Enhancing favourable investment climate

Improving conditions for investment
Improving financial environment for development
Encouraging favourable investment climate
Given the importance of investment resources in building export capabilities and the lack of investment capital (including external financial resources) in many developing countries, domestic policies in these countries will have to be geared to creating a more favourable environment for private capital inflows. Private international capital flows are increasingly taking the form of foreign direct investment (FDI), portfolio investments and bond lendings, rather than bank lendings. Financial market liberalization, stable monetary conditions, healthy budgetary practices, strengthened money and capital markets are some of the conditions to be met.

FDI does not provide developing countries with just financial capital. Other elements in the package include the transfer of technology and management skills, employment creation and labour force training. Foreign firms can also stimulate domestic entrepreneurs by introducing a source of innovation and competition, and can encourage domestic investment. FDI can also have an important role in securing access to world markets for the goods produced in a host developing country.

The nature of FDI has also changed. In the past, most direct investment in developing countries was aimed at exploiting natural resources or, if in manufacturing industries, at substituting for imports. The latter type of investment was usually motivated by market protection, not by fostering a competitive manufacturing sector in the host developing countries. In recent years, however, manufacturing direct investment aimed at production for the export market, particularly in the investor's home country, has become increasingly important. It has centred on countries where policies have made exporting an attractive activity, where labour is inexpensive in relation to its productivity, and increasingly, where countries have attained more advanced levels of human skills.

Technical cooperation activities could aim to assist governments of developing countries in designing investment promotion programmes and strengthening institutional capacity to promote and facilitate the inflow of FDI. In particular countries could be assisted to: (i) establish policy and regulatory frameworks to attract the desired flow of investments; (ii) devise investment promotion strategies, methods and activities; (iii) establish or strengthen institutions charged with regulating and promoting foreign and domestic direct investment.

Export processing zones (EPZs) have in general been a successful device for attracting FDI and thus for building export capabilities. A large number of developing countries have set up EPZs as focal points for the promotion of manufactured exports, and increasingly exports of services, and for the attraction of foreign export-oriented investment. The planning, establishment and operating of EPZs require specialized expertise, besides adequate financial resources. Experience has shown that the profitability of EPZs for the host economies constitutes a sensitive point. In the case of a number of such zones, operations have apparently not generated net benefits due to planning mistakes, operational problems or the inability to attract sufficient investment to the zones.

Technical cooperation activities can assess the investment and export potential of the projected zones, identify optimal locations for their establishment, draft pertinent laws and regulations and advise on customs arrangements and organizational aspects of zone management. Furthermore, these activities can determine physical planning needs and the requirements in terms of infrastructure and commercial support services. Detailed cost-benefit analysis to assess the order of magnitude of foreign exchange earnings that can reasonably be expected from zone operations can also be carried out. Technical cooperation can also aim to strengthen the operational and promotional capacities of EPZs, and thus put in place effective organizational and management structures with qualified personnel, design systems and procedures for the evaluation of investment proposals and establish the capacity of the EPZs to carry out promotional activities for the attraction of export-oriented investment. The provision of training, both on-the-job and overseas, would be an important element of project activities.

In the light of low investment flows, African countries have undertaken many efforts during the past ten years to increase their attractiveness to foreign investors and thus enhance their own growth prospects. These efforts have included, at the macroeconomic level, wide-reaching domestic economic policy reforms (usually at high social cost) and, at the level of the FDI regulatory framework, the liberalization of existing frameworks or the adoption of new ones, the simplification of administrative procedures applicable to foreign investors, the conclusion of bilateral investment protection and promotion treaties and accession to various multilateral treaties facilitating FDI flows.

All these efforts have led to a recognizable improvement of investment conditions in Africa, although more can and needs to be done to realize the investment opportunities that exist in Africa. As Africa, as a continent, comprises a great variety of political and economic country situations (in addition to differentiated investment opportunities), no single prescription for action to improve investment conditions would be appropriate. Answers need to be sought in each country. Some governments would need to make efforts to restore or maintain economic and political stability, as a general precondition for increased FDI. Others would need to continue with the liberalization of FDI policies and increase the efficiency of administrative procedures, learning from best practices elsewhere. Still others, with favourable indicators of FDI potential but receiving FDI below their potential, when reviewing their regulatory frameworks, would need to focus on promotional efforts and attracting TNCs to particular projects. And, finally, a small group of countries in Africa may be able to pay increased attention to policies aimed at upgrading the quality of FDI they receive, [eg] by focusing on the improvement of the skills of their labour force or on the upgrading of infrastructure.

A policy action likely to contribute immediately to the improvement of investment conditions in many African countries relates to privatization programmes. Judging from the experience of other countries, privatization programmes with foreign participation can provide a vehicle to increase FDI flows (with potential qualitative contributions to the economy) over a longer period of time, since FDI flows can continue after the acquisition of an asset owing to post-privatization investment. Such programmes have been a major factor behind the rapid increase of FDI flows to Latin America and Central and Eastern Europe, but not to Africa. To try to benefit from privatization-related FDI, existing programmes need to be improved and perhaps new programmes launched. In some cases, this may require the establishment of a broader political consensus, to end the stop-and-go nature of some of these programmes, to make them more transparent and to expand them to include firms of all sizes and from all sectors of the economy. The last of these considerations may be of special importance to countries that need to compensate certain deficiencies in investment conditions by increasing the attractiveness of privatization programmes. Furthermore, including only loss-making firms while excluding profitable firms would certainly not make a privatization programme attractive. The attractiveness of programmes could be further increased in some countries by linking them to debt-equity swaps.

The outside world has supported the efforts of African countries to improve investment conditions, [eg] by helping in the implementation of structural adjustment programmes and increasing official grants and loans (from US$14,000 million in 1986 to $23,000 million in 1992). Further assistance, however, is required -- especially in terms of debt-forgiveness and upgrading infrastructure -- in order to improve investment conditions for both domestic and foreign investors. For example, although various debt-relief schemes have been in place for African countries since the 1980s, Africa's debt as a percentage of GNP has increased from 60% in 1986-1990 to 67% in 1994, a level more than double those in Latin America and Asia. The continuing debt problem prolongs balance-of-payments difficulties which, in turn, make it difficult to liberalize the capital account and, thus, ease profit-remittance regulations -an indispensable ingredient of any good investment climate. In addition, debt-servicing deprives Africa of badly needed domestic investment resources that could be used to improve infrastructure and encourage investment, thus enhancing the prospects for economic growth -- one of the single most important FDI determinants.

An important new factor that influences prospects for FDI in Africa is the emergence of South Africa as a politically stable and economically dynamic country. For one, South Africa may serve as an example for conflict resolution in other countries plagued by internal political conflict and may thus help them achieve the basic requirement of any good investment climate, [ie], political stability. Secondly, South Africa itself has a potential to attract sizeable inflows of FDI. Thirdly, if such inflows materialize and contribute to the acceleration of economic growth, then South Africa could well become a regional growth pole, and itself become a home country for FDI in the countries of southern Africa. In addition, it could become a dynamic market for export-oriented FDI in neighbouring countries linked to South Africa by free trade agreements.

The message from this analysis is clear: one needs to stop thinking about Africa as a continent without investment opportunities. Contrary to the common perception, FDI in Africa can be profitable, and at a level above average that of foreign affiliates in two out of three other developing country regions. Firms wishing to benefit from the opportunities existing should, therefore, consider African countries as investment locations. At the same time, the governments in the region have to make every effort to maintain or restore economic and political stability, as a general precondition for increased FDI.

Type Classification:
E: Emanations of other strategies