Download Foreign Direct Investment in an Emerging Market

Foreign Direct Investment in an Emerging Market:
Implications for Policy-Making in Kazakhstan
DISSERTATION
of the University of St.Gallen,
Graduate School of Business Administration,
Economics, Law and Social Sciences (HSG)
To obtain the title of
Doctor Oeconomiae
submitted by
Vladimir Sukhoruchenko
from
Kazakhstan
Approved on the application of
Prof. Dr. Li-Choy Chong
and
Prof. Dr. Klaus Spremann
Dissertation no. 3410
Aktobe-Press, Aktobe
The University of St.Gallen, Graduate School of Business Administration, Economics, Law
and Social Sciences (HSG) hereby consents to the printing of the present dissertation,
without hereby expressing any opinion on the views herein expressed.
St.Gallen, October 15, 2007
The President:
Prof. Ernst Mohr, PhD
Table of Contents
Table of Contents.................................................................................................................... i
Abbreviations and expressions ............................................................................................. iv
Table of Exhibits ................................................................................................................... v
1 INTRODUCTION .............................................................................................................. 1
1.1 Problem presentation ....................................................................................................... 1
1.2 Objective and research questions ..................................................................................... 3
1.3 Research Methodology .................................................................................................... 5
1.3.1 Research Design ........................................................................................................... 5
1.3.2 Data collection methods................................................................................................ 6
1.3.2.1 Interviewing. .............................................................................................................. 6
1.3.2.2 Archival Analysis ...................................................................................................... 8
1.3.2.3 Mail Survey. .............................................................................................................. 9
1.3.3 Data Analysis. ............................................................................................................... 9
2 THEORETICAL FRAMEWORK .................................................................................... 11
2.1 Foreign direct investment as a strategic decision of the firm ......................................... 11
2.1.1 Major foreign direct investment theories .................................................................... 11
2.1.2 Types of investment .................................................................................................... 17
2.1.3 Strategic management view on the investor ................................................................ 21
2.1.4 Adapting the strategy-performance model for investment studies .............................. 24
2.2 Theories of Foreign Direct Investment .......................................................................... 31
2.2.1 Explanation of FDI ..................................................................................................... 32
2.2.2 Econometric studies on Influence of Tax Policy on Investment ................................. 32
2.2.3 Micro-Theories ........................................................................................................... 33
2.2.4 Eclectic Paradigm ....................................................................................................... 34
2.2.5 Macro-economic Theories .......................................................................................... 36
2.3 Motivational studies and Risk in Decision process ........................................................ 37
2.3.1 Motivational studies.................................................................................................... 37
2.3.2 Motives for FDI .......................................................................................................... 37
2.3.3 Risk theories ............................................................................................................... 39
2.4 Modes of entry strategies ............................................................................................... 39
2.5 Political environment in the context of international investment ................................... 41
i
2.5.1 Political environment as a parts of the firm's general environment............................. 42
2.5.2 The specific role of the political environment............................................................. 46
2.5.3 Political relations having an impact on international investment ................................ 58
2.5.4 Summary: The role of the political environment for the firm's investment decision .. 62
2.6 Summary of the Literature review ................................................................................. 64
3 OPERATIONAL ENVIRONMENT ................................................................................ 71
3.1 The General Reform Environment ................................................................................. 71
3.1.1 Political Environment ................................................................................................. 71
3.1.2 Regional Issues ........................................................................................................... 72
3.1.3 Social conditions ......................................................................................................... 73
3.1.4 Environment ............................................................................................................... 74
3.1.5 Legal ........................................................................................................................... 74
3.2 Progress in Transition and the Economy's Response ..................................................... 76
3.2.1 Macroeconomic conditions for Bank operations......................................................... 76
3.2.2 Transition success and transition challenges ............................................................. 78
3.3 Access to Capital and Investment Requirements ........................................................... 83
3.4. Investment Opportunities in Central Asia and Transcaucasus ...................................... 86
3.5. Investment Opportunities in Kazakhstan ...................................................................... 87
3.5.1. Investment key: Comparative Study .......................................................................... 87
3.5.2. Investment Activities in Kazakhstan .......................................................................... 92
3.5.3 Attractiveness for foreign investors ............................................................................ 95
3.5.4. Risk for Investors ....................................................................................................... 96
3.5.5. Foreign investment law .............................................................................................. 96
3.6. Foreign experience of engaging and use of the international capital and investments .. 97
4 CASE STUDIES............................................................................................................. 103
4.1 Chevron in Kazakhstan ................................................................................................ 103
4.1.1 Environmental Issues ................................................................................................ 105
4.1.2 Social Issues ............................................................................................................. 111
4.1.3 Conclusion ................................................................................................................ 115
4.2 FDI in Mining Sector of Kazakhstan ........................................................................... 117
4.2.1 Economic and Political Factors................................................................................. 117
4.2.2 Industry related Factors ............................................................................................ 121
4.2.3 Environmental Implications ...................................................................................... 124
4.2.4 Summing Up ............................................................................................................. 125
4.2.5 Conclusions .............................................................................................................. 126
ii
5 DISCUSSION: KAZAKHSTAN.................................................................................... 128
5.1 Objectives, trends and performance in relation to FDI ................................................ 128
5.2 Strengths, weaknesses and opportunities ..................................................................... 132
5.3 Policy and Operational Framework for FDI ................................................................ 136
5.3.1 The overall legal framework ..................................................................................... 136
5.3.2 Administrative procedures and practices .................................................................. 150
5.1.3 Overall assessment of the policy and operational framework ................................... 155
5.4 Policy Options and Recommendations ........................................................................ 156
5.4.1 Common Recomendation.......................................................................................... 156
5.4.2 Recommendations for government action................................................................. 157
5.4.3 Recommendations for subregional and regional cooperation ................................... 159
5.5 Conclusion ................................................................................................................... 159
References ......................................................................................................................... 164
Appendices ........................................................................................................................ 189
iii
Abbreviations and expressions
ABA
American Bar Association
BOD
Board of Directors (Administration)
CFR
Code of Federal Regulations
COMECOM
or CMEA
Council for Mutual Economic Assistance (economic
cooperation organization in former communist block)
DC
Directorate Committee
FCC
Federal Communication Commission
FDI
Foreign Direct Investment
GEO
Governmental Emergency Ordinance
GO
Governmental Ordinance
GSM
General Shareholders Meeting
JV
Joint Venture
MIGA
Multilateral Investment Guarantee Agency
NAC
National Audiovisual Commission
NAMR
National Authority for Mineral Resources
NAOG
National Authority for Oil and Gas
NCCUSL
National Commissioners on Uniform State Laws
NCS
National Commission on Securities
OG
Official Gazette
Pub.L.
