Government intervention to attract FDI

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• Foreign direct investment (FDI) represents capital invested in a country that provides manufacturing and service capabilities for both native consumers and world markets.  It is important that potential host country undertake foreign investment promotion policies. There are various promotion methods or measures, that are used by Governments around the world to attract inward FDI. These methods can be grouped into three categories: investment promotion, incentives and policy intervention.

1. Investment promotion

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   •  A commonly used definition of investment promotion is “activities that disseminate information about, or attempt to create an image of the investment site and provide investment services for the prospective investors”
   1. Labour skills

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      • Some industries require higher skilled labour, for example pharmaceuticals and electronics. Therefore, governments could undertake education and training of workers in the country in order to improves skills, therefore promoting productivity of labour. For example, India has attracted much investment in call centres, because a high percentage of the population speak English, but wages are low. This makes it an attractive place for outsourcing and therefore attracts investment. However, there is a time lag for a measure such as education and training therefore results regarding increased FDI may not be seen immediately as a result of governement intervention to increase skill.
   2. Transport and infrastructure

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      • 'A key factor in the desirability of investment are the transport costs and levels of infrastructure. A country may have low labour costs, but if there is then high transport costs to get the goods onto the world market, this is a drawback. Therefore the government can invest in infrastructure in order to reduce transport cost.  However, this would result in a n increase of government expenditure, leading to an increas in PSBR resulting in increased interest rates and crowding out effect. Tax payers burden would therefore increase. 
   3. Political/economic stability

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      • Political and economic stability can facilitate an influx of FDI. Stability represents predictability and the opportunity for enterprises to gain better foresight into the future. Alternatively, constant social unrest, rioting, rebellions and social turmoil are settings not conducive to business. Economic instability can also contribute to hyperinflation, which can render the currency virtually obsolete. To encourage FDI, citizens/workers as well as businesses should have a reasonable basis for respecting law and order. The justice system should also have effective mechanisms for reducing, or altogether eliminating, rogue and corrupt elements of law enforcement agencies.  For example, the recent Russian economic crisis, combined with economic sanctions, will be a major factor to discourage foreign investment. 
   4. property rights

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      • Protection of rights of the foreign investors. 
2. Incentives

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   • Apart from fiscal or tax incentives, defined as “policies that are designed to reduce the tax burden of a firm” (including loss write-offs and accelerated depreciation), countries could offer financial incentives, defined as “direct contributions to the firm from the government” 
   1. Tax insentives

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      • In order to attract FDI the government of the host country could offer tax concessions hence enabling the TNC to maintain high profit margins which they can use for expansion and R&D. However, it depends on the magnitude of the incentive offered to firms in relation to other countries. e.g: if China's incentive to MNCs is greater than India's incentive then more MNCs may be attracted to China
   2. Sudsidies & Grants

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      • The provision of grants & subsidies especially for exports and for R&D will decrease their C.O.P. It will make their goods competitive on the world market and therefore attracting FDI to a country.  Subsidies on capital equipment will reduce the cost of machinery which will increase production and lower cost for TNCs hence increasing their market share. 
   3. Special Economic Zones

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      • A special economic zone (SEZ) refers to designated areas in countries with special economic regulations that differ from other areas in the same country. These regulations tend to contain measures that are conducive to foreign direct investment. Conducting business in a SEZ usually means a company receives tax incentives and the opportunity to pay lower tariffs. SEZs are zones intended to facilitate rapid economic growth by leveraging tax incentives to attract foreign dollars and technological advancement. While many countries have set up SEZs, China has been the most successful in using SEZs to attract foreign capital. In fact, China has even declared an entire province, Hainan, to be an SEZ. This is likely to attract FDI due to the probability of lower C.O.Ps
3. Intervention

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   • e intervention methods should involve general steps to enhance overall human capital and technical capabilities of the economy. Governments may reduce rigidities in labour market, remove the barriers in entry/exit, promote intellectual property rights and strengthen governance.
   1. Labour Market Policies

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      • A major incentive for a multinational to invest abroad is to outsource labour intensive production to countries with lower wages. Therefor government could attract FDI through lowering the minimum wage rate in a country, to make labour cheaper therefore reducing the C.O.P for firms. This could result in opposition from trade unions and pressure groups like greenpeace therefore discouraging FDI
   2. Access to free trade

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      • A significant factor for firms investing in Europe is access to EU Single market, which is a free trade area, but also has very low non-tariff barriers because of harmonisation of rules, regulations and free movement of people. 
4. Evaluation

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   • There are many different factors that determine foreign direct investment (FDI) and it is hard to isolate individual factors, given there are many different variables. It also depends on the type of industry. For example, with manufacturing FDI, low wage costs tend to be the most important, as they are labour intensive industry. For service sector FDI, macro-economic stability and political openness tend to be more important. Also, it depends on the source of FDI, American firms may value political openness more than Chinese firms. Or American firms may have a preference for countries where English is spoken more.