THE WORLD BANK ECONOMIC POLIcY NOTES No. CPD-4 The Bank. Approach to Direct Foreign Investmnent in De vel opi g Co un tries: n Evaluation Ian Bannon DecembXer 19836 Policy Group Country Policy Department This -.eries of Economic Policy Notes is intended to bring to the attention of Bank InCmtCe and .sconom,rrist, interesting issues of country economic policy and Bank operational policy emerging from the work undertake n in the Country Policy Department. TABLE OF CONTENTS Page I ntroduction ................................................. 1 II. Foreign Investment in Developing Countries ...................... 2 - Recent Trends ......................-............. 2 - Econom-aic Impact ......................... ... 3 - Fo- eig Investment and Adjustment .. ........... 4 - Foreig-Yn Investment Policies .............................. 5 II. Ba-n.k Group Involv-sment in Fc-ir2ign Trrrstment Promotion ....... 13 Adjus tm L dot ..L....... . b....................................... 13 - Economic and Sector Work, and Policy Dialogue ............ 16 - The BLake: Initti--- ........................................ 20 - The Inte natl--ic.,Yina Finance Corporation .................... 21 - The ilvltila--nlt g .............Inves n 22 IV. Evaluation of the Banlc's Ap--roal.. .............................22 - GeLeral Approach ......................................... 22 - Institutional Reforms .................................... 23 - IcentiveSs................................................... 26 V. Forig Investment iSowe General ......... 27 A x I: An Introduction to th e on fioraigrn Investment Annex II: Statistical Tabls ALne. III: Forign Invst Objectives and Po-icias in .u&Leccc?.c Co;n'r I. INTRODUCTION 1. The purpose of this paper is to evaluate the Banlk's involvement in assisting member countries to attract and benefit from direct pr:-vate for- eign investment, and to suggest a set of general principles within which future Bank assistance and policy advice can be framed. Foreign investment is an area which has generated an extensive body of literature, especially on the evaluation of cconomic effects in host countries. This paper does not review the literature on foreign investment or attempt to evaluate its relative merits. Rather, it assumes that it is up to the host government to decide i1Yh.-B3ther, and to what extent, foreign investment forms part of its development strategy. The question then is what has been, or should be, the Bank's role -iven a government's stance toward foreign investment. 2. Through economic and sector work, policy-based lending and the activities of IFC, the Banlk has genUerally encouraged member countries to adopt a more open and less restrictive stance toward foreign investment. Although the Bank has supported countries' efforts to attract and benefit from foreiana investment, its approach has been flexible and has varied according to each country's development objectives, its potential for attracting foreign investment, and the need to correct structural and policy distortions which can reduce the net benefits to the host economy. Where countries adopt a highly def"ensive and restrictive attitude toward coreign investment, the Bank's role is limited to evaluating the economic effects of government policies and pointing out instances whlere the same objectives could be achieved more efficiently through alternative policies. -2- 3. Section II brieflv reviews the role of foreign investme.it in developing courntries, and maJor areas in which host government policies and practices irLfluence foreign inrvestment. Section III describes the Bank's involvement in assisting co;ritrieo. to improve foreign investment policies and draws from the study by K. '.ialberg, " Foreign Investment Incentives and Pestritizns in Developing Countries: An Analysis of World Bank Policy Recommendations tl (CPD, November 1986). Section IV ePivaluates the Bank's approach and Section V tug;,cs a set of guidelines for future Bank invo2lA;.-t.. Annex I 'rdeSa bri vef annotated bibliography intended as an intro c; ion to 1h-1-ta - V t: ture on foreign investment; Annex II presents data on recent .--n.s in .e:'g; investment flows; and Annex III reviews rc.4-eLi i; v tmet obj- -W,e 4-na and ;liziv in four developing countries. II. FOREIGN -TNXvthTIV,IWT IN DEVELOPTUiC COUNTRIES 4. Net inflows of -r3ign direct investment Intro develop T nc countries inciceas-a through the 1970;3 (Annex II). Its .har-- in total capr.tal inf lows, 1-weez declined sub;nan-tR i.ily iitfh the :-id rise in external bo'rro-'v,-ng, especially f'on1 :oi-jiiercial bans-ri. In 1973, direct inrestrment flows znc .ba,-i-u 20% of the comrb1:ined current account defict and net rctr a nulaton Of cio-u r lr-7 ntries, coqa r-:r th an ar-aOf iu 12% in later -zears. As a result, thasa c -,ntrias' s o f ;F,,i in': t1 . it in total 1 iab11ities . , fromi.i an -±TY1-.:Ls: 27% in 1. 3 to 17- in l>13. iuc of lt i sin :A.L±ni- owev- is cr,c~nt 'a tc in a cx,xnti'cs7 ei.-:hai { 1I lanr; >. ~t; a , are . ic:Ii -3 - in natural rrnasour:es, or have export-orient:ed economies. Six 2ount-r ies (EBrazil, South Africa, Mexi:co, Singapore, Indonesia, and Malayi7') accounted for 38% of the stock of diraect foreign i-cvestment in dvelQV.¼ countries at the end of 1983. Economic Impact 5. is co" rk--Trrabsi co1nt oversy c,unc2int' the eno-aomic effects of foreign inreIstmet in d velin.' countries. Advocates of forelgn ivestiSent tend to ~iphaa7z its po:enGtia for: O eci-ming ai3 rtn source of :3x-tarnal rislk capital; o r-.| ~ tq trl afnd erin te.tlog.csl, mannerzal, a marketing expertise, .Uich - tharwise 0ouId not be a-alblrl to the host country; o 'eratirtF, :xcsr'.l> t. iss, a,DeciaL.y in 3rms: of employm-nt e,,.tcLL.&ll n-end labor training; o providing acceasrs to forec:i-rt uterke; CLd o a .2t;np. r and f i B with local firms and Critiloes of xcrezg-n-Ykestmrznrt point to costs which may reisult f-:rou: o a net aln-zV.Cn loss when profit rptriatin and Dilr DiayFer&: .are ctan into acouint; o the use of itrs .rIcing, in inr im transt , to evade -;rcfit and %, rkign tr,:ade taxes; o ng-;at ive aernal trade effnors due to relatively higrh imlport and low ort ponsiri^s o UD rr,sfe:: of tehinllo iy shci is and InL5.f±9UAILU.3ora lao- bniai Xhiky, .1; -4- o the hiigher industrial concentration and reduced competition in doimiestic markets generally associated with foreign investment; and o financial crowding out of local firms when foreign subsidiaries are allowed to borrow domestically. 6. Although the impact of foreign irnestirent woill vary in each country, the ecnc.eniic coŽots and benefits attributed to foreign investment are determnined, to a considerable extent, by the policies of the host O-rve-L-nment. Negative ezffects generally result from, or are compounded by policy distortions in domsoti,!:k markets. For example: overvalued exchange rates discoomr,;,':-s- f- craig T troI:i exporting while making imported inputs more racti-2'e; iiELtn u.ats reduce the employment potential of OiTmelntl; *aXie ;r ac--ion insulates highly concentrated indusit5riss from fMreign co'petiti-n,. Mreover, many negative affects are cr-at-ed by the lobbying of 3 or by the is g2uided efforts of govern- ms-nts to attract -!x.s 2Ztmi-ent. These efforts are Of ten successful in attracting i t but -is&ui d--d since :-ve- the long run rhey -oftcen C reat,s distortions hich mfat-as many of thei- pztantial benefits of foreign I i' G;r 'r- -'tS'i e T11. . Formei,qr Investment an~-d Adiutft11Er& 7. Un lik-e debt, foreign v not sezvicing uniess it earns a 7-ositive retirn. To the --i- th t at e st-urns are .2*-ct by cnomic din oV as; it can be arg;.ied that -.2jucLLr;ant to zxt ei-Llal shocks e-thould 'e c; - rely easier in c.'tias with a larger h of fore-i-gir rzt,i i -k in I -'cC t :m ¶.i} a, ' A t.