The policy dimensions of FDI

The Policy Dimensions of FDI

An analysis is now made of the different FDI policy dimensions in which PIs are made to be

implemented by host countries. It is important to note here that governments of developing

countries choose PIs – generalized as incentives – to attract FDI in relation to their overall

economic development goals. Thus, different dimensions of incentives can be depicted. First,

incentives can be either general or specific (with a discretionary perspective). A second

dimension is the durability of incentives. Indeed, according to the host country’s priorities,

incentives could be either permanent or temporal. However, pragmatically speaking, PIs related

to incentives need to change in duration so as to encourage the kinds of FDI and industrial

specialization the country desires. And therefore it is useful to think of these PIs as windows of

opportunity which open and close. Another dimension exists at the geographic – or spatial –

level since IP policies can target FDI either at a local, national level or regional level. Local

incentives can be used to promote specific regions of a country that are poorer or in greater need development. Further, incentives can be used to attract foreign investors to the whole economy or only to certain sectors or subsectors, according again to the specific needs of the country. In the past, this has carried the rubric ‘negative’ or ‘positive’ lists which cordoned off strategic sectors of the economy to foreign investors and reserved others for national firm.26 Finally, at the firm level, incentives can focus either on all FDI, or only on specific investors. These dimensions are depicted in figure 4, A Framework for Operationalizing FDI Policy Dimensions and Instruments.

To say that policy craft – creating policy coherence out of the conflicting demands from modal

neutrality, market contestability, as well as scaling and measuring the factors and variables

which must be considered in policy research and analysis – is a challenge, is an understatement.

This paper makes early reference to the growing importance of investment and business climate

benchmarking as a guide to policy-making. However, econometrically, as every factor or

variable (or their combinations) has its own FDI inflow- and stock-elasticity, IPAs and policy

makers with limited resources should concentrate their policy craft on those FDI factors and

variables with the highest FDI-elasticities . In rank order, these are: (i)

growth-competitiveness, which combines macroeconomic and technology variables, with an FDI inflow elasticity of 0.63; (ii) economic freedom, combining government intervention, property rights, wages/prices and regulation variables, with an FDI inflow-elasticity of 0.56; (iii) taxation and regulation with an FDI inflow-elasticity of -0.50; (iv) quality of telecommunication services with FDI inflow-elasticity of -0.28;28 and (v) labour market regulation with FDI inflow-elasticity of -0.26. Furthermore, these elasticities have short- medium- and long-term adjustment rates.

This approach begins to lay out the choices available to policy makers in making viable PIs in a

systematic manner based on rigorous analysis. Hence, from a fourth-generation IP perspective, a focus on the macroeconomic environment stability and technology policies to increase the rates of innovation and transfer by PIs that facilitate licensing and franchising, for example, would be needed. In a similar vein, harmonizing taxation regulation across regional space would be a viable policy.

All these elements and issues in figure 4 reflect the need for sequencing and switching PIs and

incentives, both in space and time. In other words, while FDI policy-making is increasingly more complex and diverse, host governments, according to their development needs, have to adapt to the MNEs dynamic activities by sequencing and switching (in a predictable manner) their FDI PIs. Moreover, these different policy dimensions also indicate the importance for host

governments to create different levels of policies: the meta- or supra-national level, the macro or national level, the meso or regional and cluster level, the micro or industrial sector and subsector level and the firm level of organizational strategy and competitiveness . The complexity of FDI host policy-making is obvious but the policy dimensions have to be chosen and established in harmony with the general development goals set up by the government.

Whereas industrialized countries typically utilize financial incentives, such as grants, developing countries usually use fiscal incentives, such as reductions in the base rate of corporate income tax, tax holidays and import-duty exemptions and drawbacks (Oman, 2000). Incentives are widely used to attract MNEs and thus create a climate of policy competition for FDI. Fiscal incentives might be successful for attracting MNEs, but incentives-based competition also creates some problems. Indeed, the first problem of incentives is that they represent opportunity cost of resources to host governments. Secondly, there can be a significant lack of transparency regarding incentives, which leaves space for corruption and other kinds of rent-seeking behaviour. Finally, given the dimension choices in figure 4, incentives also provoke market distortions. Among them, the major ones are the fact that incentives tend to favour large corporate investors to the detriment of small ones, as well as foreign over the domestic firms because of their lower risk profile and higher bargaining power. The distortion would tend to disappear (over time) in countries adopting fourth generation of IP, as they would treat foreign and domestic firms equally with regard to incentives.