Public Law
R&D
Research and Development
SME
Small and Medium Size Enterprises
TNC
Transnational Corporation
ULLC
Uniform Limited Liability Company Act
ULPA
Uniform Limited Partnership Act
UPA
Uniform Partnership Act
USC
United States Code
USCA
United States Code Annotated
iv
Table of Exhibits
Exhibit 1. Geographical studies in comparison to investment studies ................................. 16
Exhibit 2. The basic strategy-performance model ............................................................... 22
Exhibit 3. Lahti's strategy-performance model .................................................................... 24
Exhibit 4. The interplay between the internal and the external factors of the firm .............. 28
Exhibit 5. List of Motives for direct investment .................................................................. 38
Exhibit 6. Predominant motivation factors and modes of delivery ...................................... 41
Exhibit 7. Hierarchical structure of the different macro-environments of the firm .............. 43
Exhibit 8. A general framework for political risk assessmen ............................................... 48
Exhibit 9. Components of the political environment ........................................................... 49
Exhibit 10. Types of government intervention in foreign direct investment ........................ 54
Exhibit 11. Relations of a political nature in the context of international investment.......... 63
Exhibit 12. Positioning of the present study ........................................................................ 65
Exhibit 13. Theoretical building blocks of the present study ............................................... 66
Exhibit 14. Relevant elements having an impact on the firm's investment decision ............ 67
Exhibit 15. The framework of the study .............................................................................. 69
Exhibit 16. Reform progress in Kazakhstan, compared to CIS and CEEB .......................... 79
Exhibit 17. Problems in the Business Environment ............................................................. 82
Exhibit 18. Sectoral Distribution of gross FDI .................................................................... 85
Exhibit 19. Investmrnt key................................................................................................... 87
Exhibit 20. Foreign Direct Investment in Kazakhstan, 1999-2002 .................................... 117
Exhibit 21. Breakdown of FDI into Kazakhstan by Source Country, 1996-2002 (% of
total FDI .......................................................................................................... 118
Exhibit 22. Breakdown of FDI by Industry, 1996-2002 (% of total FDI ........................... 118
Exhibit 23. Selected Minerals Production, 2002 ................................................................ 121
Exhibit 24. Selected Investments in the Non-ferrous Metals Sector, 2003 ........................ 123
Exhibit 25. FDI inflows (net), various CIS countries, 1998-2006 ..................................... 129
Exhibit 26. Sources of FDI in Kazkhstan, 1997-2005 (percentages) ................................. 130
Exhibit 27. Sectoral distribution of FDI stock, 1999-2005 (Percentages) .......................... 131
Exhibit 28. Comparative tax rates in CIS Countries .......................................................... 143
Exhibit 29. Perception of commercial laws ....................................................................... 146
Exhibit 30. Average time spent on regulatory and administrative processes in
Kazakhstan ...................................................................................................... 151
Exhibit 31. Summary of Recommendations ...................................................................... 157
v
vi
FOREWORD
I would like to acknowledge the friendship and support of many people, without whom, this
dissertation would not have been possible.
First and foremost, I am forever indebted to my mentors, Prof. Dr. Li-Choy Chong and
Prof. Dr. Klaus Spremann. They have been a constant source of inspiration, support, and
encouragement.
I would also like to thank many of my classmates, who all were good collegeagues.
I would especially like to thank my parents and all of my friends.
St.Gallen, October, 2007
Vladimir Sukhoruchenko
vii
ABSTRACT
This paper focuses on the strategy formulation process by exploring how strategies,
especially those for foreign direct investments (FDIs), are being formulated, and on what
they are based. More specifically, this research analyzes how a company's strategy
formulation process may change or may need to be adapted for the specific operating
environment of an emerging market. A decision-making process develops over the lifetime
of an organization and is thus influenced by the company's operating environment. That is
why one can readily differentiate bureaucratic government or state-owned enterprises,
which operate in a secure and stable market, from entrepreneurial organizations and young
start-ups.
The majority of publications concerning FDI describes the investment in developed
countries (i.e. USA, Western Europe), while very little is said about the investment
determinants in less developed countries or countries in transition. In addition, research into
managers' perceptions, country stereotypes and their influence on investment decision is not
adequate. This study adds to the existing information by examining a country in transition
that is new to foreign investment, from the standpoint of foreign investors' perceptions
about that country and its investment climate. The selected country is Kazakhstan, quite a
new participant in the rivalry to attract foreign investment, a country offering foreign
investors many potential advantages but also with many potential threats. The research
attempts to determine factors influencing the position of Kazakhstan in the eyes of foreign
investors.
This study investigates the investment climate of Kazakhstan as seen by foreign investors,
their level of satisfaction or dissatisfaction with their investment, and factors influencing
their choice of Kazakhstan as an investment location.
viii
1 INTRODUCTION
1.1 Problem presentation
As the globalization of the marketplace continues, companies that conduct business only
within their national boundaries will find it difficult to survive. One way to cope with this
problem is for companies to expand their operations beyond home country frontiers into
other countries through foreign direct investment (FDI). FDI plays an important role as a
tool in worldwide competition. The World Investment Report names FDI a "primary force"
shaping globalization.
Along with the globalization of the marketplace, the world’s economy has expanded in
recent years. One of the factors influencing this trend is FDI. Currently, FDI is growing even
faster than international trade, which has been the major mechanism connecting national
economy (World Investment Report). Even countries previously closed to foreign investors,
for instance China, have recognized the economic benefits of foreign investment and have
opened their borders to foreign capital. Competition to attract FDI involves not only
developed countries, but also developing countries.
Several factors may contribute to countries which are targeted as a foreign investment
destination. Besides "tangible" determinants which can be easily calculated and compared
(e.g. size and growth of the country’s market, level of protectionism, etc.) there are other
factors which are also considered by potential investors but are not easy to measure. Among
these factors the FDI literature lists the image and stereotypes of the host country in the eyes
of foreign investors, as well as managers‘ personal perceptions and preferences regarding
the host country, as playing an important role in the investment decision making process
(Stobaugh 1969, Papadopoulos 1993, Wee, Lim. and Tan 1993, Root 1994).
The majority of publications concerning FDI describes the investment in developed
countries (i.e. USA, Western Europe), while very little is said about the investment
determinants in less developed countries or countries in transition. In addition, research into
managers' perceptions, country stereotypes and their influence on investment decision is not
adequate. This study adds to the existing information by examining a country in transition
1
that is new to foreign investment, from the standpoint of foreign investors' perceptions about
that country and its investment climate. The selected country is Kazakhstan, quite a new
participant in the rivalry to attract foreign investment, a country offering foreign investors
many potential advantages but also with many potential threats. The research attempts to
determine factors influencing the position of Kazakhstan in the eyes of foreign investors.
This study investigates the investment climate of Kazakhstan as seen by foreign investors,
their level of satisfaction or dissatisfaction with their investment, and factors influencing
their choice of Kazakhstan as an investment location.
This paper thus focuses on the strategy formulation process by exploring how strategies,
especially those for foreign direct investments (FDIs), are being formulated, and on what
they are based. More specifically, this research analyzes how a company's strategy
formulation process may change or may need to be adapted for the specific operating
environment of an emerging market. A decision-making process develops over the lifetime
of an organization and is thus influenced by the company's operating environment. That is
why one can readily differentiate bureaucratic government or state-owned enterprises, which
operate in a secure and stable market, from entrepreneurial organizations and young startups.
To achieve the latter goal, data from a substantial number of firms, all of which needed to be
investigated thoroughly, had to be gathered. Through comparison, reasoning and capturing
emerging theories, this empirical data helped to uncover which characteristics of decisionmaking and which organizational structures are best suited to reach the goal of optimal
decision making for emerging markets.
To obtain meaningful results, it is therefore necessary to limit the analysis to a more clearly
defined area of research. At the core of the analysis, then, are foreign direct investment
decision-making processes of multinational oil & gas companies in the market of
Kazakhstan.
However, there is no research which explores the advantages and disadvantages of
investment in Kazakhstan. Also limited research is available concerning determinants of
investment in Kazakhstan, the perceptions and stereotypes that foreign managers hold about
Kazakhstan, and what could be done that would increase the flow of FDI into Kazakhstan.
2
This study explores these areas by examine the experience and perceptions of investors
currently operating in Kazakhstan. Investors' views are used to assess the investment climate
in Kazakhstan, and, possibly, to suggest ways to improve the image of the country.
1.2 Objective and research questions
The study will examine the investment climate in Kazakhstan and major barriers for foreign
investors by entry the Kazakhstan's market, and will define strategic problems in the
investment policy and prospects for the future. In concluding will be given the
recommendations to improvement of investment strategy by foreign investors and to
improvement of FDI policy by government to attract foreign investors.
Like other leading transition economies, Kazakhstan has adopted a series of instruments to
improve the overall investment climate, but many investors are concerned about the grey
areas which discourage decision-makers from planning and executing FDI projects. These
areas are:
•
Political instabilities,
•
malfunctioning of the judiciary,
•
poor economic and infrastructure conditions,
•
high energy costs,
•
imponderability with taxation and
•
the still unresolved land ownership issue.
In their efforts to facilitate matters for foreign companies, successive governments have
formulated a series of draft laws.
The future success of Kazakhstan's FDI policy will be determined by progress made in the
country's macro-systems. These systems need to be improved through appropriate measures.