- A c study by the IMF i suggali thF' (1D,;-' ,,ac '2on are tore j,trc y . e* 1/9:8u5? (l9 j), 22 -25 and A~wi;III -5- lated with a country's ability to service its external liabili ties than are inxtero-st payments on el:ervnal debt. For a group of non-oil-exporting coun- tries, the estimated anrniual rate of return on direct investment wes posi- L--vly associated with the annual growth rate of GDP. By contrast, there was little a&ssociati-m. between these countrtes' GDP or export growth, and the average intere2t rate paid on outstanding external debt. For 28 coun- triLS Lilr.-l in debt rexsceduling during 1983, the stock of direct for- eign invs.-:-i-XMe-!t;t sc.cou.nmtted for 14% of total external liabilities, compared with 24% for 49 sountrier, that did not reschedule. With the sharp decline in cr,inuearcial f- flows !> i Cnc 1981, there is inrrsasir:.ng a_1 Ieeaernt on the need to mobilize ---i t:oX,. non-debt creating re-sources, especially for the highly li ebtez2 cou7atr_--iso. Although at this stage of the adjustment cycle, fc->n - i>Sa ctmren is .±r-Ly preferable to additiol borrowing, as with LO'^-re>n qda-lbi,:, the long term on wiit - on grotl11 ldend on whether re- sources are Liave.-.ted in activities wuih high economic rates of return. Forej1 i Investment &I iec 8. D¶-X!e to insights g&1:Ain1e. from indu.SA--L:ial organiza-t-'io cnL theory, for- eign im'eStm3nt in ievelcping countries is commonly viewed in terms of a bil-at..-a&tel aonopo1ly 3-;Rit.uation (e.g., Kindleberger, 1969; Newfarmer, 1985). F1r%ai-n intor.t' market advantage is based upon a unique combination of :acto'D.'s not r--e.?ad Ily a-altrailabIe to C -e"tic firims, whse familiarity with local c .aniditi-on uouid othewis give them a ccnsisiderabls advan-Ctare . For- `r tsnvaVs-tJ is then, almost vessarily, associatec Vwyith iniperF ct and the .eturns to 1-Lhz. uaiquB cnibiustion of f2.ctor: are usually u.ah:r than in c y r.etitive markets. Thie host government, in turn, ~otosthe te,-rmos of s to the iome ticmuzet or ntrlrore * this viu oI f Lo re ain 3 u . ;aR.n -P lly ll cy . F|:r X$ v-~~~~~~~~~~~Zl zl, o£---*a-T- ua.a; i p-ll-y r, 5 ;vliJ]Lcy c.plt2;ion )10s -6- facrg:s, (i) n1egtia*3;,nS 'the2 1terms of entry and operation to ensure that the ari.er ;:atest share of gainls remain in the country; (ii) unbundling the f:)toeiga ietme£ t pac'.;.au to obtain these factors at a lowe.r cost; and (ii ) inzcsduc.ina omre competition. 9. A zo.ntr-=y s uInderlying attractivenss to f:reign investors is dSebrmined by a o^binatio of factos not all under the control of host gov nr-. Structural fea-tures su,-uch as mrarket size, geographical loca- tion, resource enciwents and phys lAce' as well as human infrastructure are ±inrtant eerm inaents of fLOre ign in'rstent but are clearly not within the jmxrv±e of government poticies. Takimz-Q; such fractors as given, there are four major areas : g'--ir government acctc -in- irifluences the climate for foreign 1-fla7escme-: and w½rfhe the .BIank has t-eded to focus its analysis and recoom- mendati:-'snrs. They : (i) ;zc,.rnnient-a t controls on foreign investment; (ii) the incentive framok applicable to 'er investment; (in) admin- istrative Prthedue res fr the proval and o eglaFtin of foreign investment; and (iv) the is ns promo ci efforts of host gonments. 10 . Ccoiurrs and , zulat-in gi-As. In an atteit to maximize net benefits, many councri combine an drpressA desi-L-e to attract foreign. in--,.ve v-2stment:: with restrtin -and rezu1 .atAohs on en-i-try and perforinrice. Restrictions on fre- i n L- nr esi traeni: may also respond to ad social andi political -n!l.* !* 25(l EtnLk^Xic trncd aconom3ic cons ideratians, Rl|Le ei¢ -1 - 1 ; strirons rrqety on.r me.si rptiainof nrof-ics, and ii-dn s; eployment of ;;dmcrcL.rwn;tBchnlog rnfr;or spc~cifi indus - t1 m fri ninvestment is eldd. ½LOnI glA tIons; ca be tied to ±ctiaeiiltyOr deie u.mnmmroieat,and can y:cFrits ; 2 eLployfflet.El 'i-A4tr ;D : :e l&a'£.3,-aticn: orf'i 1xi es t- i con lS,l ^E, I i l 4z^N 1r <1--'5.n p5 l^}7Urg) La2 . Issp S1t# liu -7- Although tez- contr'9lS aim to hn-reas.e the net benefits to the host country, they oftan en-tailI conflicting objeclives and can effectively operatte as stroivr barzrlers to entry. Restrictions on the repatriation of profits and C."Ildends, are a major d-isincan-C.ive to foreign investment. Performance requirevieant-- and ownership restrictions are also important det-e-rrants when set unrealisticall y high rliat-ive to the conditions and pot'cenLi&TL of the host :cotormy. For example, the proaram to encourage a of.J '7 i, -ve of n !any :si -d -F1i. - in 7-,-Tr during the early 1970s, led to a substk-antial decline in productivity as well as a loss of foreign investmt ninflows. The extent to wtI-iich foreign investment will be dis- zour;gs d, howevc;-, -erds on how the host country app-zs.-rs to x'esn ti~ Tc~ for C--s--,rAe,l ha. been eiiiA uc:2~ in Etc n fore! L iv Im e-t1 t f-L`airly -r±ct rls on foreign 12. e IIoz.: deve,.lonIng co :!,ies mbln sa degree of r-,ula-i o.r and c ntf---o-l w a o of ttiv'zs to .. oC.ign i-,ez, ntr . in- ' ~ are gene ally designed to: (i) compsLnsatBin n s- tors for r uct' -l e . g ef, :(.g. cr ct--ur small a ets lack of .killa:2 lb) and .l j -7r,s risks in the h tno 1- country; (ii) nar!ow li- h if: r±c t:vtyes son- el and privata ---etut--ns, on t-he ats,-i-p-J?On that t o ae 'i ai .a ptJ5ve e t J r (- -C t ali- - ;- i a I J ( e.g , - nS`er o f t a lc . y , 1 e Of IDEC17ULT- areas); (iii) Pronto eparticular sectors (e.g., . iu a c-c tur 1 ing) or s1 1otor rs't (e. g. 3]. ec n !c.) , J.b the ;ovs-nms ; n; b!i- I w i, , 1 c, Wi -n -iit s 2 >1- -:2* 6J'J1-|1 ''1A' ' '.n 17Sm.2! 0 r i V L v) ,J 6 EIÆ - A IS ........ "-. G *1- Cj -L ~r~l~y:d d~ :c:tins i me'ticriret~(e.g., minimum ae,ip Ii - 1 . 1S .r-n T i es-i- .,rIUve are avSil '.!- s to bo;r ut1 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ _ _ _ _ _ *;_____7!-_______________________________-*___e______________________________ I... 1;- . I i v 2 r e a ;, S1 ,, s l s o 5't -1 foreign and domestic investors, but in practice unequal treatment tends to pr-vail because foreig-Ln investors g,anerally face different entry and regulatory requirements. 