Why aren’t we resilient? What could be the matter?
Foreign direct investment (FDI) is a key to economic growth in emerging economies. It represents capital invested in a country that provides manufacturing and service capabilities for both native consumers and world markets.
As global economies are less dependent on geopolitical relationships of the last century, new opportunities emerge. As those no longer relevant geopolitical relationships fade, small economies must be creative and focused on sustainable growth and resilient community development.
So how can a small island nation attract direct foreign investment? Several factors separate those small economies that will grow from those that will not.
1. Capital Availability
Conditions in the global capital markets and general economic environment play a role in determining the flow of FDI into a country. Large amounts of investable capital that proportionately overwhelm the number of sound local investment ideas can cause company and individual investors to invest their wealth in emerging and developing markets.
Attractiveness as a destination for investment capital rests on its development of infrastructure, resource availability (physical and labor), productivity and workforce skills, and the development of the business value chain. A growing and developing economy requires infrastructure and resources in order to facilitate the sale of goods and services. Roads, highways, bridges and other forms of physical infrastructure should be present, maintained and provide sufficient safety for the transportation of goods as well as for the commute of employees. Another component for attracting FDI involves the availability of low-cost, skilled employees who possess the necessary aptitudes, experience and proficiencies to create, manufacture, and provide goods and services that can compete in global markets.
3. Regulatory Environment
When a national government enacts and enforces rules and policies aimed at favoring state entities at the expense of privately held firms, such an environment can be detrimental to initiatives that aim to attract FDI. As such, the regulatory environment can either encourage or impede foreign direct investment. Excessive regulations tend to hinder entrepreneurial and commercial activities, as managers and employees must spend more time and money to comply with rules and regulations. If an investor wants to set up a manufacturing facility in a small island nation, the high start-up costs, legal exposure and other cumbersome compliance items may encourage that investor to set up the facility elsewhere, where the business climate is more conducive to industry.
Other types of regulations include mandatory joint venture partnerships in which, together with the foreign investor, the business is required to have a local government agency or local company as a partner. A judicial system that is biased toward protecting locals who conduct what are sometimes perceived as unfair, illegal, or unethical business practices can also contribute to making a country less favorable investment destination.
Another regulatory determinant involves the government’s promotion of investment activities by providing attractive financial incentives in the form of tax breaks, grants, low-cost government loans and subsidies. Government-sponsored financial inducements provide the possibility of making a business more profitable and in a shorter amount of time.
Political and economic stability can facilitate an influx of FDI. Stability represents predictability and the opportunity for enterprises to gain better foresight into the future. Alternatively, constant social unrest, rioting, rebellions and social turmoil are settings not conducive to business. Economic instability can also contribute to hyperinflation which can render the local currency virtually obsolete. To encourage FDI, citizens/workers, as well as businesses, should have a reasonable basis for respecting law and order. The justice system should also have effective mechanisms for reducing, or altogether eliminating, rogue and corrupt elements of law enforcement agencies.
5. Local Market and Business Climate
Economic growth has a ripple effect. FDI can start a “success domino effect.” The more the region attracts FDI, the more it grows. The more it grows and matures, the more investors are willing to provide FDI. The smaller the market, the more challenging this is. The more FDI flows into the country, the greater the economic chain reaction, providing a positive effect to sustain such growth.
6. Openness to Regional and International Trade
Market openness serves several important roles in attracting FDI. Of critical importance is a business’ ability to sell its products and services to both local and foreign markets. If enterprises have limited or no access to foreign customers, particularly the United States, Western Europe, Japan, and others, then the local market may not be enough to warrant significant investment in money and energy. Regional and International Trade barriers such as tariffs are typically viewed as disincentives by other nations. Being connected, economically to the region of the small country, can assist in the flow of trade.
In efforts to create a more business-friendly environment, regional and international free trade agreements are typically initiated by market-progressive governments as reasonable mechanisms for inducing economic activity and growth.
Export-friendly policies, then, can play a major role in deciding whether to invest in a country., especially for enterprises that have a large portion of their anticipated market located outside of the local market.
The Final Word
For a developing economy, foreign investment is a key way to spur development and pull the country’s economy toward a competitive spot in the global marketplace. However, in order for FDI to occur, certain conditions must be in place. Without them, no one will be interested. The Risk is simply too great.