DEFINING INVESTMENT Domestic and Foreign Direct Investment - - PowerPoint PPT Presentation

DEFINING INVESTMENT

Domestic and Foreign Direct Investment

Investment – Definitions

What is foreign direct investment (FDI)? Foreign direct investment is the acquisition of a lasting interest, usually with at least ten percent stake, in an enterprise operating outside of the country of domicile of the investor, with the purpose of gaining effective say in the management of the enterprise. Source: Balance of Payments Manual: Fifth Edition (BPM5) (Washington, D.C., International Monetary Fund, 1993) What is domestic (direct) investment? Domestic investment is where a local company/ individual acquires a lasting interest, usually with at least ten percent stake, in an enterprise

• perating in their country of domicile of the investor, with the purpose of

gaining effective say in the management of the enterprise.

Investment – What is it good for?

Empirical studies show that FDI typically generates economic growth in the host country especially through direct employment generation, or through linkages with suppliers, subcontractors and service providers. However, there is also evidence that FDI can have negative effects. FDI is found to be favourable to economic welfare of the host country only if appropriate conditions exist in the host economy. This includes adequate absorptive capacity for instance, new financial capital and new technologies in plants, as well as human capital. Also it is important that domestic businesses are not "crowded

• ut" and are able to face up to foreign competition.

Meaning, market gaps filled by foreign companies should ideally be above what can and should be filled by home producers. This means that industrial policy - while within the rules of the multilateral trading system - should also seek to prop up infant industries to the degree that they are competitive and do not distort competition.

Investment – Some Concepts

• Host country … v. Home country
• Linkages with suppliers, subcontractors and service providers.
• Adequate absorptive capacity
• Domestic businesses are not "crowded out" and are able to
• Facing up to foreign competition.

Discussion point: What is the role between FDI and domestic investment?

Modes of Entry

• Greenfield investment: a new investment expected to bring in relatively

substantial inflows of FDI; new production capacity and employment;

• Brownfield investment: an investment into an existing facility geared

towards improving or increasing its capacity, with a quick technology and skills spill-over effect;

• Mergers & acquisitions: inflow of FDI capital, but not necessarily new

productive capacity; there are potentially spill-over effects with investment in better technology and higher productivity;

• Joint ventures: involve a strategic alliance between the foreign company

and (usually) a local company with the view to doing business together.

Explaining FDI Motivation

The Global FDI Picture

FDI in South Africa

UNCTAD Investment Policy Framework for Sustainable Development

SA FDI Policy in Context

December 15 2015 controversial Protection of Investment Act was signed.

• Replaces the bilateral investment treaties that SA terminated in 2012,

resulting in alarm from the international investment community based in the country. On December 30 2016, Trade and Industry Minister Rob Davies published the long-awaited investment regulations that will bring the act into force.

Developing countries entered into BITs to provide investors with comfort that their investments would be safe and protected. However, BITs have been criticised as creating unequal rights and obligations between developing countries and developed countries and for interfering with developing countries’ sovereignty. Accordingly, various developing countries across the globe are revisiting investment protection.

FDI Policy in SA

Interpretation: The PIA must be interpreted in a manner consistent with any relevant convention

• r international agreement to which South Africa is or becomes a party.

Accordingly, BITs to which South Africa is a party will be upheld, irrespective of the commencement of the Investment Act. Equal treatment: Foreign investors must not be treated less favourably than local investors in like

• circumstances. This provision may not be interpreted in a manner that will

require South Africa to, inter alia, extend to foreign investors the benefit of any treatment, preference or privilege resulting from government procurement processes, subsidies or grants provided by the government or any law or measure that is designed to protect or advance historically disadvantaged persons.

FDI Policy in SA

Expropriation: Foreign investors have the right to property as provided for in the South African constitution. Foreign investors’ property may only be expropriated in terms of a law of general application, and (i) for a public purpose or in the public interest and (ii) subject to compensation (the amount of which and the time and manner of payment of which have either been agreed to by those affected or decided or approved by a court). The expropriation of foreign investors’ property must be carried out in terms of the Expropriation Act 63 of 1975. Expropriation Bill passed through parliament in May 2016.

FDI Policy in SA

Repatriation of funds: Foreign investors can repatriate funds, subject to taxation and other applicable legislation including exchange control regulations. Dispute resolution: In the event of an investment dispute, an investor may within six months request the Department of Trade and Industry to facilitate the resolution of such dispute by appointing a mediator. A foreign investor is not precluded from approaching any competent court, independent tribunal or statutory body within South Africa for dispute resolution. Once domestic remedies are exhausted, the South African government may consent to international state-to-state arbitration.