13. Although not ai-med exclusively at foreign investors, protection against competing imports is the most common and powerful incentive offered by developing countries. In addition, many countries adopt a variety of special incentives directed at foreign investment. Incentives are rene-rally embutodied in an i-z.estraLlnt code which specifies concessions and/or exemptions available to firms that meet ce.rtairn conditions (e.g., size, location, employment). The most widely used special incentives are tax cocass-los eand tariff axerapLions. Tax incentives may include tax holi- days, .ac*cals-ated depreciation, and reinvestment allowalances. Tax holidays offer full or partial Bxetiptioa from income and other taxes for a period generally ranging from 5 to 10 years. In some cases the length of the exemption period varies with the size of the investment, the number of jobs created (e.g., MIalaysia, Philippines) or the use of local raw material-s (e.g. , Morocco). Acceles ated depreciation allows firms to write off the cost z,2117 capital eoui Twit-i-oe: against gross revenues over a short period. R.li-iivast.e-n all-wantcs xari. reinvSrzed income from corporate income tax, Ta-iK`e concessions generally exempt capital and intermediate goods, and occasionally raw materials, from impor-t duties for periods of 5 to 10 yeiar-.s, or in the case of some large projects, for as long as 15 to 25 years (e.g., To;o, Guinea). The exemptions often apply only to Soods not prou eca D. domestically. Other in-2sntikves may i nclude subsidized intrarest rates, ..1t Te provision of infrastrulctura and services, ifte-a in idus- t 5~ i 'Th C ;F 3or expor, it proceisslng zone-s., As an adciec± 2inceti"eLI' it a--e S. .ciIi}s.-. , pr -at pr.ices (e.g., Cameji= - r8oc-n). -9- 14. Most of the ecormniic literature tends to view the benefits to be de-,rived from foreign investment incentives with considerable skepticism--a skepticism which tends to increase in the face of most countries' weak a&ffladiist:iv capabilities, and the frequently complex and ambitious nature of incenti-ve systems. The case against protection, the most common incentive, is well established. It can be shown that under certain condi- tions, foreign imv.estnment w-kich comes in over quotas and import duties (tariff j1ugping) can be irmmlissr-izing for the host country. 2 Although import p;;irot-aciron often succeeds in attracting foreign inveStment, it *-5: a -a lly leads to inves;tment decisions which are highly distorted in co-nm c eus. For example, the protection-induced distortifon that gave rise to Chile's autc,mobile industry during the 1960s and, mcnr. rYe-cently, Togo's steel mill, have been e !-L:tesively discussed in the literature. Mioreover, iz eantives oncz granted are diff-11 cu 't to remove. Investment deci_ ijonz madi,ab on the basis of distorted incsiEtives, such as axcessive pr-otection, g- ive rise to vested interests which become powerful opponents of subsequent gove xr-n.rrit. efforts to reform its policles. 15. In addition to the risks of encouraging economically disto-1rted investment, it is not clear that through a finely tuned incentive system most develor,iz± countri-es can successfully capture positive externalitiess select ssctoro-; which w7ill be economically viable over the long run, and efficiently compensate for policy distortion3. Although extracting posi- tive ?.x-Q-3rnalities can be an imptant objective, a,eternli-.ties are dif- cult to idanr±Lify and quantify, coiiiplo,:tting the task of te-ting appropriate 2i tee fr- scem-l-e: laSu.brla9iuaia (1970)' - and Diaz-Alej-a-drCo (1,'7 7) -10- i-n-icntiv levels and evaluatli.ai- thei-r eccnorilac irmact. In practice, it is difficult to short.::,- that externalities are significant and1 that governments cEro ef fc;civly aseig-Li and iplerriemnt incentivos that -.courage positive '71ithvot; inr:ofu'n Jition.il31 distortiorns. 16. Incentive systems t r *[ v : 5 s- to be part i ula. rl 1 y inff ii en t 1 ; t th be n- e f i't2 to i i 7,. i r estors are (&nera lly smaller than they app-afLear and the costs to ths lhois,;t ount- ,.>t-.-lr may be g:ceat ' than is unecretely obvious. To the extnt tat ;eciUnl tax incer-ntves are n , they sonfer b its to ec _ o wich w . ould h--ave :vca at sth ini Ic it cost of tax±reg other Lrn: . z stors or more he--aily. lnvstcrs may m xor, modratse taxes CouuinlaJ with -!2air orrcm.nt to highwJl.y cace'- .. anal z .r-term rats follured by hghtazcina or ±.~: manner. Tax instru- L . and the , e to Lomi '1-- LR X 73' c,rCeQi inr -s>r, - 1'0.)1| i Z --3;-c j1z ,, t7 wh,rZ.. it elLilnaL speia tax i.n-c-tives in -.c- of 1of w.r tax r at - . 19. ( r'. 5.Ct £d.itrti ze. 2 *. The- Losl counat y S 5 'tJilTTih8 -¼' :3 c prnre- lue o t Xhr:n n and rglt~nof itsrce4L2.lSCift Jct.r'e=- te-Ey .2h ½ h'rtn.Drao .~ reSand the iercayrated 3/ An r , is, c to foreign investment are infrequent and, wheS7in i.cThludad-, tend to be less c ip-etfic thani. those in other policy areas. In most . host coizmtries are --braed to be miiozre open to rei i sk,c2 tmpi - and to investors th^roluig li instituitional :ltr:;s r im- °IT. i,Ing oaf a, d I T t1 NC L -c a F - pt -^.-D ue- ar,d., Jess fre uently , ch2n-g3 s i n !aKCn - In all -ass; policy re forms do not a proar to .O¢L' .t. a iiajor K In .- u...U L2 .. to;.. nv 3O tm:-nt. -14- 23. -.=...- , Al-' . ObjP-n -- -n ..ti-.- ---iinP m;)erif 1ty 'i. Sef- ; -2r(Bes ina wre-- !cll.uded in only 10 of the 34 3AL- ep roved by the ene. of CYS85. The mtl.i: -eq en t c-ci tion is the -ti or rexrii! of a L i-ei.t agency charged with promoting for- eign veftme,t or Fn' 1 tatj g i@ .nvestment approval process. The Tap riv- --L I p po;se the *?arzfn Gf a NatiLoT1nsl Investment Promotion Compa-ny aitd 'he 3e-attin. up of bgiri b -i--azs -oup,:' to identify and ceselop Thvtr!- opvs .Fr tT - in the country, The Cote d Ivoire SAL II su7-ited the cratLion of an Industr ial 2 rorsoion Lur-au while the i*±suriti-.i SAL I c--alled -r the oI fi,nt f i trh'etr tion consul- ranics in order to rt 're ,kL,-s SAL III r 2td Ltha: por, ,t -pr pC-revious govenn :3'orts to create institutions - :-c ilsllb £Q for 7oJing fI : egrL i -,, tleit 24. Al and also frequent obis to im lIC fify aDpcva raea -eLiuc,s red e,s for forei 1 - inv.ment. Often, the ini7itren- tion is to create aT =ntop" or fone-window" ini.titut1on for * ve:;msnt RT ) F. The Ja-fuEJ,7-.-s h-i.; 1 It ErcdnjtiorL Company c,sp uP-Ft2d by SAL I, is to 1 a "one-st"c=p" promotion agl'ucy t w ll r.lize all witih roreirm i-.- CO. rovk!oEdiri bua.t"'-,- itq *-. and ersx;l.r a-dy prOirig. The Korea SAL II r,sqiired a aimpliicatiGn of ±pKYVSJ. ' *cekir'ss, i.nclu i n re-l-~olri t .-D i-71ti5v- list of L 1t7tri^ cjet, to .c 1:eI&L D-a;-m-n svith a :cavelist urihero r-c-eig'n Ln3tetis 7 r -t sr . r- r n '' r ' and a r i :e . c-ioni in .he appToL-;v1 ;eari8.' f new *i:d additi . -l 2c ei i-.nvestments, -15- 25. S ci-fic-c. polic'1.O_y retormS were included in only a fwSALs. For S.saple, Farienia SAL I proposed linkling simlified export fnwentWives for t3-egrL investment to emplowmitannt cr-e-aticn. The most co,mip-rehlIensiv-- set of b tcLceig inlvesment policy reforms is contained in Norea's SAL II, w x&hich nrlrorsecd previous government rmseasur.eL to: i7creat&se the number of industries ri iwhich foreign inv,sste.--nt is zmitt; relax wneuehip restr-ictions by ring the Inexie s l for sealected indu.stries from 49% to lOt3 ; and educe rirLinLuiKs *-api'l rsouiremst. 26. cCn i t l n ro anda trade 1tol1-i.ce1 s are a cmm i swsmEen of most ; Jn. l not opecifi-Illy iwected at for- * Agn investment, many of the sectr r3zorms are rel''.rant to i In. inves- tors, esn-,.liE1 _1 y thrs deal¼r .I cii -:j ent code -.ttl inc.ThnrlroS rerorm. The aictusA ivmo-Lpct on osi e n the t3Zt&.ft to which -cki counrys m r- 4 re laion pt:rac equal trfrnor Ln for; regn and dI mSiwac n I-vestmen: co -e rr x as i-ntclud-Bald in 1 of e 34 GALe am:ccved. Generally, pcl-icy aforms arn not clearly owe-lIed out but to aymear more as of inte'nt to ur-s-i2, simpli,, o3r .Lat6oa2IZ3exist,n" pd rielns on the. Mg.i oi rirvestiea and tie- - i&*- tion o f irtcenir.r..In a fi zases rLH2 irLzetcio: is to makei 25V2 I - tLA i lw.sr.r.*..!.! 