have benefited from FDIs, many other nations have yet to see its fruits.

The Zimbabwean government should tread lightly and pursue pragmatic policies in order to maximise the benefits of FDIs. Zimbabwe like many African countries has an abundance of natural resources which remain largely untapped. It may be more prudent for African countries to adopt a ‘grow the business’ type approach to economic prosperity.

Start small, achieve competence, secure markets and recapitalise the industry to achieve growth. It goes without say that we can not do “business as usual”, i.e allow corruption, graft, obscene executive pay packages, mismanagement, government interference, party politics, tribalism, etc to be the order of the day.

The reality

In the wake of the global financial crisis, many MNEs have and are continuing to contract, re-structure and retrench.

As a follow up to my article on Sanctions: Real or Imaginary, consider the following.

European countries have problems enough of their own and are in no position to “bail out” Zimbabwe, let alone lend us money. Here are the figures:

Greece owes US$367 billion, largely to the other European economies;

Ireland owes US$865 billion, largely to the other European economies; and

Spain and Italy owe US$1 trillion each, mainly to France, Britain and Germany;

As a result, France, Britain and Germany are struggling because they have lent all these finances to countries that can not possibly pay them back. Spain owes Italy US$41 billion and Italy owes Spain US$27 billion, etc.

Are these really the people Africa should be looking to for financial advice? Are there no Africans, black, brown or white, full of wisdom and integrity who understand the times and know what Africa ought to do?

People are selling the European currency and buying the US dollar because the US economy is stronger than the European economy, but the US economy is largely owned by China! It is worth noting that China has very limited outward FDI/MNE activities but has been the beneficiary of tremendous inward FDI/MNE activities. Chinese government external projects are not be confused for FDI.

As I mentioned in a previous article, a change in presidency or ruling party is not Zimbabwe’s economic salvation. A paradigm shift in our world view; how we conduct our financial and economic affairs; change in our moral ethics and our attitude to nation building and export oriented productivity are our only viable hope.

Greed, near-sightedness, bureaucracy and indolence are some of our greatest enemies. Twenty four hours (up a mountain) of prayer and fasting will produce diddly-squat unless we apply ourselves to self-sacrifice, honest and hard but smart work. After all, God only promised to bless the work of our hands … not our crooked works or prayers.

A wise man said: “Prayer is in the revelation equation, not the success equation.”

Geoffrey Makina is an Economic analyst

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