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  1. 1. United Nations ESCAP Training Workshop on Investment Promotion and Facilitation Module 1 “Setting the Scene: Global FDI Trends, Competitiveness, and the Investment Promotion Function” Session Notes Prepared by Asia Policy Research Co., Ltd., 2003 1. Global and regional business and FDI trends and the role of AFTA: implications for IndoChina From both the business and policy perspective, any investment promotion strategy must be designed to respond to current global and regional trends in economics and business. And any effort to stimulate competitiveness must involve the creation of a competitive business environment. The following assessment of the most influential global and regional business-related trends defines the context within which the drive to enhance FDI inflows in Indo-China must be formulated. Globalization. External influences on economies, political systems, and societies are intensifying as a result of the globalization of production processes, higher levels of economic interdependence, and advances in transport and telecommunications technology. Economies that do not integrate into the global economy risk falling behind those that do in terms of growth potential, access to technology and innovative capabilities, including development of new production and management processes. Globalization is also affecting business operations. Businesses -worldwide have long been aware of the importance of overseas markets and access to overseas factors of production to expand and improve their operations. However, the rapid changes in global markets are forcing businesses to increase the scope, pace, and intensity of global business linkages in order for them to maintain their competitiveness and market position. Liberalization. Throughout the world countries are accepting the need to open up their markets to foreign goods and services in order to achieve increased efficiency through economies of scale, and better access to necessary factors of production. Tariff barriers are gradually being brought down both within the context of the multilateral trading system within the framework of the World Trade Organization (WTO), and of regional trading arrangements such as the ASEAN Free Trade Area (AFTA), the North American Free Trade Agreement (NAFTA), and others. Liberalization brings both benefits and challenges. Expanded market opportunities, new sources of technology, and increasing foreign direct investment (FDI) also result in greater competition in domestic markets. Domestic firms must become more competitive domestically and globally or risk losing their market position to foreign firms and products. Changing investment trends. As the level of world trade stagnated in 1999, the activities of transnational corporations (TNCs) increased greatly, particularly in mergers and acquisitions (M&As), making FDI the main force in international economic integration. However, global FDI inflows fell by 41 per cent in 2001, and by a further 21 per cent in 2002 to an estimated US$ 651 billion. Developing countries’ share of FDI inflows dropped from 30-40 per cent in the mid-1990s to 25 per cent in 2002. In order to compete for FDI inflows, the economies in Indo-China will have to adjust to the new determinants of FDI location. Traditionally, FDI has been attracted by the existence of large domestic markets (often protected by high import tariffs), abundant natural resources, and cheap unskilled or semiskilled labour. The current global economic and business trends demonstrate that these more traditional factors in FDI location decisions are no longer as important as before, and have been surpassed in many instances by a new set of factors. Training Workshop on Investment Promotion and Facilitation, Module 1 Page 1
  2. 2. Access to large domestic markets has decreased in importance as an investment determinant partly as a result of lower trade barriers and domestic content requirements found in many countries, though in other cases where products can only be made available to end users through direct investment, large domestic markets have kept their appeal (i.e. China, Viet Nam) while the incidence of domestic content requirements has decreased as a result of global and regional commitments (i.e. TRIMs). Access to natural resources as a key determinant of FDI inflows has also decreased in importance (with the exception of oil and gas) because of the rise of the new knowledge-based and value-added economy and the subsequent diminishing role of primary products. Likewise, low cost unskilled labour no longer has the same importance in attracting FDI as even relatively simple labour-intensive activities require new technologies and upgraded skills with the reorientation of production towards more sophisticated markets and consumers. Thus, the new determinants of FDI location are evolving and necessitate extensive economic liberalization within a stable legal framework, rapid technical progress in transport, communications, and information, and new management and organizational techniques of firms. The ability of the countries in Indo-China to attract FDI now and in the future will depend greatly on their ability to provide the required skills, adequate infrastructure, stable and efficient legal and financial systems, competent suppliers, and institutions that harness technology effectively. Global supply chains. Another key trend is the emergence of intensified and expanded global production networks created by TNCs. TNCs are forging