Investment Incentives

Schedule of characteristics for an effective and efficient investment incentive scheme:

• a system to ensure that revenue loss is minimised;
• a cap on expenditure;
• a time limit on the duration of the incentive;
• that incentives be transparent;
• that incentives be uncomplicated; and
• that incentives have low administrative costs for both businesses and government

Investors may qualify automatically for incentives, or inducements could be provided on a discretionary basis. Caution: Discretionary allocation allows for economic distortions such as, favour-seeking, corruption or procedural ineffectiveness.

Barbour, 2005

INVESTMENT PROMOTION

Investment Promotion circa 2000

Organisation for Economic Cooperation & Development World Bank (MIGA, IFC, FIAS) Government Agencies (IPAs) Site Location Consultants United Nations (UNCTAD, UNIDO, UNESCAP , WAIPA)

Investment Promotion Toolkits

MIGA, 2001 Module 1. Understanding foreign direct investment Module 2. Developing an investment promotion agency Module 3. Creating an investment promotion strategy Module 4. Building effective partnerships Module 5. Strengthening the location's image Module 6. Targeting and generating investment

• pportunities

Module 7. Servicing investors Module 8. Monitoring and evaluating activities and results Module 9. Utilizing information technology

Government’s Role in Investment Promotion

To implement their economic development strategy, most governments try to create an optimal investment policy framework, promote activities to support investment, and establish economic incentives to positively influence investor perceptions of costs and benefits related to business in a particular sector. Inward investment promotion has included investor facilitation; national image- building; investor targeting and generation; and policy advocacy. ‘One-stop-shops’ have been adopted by IPIs offering a range of services from advisory bureaus through to authorising licences and permits, and even lobbying other government units on behalf of investors.

Investment Promotion

• Investment promotion, intended to inform or assist investors in making a

commitment to invest, is a form of non-monetary investment incentive that is very difficult to quantify or monitor.

• IPAs operate in a blurred institutional environment with parallel jurisdictions and

accountability to a large range of ministries at different levels of government. Not

• nly do they themselves liaise with other government bodies but they also help

investors navigate the bureaucratic waters involved in establishing a new project.

• Effective investment promotion presents commercially viable investment
• pportunities, identifying local partners and providing a positive image of the

economy.

• Promotion should not be seen as a substitute for more general policy reforms or

try to camouflage underlying weaknesses in the investment climate.

Investment Promotion Cycle

Investment Climate

• Economic factors: e.g., information on infrastructure, workforce such as

unemployment figures and skills, and poverty; availability of natural resources and

• ther factors influencing the production processes of particular industries.
• Political factors like the ideology of the government and policy certainty can play

an important role. Governments decide how profits are taxed and lay down the legal framework for investors, including clear incentives to encourage investment.

• Legal factors provide greater structure. The ease of registering a business, to

broad legal requirements on corporate governance all influence investment

• climate. Regulatory reform can play a key role in removing the barriers to

investment.

• Social factors include the more vague aspects which none the less have an

important effect on how investments perform. Factors like crime, work ethic in a particular region and performance have an effect on investment climate. Social stability and values underlying a positive labour-business engagement.

WBG Doing Business Indicators

http://www.doingbusiness.org/methodology

Including Sustainability

Much attention has focused on countries targeting sustainable FDI, with recent research from the UNCTAD and Columbia Centre for Sustainable Investment (CCSI), in association with the United Nations’ World Association of Investment Promotion Agencies (WAIPA) focused on IPIs attracting sustainable investment projects against four criteria:

• Economic development (including linkages, training, and skills and technology transfer);
• Environmental sustainability (centring on minimising environmental impact);
• Social development (including employment standards and community development);
• Good governance (addressing issues of transparency and fairness in contracting).

Including Sustainability

Investment Promotion today

FDI involves:

• More complex motivations
• FDI flows in different directions – inward and outward
• Driven by new actors … greater competition
• Changing composition of capital
• Use of new modalities
• A patchwork of international investment agreements (IIAs)
• An understanding of the costs and benefits of incentives and when

and how to apply them

Investment Incentives in brief

UNCTAD (2004) outlines three major classes of incentives:

• Financial (e.g., grants and loans at beneficial rates);
• Fiscal (e.g., tax holidays or reduced tax rates); and
• Other, such as subsidised infrastructure or services, access to

preferential markets, and regulatory allowances (e.g., exemptions from labour or environmental standards). The World Bank’s Investment Climate Unit recognises there could be either fiscal or non-fiscal elements in two types of incentive:

• Regulatory: for example by guaranteeing property rights; correcting

for external economic factors; and preventing abuse by monopolies,

• r by easing of or exemption from certain regulatory requirements;
• Financial: e.g., subsidies, grants or administrative assistance.

