Investment, trade linked

Investment, trade linked

The World Investment Report 1996 of the Geneva-based UN
Conference on Trade and Development, besides analyzing the latest
trends in foreign direct investment (FDI) across the world,
devoted a great deal of attention to the interlinkages between
investment and trade. The 327-page report concluded that FDI
increasingly influences the size, direction and composition of
world trade. But trade and trade policies in turn also exert
various influences on the size, direction and composition of FDI
flows.

What the conclusion clearly points out is that full
understanding of trade-FDI interrelationships is essential in
formulating the right policies for FDI and trade so that they
support one another in terms of policy objectives and their
efficient implementation. Policymakers therefore should look at
trade and FDI as two sides of the same coin, meaning that trade
and investment liberalization should run at the same pace.

If a country treats the two sectors separately and moves
faster on trade, for example, it may not get the maximum benefits
from either, because restricting FDI by multinational companies
would deny the country not only capital flows but also
intracompany trade, which now accounts for more than 35 percent
of global trade. If a country liberalizes FDI faster than its
trade, it may attract mostly second-rate, short-term oriented FDI
which wants only to exploit the protected domestic market.
Import-substitution industrial policies, for example, rarely
attract long-term oriented investors who are really serious about
transferring technology and promoting exports.

For a country like Indonesia which pursues an export-led
development strategy, FDI can have big benefits in that big
companies usually have developed access to the world market
through their affiliates and other firms linked to them and most
of them have done their own market research. But there is one
vital aspect that a country should be aware of in attracting FDI.
Big foreign companies always endeavor to spread activities along
efficiency-oriented lines, meaning they specialize in segments of
goods and service production of which the host country has
comparative advantages. In that way, the competitive advantages
of foreign companies can interact positively with the location
advantages of the host country.

The question now is how a country should act to attract FDI.
There are several key lessons -- though they are not completely
new -- which can be drawn from the World Investment Report 1996.
Tax incentives turn out to be of minor importance to FDI. Foreign
investors are more interested in such factors as political and
economic stability, consistent policies, market size, costs,
skill levels, basic infrastructure and conducive regulatory
regime.

The report points out that relying too much on tax incentives
to woo FDI does not work in the long run, as any government can
offer such incentives with the stroke of a pen. In fact,
education and training as well as a conducive climate for
research are seen by investors as far more important than tax
incentives. These three factors are especially considered
essential in the developing countries offering cheap labor as one
of their comparative advantages. The rationale is that whenever
rising labor costs weaken the comparative advantage offered by
their host country, the investors should not have to move to
other locations with lower labor costs. The investors, helped by
an adequate pool of skilled manpower and a large base of research
capability, can easily shift to more innovative and higher value-
added activities.