closer links with firms around the world, both with other TNCs and domestic companies, thereby establishing global supply chains that enable other firms, including domestic companies such as small and medium-sized enterprises (SMEs) to undertake various activities in the production and service processes. Effective supply chains are seen as a critical element of modern business operations, and TNCs search for efficient and reliable suppliers and subcontractors locally and overseas through a process called “outsourcing”. The backward linkages that arise from these global supply chains, when foreign firms acquire goods and services from domestic firms, bring numerous benefits for the firms involved (both local and foreign) and the host country. The domestic firms acquire better knowledge, upgraded skills, advance technology, and at times better access to sources of finance, while foreign firms benefit from the linkages through reduced costs and enhanced access to local assets. The host country benefits from the introduction of new standards of technology and skills, which eventually diffuse throughout the country, and also from the enhanced perception among foreign investors of the country’s capabilities and increased sophistication of its suppliers. The governments of the countries in Indo-China can play a key role in promoting linkages with global supply chains by lowering the costs of establishing such linkages, raising the rewards for forming them between foreign and local firms, and encouraging deeper linkages among the existing ones. Among the tools to encourage linkages are: exempting exporters from value-added tax to encourage use of local inputs; tax deductions for costs related to linkage formation; special requirements in government procurement contracts; information and matchmaking services; incentives for technology upgrading of local firms; management training programmes for local firms; providing information on local firms to foreign investors looking for joint ventures, promoting supplier associations, etc. Production and technology. Two of the most important trends in production and technology are the shortening life cycles of products and technology, and the rapid changes in information and communications technology (ICT). These changes are putting increased pressures on the need for regional cooperation, while providing the tools for it. However, while developing countries understand the need to upgrade their capacity in acquiring and absorbing ICT, they feel they cannot keep pace with the rapid advances in this area. Governance. The principles of governance – such as transparency, accountability, predictability, fairness, and people’s participation – have become increasingly accepted worldwide . The Asian economic crisis in particular heightened awareness of good governance and accountability, with foreign investors and multilateral institutions now scrutinizing countries as potential investment destinations more closely in these areas before committing resources. Therefore, countries wishing to attract FDI must adopt systems of corporate governance that conform to both international standards and to their own public and private sector structures and implementation capacities. Training Workshop on Investment Promotion and Facilitation, Module 1 Page 2
  3. 3. Growth of Regional and Subregional Groupings. Along with the trend towards global trade liberalization within the context of the WTO, regional and subregional economic cooperation frameworks have increasingly emerged around the globe. These include formal arrangements such as SAARC and ASEAN, and less formal ones such as APEC, BIMST-EC (Bangladesh-India-Myanmar-Sri Lanka-Thailand Economic Cooperation) and the Greater Mekong Subregion (GMS) Economic Cooperation. Often, these arrangements provide effective mechanisms for both smaller economies in their efforts to integrate into the global marketplace and to larger ones in providing the opportunity to take advantage of regional or subregional economies of scale. Of particular relevance to countries in Indo-China is the formation of AFTA and the ASEAN Investment Area (AIA), which are expected to form a major attraction to foreign investors and allow relatively small countries like Cambodia and the Lao People’s Democratic Republic to expand their markets and promote FDI in a broader more meaningful context. China’s recent WTO membership. China has cleared the last hurdle in its 15-year quest for WTO membership, and its admission to the global trade body took place in 2002. China’s accession poses both opportunities and challenges for the economies in Indo-China. While a liberalized Chinese market may improve export opportunities for countries in Indo-China, at the same time they may face increased competition from Chinese products in third markets, while some forms of FDI may be diverted from IndoChina to China. As a result, China’s WTO membership has clear implications for economic policy in countries in Indo-China necessitating accelerated but sustainable economic reforms and increased subregional and regional cooperation. Newly emerging markets in South Asia. Another key regional development is the gradual emergence of the economic importance of South Asian countries, particularly India. Many of these economies, which have traditionally followed an import-substituting strategy, are now increasingly opening up to external markets, making South Asia a potentially new market for FDI but also an emerging competitor in labour-intensive products. 