Five policies so foreign direct investment alleviates poverty

05 September 2020

By Guus Hendriks

For decades the opening up of its economy and super growth attracted foreign investment into China from all over the world, but in 2000 it launched its ‘Going Global’ policy and by 2015 its outward investment surpassed its inward investment.

From almost zero China’s outward investment increased at a compound annual growth rate (CAGR) of 16 per cent, according to financial services giant EY. In 2014, EY calculated that China invested in 6,128 overseas companies across 156 countries and regions, ranking its Foreign Direct Investment (FDI) outflow third in the world at a total of $116 billion, with it surpassing $120 billion in 2015 compared to inward investment of around $118 billion.

China is not alone among emerging economies to become increasingly important investors overseas and especially in developing economies, with India, Mexico and Argentina also playing their part. Indeed, 75 per cent of China’s FDI stock is invested in Asian developing economies according to the United Nations Conference on Trade and Development in 2016.

Firms from emerging economies may in fact be more willing and able to invest in developing countries compared to their rivals from developed nations as they have experience of operating in a country where its institutions are relatively underdeveloped, presenting firms with difficulties ranging from dense bureaucracy to dubious contract law. These firms are happy to work under such conditions and understand the subtleties to make investment opportunities work.

The growing influence of emerging multinational enterprises (EMNEs) on investment in developing countries gives policymakers an opportunity to alleviate poverty not just in the nation that is gaining the investment, but also the country where the firm originates. It can create jobs in both countries.

Thus, if used well, investment made by EMNEs can fulfil many of the United Nations’ (UN) Sustainable Development Goals (SDGs) to reduce poverty, create decent work opportunities through inclusive economic growth, build economically enhancing infrastructure and even promote peace and justice with strong institutions, such as a fully functioning legal system.

However, if certain conditions are not met, the positive effects of EMNEs' foreign investment may not materialise, with the gains not being equitably shared between countries or potential societal improvements are left untapped.

After a comprehensive review of the research literature I have discovered there are five policies governments need to adopt to create the conditions for the full potential of EMNE foreign investment to be realised for countries on both sides of the cash outlay.

 

1 Long term in nature

Policymakers need to create measures that encourage a long-term investment. If firms leave as soon as they get access to natural resources, for example, they will not create many jobs.

Long-term investment not only creates jobs in the country attracting the cash injection, but also for the nation where the firm’s headquarters are. When a company undergoes a process of international expansion, more staff will typically be needed to co-ordinate a larger and more complex network of operations stretching across different countries.

For example, Chinese tech giant Huawei initiated a growth strategy that was focused on expansion into developing countries first, and grew its employee base from 24,000 by the end of 2005 to more than 180,000 in 2016, with more than 70 per cent based in China. The majority of positions were highly skilled, such as IT professionals, analysts and mid-tier managers, while more than, 80,000 of Huawei’s employees were engaged in R&D, many of which at research centres in China.

Most tax breaks laid on by governments are simply aimed at attracting FDI, but these could also be made conditional on the time that a firm stays in a country, thereby giving it an incentive to become more embedded and grow operations both at home and abroad.

 

2 Partnerships between companies

If governments are not careful attracting EMNEs can crowd out local firms as they rely on their existing supply chain back home rather than local firms. So, rather than allowing unrestricted entry governments could set as a requirement that joint ventures are created with local firms.

For example, the EMNE's existing distributors could partner with local distributors to both serve the investing EMNE and mentor the local firm. The existing distributor will gain valuable market and cultural information, while its local partner will gain new knowledge and skill sets that both foreign firms bring to the host economy. The resulting improvement in organisational efficiency and performance will also allow these small and medium-sized local enterprises to pay higher wages.

In 1997, Korean car manufacturer Hyundai set-up its largest overseas assembly factory in India by means of a greenfield investment. Soon after, many of the major suppliers that were also based in the Ulsan automobile cluster in Korea followed Hyundai to India. Most of them partnered with local Indian firms in joint ventures, which contributed to Hyundai Motors India becoming the company’s first self-sufficient manufacturing unit, with 85 per cent of the content produced in India.

This is the kind of joint venture that benefits both countries; where the host country’s firms become more efficient, while the investing EMNE and its suppliers become better at spotting international opportunities and expanding abroad.

 

3 Tapping into global value chains

Governments need to take a long-term view and identify the global value chains (GVCs) of the future before creating industrial policies to support, not just local firms to become part of these GVCs, but also to attract EMNEs.

