The title of this article comes from a study that I recently had access to and which concluded, to my enormous surprise, and perhaps that of my reader, that Foreign Direct Investment (FDI), in the 44 developing countries analysed, on average, contributes negatively to their respective economic growth.
In other words, in developing countries (including the SADC region), FDI does not normally make GDP grow but, on top of that, it generates diseconomies.
Perhaps now we can interpret in a new light, i) in addition to the reduction in commodity prices in 2019 and ii) added to by the Covid-19 pandemic crisis, why the stock of FDI, on the African continent, has reduced by 10% ($45 billion USD) in 2019, and in 2020 the estimated contraction is between 20% and 40%.
And this trend is here to stay.I leave the explanation of the causality of FDI generating diseconomies in developing countries referring to the excellent study whose reference I leave in footnote.
In this article I invite you to analyse FDI from a different perspective: what are the effects for the host country of abandoning a large FDI project.
In this context we will see successively the i) Concept of FDI and its benefits; ii) Concept and modalities of linkage; iii) Negative Externalities resulting from the exit of FDI; iv) Mitigation solutions and v) Conclusions.
i) Concept of FDI and its benefits: “It is the investment made to create (new investment or Greenfield), or acquire (M&A Acquisition & Merger or Brownfield) a lasting interest in companies operating outside the investor’s economy. The FDI relationship comprises a parent company and a foreign subsidiary, which together form a multinational company. To be considered as FDI, the investment must give the parent company control over its subsidiary”.
The popularity of this instrument of economic development is rooted in the fact that it generates, for the host country and its enterprises, communities and populations, a series of positive externalities that we can synthesise through the notion of capital accumulation:
- Financial capital: for example, through the inflow of financial resources from the parent company;
- Human capital: for example, the creation of jobs, particularly highly qualified positions
skilled positions; - Technical capital: e.g. knowledge sharing through training programmes and internships at the parent company; sharing of best management practices
- Technological capital and industrial property: e.g. through the import and use of state-of-the-art technology and flexible, high-tech manufacturing processes
- Market-capital: e.g. through the opening of new export routes and internationalisation of domestic firms;
- Public capital: e.g. through increasing the tax base and consequently the collection of taxes, fees and licences resulting from FDI inflows;
- Community and environmental capital: for example, through resettlement programmes;
- Other positive externalities of FDI: e.g. from the construction of road, rail, port infrastructure, etc.
Surprisingly, in developing countries, including the SADC region, on average FDI contributes negatively to their economic growth
ii) Concept and modalities of linkage: But the accumulation of different forms of capital does not only occur in and through the multinational company: the charm of the FDI instrument for the host countries lies in the opportunity to involve domestic companies in this capital accumulation effort so as to qualify their talent, upgrade technology, strengthen their management practices, improve their productivity levels and thus be able to produce products and services of higher added value enabling them to compete in international markets.
And so the linkages/linkages between multinational companies and domestic companies arise, sometimes voluntarily, sometimes imposed by local content regulations.
Although the linkage modalities may be diverse, a recent study points to vertical linkage (that which occurs between the multinational company and its suppliers in the host market) as the most frequent modality (horizontal linkage being that which operates between the multinational company and its clients).
iii) Negative Externalities resulting from the exit of FDI: And back to our surprising opening note. Now, FDI in developing countries contributes negatively to economic growth.
And what about the consequences of the multinational company leaving the host country?
The concept of negative externality helps us to answer this question: in a given economic activity (e.g. FDI), negative externalities are the negative effects on third parties that did not participate in the decision-making process (e.g. abandonment of the host country) and that do not have (e.g. individuals, companies, communities, the state) effective feedback mechanisms to demand compensation.
And, in the case of FDI exit from the host country, the examples of negative externalities are the other side of the coin of what we have enunciated above as forms of capital accumulation: in this case, rightly called diseconomies or destruction of financial capital, human capital, technical capital, technological capital and industrial property, market capital, public capital, community and environmental capital, other externalities (negative effects on infrastructure maintenance programmes, etc.).
iv) Mitigating solutions: In the context of developing countries and in the face of this double FDI scissor effect (when entering, FDI does not generate value, but rather destroys value, and when leaving, it worsens the capital destruction effect), what defence mechanisms do host economies have? Reducing the volatility of FDI involves
1) Increasing political, economic and social stability in the host country;
2) Minimising, simplifying and streamlining the Doing Business environment;
3) Reorienting FDI away from natural resource dependence and diversifying the economy;
4) Granting tax benefits and exemptions on a conditional basis (e.g. to the permanence of linkage effects in the territory, not necessarily of the multinational).
In conclusion
FDI is a powerful tool for economic development as it allows the host country to accumulate capital, in its various forms.
It is no wonder that countries struggle to attract FDI. And most particularly in developing countries, where the double effect of lower commodity prices and the pandemic crisis has generated gigantic losses of FDI inflows.
Surprisingly, in developing countries, on average FDI contributes negatively to their economic growth.
Less surprisingly, the abandonment of FDI represents an opportunity cost, which may become a lost linkage if no innovative measures are taken to decrease its volatility.