2. Impacts and benefits of FDI: building competitiveness and strengthening supply chains FDI brings with it a number of benefits: • • • • • • • Job creation – the most common benefits associated with FDI are increased and protected employment in a better working environment. Together with new employment, additional income and spending power for local residents will come and with it a widened tax base. Revenue benefits – FDI will widen the local tax base and contribute to Government’s revenue. Even if foreign investors are exempted wholly from corporate income tax, the Government can generate revenue from personal income tax and other indirect taxes. Positive impacts on local investment – FDI inflows will encourage the development of domestic investment since local companies have access to distribution channels, become suppliers and/or respond to competition from foreign companies. Technology transfer – FDI can contribute to a country’s access to and development of technology through licensing, joint ventures, local trade and establishment of local R&D centres. Improved skilled labour – Local employees can be exposed to new technical and management skills. This will stimulate higher productivity, entrepreneurship and promote the quality of local education. Improved export – Much FDI is export-oriented. With their access to overseas markets and global distribution networks, foreign companies can export more effectively than domestic companies. If properly managed, many countries can use FDI as a way to increase their export levels and improve foreign exchange earning. Improved international competitiveness of local firms – Through the interaction with foreign invested companies, local firms can improve their quality level and reliability and therefore become more competitive in the international market. More generally, FDI can improve overall economic growth by increasing competition in sectors that are dominated by a small number of local firms. However, within the context of the rapidly evolving global marketplace described above, major national investment promotion challenges can be identified: in two key areas: first, in creating a business Training Workshop on Investment Promotion and Facilitation, Module 1 Page 3
  4. 4. environment that combines the micro-concerns of business with the macro- concerns of policy makers to build competitiveness; and second, to link the country more to global supply chains. 2.1. Building competitiveness It must be emphasized that the end goals are continually moving as the dimensions of competitiveness evolve and become more complex. In general, macro-environments around the globe are converging, pressured by global liberalization trends (i.e. WTO), and micro-factors are becoming determining factors in location decisions made by private companies. In particular, as tariff rates are falling and investment incentives are converging in most countries in the world, investment decisions are increasingly based on other factors such as the quality of local suppliers, ease of operating in the country, costs of doing business, stability of the legal system, and other factors. Macroeconomic policies are a necessary but not sufficient contributor to economic growth and development. An improved macro-environment will not necessarily generate sustained growth unless the underlying micro-foundation is sound. And eventually, the key determinant of sustained productivity growth will be the extent to which continual innovation is adopted and accepted as the fundamental principle to deepen and strengthen the microeconomic foundations of competitiveness. Michael Porter (WEF Global Competitiveness Report, 1998) points out that the competitiveness of a country depends broadly on three factors: (a) political, legal, and macroeconomic context; (b) quality of the microeconomic business environment; and (c) sophistication of company operations and strategy. This simple conceptualization provides a framework for considering a whole host of policy measures and mechanisms and for developing a new rationale for public sector involvement in building the operating environment (factor a) for companies within the economies of Indo-China, both individually and collectively, so that the so-called "microeconomic foundations" (i.e., factors b and c) can flourish. Given that a generally accepted core objective of development is the creation of “conditions for rapid and sustained productivity growth,” the above framework permits the explicit consideration of both the macro- foundations, which are clearly required for sustained growth, and of the micro-foundations, which reflect much more closely the concerns and issues of the actual operating units (i.e. businesses) that generate wealth in the economy. Therefore, without down-playing the importance of macroeconomic issues, one can examine in detail the micro-factors that need to be considered to support the operations of the business community; in particular the infrastructure, advanced institutions, and human resources needed for companies to develop more sophisticated business strategies. Porter characterizes the business micro-environment in terms of four interrelated influences: • • • • Factor (input) conditions: The quality and specialization of underlying inputs that firms draw on in competing. Demand conditions: The sophistication of home demand and the pressure from local buyers to upgrade. Related and supporting industries: The availability and quality of local suppliers and related industries. Context for firm strategy and rivalry: The context shaping