Guidelines for Effective Incentives

• A system to ensure that revenue loss is minimised;
• Cap on expenditure;
• Time limit on the duration of the incentive;
• Incentives that are transparent;
• Incentives must be uncomplicated;
• Incentives should have low administrative costs for both businesses

and government.

Barbour 2005

INVESTOR DECISION MAKING FOR LONG-TERM VALUE

Investor motivation

Evidence on the determinants of FDI reflect a wide range of influential factors relating to its destination:

• Access to markets,
• Macroeconomic stability,
• Predictable policy environment,
• Efficient regulations and procedures,
• Low level of corruption,
• Well-educated labour force,
• High-quality infrastructure, and
• Location’s historic cultural ties.

Investor motivation

Investor motivation – Basic steps

MNCs expand to maximise profits when the firm has grown so large that the domestic market is saturated. Larger organisations have greater financial assets and are better able to recover from shocks. As a result, larger companies enjoy a greater role in global FDI flow. FDI is typically characterised by a company’s market-specific prior experience with increasing

• commitment. So, export is the first step, allowing a firm to enter a foreign environment without the

immediate increase in production capacity required by FDI. The greater a company’s international operations and direct export for sales, the more likely the company is to invest to preserve market share and to lower costs associated with tariffs, production, trade, and patents. As demand for a product increases in a particular market, the company may establish local production.

Investor motivation

Market-seeking: in search of new consumer markets for the firm’s goods and services. (Examples: commercial banks, professional-services firms and retail stores of international brands.) Efficiency-seeking: in search of low labour costs or making operations more efficient by lowering production and transport costs. Mostly export-oriented, although can be built on a strong domestic customer base. (Examples: automotive, textiles and electronics sectors, as well as business processing and call centres.) Strategic asset-seeking: tangible or intangible assets via investments, acquisitions or alliances with competitors to strengthen a market-leading position, (Examples: cultural or historic tourism ventures, or biotech clusters.) Resource-seeking: cheaper/ higher value natural resources and raw materials. (Examples: international oil plant, mines or agricultural land)

The OLI paradigm (Dunning, 1977), that explains why (Ownership advantage) and how (Internalization advantage) a firm decides to become a multinational and where (Location advantage) it is more likely to invest.

Investor motivation & Incentives

The impact of incentives varies depending on the strategies and motivations of the investing firm and the market where the investment is directed (for instance whether the investor has an established presence, or is a newcomer). The investor’s country of origin and particular sector of operations play a part in determining the influence and impact of incentives. Fiscal incentives are typically less effective for resource-seeking FDI or for investments intended to serve the domestic market. Incentives offered to resource- or market-seeking investors may be wasted, since such investments would probably have occurred anyway. Efficiency-seeking FDI, on the other hand, or investment in technology industries or export-

• rientated investment projects, are much more susceptible to tax relief, not least because firms in

those fields are relatively mobile.

Investor motivation

Assumption that multinationals are knowledge-intensive firms and this generates ownership advantages: Mobility: the services of knowledge capital can be easily “shipped” across borders;

• Labour-intensity: knowledge-based assets are usually skilled and labour-intensive relative to

production, and this generates a motive to operate different tasks in different locations; and

• Public good nature of knowledge capital within the firm since once it is created it can be exploited in

all the subsidiaries at very low cost. Location advantages

• Horizontal Expansion: the MNC sets up foreign facilities that mirror those at home. In this scenario,

location advantages arise when the host-country economy and trade costs are large, and FDI would serve as a substitute for trade.

• Vertical Expansion: the MNC chooses to fragment production and to locate some stages of production

abroad in order to access specific resources not available elsewhere or to arbitrage differences in relative factor prices. Internalisation advantages Knowledge capital generates ownership advantages and risks of asset (e.g., IP) erosion associated with arm’s-length transactions. Carr et al (2001)’s Knowledge-Capital model of FDI connects Dunning’s ideas with specific firm and country characteristics.

The Rise of Value Chains

A value chain refers to the production flow that a product follows from the point of its inception until it reaches the customer.

The Rise of Value Chains

With deepening interdependency of economies through international trade in completed goods, the share

• f trade in intermediate goods has substantially increased with global production fragmentation.

Source: Quynh, Nguyen P .; Thu, Le T . A.; Thuy, Le M (2016)

The Rise of Value Chains

Source: João Amador and Sónia Cabral(2012)

The Rise of Value Chains

The Rise of Value Chains

Discussion: In light of Africa’s industrialisation and regional integration imperatives, what

• pportunity does value chain development present to South – and Southern Africa?