3
Legal system
Socioeconomic system
Political system
Financial system
FDI
FDI
enhancement
enhancement
Administrative system
Education system
Cultural system
Starting from the early 1990s, practically all leading large emerging market governments
have introduced new macro policies in an effort to make general framework conditions more
conductive to foreign investors. They are in line with basic policy recommendations recently
made by the World Bank following a survey of 3600 entrepreneurs in 69 countries. The
Bank has established a list of basic government tasks for attracting FDI:
•
Building a solid legal foundation,
•
Maintaining macroeconomic stability,
•
Investing in basic social services and infrastructure,
•
Protecting the socially weak and the environment (World Bank, 1997).
Conceptual framework of the research can be described as follows:
Motive of
investment
Barriers for
foreign
investment
Investment
Process
(Strategic
Problems of
FDI)
Prospects for
the Future
Thus, this study should answer six research questions:
4
Recommendat
ion:
MNC &
Govern.
•
Why do foreign investors invest into Kazakhstan? (Why not?)
•
How do foreign investors invest into Kazakhstan?
•
How successful are foreign multinational Oil & Gas companies in Kazakhstan and
why?
•
What is the Prospects of FDI policy in Kazakhstan for the Future?
•
What can be done to improve the investment strategy of foreign investors in
Kazakhstan?
•
What can be done to improve the FDI Policy for attraction of FDI?
1.3 Research Methodology
As several researchers have mentioned, there are considerable methodological problems
involved in any investigation of variables related to strategic FDI decisions and firm
performance (Agren 1990). Firstly, the variables are both difficult to define and difficult to
measure. Secondly, information of this type is often sensitive, and thus difficult to collect.
Thirdly, such information is often hard to interpret.
1.3.1 Research Design
The research design of the study can be described as follows:
5
Defining the
motive and
barriers for
foreign
investors in
Kazakhstan
(Surveymethod,
interview)
Comparative
study on
barriers for
foreign
investors by the
entry the
markets of CIScountries
(Case study
analysis)
Investment
process:
Strategic
Problems of
FDI in
Kazakhstan
(Archival
method,
interview)
Investment
climate:
Prospects for
the future of
FDI into
Kazakhstan
(Archival
method)
Recommendati
ons to
improvement
of FDI policy
(Data analysis)
The methods chosen for research will be described in the next part.
1.3.2 Data collection methods
Archival analysis, mail survey with follow-up interviews were chosen as the data collection
method for this research.
1.3.2.1 Interviewing.
The following discussion describes the interview process in some depth, as it was the main
method of data gathering. The quality of the overall results depends on the proper planning,
execution and analysis of the interviews with managers of sample firms.
6
For interviewing individuals, there are two main types of interviews in social research,
structured and unstructured ones (Fontana / Frey 1994: 363ff.). The latter can also be
called 'focused' interviews which convey the meaning that the interviewer focuses on some
research questions but does not prepare any specific questions in advance (May 1997:
109ff). Focused interviews were used as the main method of data gathering for the
following reasons.
Firstly, focused interviews, in contrast to structured ones, are the preferred data gathering
method in qualitative research. With their open-ended character, they allow, "to challenge
the preconceptions of the researcher, as well as enable the interview to answer questions
within their own frame of reference" (May 1997: 112).
Secondly, this type of interview also allows the researcher to actively consider the concerns
and frames of reference of the interviewees (Bryman 1988: 47). The unit of analysis is the
firm and the decision-making process of the whole organization needs to be studied.
However, it is possible that representatives of the same company may have different
perspectives about a specific topic. These differences can be influenced by a variety of
reasons, of which the hierarchical layers of their own organizational unit (headquarters,
regional headquarters or local subsidiaries) is of particular importance. Another important
factor that could result in managers having different opinions may be differences in job
functions (managers or project team members). Therefore, the method of doing interviews
must be flexible enough to ask the right question to the right people. Drawing up a special
questionnaire for each subgroup of interviewees does not seem to be helpful, because the
goal is not to compare, say, the views of regional headquarters managers across
different organizations, but to understand the 'whys' and 'hows' of decision making in each
organization separately.
On the other hand, there are some bits of information that need to be gathered from all
companies and some questions need to be raised with every interviewee. These questions,
called 'structural questions' by Spradley (1979: 120), have changed - more precisely mostly
expanded - over time when the model-building was progressing. Therefore, these general
guidelines that aid the interviews have changed as well.
To sum up, the method of focused interviews enabled the researcher to follow his research
goals without restricting the interviewees in their freedom to talk about the topic in the way
7
they thought fit. "Thus flexibility and the discovery of meaning, rather than standardization,
or a concern to compare through constraining replies by a set interview schedule,
characterize this method", which is exactly what is needed for thorough grounded theory
research (May 1997: 113; sic, italics in original).
When writing about interviewing, it is necessary to mention that great emphasis should be
placed on how the interview is constructed, which questions are raised, how trust should be
build up, how well the researcher needs to be prepared, and 80 on. The focus of this research
does not allow discussion of these important topics at great length, but it should be pointed
out that these methods and techniques were all taken into account throughout the field
research.
To preserve as much data as possible, all interviews will be recorded on tape whenever
feasible. Soon after the interviews, these tape recordings will be transcribed word-by-word
for further analysis later on. When tape recordings will be not possible, special attention will
be given to a quick write-up of the field notes.
1.3.2.2 Archival Analysis
In an archival analysis, sources of data are various types of documentation, public records,
or other units of analysis. Dane (1990) defines archival research as any research that deals
with public records as unit of analysis. Content analysis as one form of archival analysis, for
instance, proceeds systematically and makes inferences from theory (Dane, 1990). What
distinguishes archival analysis from other research methods is that information is available
through archival analysis before one’s own research (May, 1997).
Through an archival analysis in the form of a formal theoretical inquiry, new knowledge
based on extant knowledge can be created by means of combining, extending, analyzing,
and integrating existing research areas, namely an interdisciplinary approach, allows one to
gain new insights. A further advantage is that this research method is economical regarding
research resources. This is especially true where access to the research object is costly due to
geographical or social barriers or non-reactive research.
8
Disadvantages of archival analysis include the potential considerable age of data and the
differences in the unit of analysis of previous and one‘s own research. The dependence on
the quality of data from previous research is a further problem, the reliability and validity of
data collected by others being difficult to determine (Dane, 1990). In conclusion, pure
theoretical analysis is important to complement other research methods, but it is certainly
not sufficient on its own.
1.3.2.3 Mail Survey.
A mail survey with follow-up interviews was chosen as the data collection method. The
main advantages of mail questionnaires as a data collection method are, firstly, their wide
scope: a great deal of information can be obtained from a large sample, and secondly, it is
economical in comparison with other data collection methods. However, mail questionnaire
research has a significant disadvantage in its ability to provide in-depth information.
Another main drawback of mail surveys is often the relatively low response rate. Geringer
(1989) has stated that the average response rate seems to have been about 30 percent, but
response rates as low as 5 percent have also been reported. It seems that in those studies
made in the Nordic countries, response rates have usually been clearly higher.
A survey is considered an appropriate research methodology when the research question is
of a "who/what/where/how many/how much" nature. Furthermore, a survey is applicable
when no control over behavioral events is examined (Yin, 1989). A survey is also suitable
when data across several time periods are to be collected (Snow, 1994).
1.3.3 Data Analysis.
"Analysis during data collection lets the fieldworker cycle back and forth between thinking
about the existing data and generating strategies for collecting new - often better quality data; it can be a healthy corrective for built-in blind spots; and it makes analysis an ongoing,
lively enterprise that is linked to the energizing effects of fieldwork" (Miles / Huberman
1994: 49). Following this advice, data analysis accompanies the field research phase and
will be done partly in parallel to it. This parallel data analysis phase helps in modifying the
9
research questions during the interview process based on the results of previous findings.
The model could thus emerge from the data, gaining shape and precision with each
interview.
10
2 THEORETICAL FRAMEWORK
2.1 Foreign direct investment as a strategic decision of the firm
The first research task of the study aims to uncover a model that recognises both the relevant
internal and external factors having an impact on the investment decisions of TNCs. The
discussion will be started with a brief analysis of the FDI theories in order to get a clear
picture of the concept of direct investment and the major studies on FDI. At this stage, the
focus is on international business literature. Then, the firm's perspective will be adopted and
FDI will be discussed as a strategic decision of the TNC. Thus, the discussion will be
extended to the field of strategic management, which has explicitly studied the firm's
strategies and performance. The fields of international business and strategic management
have common ground, which is visible especially in the context of FDI. Similarly, field of
the geography of enterprise and strategic management have a lot of common as they have
been developed in close interaction. Finally, the literature review culminates in the adoption
of a model that recognises the relevant general factors having an impact on the firm's
investment decision.