corporate investment, the types of strategies employed, and the intensity of local rivalry. Each of these elements needs to be considered in order to understand (and influence) the microeconomic business environment in such a way as to enhance competitiveness and sustainability. Increasingly, a critical challenge for all emerging economies will be one of developing the innovative capacity to develop and commercialize new technologies, products, services, and processes. Innovation can be said to “drive the rate of long-term productivity growth and hence future competitiveness” (see the WEF Global Competitiveness Report, 1999). While this concern with innovation may appear beyond the immediate concerns of the economies of Indo-China, the importance of explicitly linking measures today with those that will be required in the future deserves emphasis. The whole point of the focus Training Workshop on Investment Promotion and Facilitation, Module 1 Page 4
  5. 5. on competitiveness is that a business must consider all the elements of the operating environment at the same time – from macro to micro. Future developments must be factored in, suggesting that efforts to influence investment decisions must also lay out a vision for the future in order to be effective. 2.2. Global supply chains A concept that has featured increasingly literature on competitiveness is that of supply chains. Increasingly, supply chains and the related logistics issues are critical competitive business tools that establish and maintain company competitiveness, facilitate entry into new markets and, more recently, harness the power of ICT and the Internet. Just to provide an indication of the extent to which supply chains can make a difference in improving competitiveness, one need only compare the logistics cost/GDP ratios in the United States and in Thailand. Currently, the ratio is 10 per cent in the United States, while it is estimated to be approximately 30 per cent in ASEAN. It follows that a 5 per cent reduction in logistics costs in Thailand would result in a cost savings of 5 per cent of Thai GDP, working out to US$6.75 billion (Year 2000 data). Such huge cost savings would have a positive, sustainable impact on national competitiveness. Supply chain management (SCM) as a means of improving firm performance has been prevalent in western business thinking for three decades, and during that time it has evolved through at least three distinct stages: • • • In the first stage supply chain management focused primarily on integrating productive processes within single companies and removing the internal obstacles and organizational rigidities that prevented companies from operating efficiently and from responding more quickly to new opportunities. Dramatic cost savings were achieved in this first phase, demonstrating clearly that the supply chain is a major factor – if not the most critical factor – in achieving cost competitiveness. In the second phase, SCM efforts were extended to create seamless linkages between and among companies, dealing mainly with issues related to production and related flows of products and finance. Again, the competitiveness gains realized in this second phase of SCM development were quite extensive. In its third phase, SCM has increasingly focused on engaging the ultimate customer directly into the value creation process. This third phase of SCM is highly dependent on ICT and in particular on developments taking place with the Internet. In this third phase of development, a diverse set of new business models have emerged that create value and distribute it among chain participants in new and innovative ways. According to supply chain expert John Aitken, the supply chain can be defined as “a network of connected and interdependent organizations mutually and cooperatively working together to control, manage and improve the flow of materials and information from suppliers to end-users.” Supply chain management, in turn, is “the rationalization and control of all activities in the supply chain, encompassing sourcing, manufacturing, distribution, marketing and most recently sourcing and shopping.” In the quest for improved competitiveness, supply chain management offers business a dynamic commercial weapon which provides the capacity to increase revenues, reduce costs, reduce working capital and achieve other related capital reductions. 3. New Characteristics and Forms, Modalities and Determinants of FDI Flows In a recent major report on science and technology in the Thai economy1 , the authors identified five critical concerns that underpin the need for a more focused effort on industrial upgrading: • • 1 The pervasive importance of knowledge resources and innovation capabilities; The critical significance of creating a basis for dynamic competitiveness; Extracted from: “Knowledge Resources, Innovation Capabilities and Sustained Competitiveness in Thailand: Transforming the Policy Process”, Martin Bell et. al., 2003 Training Workshop on Investment Promotion and Facilitation, Module 1 Page 5