STRATEGIC INTEGRATED PROJECTS

South Africa’s Economic Priorities

Challenges: South Africa’s economy has been characterised by low national savings, and investment financed largely through unpredictable portfolio flows rather than longer-term FDI. Some long-standing political legacies such as widespread unemployment, high crime rates and generally low education and skills development are difficult to shake off. Still, the country punches above its weight on the global arena – as the only African country in the G20 and the BRICS. The government’s economic vision to address the challenges is expressed in the New Growth Path (NGP) of December 2010 focused on:

• Expanding public investment in infrastructure;
• Concentrating on labour-intensive value chains in agriculture and mining, as well as in

manufacturing, construction and services;

• Promoting innovation through low-carbon initiatives; and
• Supporting rural development, including agriculture and regional integration.

South Africa’s Economic Priorities

The National Development Plan (NDP) 2012 The National Development Plan (NDP) offers a long-term perspective. It defines a desired destination and the role different sectors of society need to play in reaching that goal.

Minister in The Presidency: National Planning Commission, Trevor Manuel

The NDP aims to eliminate poverty and reduce inequality by 2030. South Africa can realise these goals by drawing on the energies of its people, growing an inclusive economy, building capabilities, enhancing the capacity of the state, and promoting leadership and partnerships throughout society.

South Africa’s Economic Priorities

The National Development Plan (NDP) 2012 calls for

• development of a more competitive and diversified economy with a higher share of global

products and domestic linkages.

• sophistication of South Africa's overall exports shifting from the country's dependence on

commodities

• deepening the productive base in mining, agriculture, manufacturing and services and

strengthening of conditions to support labour-absorbing activities.

South Africa’s Economic Priorities

The Medium-term Strategic Framework (MTSF) 2014-2019 positions the Industrial Policy Action Plan (IPAP) as one of the key pillars of radical transformation in South Africa, based on inclusive growth in the productive sectors of the economy. Industrial Policy Action Plan (IPAP) Aimed at achieving higher levels of inclusive sustainable economic growth and radical transformation, structural change in the economy through breaking out of commodity dependence and moving towards a diversified, knowledge economy in which increasing value- addition and export intensity, define South Africa's growth trajectory. Prioritisation of labour intensive sectors to increase job opportunities; increasing participation in global value chains and broadening economic participation. The IPAP is a product of the Economic Sectors, Employment and Infrastructure Development (ESEID) cluster. The responsibility for its implementation lies with Government as a whole and a wide range of entities, including SOCs.

South Africa’s Economic Priorities

Source: dti

South Africa’s Economic Priorities

• http://www.gov.za/sites/www.gov.za/files/IPAP%202016_0.pdf – 2016/2017 – 2018/2019 IPAP

Iteration.

• Public procurement- greatly enhanced and enforced compliance with localisation targets. IPAP

has over the past few years developed a very strong emphasis on the deployment and strengthening of public procurement to support the local manufacturing sector and the growth of world class industries. Compliance across government and state-owned companies (SOCs) is now identified as the critical issue in ensuring that this policy instrument reaches full effectiveness.

• Carefully targeted Industrial financing and incentives - including a) much stronger export credit

and export credit insurance support, in combination with a wide range of sector-specific incentives; and b) energetic implementation of the recently launched Black Industrialists Incentive.

• Leveraging the devaluation of the Rand to make South African manufactured products more

globally competitive and create opportunities for the expansion and further development of SA's domestic manufacturing capabilities.

South Africa’s Economic Priorities

Growing exports: there are four main pillars to the IPAP export strategy:

• Building partnerships with global Original Equipment Manufacturers (OEMs) focused on

transferring technologies and growing our exports in OEM value chains;

• Partnering with national export champions to catalyse increased national technology

absorption for the development of high value exports.

• Strengthening existing Industry Associations and Export Councils; including establishing a

dedicated new Export Council for Africa.

• Developing export-oriented production hubs in SEZs and Regional Clusters and fostering

industrial decentralisation.

Infrastructure

Infrastructure development is central to the NDP , and so high levels of investment in infrastructure will continue into the foreseeable future. The Presidential Infrastructure Coordinating Commission (PICC) developed the National Infrastructure Plan Identifies 18 strategic integrated projects (SIPs), clusters of infrastructure projects considered key for promoting economic growth and supporting service delivery to the poor.

