Attracting Foreign Direct Investment and Benefiting from it: Challenges for the Least Developed Countries

Abstract

All the least developed countries (LDCs) need to attract foreign direct investment (FDI) and benefit from it as much as possible in order to advance their development. In fact, LDCs as a group are not doing that badly in terms of FDI inflows. The US$25 billion they attracted on average during 2011-2013 constituted about 2% of world FDI flows. But these US$25 billion amounted to about 13% of these countries’ gross fixed capital formation. And that is a higher percentage than for any other country group. In other words, the FDI that LDCs received is more important for them than the FDI that other country groups received – although it is quite unevenly distributed among LDCs. And while it is also true that most FDI in LDCs is in natural resources, an increasing share goes into manufacturing and services. Transnational corporations (TNCs) from all parts of the world, including those headquartered in such rising emerging markets as China, India, Malaysia, and South Africa, invest in the continent. Interestingly, outward FDI from African LDCs is rising as well, having reached US$4 billion last year. This indicates that some firms in a number of these countries have reached the international competitiveness that is needed to flourish in the world FDI market. These are encouraging trends. The international community needs to support them, precisely because FDI can make an important contribution to economic growth and development. The challenge is twofold: to help increase FDI flows to LDCs; and to increase the contribution that the FDI flows that LDCs receive make to the development of host economies. To turn to the first challenge: as we know, FDI is undertaken by private firms (although state-owned enterprises are also becoming important) that have the capabilities to compete abroad and find it advantageous to do so through international production. Understanding where their FDI flows are directed requires that we look at the locational determinants of FDI. Three sets of determinants at the host-country end are particularly important: the economic determinants; the regulatory framework; and FDI promotion. The most important factor for enterprises to undertake FDI in a country is the nature of the economic determinants: quality of infrastructure, size of the market, growth of the market, availability of skills, technological infrastructure, etc. If the economic determinants are not favourable for firms to make a profit, FDI will not take place. To put it differently: while the economic determinants are not everything, everything is nothing if the economic determinants in a potential host country are not favourable. The economic determinants are the key for attracting FDI. As we know, however, the economic determinants in LDCs are not favourable. They need to be strengthened, and official development assistance (ODA) is critical for that purpose.