1 .1 - fi.lS atltI Ca; fccu..- on the naed to r-crm 5.thGn codes c-inc L-2, r, dminiraiva prcd'.n:es. Thl' e- ooie report on J ,1mai o, E.t.h^! o h th i. rec_P: progv;- in o La-, 2f;reLe, 1i .e tM t1, o17- identified the complexity of Jamiaicas public 3ector as a major constraint on foreign in-eszti-ient.. The report called for: rat-lonalizati-on of public aistratio, .including the simplification and red.ctio,n of statutes and r'?gulatory requuirements; consolidation and elimination of a substantial number of public a-encics; and a Sharper demarcatio-n of responsibilities amongc, those that remain. In Somalia, while recognizing that the country cannoit. expect a large inflow of foreign investment, the 1985 economic report suggested clarifying and increasfing the automaticity of incentive eligibility as well as removing ret'rieticnL' on profit repatriation. 29. Althoug1-h economic and sector work (ESW) on industrial poli-cies is ext,eCsiv, only rarely has the Banki carried out a systematic review of a CO*.ntas f z l investment eii- ither as a self-contai-a-d s2tuc1 or as a major cofponr,,nt of an industrial sector report. Two exceptions are Pakistan and Indonesia. The 1985 r-eporit, zMr5e Foreign Inves.tm Irtients in Pa½en, prov&.1did2ed a detailedsd review of pol icias and regulations, recent trEocLnd<1 and iattns in7 inomeLret flows, and a. set of policy r-cararenda- tions. The rep mat's major commendations included: adoption of equal treatm eaiit for investment approval in selected industries; establishment of a llone-sQtop" approval proce;-o; -r-evie-.; of industrial location poli'ciess; reform of ;ForignL in-vestmen-L; inc,nti-ve-s to levels comparable to those of othe-, Asian ao12ntries; a-nd more liberal policy toward royalty and tech- fc!l fee ,g:eeri-.n.. Indones-ia's 1981 iln-ds-trial Sector ReporLt contaIls an e-e nrii-e anal;r.. i's of irr;n y investmenL. Citing the past and pi-,tr,>tial iptneOf e o4 inve tme.-t in Indonesila, the r,Caport 'L'aVY-C-tWS foreign nv:-1-rI-p: pCL!c4;-J., the ii1p.ot of the c1hang-Ing p-licy envir,mmiient, and mal-kes detail policy rL-mmen>tions which the h'z ?.0flX12.c costs of I v-r, enb re il.¶t:i and in,er;-ent ri. p ; O CllY .~mr,snaraszlcwraot La~:atj;;tA. a and f2inan,cial policy made for the,- roale of rhc.:w,) mv- .;g-<,r -n ,DL'- rciflg Bo"ard inesmet-<76''u *e' 'j i! n ares :- '. .!i to 1 1 I C3 r'jE \.r4 L', 30. In 1980 t - UNDP a study on the investment incentive iystem om T1l X].-.nr1. This : .-apor t ti7f from most Bank approacll: in -,is; it .sa 3oril.Lal- mc,r restrictive stance toward | 46 ;|5-- 0 2.>.Naiuple,1n6. g t C-19 r-pot * 05is 2 co0l5 ncernd 4thL: -excefsso.v otnu Lc-' nd' its iiing effect on the develo'pmient of indigan s- tecnology; acelerating the sutituion of local for rodtr- eign ind of forign-11'- technolo,4gy, mr,tannegemzen.t and cr "l flw-cl In t - to enourag c?l oVneahi and conto it called 23- iga t.L to ;h OS N-hi.e: .fr Z I-, st i inve s enis cEqr.-i, r. and *eu-.sUring bc ." JaL'.Lnr and control sz-`Lsts unless itu can be clearly (eKEtEcdthat cs4gn controlg is esn~a to sensure nec~aszaLy)- tech- :alc ;L L . r, tvt itsl itfl ':l or market aO. Sc. T goverment 'wa also - to c0- i uil its k? : 't-na1 e"ic1rt, to r ountr-ri- es other than .ti!U.S. and Jsn rhich already a-ccomnted for a large chare of fri 31. In zasr A : r sector'- repir-a )o,orts have cs incentIve . {turfl5: Impr in approval p rocvdu.re and irseud a1tomsa-1-ti city. For exŽtw35 , the 195report ictua, -n.7das a2uz a,.-r a sector ae-lp.'t-Laized ih-. i'0 i ,-, , . and ht1i!ghl y iccronry system of --antiig special bae- i / to c" "s.'- t 'U' l nvestmeDt. It nroE U a iplfo on of app v3al pro- d1- K ifutinof, ndl2&'d tr tcL'in, the granting of It a Iso . ifeO. that pd I - -- l' u tj $ Z :nnoreotfcLn: notedl "at'wflil HQ ~~gA~TZ -19- e.clirts to sno, rg me nvani,La 1-n. were unart'rw3sla it was not ceaar that Iimi-:ations on 2oueign zm.rsmertt We2:e, achiv½g the i nt.a-ndsr (Ji obj'ec- tives SnQ genershted negative e:ternalit-is with respt to heDcal borrowing limits. ½owevr it cneUi led that under e,x istig ionitionst would be aPrc pLfl for the gcqvertme-nt tO ma.ncain to-crowing and repatriation rest4-ctic',- in order to prevent financial (]trrX-FCw½g, out of local firms and cm,tal .-ight. The report also s%gestd that the Promotion of joint -vent LCu rus would be onsistC i. witth the g.cv-srnwnt' s obj,ictieres of tbot 1nl easing forei investment flows and en rgrLoragin loca pcrtieition 32. I s c the IDF di&si_clwn has b-en actively involvs-d1 in £J.WiSiflc rn e c cr:r on rnvo s, -"t- 7 s- s Dnt-,* c o de re B :frmsi to r'au - dXV i s t ;r io n s > both thoh oi,ni ESW and in'c*rl- . policy t2ia:ussi The most 1n;'es--irj involuvOent Ci,z beee in Cote d I-'QImO where e dth is eon s 1 '. has % bchgru± Zor invet-et coon .wc included in the m3 tL tr-F'; m' IrtK n zode. refo'rm have also '- -n ,Lg,escwi; for Cimna, Senegal and To:. 11n Lti --tm erKzic'-. z-n-! CL tie-L-i1,s the B an1 h as .' roztsLtavseon ooen nrcmetroiisr reiws hee*pmpcr to be tiqo iaciPSfl.In Latin ~r~--vmi ~i2Zto be pol "' I 1 iy sastaand the 1tpc CUWC s ara' os~sIcA~r2t to evlaeanid hlfbi 33. Th a, t-sico of Lo:e_nir-smef:n ccin the ¾-al\'s -2iror-ts to -zn",~'-c~~ ~ ;;' o:rtzci~tI 1 t i i;r zstio ,i; as the narrcny fi % I ofctnt2 v haae generally I½ to di. .~&.:r~ .= In iimarryi i u9Z r 1 out asn;*. (.g, -K-sh Bw vJ.ta, n re (e rc - or o i 1'orshms ta :Tcr- t l'n i as - L- X;; ^1 -L; - 2 5,q N ;t \(X ;Iha . 5C- 8RW4ET;GB NLt -20- ii i- by law or in practice. In dealing with this issue, th, Public Sector iManag.ement Unit has not explicitly recommended sales to foreigvt.rs. Foreign participation, h1.oweve r, has been an implicit issue in some cases where a foreign Tarty- was the most likely or sole investor (e.g., Panama). ESW generally does not address this issue or treats it only in general terms. For sxamim-1, the 1985 industrial finance report for Kenya cautiously suggested that sncoureging increased participation by foreign firms and improved incentives for foreign equity inflows could become pert- inent if th1a government eventually decided to divest any significant part of its sqiiity holdings in indl.s t-rial con.;.crns to foreign firms 'The Baker Initiative 34. The nea1 to increase feign investment is part of most medium- term adjustment strategies under the Baker initiative. Specific policy reforms vary by country but generally include: ref-o-rm of inLvestmient codes and incentives; zt-reamlinir_ng of investment approvals, and incentives; equal t- eatmenat for -fore-sign and domestic inv-irstor-; promotion of joint ventures in the energy sector; and reduction of risk associated with cur-riency incon- vertibility and expropriation. For example, the strategy japepr for one of the 3ake 'otr'Zs :Wen'fies unclear rules of the game for -n-foreign inves- tors, derlys in ivfvestmernt apprcral__, and the limitation of 49 percent for- eign onerahip as important :oz5istra7T=n!Ss to foresin investment. The paper r;ec1eri?i.