2.1.1 Major foreign direct investment theories
FDI refers to the transfer of the capital, managerial and technical assets of a firm from the
home country to the host country. It is a form of international finance, together with lending
and portfolio investments, but different from lending because it entails ownership, and
different from portfolio investment because it entails control of financed activities over
management and profits. Often portfolio investment is made for the sake of investment
income, while FDI is made in order to control the foreign enterprise in the host country.
Portfolio investments are excluded from the present analysis.
There is no single theory on FDI, but various approaches from different disciplines, such as
economics, international business, and organisation and management, explaining different
aspects of the phenomenon. Basically, three levels of analysis have been distinguished (eg
Cantwell 1991, 17; see also Calvet 1981 for a summary of early FDI theories):
11
macroeconomic, mesoeconomic and microeconomic levels. The macroeconomic theories
based on traditional trade and location theories, consider the national and international trend
of FDI. The mesoeconomic theories based largely on industrial organisation economics,
study FDI on the industry level and emphasise the competitive economic environment.
Finally, the microeconomic theories are based on the theory of the firm and focus on the
competitive advantage of the firm. In addition to these three levels, Luostarinen has
identified a fourth level of analysis, the sub-micro level (later milli-micro level), which
refers to investment decision-making processes in the investing companies.
In the following, the major avenues for the studies of FDI are overviewed. The theories are
briefly studied starting from the macro-level and continuing towards the micro-level. This
order reflects also the shift of focus of international business discipline, since the 1970s,
from the international economy level to the firm level and even inside the firm, as in the
case of milli-micro level of analysis. Actually, the shift of focus has not been
straightforward, and it has aimed not only at progression into a more detailed level of
analysis, but to more complete explanations (cf. Bartlett & Ghoshal 1991,6).
Traditional international trade theories have been extended to FDI with regard to the
international movement of factors of production. Examples include such extensions of the
international trade theory, as factor endowment theory that contains factor mobility (eg
Helpman 1984) and specific factor models (eg Markusen & Venables 1998), which both are
representatives of the new trade theory. They are applicable in the context of FDI, as they
allow imperfect competition and product differentiation. Also traditional location theory (eg
Weber 1909) can be discussed in the context of FDI because it understands the least-cost
location of production as the optimal location of the firm. According to Hanink (1994, 212),
traditional location theory suggests that there is potential for FDI if the low-cost factor of
production is located in a different country than the market. This refers to core-periphery
investment, which has been historically typical as the foreign resources of raw materials
formed the major motivation of FDI. However, in the case of an imperfect market, where the
market share is put before profit maximisation, FDI is likely to take place in an intra-core
context. (Hanink 1994,212)
Macro-economic investment theories include also Dunning's (1993) developmental model of
international investment, which relates the determinants of outward and inward investments
to the developmental phase of the country. According to the model, outward investment
12
exceeds the inward investment as the economy develops. The gradual shift from negative
net investment to positive, depends on a country's factor endowments, politico-economic
system and its interdependencies with the world economy. Investments develop through five
phases. In the first phase, inward and outward investments of the developing country are at a
low level. In the second phase, market growth and enhanced human capital raise the inward
investment while the outward investment still stays at a low level. In the third phase, both
inward and outward investments have a significant role in the economy, which has reached
an intermediate level of industrialisation. In the fourth phase, the outward investment
exceeds the inward investment because the domestic firms both compensate the location
disadvantages of the home country by engaging in outward investment, and complement the
location advantages offered by the immobile factors of the host countries. Finally, in the
fifth phase, outward and inward investments become balanced and are both at a high level.
(Dunning 1993)
In FDI literature, the increasing role of TNCs has been rather difficult to fit into a national
level frame. Thus, many theories have been developed from the base that FDI is not a result
of the relative comparative advantage of a country but an implication of the competitive
advantage of the firm. Industrial organisation economics is an application of
microeconomics, which has broken the classical assumption of perfectly competitive
markets, and is interested in FDI as the TNCs way to utilise firm-specific advantages and
survive in oligopolistic competition. A representative of industrial organisation economics is
Hymer's study (1976), according to which TNC has to earn a higher profit abroad than on
the home market because of the greater risk involved and the additional costs caused by
operating at a distance. Thus, the competitive advantage of TNC is both transferable over
borders and difficult to acquire by local firms. Although the industrial organisation
economics emphasises the firm-specific advantages and the strategies a firm can adopt for
increasing and maintaining its market power, it also reminds that industries utilise a certain
proportion of factors and thus, fit best to a country that offers the particular factor. However,
industrial organisation economics focuses on strategic matters and firm-specific advantages
rather than country factors.
Similar kinds of views to Hymer (1976) are shared in many other theories, such as the
transaction cost theory, product life cycle theory, and eclectic theory. Among them, the
transaction cost theory developed by Williamson (1975), with its roots in Coase (1937),
argues that trade is beneficial for firms as they can avoid costs arising from the unfamiliarity
13
of the markets. However, if the transaction costs of exchange are lower within the
hierarchies of the TNC, the market will be internalised. Thus, FDI is not just a capital
inducement but an international extension of managerial control over a subsidiary abroad.
Vernon (1966, 1979) introduced the product life cycle theory already in the mid-1960s, but
developed it later to an explicitly oligopolistic interpretation. The theory explains the
geographical process of locating the manufacturing units in the four general stages of
maturity. In the first stage of the life cycle, new products are introduced by a firm that holds
technological leadership in a location where it can enjoy agglomeration economies.
Overseas demand is served by export. In the second stage, the firm starts to establish
production facilities abroad as soon as it finds an opportunity to reduce costs by doing so, or
its market position is threatened. The first overseas production tends to be set up in the highincome market. In the third stage, the newly established plant serves the local market in the
host country and displaces exports from the home country. Consequently, home country
based firms export directly to third countries. Finally, in the fourth stage, the newly
established plant in the host country expands its exports also to third-country markets. When
the innovative lead is lost and the product becomes mature, the production facilities will be
relocated to low-cost locations from where the products are exported to the home country as
well. (Vernon 1979,265-267)
Finally, the eclectic theory is Dunning's attempt to combine various theories on FDI (eg
Dunning 1993). Eclectic theory is based on the idea that, compared to local competitors,
foreign firm does not have as good information of the local business environment. Thus,
TNC will engage in international production only if a set of particular advantages are
present, namely ownership advantage, internalisation advantage and locational advantage.
The ownership advantage determines which firms will supply a particular foreign market.
The ownership advantages include all the specific, often intangible, assets, which a firm can
either create (eg knowledge, organisational skills) or purchase (eg patents, brand names),
and which its competitors do not posses. The internalisation advantage explains why firms
will internalise transactions within their hierarchies rather than allow transactions to be
made within the market. The more ownership-specific advantages a firm possesses relative
to competitors, the greater the incentive to internalise their use. Finally, the location
advantage explains whether a firm will supply foreign markets by exports or through local
production. The location advantage (eg spatial distribution of inputs) makes it profitable for
14
a firm to exploit its assets overseas. Otherwise, it would serve a foreign market through
exports from a home country base.
Microeconomic theories of FDI include also the internationalisation theory of the firm.
Luostarinen's (1979) model explains the internationalisation process of the firm through the
starting, development, growth, and mature stages. During these stages, operational methods
of the TNCs are manifested by the trade in goods taking place in the earlier phase of
economic interaction compared to international investment. The explanation goes that
exports prepare the way for investment by establishing business contacts and sources of
information and creating a special knowledge of the market. Once established, direct
investment allows firms to gain a much better understanding of foreign markets, thus also
facilitating further exports of the parent firm. (Luostarinen and Welch 1997)
FDI can also be seen as a result of the growth of the firm. Luostarinen's study (1979) has
many similarities with Hakanson's (1979) five-stage model of the geographical pattern of a
corporate structure that explains how a firm expands from the home country to overseas and
grows from a single operation plant to TNC. A firm grows gradually by employing new
international operations, starting from a sales office and ending in a subsidiary or acquisition
abroad. According to the model, the mode of operation is influenced by changes in the
company's environment and the company will choose the FDI mode only after it has
achieved a certain level of trade.