SIPs and the PICC

• An Infrastructure Plan with identified Strategic Integrated Projects (SIPs) has been

developed and adopted by Cabinet and the PICC

• PICC is the established structure to address the challenges through coordination,

integration and accelerated implementation

• Develop a single common Infrastructure Plan driven and monitored centrally
• Identify who is responsible and accountable
• Develop a 20-year planning framework beyond one administration
• An Infrastructure Book has been compiled, which contains more than 645

infrastructure projects across the country - http://www.southafrica- newyork.net/consulate/pdf/SA%20investment%20opportunities%20June%202014_2.pdf Public infrastructure projects to the value of USD360 billion for implementation up to

• 2023. Almost 80% of the value is in the electricity generation and transport sectors.

Projects at the conceptual, pre-feasibility and feasibility stages represent 48% of the total in value terms.

Characteristics of Infrastructure Investments

• Long-term assets with long economic life
• Low technological risk
• Provision of key public services
• Strongly non-elastic demand
• Natural monopoly or quasi monopoly market contexts
• High entry barriers
• Regulated assets
• Frequent natural hedge against inflation
• Stable, predictable operating cash flows
• Low correlation with traditional asset class and overall macroeconomic

performance

Channels of Financing Available for Infrastructure

Della Croce and Sharma (2014)

Institutional Investment in Emerging Markets

Georg Inderst & Fiona Stewart, 2014

Institutional Investment in Emerging Markets

Georg Inderst & Fiona Stewart, 2014

Estian Calitz & Johan Fourie (2007)

Sources of Financing for Infrastructure Projects in South Africa

PUBLIC-PRIVATE PARTNERSHIPS

The emergence of PPPs

The 1980s saw the advent of new technologies, and economic and managerial principles questioning the efficiency of public bureaucracies. This “New Public Management” introduced the implicit goal of getting public administrations to function more like private companies. Roll-out of deregulation, liberalization and privatisation policies continued worldwide, and were presented as the remedy for underperforming, cash- strapped public enterprises. In Latin America, Eastern Europe, Southern Asia and Southern Africa, required reforms, institutional framework and competitive markets were

• ften not in place prior to privatisation.

Problematic transitions of infrastructure facilities to private operation, with associated user and public dissatisfaction – and violent protests.

The emergence of PPPs

• From the late 1990s to date, private sector involvement in infrastructure has

deepened and matured.

• Governments, private contractors and advisors in the field have experienced

the benefits of hindsight, as well as a variety of modern evaluation techniques.

• The approach to private participation in infrastructure (PPI) has become more

measured and bespoke to the project requirements, as well as to the economic and political climate of the day

Public-private partnerships (PPPs) are projects where private sector contracts with the public agency (at national, federal or municipal level) for the right to provide a service or build and/or run an asset. In most instances, while the asset is built or managed by the private sector, the government agency maintains a residual ownership and control over the asset (or service). The respective rights and obligations of each party are set out in a medium- to long-term risk-sharing concession, licensing, or management contract that, unlike traditional procurement, can take

• n a variety of forms and allocate risks in different ways.

Guislan and Kerf, 1995

Risk in PPPs

Value for Money

Stakeholders should be able to take an overall view of the project objectives and decide whether a PPP is the best way to proceed. This requires a realistic cost-benefit assessment to determine whether the government or a private contractor would be able to provide the service more cost-effectively. The public sector comparator (PSC) model is a detailed and pragmatic assessment of all costs of the proposed PPP project – with “delay risks … inflation effects, lifecycle costs, finance charges [and] operating costs” included. A net present value calculation is performed to compare the public sector cost against the price of PPP project. The value for money (VfM) assessment is the difference in cost estimate between the traditional public delivery (public sector comparator) and the proposed cost of the PPP model. Recommendations that VfM tests be conducted at each of the points – when selecting the appropriate procurement methodology; when assessing the PPP bids; and at fitting stages through the duration of the contract

Continuum of Control: Public Asset

PPPs: Risk-Reward

Enabling Environment

Apart from assisting with the facilitation of financing for the private sector, governments also have the responsibility to ensure that the legislative and regulatory framework is conducive to implementing partnerships. This includes putting in place policy governing the establishment, development and maintenance of PPPs. In addition, regulation and rigorous contracting must be put in place concerning the details of how government will interact with the PPP partners through the duration of the procurement contract. With the inherent complexities of the infrastructure sub-sectors, clear political will and a favourable legislative framework is necessary to push forward development. With increasing interest from private sector to develop infrastructure projects in support of commodities investment, a spate of new PPP laws, laws of concession and sectoral laws affecting private participation in infrastructure.

Addressing Potential Failures in PPPs

Cases

Cases