Apart from capital, FDI flows are expected to bring key resources to their host countries such as technology and organisational skills. These resources could be used to create jobs, develop new industries, expand the base of manufactured exports and contribute to productivity improvements with spill-overs of knowledge brought by them to domestic firms.
However, these benefits do not always materialise as FDI inflows vary greatly in quality. While some FDIs may benefit host economies, others may crowd-out domestic enterprises and actually reduce host country welfare.
RIS studies examining the effect of FDI inflows on domestic investments for a large sample of developing countries in a dynamic setting reveal that a greater number of countries experience a net crowding-out effect (29 countries) while countries experiencing crowding-in is smaller (23 countries).
In general, crowding-out dominates the relationship in Latin America and the Caribbean region. In Asia and Africa, the cases of crowding-in and crowding-out are evenly distributed. Therefore, increasing FDI inflows may be desirable but it is equally important to pay attention to their quality as they are the means for development and not the ends by themselves.
The quality of an investment is to be judged from the externalities or spill-overs on the economic activity in the host economy. Many host countries employ regulations such as screening, performance requirements, and incentives to maximise the favourable externalities from FDI. The objective of such policies is to maximise the chances of FDI crowd-in and prevent crowding-out of investments.
FDI taking the form of a greenfield investment has better chances of generating positive externalities in terms of generation of employment, fresh output and transfer of new technologies compared to acquisition of a running enterprise. Hence, some countries discourage acquisitions by foreign enterprises.
Similarly, export-oriented FDI has better chances of favourable externalities compared to FDI targeting the domestic market. It minimises the possibilities of crowding-out of domestic investments and generates favourable spill-overs for domestic investments by creating demand for intermediate goods and transferring world?s best practice technology to the host country. Therefore, a number of countries employ a variety of policies to channel FDI to export-oriented production.
China?s record is most impressive in pushing FDI through performance requirements to develop export-oriented industries which now account for 55% of the country?s manufactured exports and 80% of high technology exports. Multinational enterprises (MNEs), in contrast, account for less than 10% of India?s exports.
India?s experiences with export performance requirements have been successful in inducing MNCs to exploit its potential for export-oriented production as documented by RIS studies in food-processing and auto industries.
In terms of entry mode, joint ventures improve the chances of learning by local joint venture partners which can absorb know-how and build on that. There are a number of cases of local partners in India building their technological capability and emerging as internationally compe-titive (like auto industry). A number of countries, therefore, tend to limit the extent of foreign ownership to encourage joint ventures.
In India, availability of a vibrant domestic entrepreneurial pool makes joint ventures an interesting proposition even for the foreign entrant.
It may be argued that FDI in manufacturing may have more favourable spill-overs in terms of employment-generation and backward linkages than in services. Governments, therefore, have been more restrictive to FDI in services than in manufacturing.
In China, the bulk of FDI is in manufacturing with very little going to services. Thus, it can be concluded that quality is as important a consideration for FDI inflows as magnitude.
India has not been able to exploit the potential of FDI for building export-oriented production capability. The challenge is to effectively leverage its large and expanding market to attract new entrants and push them towards using India as an export-base.
Proactive targeting and promotion of export-oriented FDI could also be useful for exploiting India?s potential in attracting export-platform FDI. This may be kept in mind while considering opening new sectors of the economy such as retail trade .
For instance, it might be useful to insist on joint ventures. To exploit the marketing prowess of foreign entrants, certain export performance requirements may be imposed to prompt them to source inputs from India for their markets in other countries.
Export-obligations are fully consistent with TRIMs (trade related investment measures) Agreement of the World Trade Organisation and can be employed without problem.
These export-obligations may actually help MNEs discover the potential of the country as their global sourcing base and a win-win opportunity may emerge for both.
The author is DG, Research and Information System, Developing Countries. The views are personal