In addition to traditional investment theories, economic geography has attracted special
attention to intra-national patterns of FDI. The core-periphery framework that interprets the
spatial organisation of the world economy through a powerful core, weak periphery, and
transitional semi-periphery, is adaptable at any geographical scale. With reference to the
intra-national context, an urbanised capital region usually forms the core of the state and is
surrounded by rural areas, or periphery. Many countries have several regional cores.
Traditional industrial location theories explain the regional distribution of FDI in terms of
transport costs, wages and infrastructure, while more recent theories have emphasised such
issues as the role of agglomeration with demand and supply linkages (eg Krugman 1991).
The FDI can be seen as a catalyst for local development as TNCs may speed up growth rates
in the host countries by applying their experience to build and operate factories. (Hayter
1997, 390) Thus, governments are eager to intervene in the locational decisions of the
15
TNCs. Altogether, it is important to put an emphasis both on the role of locational
conditions and the role of the host government that may aim to fill the gap between the real
locational attractiveness of the country and the degree of expectations by the TNC for a
desirable investment location.
As the economic geography searches frameworks applicable on various spatial scales, it is
characteristic of the studies to penetrate the above-mentioned levels of analysis. Thus,
economic geography may study FDI through various spatial scales that may include global,
international, regional, national, local, industry, firm, and even individual levels, as shown
in Exhibit 1. In the case of the geography of enterprise, the firm is the central focus and level
of analysis but not isolated from the other levels that affect the firm. As mentioned earlier,
the present study highlights the importance of both firm-specific and country-specific
factors thus focusing mainly on the national and the firm levels of analysis. This is essential
because it is impossible to understand the nature of macro-level FDI inflows from one
country to another without analysing the micro-level FDI decisions by the investing firms.
In addition, the present study will put emphasis on meso-economic level by recognising the
location of the firms within the regional structure of the host economy.
Exhibit 1. Geographical studies in comparison to investment studies
Exhibit 1 illustrates the four traditional levels of investment studies according to Cantwell
(1991). Basically, the levels of business studies include at least individual, management,
functional, firm, inter-organisational, industry, and economy levels.
16
2.1.2 Types of investment
Taking a more practical view of FDI, it is possible to distinguish various kinds of investment
types based on such issues as the target market, strategic motives, internal structure,
industry, way of growth, ownership, and others. The types are partly overlapping reflecting
the multidimensional nature of the investment decision. In the following, the types will be
overviewed. The basic division of direct investment into two is made according to the final
market for the produced item or service. The local market-oriented investment refers to the
case in which the output of the production site in the host country is directed to fulfil the
demand in the host country. Consequently, the international market-oriented investment
refers to the case in which the host country is used as an export platform and the final
product is directed at the international market. The latter is also called export-oriented
investment.
It is obvious that a firm makes its investment decision to meet the general motives of
corporate strategy, especially economic performance. Investment literature has studied TNC
motivations to invest abroad widely from different viewpoints: different firms, different
industries, different host countries, and different periods. As a result, great numbers of
various motives has been listed. Nevertheless, investment literature (eg Behrman 1981;
Buckley 1988; Dunning 1993, 1998) has been able to define the five main types of direct
investment in terms of strategic motives, although investment is usually not engaged due to
the one single specific motive, but a combination of various motives (Eiteman et al.
1992,436).
1.
Resource seeking investment is based on traditional locational advantages, such as
costs of inputs, and transaction costs. This type of investment usually extracts raw
materials for export or for further processing and sale in the host country. Typical
representatives of this kind of investment are the extractive industries.
2.
Market seeking investment is based on strategic locational advantages in order to
increase a company's market power. The aim is to find better opportunities to
enter and expand new markets either by satisfying local demand or by exporting to
third markets. Investment is usually motivated by such reasons as market size,
growth prospects of the market, market share, or competitive situation. This type
of investment is nowadays the most common type of investment. In it,
17
engagement with the host market is the greatest. A typical example is foodstuffs,
which cannot be exported but have to be produced on the spot.
3.
Production efficiency seeking investment aims to find production factors that are
cheap relative to their productivity. Investment may be motivated by labour cost
advantages, low raw-material costs, low transportation costs, low energy costs, or
the availability of a skilled labour force. It refers often to off-shore production,
which uses the special economic zones of the host countries. Typical
representatives are thus the sourcing industries.
4.
Knowledge seeking investment (strategic asset seeking investment) aims to gain
access to technology or managerial expertise in the host country. It has specific
locational needs (eg technical knowledge, learning experiences, management
expertise, organisational competence) and is mainly concentrated in advanced
industrial economies. The increase of mergers and acquisitions (M&A) emphasise
the increasing role of knowledge seeking investment. (Dunning 1998, 50)
5.
Political safety seeking investment aims to minimise expropriation risks and is
undertaken either in the form of investment in countries unlikely to interfere with
TNC operations, or in the form of divestment from politically unsafe countries.
(Behrman 1981; Buckley 1988; Dunning 1993,1998, Eiteman et al. 1992,436)
Different types of investments can also be classified according to the investor's internal
structure. This classification distinguishes between horizontal, vertical, conglomerate and
concentric investment. In horizontal investment, which is the most common type of
investment, a company duplicates the whole production process, except the headquarter
activities, in its subsidiary locating in the host country. Through the local production, the
investor is able to penetrate the local market and increase its reputation with customers as
products can be modified for the special requirements of a particular market. Differently, the
vertical type of investment refers to the establishment of a subsidiary in the host country to
serve at different stages of the value-added chain of the investor, notably the next stage
forward or backward in production and sales. (Larimo 1993,47)
Concentric investment, in its turn, involves foreign units serving the same customers as the
investing company through different production methods and research and development
(R&D). It may also involve foreign units serving different customers through the same
production methods and R&D. (Larimo 1993, 47-48) Concentric investments may also be
called horizontal diversification. This is still different from the conglomerate investment,
18
which occurs when a company manufactures an internationally diversified range of products
so that the foreign unit differs from the investing firm in terms of all major characteristics,
including production, technology, customers and distribution channels. (Larimo 1993, 48)
Due to the differences, conglomerate investment usually takes place by acquisition.
In the case of mergers and acquisitions (M&A) the above-mentioned terms get a slightly
different content. In addition, it is possible to divide investment simply into related and
unrelated types of investments. Related types of investments include horizontal and vertical
types, which are related to the investor's industry or customers, while unrelated types
include conglomerate and concentric types of investments, which are driven by a firm's risk
dispersion. Basically, unrelated types of investment cause more risk for the investor as the
field of industry or target market are unfamiliar for it (Larimo 1993, 48). Therefore, firms
engaged in related types of investment more often than unrelated types (ibid.). Moreover,
they tend to engage in unrelated investment in a familiar market and remain in related
investment in a more distant and unfamiliar market (Borsos-Torstila 1999, 57).
Investment can be seen either as an internal or external process depending on the firm's way
of growth. Internal growth, or greenfield investment, means investment in a new plant and
equipment, which builds up knowledge and capability inside the firm, while external
investment means the acquisition of existing plant and equipment. (Luostarinen & Welch
1997,164) The greenfield strategy is applicable if the product or the production process
demands unique technology, which forms the company's competitive edge and thus, cannot
be endangered by technology transfer to local firms in the host country. The greenfield
strategy is also applicable if the host government's incentives are valid in a particular
geographical area where suitable partners are not available. Consequently, a particular
location may possess some important production factors, which results in a TNC to adapt
the greenfield strategy if there are no suitable partners, (ibid., 166) Greenfield investment is
a dominating way of FDI in developing countries (UNCTAD 2004, xvii).
