Interdependence of FDI Quality and a Country’s Political Infrastructure: Impactful Foreign Direct Investment (IFDI) Benchmark
illustration by Denis Maksimov
in the context of Denis Maksimov’s PhD research (2011-2014) at the Department of the Theory and Practice of Business-Government Interaction, the National Research University Higher School of Economics (Moscow)
FDIs are an important resource for the economic development of the countries. The flow of FDIs in the world is constantly growing, being slowed down just in 2008 after the economic crisis. Perspectives of globalisation of the international trade suggest that the overseas investment activities would continue the steady growth. FDIs are not coming to the country-object of the investment alone: high-quality FDIs (impactful FDIs, ‘high-quality’ FDI - IFDI†) directly contribute to the competitiveness of the countries economies, bringing in technologies, innovation and unique competences. The researches show that FDIs also motivate national investors to accelerate their investment activities domestically*. On the other hand, short term oriented investors are not interested in development of the fundamental infrastructure and might be even supporting local corruption and underdevelopment of the institutions‡.
Competition for the FDIs among the countries is growing constantly on the global scale. The quality of the investment climate is one of the crucial parameters for the investors. The investment climate is a comfort level of the conditions for doing business and living in a country, defined by sets of variables: macroeconomic policies such as fiscal, monetary and trade policies; governance and institutions; infrastructure§. Investment climate and the country’s reputation among the investors are very interconnected. Both are dependent on the political atmosphere and political risks, which the country’s political system might be generating.
Political infrastructure of the country is a combination of parameters of political system and political regime of the country, that can directly or indirectly affect performance and valuation of the business of the investors. The research will investigate different approaches to definition of the minimum viable quality of political infrastructure for the market entry for the foreign direct investors as well as conditions, that are necessary for strategic entry to the market with long-term perspective. In the case of “low quality” investments the investor is hardly interested in contribution towards long-term development of the country. Therefore investor approaches enterprise in the country exclusively in the framework of quick gains and quick possible exit from the country. Investor in this case will rather participate in corruption schemes than try to contribute to eliminating or transforming them, will not be interested in training personnel and delivering new skills to the population, but rather prefer to import skills for short term.
Quality of the FDI is defined by the period of the entry to the market (short-term vs. long-term), type of the business (ex. natural resources mining vs. technological innovation, high added value production), orientation (external vs. internal market) and another parameters. Quality of the FDI is defined from the data provided openly by the World Bank, MIGA, the World Economic Forum, the IMF and other international organisations and institutions.
The focus of investigation on high quality investments, that accelerate modernisation of the country’s industries, elevate total factor productivity, have positive synergic effect on other economic sectors, contribute to the human capital, education, basic infrastructure and etc. These should be the most desirable investments for a country by default - as they provide direct contribution to country’s long term development.
What are the most important characteristics, that influence the decision of investor concerning the type of business activity he/she plans to pursue on the new market (long term, short term, etc.)?
Low quality political infrastructure generates political risks for the investors, that might cause fatal damages for the business and affect their operations worldwide. As soon as the political infrastructure lacks mechanisms of checks and balances, predictability, cross-controlling functional instruments for defending rights and interests of the investor, the probability of generation of political risks is high. Whatever is the agreement with the strongest political group in the country, investor, by committing to work in such an environment, takes up significant risks for their business, what may result in grave consequences - from financial, reputational and other perspectives.
The importance of the political risk assessment for the investment activities in the world is constantly growing. The ownership and controlling share of governments (posing “compliance risk”) in the national economies is on the rise globally. The political instability, rising level of chaos in the fragile global governance, the economic decline of the West and the rise of the developing economies are among the factors that drive generation of the political risk. From the perspective of post-structuralism, the political, economic, social and cultural institutions (both formal and informal) don’t possess strictly aligned institutional borders - and the process of fuse, blur and deterioration continues. Risks generation occurs on their former borders and enlarging overlaps. Political risk generation occurs in “the loop holes” of the political system. Political risk itself is a certain, generated by a political system event (or combination of events), which causes direct or indirect financial losses for the investor. The parameters of the political risk are diversifying: expropriation, sovereign debt default, currency inconvertibility, violation of the state contract terms, legislative actions against the interests of investors, political violence, riots, strikes, revolts, revolution, civil war, attacks on the employees due to xenophobia/intolerance and other. In order to define exact specific list of the risks for a particular country it is important to make an analysis of the country’s quality of governance beforehand, application of sorts of ‘one list fits all’ types of classification gives vague approximation.
This research aim is to identify the conditions of improvement of the parameters of the political infrastructure, that have potential to attract high-quality investments to the country and improve it’s long term chances for economic prosperity, development of fundamental institutions, transfer of innovation and skills, etc. The idea of introduction of the mechanism for fining the countries with low-quality political infrastructure by introducing the contractual framework in which these the government would be obliged to offer their resources on more favourable terms in case the progress in development of their political infrastructure is not happening. In the times of growing economic and political interdependence of the world, it is important to explore potential of increasing pressure on the countries that are lagging behind in the social performance - causing general slowdown in the global human capital development and economic skewness. It is illustrated by forced migration from place with low quality of political infrastructure to ‘better places’. It is especially important in the modern condition of globalised and increasingly interdependent world economy. The Westphalian political order is hardly representative as the responsibility of the countries for the quality of well-being of their citizens is internationalised due to immediate effects of globalisation.
—-
† FDIs, that have a set of the certain characteristics: strategy assume long term involvement of the investor (10-15 years or more); import of technologies and innovation; creation of jobs for the local population; transfer of new skills to the local population; increasing level of localisation of the production over time; contribution to the competitiveness of local industrial clusters, synergic driving of other businesses’ growth; motivating other investors to come to the country; positive influence on the quality of life of the local population; contribution to the democratisation of political system, increased level of politicians’ accountability.
*Eduardo Borensztein, Jose De Gregorio, Jong-Wha Lee. How Does Foreign Direct Investment Affect Economic Growth? NBER Working Paper No. 5057, Issued in March 1995, http://www.nber.org/papers/w5057
‡ Laura Alfaro, Andrew Charlton. Growth and the Quality of Foreign Direct Investment: Is All FDI Equal? Centre for Economic Performance, LSE. November 2007. http://ideas.repec.org/p/cep/cepdps/dp0830.html
§ OSCE. Best-Practice Guide for a Positive Business and Investment Climate. http://www.osce.org/eea/19768