Rethinking foreign infrastructure investment in developing countries

Abstract

The 1990s witnessed a boom in foreign direct investment (FDI) in infrastructure sectors in developing countries, which was surprising for at least two reasons. First, infrastructure sectors, unlike manufacturing, suffer from the “market failure” problem, and the solution to that problem—government regulation—brings with it the “obsolescing bargain” risk. Second, such investments are even riskier when made in developing countries, which are characterized by weak institutions and political instability. Why, then, did the boom occur, and will it continue? Three industry-specific drivers and two country-specific drivers are considered for the boom. Foreign investors may have believed: (1) that infrastructure sectors were losing their “natural monopoly” characteristics; (2) that first-movers would profit handsomely from the emerging globalization of these sectors; (3) that novel techniques like project financing would reduce their risks sharply; (4) that the climate for FDI in developing countries had changed fundamentally in the 1990s; and (5) that host developing countries would not expropriate foreign-owned infrastructure assets as they had in the past. Based on actual experience in the 1990s, we evaluate the strengths and limitations of each of these drivers. Our overall assessment is that infrastructure FDI in developing countries will stabilize in the future at a lower, more sustainable level. We conclude with policy implications for multinational corporations (MNCs) and governments.