29 May 2017

Foreign Direct Investment and Economic Progress


Economic development derives from the combination of capital and labour, and the efficiency of the use of these resources.  In simple terms, economic growth springs from the accumulation, and efficient application, of physical and human capital (labour) and advances in production technology – total factor productivity.

The 1980s ushered in a period of increased global integration.  This global integration of markets, spurred by increased economic liberalisation, rapid innovation in financial instruments and information and communication technologies, described aptly as globalisation, has led to dramatic resurgence of private capital flows which accelerated in the late 1990s, reaching a remarkable $1271 billion in 2000.  Since then FDI has varied between $1.4 and $1.8.

FDI is a major source of external finance, which means that countries with limited amounts of capital can receive finance beyond national borders from resource-rich countries. Apart from being an important source of private external finance, FDI is also a means of transferring production technology, innovative capacity and organisational and managerial practices between locations.  Given its potential role in accelerating growth and economic transformation, there is fierce competition among developing countries in attracting it.


To take advantage of the benefits of FDI and capital accumulation, most successful developing countries like Singapore, Malaysia, Thailand, Hong Kong, India and China have taken serious steps to attract and sustain inflows of capital.

The Asian Tiger nations, most of which were ex-colonies like Ghana and Nigeria have over the last 30 years got their act together, attracted much foreign direct investment (FDI ) enacted policies for growth and raised the quality of life of their citizens significantly, whilst in most of Sub-Sahara Africa these have declined .


The Irish Miracle

As regards FDI-led rapid growth, the case of the Republic of Ireland in the 1990s has really been remarkable and takes pride of place.  During the 1990s and early 2000s, Ireland registered one of the fastest economic growth rates in the developed world. Long viewed as an economic underdog in Western Europe, famed only for its export of people and its relative poverty, Ireland’s GDP grew at an average rate of 7.24 percent per year be­tween 1990 and 2001.  At the start of this period, the GDP per capita in Ireland on a purchasing power parity basis was $12,687. By the end of the period, it had reached $32,133, putting it ahead of countries such as Britain ($24,421), Ger­many ($25,715), and France ($25,074). Driving much of this growth was a rapid expansion in exports from Ireland.  In 1985, Ireland exported $10 billion of goods and services. By 2001, the figure had risen to $82.8 billion. Also, the structure of exports changed dramatically during this period, shifting from primary products, which constituted 20.5 percent of the total, to 6 percent, to high-technology manufactured prod­ucts, whose share rose from 23 percent to 36 percent.

The engine of this export-led boom was an inflow of foreign di­rect investment. Inward FDI grew from $154 million in 1985 to a record $24 billion in 2000, before dropping off to $9.78 billion in 2001, reflecting a general slump in global FDI activity. Much of this FDI was undertaken by large multinationals that saw Ireland as a conducive host for foreign operations and a desirable base for exporting to the rest of Europe. Among the major investors were large American high-technology multination­als, including Intel, Dell Computer, Microsoft, Gateway, Ap­ple, and IBM, and several major pharmaceutical firms including Johnson & Johnson, Bristol-Myers Squibb, and Eli Lilly. By the early 2000s, the Irish subsidiaries of foreign multinationals were accounting for more than 80 percent of Ireland’s exports, with Intel and Dell both exporting more than $4 billion each from Irish factories, Microsoft almost $2.5 billion, and Eli Lilly and Johnson & Johnson more than $1 billion apiece. Of great significance was that two-thirds of Ireland’s top exporters were/are the Irish subsidiaries of foreign multinationals.


How did Ireland become so successful at attracting FDI?  First, Ireland benefited from a number of favourable location factors. With Ireland being a member of the European Union common market, subsidiaries based there have preferential access to EU markets. In addition, Ireland was blessed with a highly educated work force including many engineers, rel­atively low wage rates, low corporate tax rates, good ba­sic infrastructure (e.g., roads, water, electricity, telecom­munications), English as the main language (important for American multinationals), and a government that was friendly toward foreign businesses.

The last item became the linchpin in Ireland’s success. Since the 1980s, Ireland has implemented an industrial­ization strategy that relies on FDI to promote dynamic export-led growth. The centrepiece of this strategy has been the country’s Investment and Development Agency (IDA), which has been endowed with a large budget to at­tract FDI (in 2000 this included $160 million in grant money that could be used to attract foreign multination­als). The IDA has helped to coordinate a combination of tax breaks and outright grants that, when linked with other location-specific factors, has helped to attract many multinationals to Ireland. Also, the IDA has been very proactive in seeking out investors from the high-technology sector. What is more, the IDA was early to realize that Ireland could be a good location for centralized call centres, and companies such as Dell Computer now have impor­tant customer service call centres in Ireland.

Perhaps more importantly, the IDA was instrumental in persuading Intel to open its first plant in Ireland in 1990. Subsequently, Intel’s investment helped to encourage or pull many other high-technology firms to locate facilities in Ire­land, a fact that is in line the Oligoplisitic Reaction theory of FDI developed by Knickerboker in 1973. High-technology investments have also been stimu­lated by an Irish government policy that all royalty income from products developed in Ireland is tax-free. This has created an incentive for foreign multinationals to establish R&D centres in the country. By the mid-1990s, the process had become self-sustaining, with the concentration of high-technology enterprises in Ireland attracting other high-technology companies to the country, where they could benefit from being close to suppliers, providers of complementary products, and even rivals.  A high-tech cluster with substantial  locational economies has crystallised.


Lessons for Other Countries

In today’s globalising world, where the incredible advances in communication technology have rendered the notion of time and space virtually irrelevant and obsolete, capital flows tend to go to places which are conducive for successful business.  Such conducive environments are not a given, and must be fashioned.  The case of Ireland can provide a lesson or two for other developing countries, with regard to the provision of leadership and the fashioning of the kind of policies which can create/foster an environment that attracts inward FDI.  There are billions of dollars of international capital at footloose, but only those who dare benefit from it.