  6. 6. • • • The increased knowledge-intensity of resources required for dynamic competitiveness today compared with the 1970s and 1980s; The emergence of China as a major competitor in the regional and global economy; and The growing significance of new forms of FDI in the global economy. Knowledge-resources and innovation capabilities contribute to rising real incomes mainly by raising the dynamic competitiveness of locally owned enterprises. But they also do so in a more indirect way via their impact on FDI. The potential importance of this argument not just for Thailand, but also for the economies in Indo-China, has increased in recent years. Traditionally FDI in industrializing countries like those of Indo-China has sought to exploit low-cost, low-skilled labour and/or relatively cheap natural resources. Also, FDI has been attracted in the past by with two policy-created environments: (a) protected domestic markets for relatively high cost goods and services, and (b) tax and other incentives for starting production in the country. Traditionally also, unless other kinds of valued resources become available to such foreign firms, they tend to close down or move elsewhere as: (a) labour costs rise, (b) natural resources become exhausted, (c) domestic market protection falls and (d) initial incentive packages ‘run out’. As a result, one might be tempted to argue that Indo-China would be best served in the longer run by giving somewhat limited attention to FDI as a mechanism to strengthen competitiveness. But that is far from the whole story. Another critical factor, the skill base and wider knowledgeresources of host economies, have become increasingly important in shaping the pattern of FDI in industrializing countries in two ways: • • They are increasingly significant in influencing corporate decisions on start-up of production via initial investment in countries like Thailand at the present time, and likely Indo-China in the near future; and They are probably even more important in influencing later decisions on whether to expand and stay in particular countries or to move elsewhere. In both cases it is evident that corporate decisions are strongly shaped by the extent to which subsidiaries of TNCs are fully utilizing strong local bases of skill and knowledge resources, along with associated structures of knowledge-centred institutions – training centres and colleges, knowledge-intensive service suppliers, universities, research institutes, and so forth. At the global and regional level there is a growing segment of ‘higher quality’ FDI for which these knowledge-based assets are specifically valued when corporate decisions are made about a range of key issues: starting up, expanding, investing in the production of more advanced products, or moving on elsewhere. More generally, cutting across locally and foreign owned enterprises, this knowledge-centred resource base is a critically important component of a wider package of assets and resources that contribute to the localized agglomeration of production around particular sectors and supply chains. Whether undertaken by locally-owned or foreign-owned firms (and it is frequently a combination of both), these clustered patterns of production are increasingly significant as bases for competitiveness in the global knowledge-economy. In this context of clustered production and knowledge systems, the ‘higher quality’ forms of FDI differ from those of the past in one fundamentally important respect. Traditional forms of FDI typically employed local labour and exploited local natural resources, without adding very much to those traditional determinants of competitiveness. In contrast, while ‘higher quality’ FDI obviously does draw on the existing local resource-base of skills and knowledge, it is much more likely also to strengthen and extend these knowledge-centred resources – adding to a cumulative process of building and renewing the basis for future competitiveness. However, the extent to which this happens varies. It seems to depend partly on differing company-specific strategies and partly on policy measures in host countries. A major aim of policy in host countries like Thailand, but also of countries in Indo-China, should be to exploit this variability. Training Workshop on Investment Promotion and Facilitation, Module 1 Page 6
  7. 7. New forms of FDI which are more knowledge and technology-based will undoubtedly demand more sophisticated infrastructure and institutional support, not least in the area of ICT. As a result, these forms can only be attracted by countries that have devoted significant attention to developing the “knowledge” sector and its related elements. 4. The Evolving Investment Promotion Function and the New Challenges for Investment Promoters A lot of ground has been covered in the previous three sections – from global and regional challenges to the competitiveness environment and to supply chains. This concluding section tries to draw together the main lessons and implications for Indo-China investment promotion policy makers under a number of key headings: General Competitiveness Issues • • • • • • • From Macro to Micro. Macro factors are necessary but not sufficient to create a business environment that can support sustainable productivity growth; micro factors are the key to sustained economic development in the medium term. Looking to the future, the framework highlights the need to link together the measures needed today with the challenges to be faced in the future, in particular the need for innovation and creativeness. The importance of integrating all aspects of the development policy framework together, perhaps in the context of moves towards a Knowledge-Based Economy (KBE), is a critical element of any successful effort to enhance competitiveness. A key element of the competitiveness drive involves the importance of benchmarking key indicators of the business environment and investment framework against those of neighbouring countries and others, and using these benchmark results to target the key needs