^ placing three or four investment proposals on a fast-t-rack approval par-L every yFr, in order to improve the country's iimag- amonr; fC, i n i',' ve-7 S, O Over the mitediu-mi term, there would be a neer:i to review ie, ltme *-TiborZ, and cU-icr lq to broaden, clarify and s-irpl ify the terms a c .L 5 co-nditions t,.nr2er which ri ic rt-':-vc is ; 0tL. -ther -21- policy changes would include the acceptance of international arbitration for investment .:isputes and the establishment of internationally acceptable rules for patents and copyrights. The International Finance Co ration (IFC) 35. IFC has played an important role in attracting foreign investment to developi-;.g courntries, especially to countries and sectors that generally have not been the larrge-t recipients of direct investments, By providing complementary financing, IFC acts as a catalyst for foreign investment in specific projects. Since 1974, IFC has been involved in the financing of over 150 joint ventures betursen foreign and domestic private investors. This accounted for about 25 '-ercant of the total number of projects in which IFC -made- investmets during the period. 36. IFC's efts to aitract foreign investment often e-x-tend beyond a purely financial role. In addition to assistance in structuring project concspts and f;inding foreign partners, IFC has -viorked with governments to de;e,1op 5,appropriate policy rm-- ewoam-uarks, In or.der to expand its advisory function, IFC recently created the Foreign Investment Advisory Services (FIAS) to provide assistance in four main areas: (i) formulating a general framework of policies and institutions to p:romotes and regulate f-oei n investment; (ii) establishing the policies that will faci°l-i°tate direct 2Anvestmeint s in specif2ic priority industries; (iii) devising foreign invElrest- ment pro-mc-tion strategies; and (iv) developin-g policies to xovern tech- iolo.yg transrers. FIAS can also help countries to implement its recom- menat- i o,. A f2eea is agreed for each assignment but a siJ-n L--iCant portion may be c rvered by third party i-Lnn nin. ,, 37. AN±other reent IFC L-mnoxvation is thie Cuarantee;d Racovery of I -rnV I- 2 -tpin ci a 1l (G)S pr ) r 1 im a i ly deg -7nezd to- redue -s Juit -r-it i sks for -:equity in 'lsvelopi-Lg countries. Under tLIP the inv2stor provides the f2Pmiin whi s-'J- uSC 'hiI i., t7 invet in its name and css-uc-S t1f.a full riskg of loss of mcinral Dividend income a-nfd capi eel gaSins on the ince,-ment are 2hE!r- anid, at the end of arn agreed pe.r*i, the izn-vestor canr deca-. tt o eo.ate full lea and b-anef-i cial ouFsr of the sbr:es, or disenraage frc the ½ tn1en with princin-.alilC 1T½te UzX. tiltX.;-TnvaP-r? tmen-;i-tl Gul--aran'Lftee. - Agency,,i 38. The need to rciue no"n-c m-zrcial riskls f'ac:d& by foreign °-r aes:Ccrs an.t. the semi± under-n-ror7ision of risk insu.-°raince by private m-a ts t-nd o i government a g iro--z5, have p rmp G tad ti -e. BankI to creat- the UIt i- I c--7ti I-ira! Inv bm,t - Gurantee- Ag- encGy ). The obj ectives of MICGA gill be to i and atatliza coraditicr±s for productive foreign --in vest -'ent': in I-rirn1 ir .7' h t - ThefFJ& I, ounte and --l . ii to e nhce the ben2fir-i s of such i n-abmerts - t 2 to nos.: <; i-& , Thes. c jsccai.;rs are to be met by: (i) offering investment " tarant;; to in f.rom both- i:dns-tr-m;-e Lnd developing Crfait nrc risks; (ii) -orov.riding a consul1 ta_ tive foru m c'r the rYahang or experience eman2 ebes. on lures tmntporllcis-, and rgra- Irasue -.s; (ii) -otircg agre.ameintz related.ia to guaranteed invest- eT; S ind (i v) technical a si,an ce and r.Sear services. MIGA will also '. . ' 5 s :LS.i ' .L'' irfoatir on iin etment -Dpportun-Ans in evloping menmber (C.TZ5to potre oeinivsos 39, z :: th' r.rcmci-on of forei:n inestment has not ;.,ure ; 1 p rom i, - t.y i D policy d a a c , reY ! rercrnz prcgrams the ahas bex o.-al rrorcz y i cuzng- on I v,cri~ the -23- ienee1.S iStMG-t CliA--.e1t through the acdptL-'in of an appropriate macro- economic a^-nd sectoral pz' 1 ay °mewo ; (ii) an.l:ou&agin- governments to uce-B controls on r;'on-ign investment; (iii) emphasizing the benefits of c1ea4er $ .n-yle, and less deticnery administratire procedures; and (iv) garierr,lv1y Dla iA- the issue of foreign inv;estmi-nt incentives within the wier--Z ccntex't of overall invr 3;^i:ient and trade incentive reforms. In zl.dclitic:, the more important role assigned to foreign investment under the . ini .tiv-e. , incr sinc; bsupot by IFC, and the establishment of MIGA are ,eted to improve t-he p- -z-pecs for increased foreign investment . s to developing c.'m ris 40. Tha adoption of a domestic olicv environment that sets macro-' f oa. oe i and sectoral condit_io-n -Za-vo-0rabAe to sa-_ viLgs 'ri i-rTxesti-n'w'nt, and allows input and o'unpL wi-1res to rKef-lect real scaircities more closely, is the most a ecse way of maxlmizlng net benefits to the host economy. Bank si^eistance to i r.cve c.:concm-°. management, reduce economic distor- tucr±s, Ž5nd *:d ,. out inst-itutional Iefriosis its most important ccontribu- tion to the ..ipormCCtlion of ef-Lficient fore irun irfie-stmerjt. To this extent, the Lenls emW~i:s>s on s:tural adjustment prograrms and policy reforms to S. ixr- the supply : - ca-. of produ01i em sector_s is appLopri, even 7 hbrn dir;a - . Ot :orct . °gn investrect are not . ic-ly 41. Yinirnart: mert n the promotion of f_'or, Cgta invst.m Ai -t has on need for ins t_-itL-utL-ionial re LD"ROia in twqo major areas: adniini-s- r auw1L pr] ' : :.t- m Je!. a L n ,iot1 ,-a- c.Nities. Nost of the nsi-cuil ;^') - "'en ~Or 's m,rLeo-d-.SL;L by t--h li-iar-J aim to .m ro.a or 5 .I -'3 . ,1,t rIVe ` + I - ? - t T ! o f ti i E & t i .; Y -24- investment polt.ic .. lthough te desirability of increasing automaticity in both irn-e-stment approval and incerntive eligibility is frequently men- t-ioed1, it is us--uially 1 1°irA_tred to st.ai--lng general principles or endorsing goverLlma-it- 3-ffort3. to reduce the discretionary eleEient in investment codes. Only in a few cases does Bank analysis and conditionality target specific -gz-u orati oC- or ircondx-is c,ich can be made less discretionary in their application. 42. Given the co n w°f.lc inlwluence of bureaucratic barriers on the ovara'.ll 'i esu - climate, the Bank's emphasis on reducing barriers to entry and simplifying a,irfi.ristrative procedures is clearly approiate. Lkwi3ver:,-, tC.e+. 3o.t..s can be Da:4 for strengthening f Bank analy- sis and First. i greater aEiphasie should be placed on the severe burden ioF on many c1ountriaS administrative capacity by a highly detail-e1dS a-vi '.diOeton-y system of investment regulationLis. In many cases the complexity and monitoring -nBquir iTizsntx; of r-e'agulations designed to implement f ;9 inez.trn Aic½5 bear little relationship to the coun- try' s adminis-CrL.ive- oa-P:abiliitiaz. Ailtho,ugh the opportunity cost of scarce EiiiL :; L.7 ,-expertise d.e oted. to resul:atory functions is frequently men&-irricnd in Danlk anal-ycis, it net7ic-ds to be _tre.ssad! and doctmenterl in -t-r detail, aE;p--ecially in smallrA countries with skilled manpower con- straints zi-i -vibe- regulations are clearly redundant or d5,stortionalry. 43. Second, Bank- support for less - c io r systemis could 19 ,e ri1 fLrem g.re71:-.ater Specif'icity. ZA-lthatulgh. many gove-arnaiaents attempt to introduce more pr3ocaeduzres, the-lir efforts are oft-n derailed by the Aureu- .zracv- itsel-f-, ghki -ieraliy has a vested interest in m-aintaining a highly oy.