Globalisation has led to GVCs that stretch across many countries; starting with sourcing the natural materials for a product, through to its manufacture, marketing and selling to the end consumer.

Although multinationals from developed economies control most GVCs, EMNEs are increasingly rising up these chains and becoming more prominent players, such as in the car industry where Asia is now a significant manufacturer and market.

Governments can help EMNEs take increasing control of GVCs by supporting them with local firms that have the skilled workforce and infrastructure, such as important fourth industrial revolution technologies like AI and the Internet of Things.

Especially as, for developing-economy firms, it may prove easier to carve out their place in GVCs that are yet to be fully established and the major players are still unknown.

This uncertain and changing landscape is an opportunity for governments to co-ordinate policy and help EMNEs, and firms in the country looking for FDI, to assume new roles in GVCs. Governments can prioritise the cultivation of industries that best support these emerging GVCs, setting up innovation centres and investing in reskilling workers.

By becoming part of an important future GVC, developing countries can also help firms upgrade along the chain, from manufacturers to innovators and marketing brands. This creates more high-salary jobs along the way and improves the nation's standard of living.

 

4 Upgrading institutions

EMNEs can also play a role in improving a country’s institutions, with policymakers’ utilising the experience they have gained in overcoming institutional voids, such as weak contract law, in their own nation.

When investing in a developed economy EMNEs often take on the role of government, such as building much-needed infrastructure like roads and railways. Governments need to work with EMNEs and insist on them helping in upgrading its institutions.

EMNEs often have experience of working in developed countries and can bring this knowledge of how institutions work to developing economies, having already done so in their own nation. Increasingly EMNEs are adopting the environmental, ethical and business standards of Western firms they compete with in an effort to improve their reputation, and can bring this knowledge to developing countries, passing it on to local firms as well as policymakers.

Governments need to exploit the knowledge and power of EMNEs to improve their institutions, such as Indian conglomerate Tata Group has practiced when expanding domestically and when investing in developing economies. It has helped a host of sustainability policies, ranging from quality of life initiatives to the provision of basic healthcare and education. Research by US-based academics Valentina Marano, Peter Tashman and Tatiana Kostova found this has also generated goodwill and forged strong relationships that have increased its growth opportunities in those countries.

Furthermore, the improvement in ethical standards and institutions will help countries to attract more FDI and better quality EMNEs, which would be willing to invest in societal projects. This will also improve the standing of the country of origin for those participating EMNEs, plus help produce more jobs at their headquarters as their global reputation grows, making it more resilient.

 

5 Infrastructure development

Without deterring EMNEs, sensible policies should be created that any investment is conditional on helping build roads, railways or internet infrastructure.

This should especially be the case when accessing natural resources that will benefit the EMNE’s home country. EMNEs often bring expertise and high standards of engineering and construction that governments can utilise, while the investing firm can also make sure that the infrastructure is built in line with its own needs.

A good example of this win-win situation is in Zambia, where Chinese and Zambian officials have worked together to establish the Economic and Trade Co-operation Zone, providing Chinese investors with favourable tax conditions and opportunities to develop good infrastructure. CNMC, a large Chinese mining firm, has subsequently purchased the Chambishi mine in that area, a move it would probably not have made otherwise.

 

At the moment, there is concern that the growing influence of EMNEs is skewed in the firms’ favour, but by adopting these five policy principles developing countries can begin to redress the balance.

Governments have an opportunity to co-ordinate policy that will create a mutually beneficial environment conducive to benefiting their citizens and the long-term growth of their economy.

By encouraging the adoption of these five policy areas the UN can meet some of its SDGs around alleviating poverty, spreading higher skilled and higher paid jobs to developing nations and improving their institutions to develop a more equitable world.

Further reading:

Hendriks, G. (2017). "The sustainable development effects of investment by emerging-market multinationals: shaping beneficial outcomes for home and host country", Transnational Corporations.

Hendriks, G. Slangen, A.H.L. and Heugens, P.P.M.A.R. (2018). "How a Firm's Domestic Footprint and Domestic Environmental Uncertainties Jointly Shape Added Cultural Distances: The Roles of Resource Dependence and Headquarters Attention". Journal of Management Studies.

 

Guus Hendriks was Assistant Professor of International Business at Warwick Business School and is now Assistant Professor at the University of Amsterdam.

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