Buying an existing company in the host economy, or cross-border M&A, is the most rapid
way to enter a new market. It may solve the difficulties of hiring local personnel and
penetrating local distribution channels, and it brings a readily-built market share and
customer group with it. Based on these facts, the time needed to pay back the investment is
relatively short. However, acquisitions usually face serious problems in integrating two
previously separate organisations together. (Root 1994, 164-166; Luostarinen & Welch
19
1997, 164-165) M&A is the most common type of FDI in the developed countries
(UNCTAD 2004, xvii).
With regard to ownership, a TNC may set a wholly-owned subsidiary or a joint venture. The
advantages of a wholly-owned subsidiary include the total control of operations, decisionmaking, profits, management and production decisions, and the security over the
technological assets and know-how. The constraints are mainly related to the capital
requirements and the shortage of management personnel with international experience.
Success in a distant market without a local partner may also be difficult due to the different
cultural backgrounds, different corporate or industry cultures, and different national or
ethnic cultures, not to mention different legal, economic and political aspects. (ElKahal
2001, 237)
In the form of a joint venture, the investor has access to local partners' specialised skills,
knowledge of a local market, and government contacts. Thus, a joint venture with a wellconnected local partner is often considered as the best way of investment. In many cases,
however, the contribution of partners have been disproportionate, as the local partner has
provided only labour and local facilities while the investor has to provide capital, training,
technology, equipment, and know-how, (ibid., 227-231) A joint venture can be set with one
or more local partners. Sometimes, the partner or one of the partners is from the home
country or a third country. If at least one of the partners is a government-owned firm, the
joint venture is called a mixed venture. A TNC may set a majority joint/mixed venture, a 5050 joint/mixed venture, or a minority joint/mixed venture (Luostarinen &Welch 1997, 156158). The entry mode is not always possible to decide according to the TNC's own will, but
may be regulated by the host country.
Investment can be classified by its function as a direct investment production operation
(DIPO), which includes assembling and manufacturing subsidiaries, or a direct investment
marketing operation (DIMO), which includes sales promotion subsidiaries, warehousing
units, service units, and sales subsidiaries (Luostarinen 1979, 105-112). Again, the functions
are overlapping and can be utilised separately but also together.
In addition to the above-mentioned classifications, the size and industry of the investing
firm, as well as its earlier experience in internationalisation are factors which can be used to
make a difference between FDI situations. Among them, the size of the firm is usually
measured by the turnover and number of employees. According to Harvard criteria, a
20
multinational enterprise (MNE) is a firm that has a turnover of more than USD 200 million
and at least six production units abroad (cf.Vaupel & Curhan 1969, 3), while the smaller
firms can be classified as SMEs. These two groups differ in their investment behaviour in a
sense that MNEs have much larger resources than SMEs to fulfil their strategies in the host
economy (Larimo 1993, 32). Similarly, firms having broad earlier international experience
have better starting points to operate in the host economy than firms without such
experience (ibid.). Finally, FDI experiences may be different between firms representing
different industries.
2.1.3 Strategic management view on the investor
The geography of enterprise and strategic management traditions have different approaches
to the firm, but they are by no means contradictory to each other. The geography of
enterprise approach asks where the firm should exist in order to perform better than the
other firms, while the strategic management literature asks how and why some firms are
able to perform better than other firms.
As mentioned earlier, the geography of enterprise literature has recently put much effort in
conceptualisation of the firm. This has been seen necessary, because the concept of the firm
has been understood as rather confusing, as shown by Machlup (1967) who has recognised
21 different definitions of the firm. The difference between the various concepts is how they
understand the firm, the environment, and the relation between the firm and the
environment. A rather established definition of the firm among geographers has been the
one by Cowling and Sugden (1987, 62), who define the firm as a "means of co-ordinating
production from one centre of strategic decision-making". This definition has an implicit
idea on the firm as a network and as a homogenous decision-making unit, characteristics
widely discussed in economic geography. Moreover, Cowling and Sugden emphasise the
firm's ability to co-ordinate the system by internalising transactions within the firm. Thus,
they emphasise the role of strategic decision-making over the production system including
not only the firms themselves, but also the relationship between the firms, their suppliers
and customers, and the host governments.
In strategic management literature, in its turn, a firm is defined "as a purposive organisation
whose behaviour is directed toward identifiable end purposes or objectives", and which
"seeks its objectives through...conversion of its resources into goods and/or services and
21
then obtaining a return on these by selling them to customers". (Ansoff 1987, 23, 48;
emphasis by Ansoff) Moreover, these purposes are economic in their nature. In brief,
strategic management approach focuses on defining a firm's abilities to perform, while the
geography of enterprise approach continues the definition by adding the spatial perspective
that highlights the characteristics of the modern TNC. In the geography of enterprise
approach, 1) a TNC is able to extend its control over legally independent firms, 2) a TNC is
a network-type organisation consisting of collaborative relationships, 3) a TNC is able to
move operations betweens various geographical scales, 4) a TNC is able to take advantage
of geographical differences, 5) expansion of TNC is directed by strategic decisions based on
the availability of resources for investment purposes, 6) strategic decision-making is a
centralised action, which allocates resources, and 7) production may refer to service
production as well as to manufacturing. (Cowling & Sudgen 1987,60; Hayter 1997; Dicken
1998,177; Oinas 1998, 34-45; Yeung 2000)
The two definitions of the firm by strategic management and the geography of enterprise
approaches complement each other. This compatibility allows turning the discussion to the
concept of FDI. In the context of the FDI, the geography of enterprise literature recognises
the corporate strategies behind locational decisions. In addition, this tradition understands
FDI as a TNC - a host government bargaining process, which is explained by strategy and
the power of the firm. This means that the decision to go abroad is strategic. Thus, a further
look at the strategic management approach is needed in order to understand the corporate
behaviour behind the investment decisions.
Strategy is defined "as the determination of the basic long-term goals and objectives of an
enterprise, and the adoption of courses of action and the allocation of resources necessary
for carrying out these goals" (Chandler 1962,15-16). Consequently, strategic management is
"the process through which strategies are chosen and implemented" (Barney 1991, 27-28).
Also Hofer and Schendel (1978, 4) put it similarly: strategy means matching between the
organisation's resources with its environment in order to accomplish its purposes. As a
result, strategic management models, such as strategy-performance models, argue that the
firm aims to gain economic performance through the set of scope and the resource
deployment decisions, as shown in Exhibit 2.
Exhibit 2. The basic strategy-performance model
22
The aim of the strategy is to combine the strengths of the firm with the opportunities of the
environment. As a result, the firm gains economic performance. The aim is to avoid the
situation where the weaknesses of the firm are met with the threats of the environment. If
the firm succeeds to combine the strengths of the firm with the opportunities of the
environment, only the simultaneous change in both the environment and the firm can move
the firm towards the worst alternative. Accordingly, with the help of its strengths, the firm
may hinder the threat of the environment. However, if there are weaknesses in the firm, it is
not able to fully exploit its environment. (Lahti 198,24-29)
By definition, risk means uncertainty in achieving the firm's goals (Atkinson 2004). Risk
can arise from the strategy, the environment, or the operation. Strategic risk refers to the
concern that major strategic alternatives may be ill-advised given the firm's internal and
external circumstances. The risk arises if the firm's environment is misread or an
inappropriate strategy has been developed to deal with that environment. Environment risk
arises from the firm's external environment and the firm cannot directly have an influence on
it. Firms can, however, manage the environmental risk by scanning continuously each of the
changeable environment elements, identifying the risks, and acting on the risks in an
appropriate and timely manner. Finally, operational risk is related to the firm's ability to
achieve its objectives and the potential failure to operate according to objectives.
The basic strategy-performance model is easily adaptable to the case of direct investment
decisions, which are the firm's decision on the geographical scope. As such, the investment
decision is one of the major decisions of the firm, which is made once and not changed for
23
several years. It is a part of corporate level strategy, which defines what set of businesses a
firm should be in. Thus, it has to be made in a consistent way with the organisation's
strategies. Based on Ansoff (1965), Hofer and Schendel (1978,25) present the four elements
of any organisation's strategy:
1.
scope of operations, the organisation's present and planned interactions with its
environment
2.
resource deployment, the level and patterns of the organisation's resource and
skill deployment, which helps it achieve its goals
3.
synergy, the joint effects of resource deployment and scope decisions
4.
competitive advantage, an organisation's unique position vis-a-vis competitors
through its resource deployment and scope decisions
In Hofer and Schendel's definition, resource deployment used to be a new element, which
had not been included in strategy elements by earlier authors (eg Ansoff 1965), and they
emphasised it even more than the scope of operations (Hofer & Schendel 1978, 25). As their
definition refers to managers' tools for coping with external and internal changes, it has
many similar characteristics to the decision on the internationalisation of the firm, including
FDI.