- ,, trn . Bank analysis whi clearly i de-al ntifies r-dundana--t and -' !r -Lc ,- r- . l:1; can ctn .deO -Ly si:ra4 i;hen the proS ts for -25- adminiistrative reforrcS. In addition, two approaches offer considerable copre for grad.ually -intrroduc17:og the I-ori-hciple of automaticity in countries' regulatory systems. The first approach involves adopting a negative list, which zPeAiis only those industries where forsign investment is excluded or subject to special Aeg1tions. As was done in Korea, the initial list can be quite extensive but once the principle is accepted, efforts can cncnentrats on uradually reducing the number of industries subject to dis- cr ti-onary rules. A se.co-nd approac-l-z -icrrolves replacing approval require- Mncits by a reporting or registration syst-,em. For example, in Norea firms xwanting to imp'ort techl,nology report their intention to the relevant min- istry, which has 20 days to respond or the import is considern!,l approved. In Paki-stan, firms need only register royalty and technr-cal fee agreements and no prior approval is requi-red if they ;c'nfcrm to publi'shed, albeit restrictive, guidelines. Firms seeking exceptions to the ggu idel `Lnes must go r-hg- h a cumbersome apzroval proce at the Centrlc! Banlk as well as the relevanat ministries. 44. Third, Tintr-i,'-r--,rocadu re_- s do not always follow the rules aen, iide1L-- set by I ln and official government policies. In sc 3 a ou ries, the gap ;-treen ';rracir1 rules -'n th-ir practical applica- tion can be 2,, nsidLalrable. For ezzrayple, some i granted tax . 2ti' Under Zairels Thve tmlr otent Code cormplaii,rd that -hey were effec- tively called l on to pay the taxes (Fitsgera.d, 1985). For this reason, Bannk analysis of cornustr-ecir traints on foreign investment can often be st: th/neci by rererer-.o to the manner in which ac'Jm1nistrative 2ct° f-;s are actually app!licd.. Clearly, this is not an cEasl ; sk and rt uinzot be ' . pl -hs :ely in all soun-L'5ri-S5, 3t2vies and ancl .rai,mpe-; .les may provide vaThs-,ozibis in3il_±ts on the ac-utnal -26- nroblems faced by inr-vestorsn. WLhere govern-ients are attempting to str,ea-a line re,gulations on f-ore- n 9-rcc stmnt, imparting a more pr.-act,ic-al tone to the analrsis of ad-ini--'.strative oarri;:s wou6l enhance the effectiveness of the Bank's policy di-alogue. 45 The Lankls approach to promotional activities has been supprtive of n intentions to establish or promotion agencieis, oLftn rith pi-ivatz sector participa-tion. TWrhAlle some amount of promotion miay be ppoia perhaps he rlintries Lhere the inv-Yes tilirLet climate is clearly impr,-oving, the hankc has not atteppted to evaluate the fct-FL iveneLs of various promotional activities. The -Lank should encrur1-age go-vernTiets to monitor closely the cst-effecivenesof their promotional act-iv, ities and to the tt-ant thcr efforts are bein- miad,e to stre-alin.-Le adxiistr-iv p |;; - 2>1 CmDh tEtsKZe t r" f he ircxv-stme]-nt fclita ; tioin rather *JiaLt t er mark Oetinc. aspect of promotion agencies. Care solould also be taken to av-oid raisin 11 real1S c xpctations about i-the effectiva-n-ass of prootihon -masue.s en not cnmple-ment by t-t-.ps to improve the htcoutryL.-ts- iL n tnt' cimSae, Incenitives 46. Th- Bert's muphrsi a on ii.p roving c mana,exv.en and reducing bureaucratic barriers rather 1than increa-sing or fine,tuning inc tiverFs to attract fcwe nv.stment is j-ustifie d. i2 Cnr:.iva ra.`LTas are Pr oC - pcx--?i or 5n-tc-rc .-iBank aetLomeiatior and l a-rc.a C-enarPlly -Parct of a w' 1 of in-,7m and t! Vl incentive retl-x-rii*s. In most Z2-, LAW t-' are ouiscuo. to move closer to equal teqatment for fo'r;i Tfl XI~jf dv.. - 1.i e tend in a -. instances to bring; incentie more an line I;x ;- iover nevlopn; countrees T;hich cor - the saeies ty- siet Only in the caeof xpr cuszAg zons -27- are riri . 33rJD87 r-cezltiveo t sa-C_I -d aea.sy fr tha :Jomls-tic prJi- enrTh7-; t, but in scm1 eSF.s the iowrmint is advised to extenrl s - 7! m. i Ls r !! b r;. - s s 5 Lo s t o z ! (,, a i~ - t io c Tp -Z '-1 &_ ; c- s 47. Tw o su;-,estiUns can be made co strerignthan the 3afklc's analysis of ies Iei inT- mcai ° -'-s. First, alth,;aurjh it is appropriate, to evaluate in- vestment incentives relative to trade policiesX, it is also important to v,-.D.7w them as part of tax - crioli°es and, if relevant, -ubLiL Lc expenditures. ToC7J S.Wr :..3-I\-L in !inrv,ment co f'd are evaluare.- apain3t altrnati've c-oes, with little or no analysis of the iniplicetions for COut-r 'trLes" over- all a 2' polic ies;. f3sccrd.1 advising courntrie-'fs to make their ies-ii--':rves c"l |2ra a with Th:.'se of z cntn Ari-o r m ay be -etri t- . to develop- ing n tmt as a whole. To the tent hat competition a count-i.' .,5 in ,nve t-- x .nce -:-\;e 1nJ i the l£ of ac,2zomilc -a< tivilty, it Žrr--_,v l T ade .e Fcr 'r ve-t-rc t'o rT- im#.e their tax :p ayments . Although 'LJ 1. :.L wS , ap? .L. to maximize its level of investment h te cl-.Ijl'Q tion iiiay JL--_-.d to a net -.^s:-r from Jlsv,de ,:)-pinEc- to developed countries, Vi7c, .L L s ito:a Irv. ;t. hn t.- . If rnarginal ch-ange in inc 'Br*tivei do n':t infl the i o,.-ticz-i of irovut-ent, revzues fcregon e or e-qpe-iitdHLL t:rLi-r--nd are a ne;rc_- lc'-s to the -i countr. i. V. fz'j.EG'F irUESTiJKf' POLICIES: SO"i.'4: cENERPi L PRINCOILLES, 48. o obj ecUive of the E3aik s aLdvic-e on :,c'.1'ein VeLSi7i,3l nJlicies .;. .iot 7e to crease the U- of forei n investment at any cost, but to t UL2: UL-.cc.v:er scn;e'As take ,lace have hi.--l economic o f £r ;tiu c3.-e any i-rre.stnfient can be ia.adi ' 1 -.; TMrVt4 1j.bi .l 3 ir?'':Ln VGiso w. de . N- 7 f'C JIE1l P'Zc -28- ;0l-ld not be jud: in ti nE' of the investments they may help to attract, but on th.?. contributi-1a to a more fii5 r±t utilizati-M of reootrces. ThuLs, in some inotances Bank advice may well discourage foreign ivtrestment ov.e-ar the SIor i=u er1.°rn term. For example, Bank ippcrt for trade liber- alization, elimination of special concessions, or easier entry into domes- tic mnarkets, may act as a disincentive to 2"uture investors. Concerns over the i iz-r cn;- al ocE.tic of rcrte,zc s , however, should override the desira- bility of raising reigi-i Lnve',rnent levels. 49. This paper has r-rUeLO that for most .7ountries, the 'u-Iburndln, of foreign i - - nt, and negotiating terms of entry and parfor-niance turn out to be very di-i" mi; to do ef.t7ey and run the risk. of c-reatiz: a t g:eater distortiozs tC1, .ha-n they T This does not imply that . tri cannot, or have not, s.u.ed in these efforts--Japan, Taiwani, Korea, and Brazil appear to have Aoivn so- - only that very fe8.: ntries have sufficient lever- age and ad6xriniztrative a-kills to do so eff-ectively. Important exceptions may be i£' n in natural re- *u e nu! e or very large -.i-ngale projsct. s tJi7erri-e the-m: hostr ntr holds a particular advantage. In such c vses vigorous - i--1.1 over entry and perfomraSce,nt 5c if necsZ-:sOary with the assist.ance of ou-otide exprtise, may be advisabla. 50. The fact t-hat .-oreirn investment is almost invariably as¢.ciiaie-d. with iiape ctf ark-ets stuggests that a major focus of foreign inveci:rnt poleil_--s should be to incr-e.asa comFipetition in domescic -arks.ts. Trade liberay Jl i 1 v aii L.. Zrr|r -Ea lci:or wiarlkets, and lower sentr reqy u .emenl,. can -e sustantiaiy 1,the oll;gopolistic aJdv.a-ntaes,s enjoyed by most foreign in M. t-Ats | as well as _incrEasing the rc.onomic efficiency of i tnviast- ' ijienI.S. Ot,t-1Ir i .'c. to in se suB, amptltLon sun as: anLust :Legis- Lt ont!: -c,-c,,1 on r 1eJ;jJc!ative Sorct-Ax-a- i&n j t and lice:i n.