in creating a more competitive environment. Ensuring a level playing field. Transparency is a key, with unbiased modalities for settling disputes when claims of unfairness arise. In particular, greater use of e-government, namely in terms of information availability through websites of the implementing agencies, can facilitate transparency and awareness of the rules in the operating environment. Looking beyond borders. Maximizing the benefits from regional economic cooperation, particularly in the context of the GMS and ASEAN. This will especially benefit smaller countries, for which it is also more difficult to compete in the global marketplace. Greater private sector participation in the policy-making process is a critical element of fair and unbiased policy making, particularly if business associations and other broad-based private sector institutions are involved as opposed to individual firms seeking preferential treatment. Private sector participation should include domestic and foreign businesses to ensure fairness and access to the broadest range of expertise and resources. Supply Chain Management • • • • • • Logistics and supply chains can serve as valuable blueprints for facilitating the national ability to compete. In particular, they offer valuable: Guidelines for national policy making to support competitiveness – seeking new policies and programmes that can enhance private sector operations; and Insights for creating an environment to support business in improving value chains and finding new market niches. In a more direct sense, SCM offers tremendous implications for improving the effectiveness of public sector services, often with a direct impact on the competitiveness of firms. The increasing integration of SCM and information technology makes the better understanding of SCM especially important in building up the ICT infrastructure that will become a prerequisite for success in global markets. Given the extent to which SCM issues will resonate with the private sector, this framework provides a useful foundation for enhanced public-private sector collaboration. Training Workshop on Investment Promotion and Facilitation, Module 1 Page 7
  8. 8. Implications for Investment Promotion Agencies • • • • • Given the growing importance of competitiveness and the underlying foundations for competitiveness as determinants of FDI, IPAs must take a proactive role not only in keeping up to date with global and regional trends, but also in disseminating information about and promoting awareness of the policy implications of global and regional developments. The IPA can play an important role in making international benchmarks available to local business and stimulating activities that spur greater interactions between local and foreign businesses. The IPA must act as an ombudsperson for business, ensuring that factors, which inhibit the ability of the private sector to function, are rapidly and effectively dealt with. The IPA must ensure that the investment promotion cycle is implemented as effectively and smoothly as possible, with careful attention to obstacles that impact greatly on competitiveness. IPAs must also assist in ensuring that macro policies are consistent with FDI objectives and policies. Promoting new businesses. Global developments will have strong implications for the types of activities that an IPA will need to promote and IPAs must be responsive in this regard. For example, more efficient supply chains require a wide range of specialized services that are not often available in developing countries. The IPA must be aware of these and be proactive in developing strategies to attract them. In general, the greater complexity of the business environment facing developing economies could be said to call for IPAs defining a new role more explicitly on the public-private sector interface. Lessons Learned From Thailand A number of key lessons relevant to Indo-China can be derived from the Thai experience: • • • • • • • • FDI policy making has tended to be determined in a reactive manner, rather than used as a tool to strengthen industrial competitiveness; The outputs of FDI have been judged more on the quantitative results (such as FDI inflows and exports generated by FDI) than on the qualitative impacts, which have become more important; In general, as the balance between investment promotion activities moves away from the provision of investment incentives, there is a strong need for better promotion activities; Investment promotion resources should increasingly focus on the strategic targeting of investment, and must address areas beyond the basic incentive package – such as technology, human resources development and modern infrastructure facilities which are needed by industry; The critical need to work more closely with TNCs already in-country to maximize spillovers and enhance benefits to the domestic industry and community at large; The importance of building and maintaining networks with all key players – domestic and international; The importance of a basic analytical capacity to relate FDI policies to broader policy issues, and the need for a firm-level tracking system to evaluate and improve promotion activities; and The availability of software and analytical tools means that even small IPAs can develop and implement Investor Targeting Strategies – something that can greatly enhance the investment promotion effort as well as utilize financial and staff resources more effectively. Training Workshop on Investment Promotion and Facilitation, Module 1 Page 8