2.1.4 Adapting the strategy-performance model for investment studies
The strategy-performance model is an attempt to recognise all the significant factors, which
help the firm to achieve economic performance. It has been gradually developed from the
basis of Hofer and Schendel (1978) by Lahti (1983,1985, 1987). Theoretically, the model is
part of the Ansoffian strategic management research tradition with a recognisable chain of
evidence. Lahti has used the basic strategy-performance model shown earlier, which he has
deepened through Hofer and Schendel's strategy elements (scope of operations, resource
deployment, synergy, and competitive advantage) and finally explained the relations
between the elements explicitly. In addition, Lahti has linked the strategic view to the
operative view (from the definition of the potential and the exploitation of the potential to
the performance), as illustrated in Exhibit 3.
Exhibit 3. Lahti's strategy-performance model
24
Source: Lahti 1987, 49.
The model explains the performance of the firm through three dynamic stages. The first
stage refers to the firm's strategic decision on how to fit its resources to the scope of the
operation. This stage is called performance potential, because the strategic decision creates
future potential for the firm. Combining resources and scope in the best possible way, results
in synergy. This means that the combination creates more potential than the sum of the
elements. (Lahti 1983,30-33)
The second stage of the model is called performance realisation and it refers to the firm's
capacity to implement selected potential. Potential is utilised by interacting with the market
through marketing and serving the market through logistics. The potential realisation stage
results in a competitive advantage over competitors. Competitive advantage is thus based on
those resources by which a firm can compete more effectively in the specific environment
than its competitors. It may be based on the same resources as synergy, but added to the
component of competition. Finally, the third stage, performance achieved, refers to
performance, that is the result of the strategy process. Lahti (ibid.) highlights the economic
perspective and as such, excludes other possible perspectives like the learning perspective,
for example.
25
Lahti's strategy-performance model has proved its validity as it has been tested in various
contexts. In the following, the content of each strategy-performance model element is briefly
overviewed, and the adaptability of the model for the investment studies is discussed.
Scope of market operations. The first element of the strategy-performance model, the
scope of operations, is defined broadly by Hofer and Schendel (1978, 26): for some
companies, it means product or market segments, while the other companies may identify it
in terms of geography, technology, or distribution channels. Lahti (1987) explains that the
scope of operations means the firm's choice over the customers, the products and the
markets. Through this decision the firm selects its external environment. For example, by
choosing a target market, the firm also chooses its competitive environment.
Lahti (1987, 50) defines the firm's environment as composed offerees and institutions that
can have an impact on the firm and the market, but which the firm cannot directly influence.
Hofer and Schendel (1978, 47) and Lahti (1987, 50) divide the environment into the firm's
general macro-environment and the specific competitive environment. Lahti (ibid.) divides
the general macro-environment further into natural, demographic, cultural, political,
economic, and technological environments with reference to Kotler (1980, 96-128). All the
above-mentioned definitions of the environment probably have their roots in traditional
Andrews (1971) environmental model that has been widely recognised in the field of
strategic management. Andrews' model defines the relevant environment to consist of
economy, politics, society, industry, technology, and ecology.
The present study takes Kotler's (1980, 96-128) division of the environment into six parts as
given because more or less the same division is used in other models that are built explicitly
to analyse changes of the environment, such as the PEST analysis, the STEEP tool, or the
environmental scanning. PEST analysis studies the changes in the firm's macro-environment
in terms of political (P), economic (E), socio-cultural (S), and technological (T) forces.
Later, the analysis has been added by legal (L), ecological (E) and competitive (C) forces
and thus, may be called LE PEST С analysis. Accordingly, STEEP is a tool of strategic
management that summarises the macro-environment factors that can affect the firm,
namely social (S), technological (T), economic (E), environment (E), and political (P)
trends. The five can be traced back to Kotler's (1980) six environments if ecological aspects
are incorporated in the natural environment and social aspects divided into demographic and
cultural environments. The same is true with the environmental scanning, which is a
26
systematic futures methodology that focuses on five knowledge areas of economics,
technology, politics, ecology, and socio-cultural factors (eg Lang 2003).
Strategic fit, which reflects the alignment between the firm's internal potential and its
external opportunities, allows a firm to compare and choose among attractive investment
destinations. However, the characteristics of the environment are not interesting for the firm
as such, but it is interested in the best possible match for the firm's resources. This is what
the geography of enterprise approach argues while explaining location as the relative
optimal location. Location is optimal in relation to the firm's strategies. In this context,
geographers (Nishioka & Krumme 1973, 202-204) have developed the concepts of location
conditions and location factors, which give an additional explanation. Location conditions
refer to the differences between locations. These differences are the same for all companies.
Differently, location factors refer to the interpretation of the location conditions from the
perspective of a single firm and its purposes. Thus, the firm perceives the location
conditions of the host country as a more specific set of location factors. Different strategies
and resource deployments of different TNCs explain why the firms may value the same
environment differently.
In practice, a single location condition can be interpreted in various ways depending on the
firm's strategy. For example, such a location condition as access to market may refer to
advantages resulting from transportation costs, or advantages resulting from close contact
(eg customer services), or advantages in the selling price or quantity resulting from the size
of the market. Furthermore, the same location condition may be a desirable, undesirable, or
inconsequential location factor for a TNC. For example, the host country's environmental
policy reform may be desirable for an investor transferring new environmental technologies
to the host country, undesirable for an investor using contaminant technologies, and
inconsequential for an investor operating in a not environmentally sensitive field.
The analysis, based only on location conditions of the host country, does not explain the
effective location factors relevant to a TNC, and vice versa, the analysis of location factors
only, probably gives an incomplete picture of the region (Nishioka & Krumme 1973, 202204). As explained by Harvey (1997, 98-100), location conditions in a particular country
may be listed by reasoning, but location factors have to be identified by numerous
questionnaire surveys. However, the surveys conducted in international business, for
example, have used various different scales and contexts. Therefore, conflicting results have
27
emerged. In addition, location factors may be subjective and cannot be generalised.
However, by adopting the strategy-performance model to investment studies, the firm's
external environment can be included in the analysis in order to explain how the countryspecific factors influence the firm's scope of market operations, resources, marketing and
logistics, and finally the performance, as illustrated in Exhibit 4.
Exhibit 4. The interplay between the internal and the external factors of the firm
Resource deployment. In order to extend its scope of market operations, the firm has to
invest. By investment, the firm actually changes some of its resources. In this point, the
analysis has to be turned inside the firm, as the decision to invest has to be based on
knowledge of the firm's patterns of resource deployments (Hofer & Schendel 1978, 23-25).
However, the investment decision may also create a need for additional resources that has to
be achieved in interaction with the firm's environment, as explained earlier. Thus, the
achievement of additional resources calls for knowledge of the environment, as well.
Early authors (eg Ansoff 1987, 23) have classified the resources of the firm into three
categories of physical, monetary and human resources. Hofer & Schendel (1978, 145) have
developed more sophisticated classifications by adding organisational resources and
28
technology. There is no clear consensus on the classification, and there are continuously
new emphasises for the purposes of new types of organisations, such as new ventures. The
resources, which the firms possess and can use in order to achieve their objectives, are
defined according to Hofer and Schendel (1978, 145) to consist of:
1.
physical resources (eg raw materials, buildings, machines)
2.
human resources (eg staff number, education level, language skills, professional
skills)
3.
technological
capabilities
(eg
systems
of
production,
information
and
telecommunications)
4.
financial resources (eg cash flow, equity capital, short and long-term liabilities,
return on capital, liquidity, solidity)
5.
organisational resources (eg organisational structure and capacity, R&D degree,
innovativeness, values)
The resources of the firm are not just given, but they are dynamic: the firm has to
continuously upgrade and develop them, or as Ansoff (1987, 23) puts it: "All three [physical,
monetary and human resources] are used up in the conversion process: plant becomes
obsolete, money gets spent, and executives get old. In this respect, survival of the firm
depends on profit; unless profits are generated and used for generation of future profit and
replacement of resources, the firm will eventually run down". Financial resources have a
special position among the resources, as they are the only resource generated by the
activities of the firm in the market place and, moreover, directly convertible into the other
types of resources (Lahti 1985, 6). All resources have also spatial dimensions, as the
operations of the firm are partly tied to resources available in the host country, in the case of
FDI.