-ing (as il 29- arid M4exico ha-uv done effectively), and public efforts to support local reas'er-"Ch and developiienrot, may be feasible for the larger and more advanced c37v Uloping t'Lntris-e0 51, As a 7enears rule, a strategy to promote foreign investment should place less emphasis on special incentives to attract foreign investment than the eai c-c of a sound i nvstreiant climate. The two most important n'luen.ce on the investment climate whih are under the control of the gCV,3riZ5-ment are the general economic poli-cy- fri-ameCr1c, both at the macro- economic and sectoral levels, and the administration of rules and regula- tions governing foreign ig, t -r,n . Improved economic policies and st-raam- lined pdminicaueiUe - u- -rs should precede and, in fact, be the major s7lliri r,mins of orsiogi Lin t L r-i Op ation policet. 52. In most vq1un t-oi -s w r, reforming economic policies and admin- is't'Lat 'pV5ro 9r. ican be di-2,fficult and Mrot- t.. 4oreover, most coun- tries t!1l c:to* X---e t io m a ina-,-Ia a cb i :aicr±- of iminc t-iv-L ves and -xeguThtk rDrs on ign I t iv2nt tr azrve ec 2Lc, political or social objoactilves. In the absEnc .- of wide-reng,Diug policy a-nd tdiri_a ati: reforms, a rt-xm,n1TieT.r of general -rincip.ss can be suggas-ted. as a guide: First, incentives should be 2irft,L±-B. Direct, clear, and tn7iporary c. ive.-c-ti are gen-lly __,_,:3-'er"r5 a to indirect and .'ructwr al kln c'ntives. Second, a--nci:°oirvas shoi.ld be neutral. Incentive,,c:s which are Yv,IS-utrzl among .Ge-CLtors, e-specially alv;L':cture relative to manuf|ct'8l i"l, and among i ndust rie s, should be -p ferred. Thk~1q the9 a1i- t Ceion of ncentives should be . utiatlr Whe.-irm°re is - :Lqec it should le bountl by clear and publi.sh,-ed cto rmdiuca i. and arbi o s on the part of &&O-Diiistrators. -30- 53. Clearly, theo._ are rYcrieral principles only and valid ex~ceptionrs iayv est. In all cases, hcuevekrr, the analysis of fore Ig invsst:ment-'_ incentives s!-ould be fr wdithin a wider eva-luat:ion of the cou-itry'.,s oealtax, rrd,and inetetincentives stru'Lctur_.e. 'Since, most coun- tries do not apply equal treaatmentrv' to 2c-reir;n and domiestLic iTnvres-tors, the de-cis-i7on to rlxforeign inv1,estment regulations should consider the impact on existing distlortions and dow ..tc ma.arke3ts. Major chang.~es in a country's t~inigmsjt'tpolicy myraise ciuaetions of sequsnancie, when combined wihohraoo~c:lbrlstinre-form,s. Analysis of for-e{cnr investment policies needs to cosdrthe timing of re-forms aimed at iincreasing incen- tives and/or esabisin -qt2lfl tre-.-atixzentil for foreign and 4rsccinves- L.'Drs -vhewa... there is alzo a nec Ia.-. to libreiz -avde. the -car,-ital acrn an !et a~tl2rQC.The recent lieaueon the Cciu,cw-_nr 25lap; of 1 T'.alictcnsugeas oaae ge.nera-.l ririnciple-s applizdble to -Fcre`-n ines n t. c! 7 i In :drto avoid ccuJudlgeitn itrin,acro- Yi-,:meLe and eetrleoms1-should be implemente 41-.s bforesusatly ____ i -iumzzz Jnent,poliCieS . T--rlad lieaiainIn narr LCU- lar 2.tc-U . iecad -eJfern of adiin netvsor rm alOf my-arci--ricnL- I.nvestment. xtnigthis prn tl o the CVmt- apital in'scit can alobe arg-uedU thiat iPeeiainof the tomsez YTLE~ C1 syte ould pcdethe lfigof restrictin on lega Lorro'C.7-n by fr4- xvscw,:eilywhntr are x ajor -L.-us.rate (2 r~ _- ___, c: 54. TLa:ara~eo uofitc.y5c' 6 appIy aloto th hstcort try's5%dmnsrtv.rzdt for th cruair.and imbenna:atof einIYVC7tL43-nf -.r',D1:ig¶h, pei in relti . to en arClineaiv eigbiiy. Emphapsis. shouldI be plcdon hopwr:z% -31 costs ndi r- ly sociated with highly a-gUl ndid d C__ o -a y '!-i.1ures. Excessive luur;e.aucrai:t c 'arr`srs shcid lbe elidd. pa or rinii par T2u1ala-i-ly ihere they are -'a-lundant anr in rc1ve n lap.ng r p:. nbil cL s. Regulations shouLld lend theu-I.seI'Ves to h- hzi, pase-d out once clearly defined miarLlkt objectives have L':±|" achi-wd Ui here ment -'Ll'ta are charged with both regulatory -prosE i es l .. r, e- 31Ast e -1:rpr7iation or the wiillingnes5 to st'ubrAit rto L 4.n can 'i-±av' a fa'ycraf,Ile tact on the parc-ptions of 55. Izz1nent rJ .xWicnal .r-f!i es -*.hold1 be as sr3-ific as pos- cbI,c be ilznid to facilitate F orEeiY iFAnv.3,1Ll- w' j th-- t he Th:. bh .?l.tc a'i;tand wit. lthshing Ac ': it the local l - comunity. l:! ½ni activities .Z|hculd be evaluated and jU~5 Cia~y . to t2Cal aecri_.nt of changes in 5 12r,tbc and host coun- tries' economic and bse:- envircumzt. p. ta-iz-. cn-sg, the .k|.'v-r{::l',-`s',-5 of promot-L.in-t1. activit i-e-s should not be ei.u.g-ted. The illipe av- of Irockt' ;-in is rI111l , mal; coIT)r, to j i h ar e invPvcc7in the -.i .tenci- .--, ~ ANEX I An to the Literature on Forei . Investment 1. The O11following list is int--7ndc as a brief introduction to the e-xt^eniva literature on fo-rei-ign investment. References are grouped accord- ing to major topics: (i) general; (Ui) costs and benefits, (iii) technol- ogy; (iv) Ladustrial structure; (v) balance of payments; (vi) inficenti-ves; (vii) ,o !i.,n; (viii) home country policieaz; and (ix) data and d*.3finitions. General 2. A good generaI introduction a-nd review of the literature on for- eign inv.st-seni; can be found in: - Caves, R. E. Multinational Enterprise and Eonoic' A-nalysis. Cambridge: Cambridge Unid-wersity Press, 1982. - D-ing, J. H. (ed.) Economic Analysis and theJul :i.Lati ona. E 'r! :. -,ndrn: UAillei & U-a£ ''.J,i, 1974. - TC1-al^i'eXSS C P. American Business Abroad: Six Lectures on Direct. New Haven: Yale 7J-A-i7ers.gity Press, 1969. Vernon, R. Soveat Ba: The Xultinacional Suread of S-.. 1Nn,'re- New Drk: a Bsi : Books, 1971. Costsan tIt 3. A full i oof Q!l,ic costs and br-nefit; of foreign investment :coL~L~ ~; levlo otiriun-:izs can be found in: _-iestelcar, T. J.Dstrino eon? ContendinZ T Vh -hertG%l!<-on the Mu1tinalt-nalz Cor oration. C E M IT 2ras, 1978. aii1 S. and P. S Forei 7n vecti-nt T and De 1-1- CounLtvie9, London: Mac1Millan, 1977. -!R. Tsnay- tio7nal C ietes and the Economics of U&!ql~rkt_ Devae1- oPme Cr(cen&wich: JAI Przs 1980. - -Li_s, G. The Corporation as an Instrument o:-F 13eV 3 2New Haven: Yale Univarsity Press, 1976. , i jn Centre on Con l T ti= . -_-_ i a Yrl k: UN, l33,3. 2 4. I.uvz eTht to the diffusion of tcch-;n ,olo-V through f£-:reigrn i,nv.rsant are c_Jvs-_-ad in: - Lall, S. and P. Streete. n (1977). - Morley, S. A. and G. W. Smith. "tThe Choice of Technology: i-¢ultiSatiorial Firms in Brazil." Economic Development and Cultural Change (25), . anuary 1977, pp. 239-64. ' I.b:D5§R. W. "The Cost, Conditions, and Adaptatilon of MC Tech- nology in De-.T3l-oing Countries, in The Economic Effects of the Multinational CorRoration, edited by R. G. Hawqkins. Greenwich: JAI Prass, 1979. - rSl!Lrrne, $R. (l¶c';30) V /'ai'sos, C. "The aiv-k3ision of the Int-sruatiLrnal Pt-en stei-: Jlrg& C .ic-r for a Thizd 71Wo:r1 d Position, UtWrld lF-Jprir.t. bruC,N'1976, pp. 85-89. - TYastal, L. , Y. th, and G. Purszell `Kcrean Z untr al Compe- tence: WTI-is,ere It Came FT h3,Y " World Ba.n?. Staff Working No. 469. D.CI.gz: World I-an-klk, 1981. Tnadust-,i1 t' 5. A e -K' rC i re analysis of the ceriLrThu of indust- r ial o,r-Lani- zation thecr to the eva! c of the costs and I[Gerna-f,its of fereU - n iz-nr-Bst-uieLt, as well as jnoase ;E:t.5ia of indiastries in Lat;ina .veriqe-;P can be fouanal in: - bTs r axi 1- R. (-1.) Profits-.Prress and oeyDame University of Notre Dame Pr-ess, 1985. Other ~yd~ .aii~with ir~utiLstructure a-!.Id£JJet~rri Cav -, R. E. (1982). ½211 S.arn..tcJ, Domiiestic_ er-rS9,.nkt~u~' S 1ru tur. in Host -1Cs: A Surv-;i.t 0-; rfor.j Papr ((Q-act investment. The main incentive has been access to its large domestic market which has enjoyed mocerate to high protection. In a number of cases, Brazil has also attempted to promote foreign investment in speci- fic sectors (e.g., aotomobiles, shipbuilding, chemicals) by negotiating comprehensive programs with multinationals, which satisfied government objectives, such as types of foreign invsstminent and technology transfers and the requirements of -' igr r investors, such as level of protection and availability of imported inputs. ThesEe efforts were mainly aimed at import substitution. 2. Brazil's approach to foreign investment began changing in the late 1960S. The government adopted a more export-oriented set of policies which changed the incentive system facing Brazil's manufacturing sectors. As a result, exports from foreign as well as domestic firms increased rapidly during the 1970s and 1980s. More recently, Brazil has become more restric- tive toward fo'.Cei,rrn inve--s ,-u,ent. There is now great-er pressure to form joint ventures and the importation of technolog- has become more difficult when there are local substitutes available. The government now also i miposes limits on r-oyalties, fees, and license payments. This change in policy reflects Brazil's objective of reducinig dependence on foreign tech- nology and the counzitry's increa sed confidence in its ability to develop and utilize its own technology. Korea 3. During the 1970s the scale and pattern of di-ect foreign invest- ment in Korea was controlled by the government through a comprehensive set of Cguideliines and regulations. Elaborate criteria were se.. up to screen applications so as to kaesp out projects which might offer oinifialft com- petition in domes-ic or over-se1as rki2'rkets to local firms, as well as pro- jecto .hlaich essserti.ally provided only ca-ital and not much t:echnology. The Iavel of foreign 'c;Th'ip was zffectively limi ted to 50% by a plethora of guidelines whiuk made it difriicult to obtain approval for a majority s einw: n, d Ftrl -'. Furthermore, the minimum scals of investatent was set at $50,000 per p roject, and 2--radually --raisecd to $500,000 in 1979, to eravant small-scale, footloose investments saeeing only to take aIdvantage1 of (orea's l-cost labo.r) in as-eimbly au-ici packa-ing oplrto±. All con- -2- dC. d diiring t-his pe- j Korea possessed one of the mItora forbidding environments for Ioreign investment in developinig countries. Consequently, foreign investment playred a relatively aii`nfor role in 'or-a's d-e-lvlopmean.t. 4. vGe;nu- mert policy toward foreign invastmant Lcp- , n.d a revars-al in 1980 when, in an atempt to cope with an economic crisis featuring high inflation, naeagti- growth, --rov.|-iin debt-service difficulties and a larg- balance. of pawrn nt.z deficit, a broad-based program of trade and financial liberalization was adoptedl AmGng the elements of this program were several measures to liberalize the regulations gover-ining foreign inva-st- ment. Since then the scope 1hlas, been expanded and the procedures simpli- ZI-siA. In particular, un&d.er a set of xuidelines, adopted in July 1984, an auzC,or¢iatic approval syster-m and a negat-i°|ve list system have come into opera- tion which now make Korea one of the developing countries more o-pan to foreiI invst.Smenmt. Only 82 of Korea's 999 industrial sectors are pro- hibit-ad to foreignl; °nve:iien and a further 215 are subject to strict restri,-ctioris. The remaining 660 sectors are now open. In the onsI- a'E;ctors, a project is given automatic approval if the amount of foreign ine1; mntra is not more than the equivalent of $1 million and the ratio of o B in eL st rmen t is less than 50%, In addition to more libearal lines for ircvs stm -trn-t and the fa-±da'l g1''ntee for repatriation, ;x.ora now Bncourage7ar..r i-ziyin z1:mset also through its tr.de and f-i n.ancial lib .lzainpolicis:; which pern m it - greater ti1i :y in de- sions ra;E.arding .-Fou-iarcing of inputs and disposition of outputs, in the use of fi nancial facilities, in the imanagms Rnt o,§ ll½c. ibiliti .ss and i n f,i 5. The sp'r :oi environme-nt for foreign investment since 1980 has :3hcom .,ncri results. During the two de,a.s L eding in 1981, the cumulative volume of direct foreign in'vts-i;-n- was around $1.2 billion. :'ineq ther, the cumulative stock has more than doubled to $2.6 billion. Korea's'11'LJ1, ion program shuil:I2 enhaLw.' its carnie.e and -thsrsby make the country even mr L to 6_'G!.reini .s nt. YtU t 'i *J -; 2 ;5 a- ld 2, 4-7-R; 6. YuEcslavia and Egypt cha-'cged their por-Ic , pZoarch to ltoreignLr .:15 -,in'estnt rit-'i-in the p e* Olt 20 in the lateF 196i3%,,, and 2gypi in the oaQ,.ly 1397kvXs, decride&d to atms their onomies to nli' n investment. A major m-iatlcn for Yugoslavia's 1967 lgslas tion allowilag iL.e ,17 s' t oivstz.rs to n vest 2:J ki Itly tlhrIg 2i j o in T 7t v3tui.re wa s a di sa-tisn- &a , c ,I-7ih -s i r * 1 n , which asqp y e Xar,2d to haye bee su unsuccess- ful in tran 1s t chnolo gyto the country. T g.fse en1: also - ,te;L that a o l pop:-n ap°ro:ach -ould improve the t i'Js s of Yu,sl'-av %-? L. Id abal nbl them to air.as' exports to the |1e Di--st inve tment as e7(l Med-d from. only afw v tcr cnd thew Fgoeisiient also 2ocpl a -LUr3L of TIrcific tax incr±t1-i-; taves to en . rage x :ti . ii~s3m ntils- elodara of teCOI_tr-y. 7. 33-r-pft, like uo2ai, ~,cuuht ic ncuag the frof c- 7 e- 2 -5 5 i ; a L )I s L - ;-q c - I I If-vV t I rf oL r7 'L impor i 0 - L tution. A w1-7e La r' of EC-trcrs wr. pe,-n to direct i:ig k-n _ investintn i;' -.i-a.L priority g - ,* to lanl : 12me' i, o ier. 2 and animal IbiLic1bad r; o:,g- n J. stmi-rt aLuIt, be through joint Sient r- withthepubic ' ~ Pcto but, with the exceptionL of cartai-n with the public or p -ii X- L-D-.¢ ;-C)'.tBA7l'itl fl@@Cl£1O D FL-e sestars such as ao-strS ci and ibanking, there are no strict percentage requ're'nints: "or local >wt ic-pat½n. In order to n-nCour-.fe;lae ithe transfer of labor skills and : ^!-lem;.,G' expertise, the government imposDeas local employment quiremerrL s OBoth cofoi.L e l':zJui- feI-n ventures ftrom their normal sy,temA1 of foreign e-5:chacg- allocation, requi-1°ng firms to use a fixed percentage of witv ver foign e-ch.eange "tejr enL."Elad for their import and profit repatriation requiramants. After some time, both Egypt and Yugoslavia aased somPhat the foreign exchange reULL'uiera>nants in Yr,sponse to complaints that it was disccourajfgIng oe ne:mn. 8. De.spite having rlatively l2arge domestic 1zets foreign invest- rilent in Egypt and, to a gi - extant Zuposlavia has fall.en well below 3xp-ctAt3. ^Although a of : of r-tn-Cc country re ,-asons have discour- aged foreign investment, a major obstacle in both countries has be-n the lack of consistency betn7swn their :cren investment obje3lcive and their uiacrn,-Bi:2onomi policies. For eamL, both countries ir 'dsz a f2oreign exoh-n,g7-e balancing requirement on foreign firms but thseir 1 cono-mAIoiic policies disc~"'-nn- .:ed aginst exports. Technology tafeswaz-e also discouraged by the foreign exchange L-_ 1anci-1i rn uiment. In Yiueoslavia it is likely that agricultural p?1ic controls d !;troy.3d the incnt-ive for &-z-o-iLn dustry i i tmr-E i-,'::r, Lent s w-hich would have a; .itL. r dr , jls- el L-g regions.