Synergy. The joint effects of the set of scope and the resource deployment decisions
produce synergy. The level of synergy defines the potential of the firm. In the case of direct
investment, however, an additional element of the host country has to be taken into
consideration. With regard to scope decision, the host country may be the same as the
chosen target market (local market oriented investment) but it may also be different
(international market oriented investment). Accordingly, with regard to resource
deployment, investment may be driven by the existing resources of the firm to be utilised in
29
the host country, or the investment is attracted by such resources available in the host
country, which the firm does not possess beforehand.
Marketing and logistics. The second stage of Lahti's strategy-performance model,
performance realisation, consists of marketing and logistics elements, as discussed earlier.
The aim of marketing is to utilise the firm's chosen potential efficiently (Killstrom 2005,
54). Through marketing, the firm positions itself in the competitive environment. Firms use
the set of various activity patterns to pursue their marketing objectives. This set is called the
marketing mix and it has been popularised by McCarthy (1960) in a four-factor
classification, which includes product, price, place and promotion decisions (4Ps). Firms
prepare products or services with certain prices for the target market, which is reached
through the distributions channels (place) with the help of promotion (eg sales promotion,
advertising, sales force, public relations).
In Lahti's strategy-performance model, place decisions are incorporated in the logistics
element. Logistics refers to the arrangement of the availability of products and services and
to the creation of contacts with the customers (Killstrom 2005, 53). It is a part of the supply
chain process that "plans, implements, and controls the efficient, effective forward and
reverse flow and storage of goods, services, and related information between the point of
origin and the point of consumption in order to meet customers' requirements", as defined
by the Council of Logistics Management (2003). Thus, logistics does not deal only with
delivering products from the supplier to the manufacturer and to the end-user, but is
comparable with the broader concept of supply chain management (SCM). In practice,
logistics can be measured by such variables as delivery reliability and time, flexibility of
order-delivery process, warehousing, transportation routes, and telecommunications links.
Competitive advantage. Competitive advantage refers to the organisation's unique position
vis-a-vis competitors. Based on the firm's resource deployment and scope decisions,
competitive advantage is created through marketing and logistics if the supply of the firm
fits the market demand better than its competitors' supply. Competitive advantage results in
the firm's performance.
Performance. The third and final stage of the Lahti's strategy-performance model, the
performance achieved, or the result of the strategy, is composed of four kinds of results,
namely profitability, external effectiveness, internal efficiency, and flexibility47. Among
30
them, profitability is the basic indicator of the firm's performance. External effectiveness
indicates the firm's position in the market in relation to competitors, which can be measured
by market share or corporate image, for example. Internal efficiency refers to the firm's
ability to generate turnover and profit through its existing resources. In this context, the total
sum of the balance sheet may be used to indicate the resources as a whole. Finally,
flexibility explains how the firm has maintained its profitability in a changing environment.
As such, it indicates the continuity of the business.
It is obvious that also in the case of direct investment, the foreign unit has to make
contribution to the TNC. When the success of foreign units is evaluated, various
perspectives of its contribution are possible. For example, the behavioural perspective
emphasises the development of the separate culture and identity of the foreign unit, while
the learning perspective focuses on the creation of knowledge in the foreign unit (cf. Buchel
et al. 1998, 198). In the present study, however, an economic perspective is chosen, similar
to Lahti's strategy-performance model. It means that the foreign unit increases the value of
the parent company. It has been stated also in empirical studies (Kelly & Philippatos 1982)
that FDI is motivated primarily by profit rather than behavioural considerations, for
example.
2.2 Theories of Foreign Direct Investment
Economists and policy makers in developing countries often expect very much in respect to
FDI. Investors are not in a hurry to invest their money there They have several options how
to enter a foreign markets: they can do it in the conventional way by producing at home and
then going for trade in goods and services or they can build up a foreign production base
either by a greenfield investment, by joint venture or by acquiring an existing company. And
they can opt for an intermediate mode of market entry: they can conclude a contractual
arrangement with a foreign producer in form of licensing or offshore processing (Schmidt,
Naujoks, 1993).
Although there is an enormous literature on FDI, a generally accepted theory is still lacking
(Agarwal, 1991). Even the most popular approach, the eclectic theory of international
production developed by Dunning (1980) and others, is far from a generalization (Parry,
31
1985; Rugman, 1985). Notwithstanding the reservations it postulates the conditions under
which FDI is undertaken at all (Sander, Schmidt, 1993).
2.2.1 Explanation of FDI
The macro-economic question about why FDI happens is usually answered on an aggregate
level, using rational choice theories. One of the oldest approaches is developed from the
product life cycle hypothesis by Vernon, who argues that the more mature a product and its
production process is, the more likely it is to be produced in developing countries for cost
saving reasons (Vernon 1996), A different explanation is the oligopolistic reaction theory
which states that an initial FDI by one firm induces the other firms in the same industry to
follow their competitor abroad (Knickerbocker 1973).
Dunning's eclectic FDI theory tries to incorporate as many reasons for FDIs as possible. He
hypothesizes that FDIs happen if the company has in a certain country ownership-specific
advantages, internationalization advantages and localization advantages (Dunning 1988).
Dunning's theory and the others in this tradition of research are situated on an aggregate
level, and do not pay specific attention to the individual firm. However, these theories help
to understand the rational of some direct investment decisions even on a firm level.
Although they are generally macroeconomic theories, they do help to explain why particular
FDI decisions, e.g., the production of product X and not product Y in a foreign country, are
made by individual companies.
2.2.2 Econometric studies on Influence of Tax Policy on Investment
Much econometric work on the cost of capital has centered on the specific issue of the
effectiveness of taxes on investment. Bosworth (1984) in a survey of the literature
concluded that taxes probably have a significant, but small, effect on investment, but also
that the evidence for this proposition was weak. Investigators in other countries have also
concluded that tax policy has a small effect on investment demand (Sumner, 1986;
Devereux, 1989). Feldstein has been perhaps the strongest proponent of the importance of
taxation (Feldstein, 1982).
32
Bosworth (1985) assessed the 1981 and 1982 reforms and found that they did not have much
influence on the pickup of investment demand in the 1981-84 period. He found that the
investment recovery was the strongest in sectors where the tax changes were relatively
minor. Corker (1988) attributed only a distinctly subsidiary role to the three reforms,
arguing that output was the dominant factor. Boskin (1988) in contrast concluded that tax
policy "is an important (but hardly exclusive) determinant of investment", and that the end
the 1981 and 1982 U.S. tax reforms had a substantial influence in stimulating investment.
2.2.3 Micro-Theories
What determines whether a firm decides to establish production facilities abroad rather than
export its product or license overseas entrepreneurs to produce instead? A common sense
answer might be that it is the prospect of earning higher profit which induces firms to invest
abroad, primarily because of lower labor costs. However, although differences in labor costs
may sometimes help influence firms' decisions to locate abroad, this is far from being the
whole story. As the FDI data in the previous section showed, the majority of FDI still goes
to the advanced countries, in particular the United States where wages are high relative to
those in developing countries.
Economists have long recognized that there will normally be extra costs involved at least
initially for a firm investing in a foreign country where it is not familiar with local markets
and institutions. At a theoretical level, economic analysis offers three main explanatory
approaches which attempt to show why, despite these disadvantages, firms may still wish to
invest abroad. These approaches focus on different aspects, namely:
· ownership advantages: (Hymer, 1960.) such advantages are thought to arise from
economies of scale with respect to intangible assets such as skilled management capacity or
organizational know-how which may also be exploited to even greater advantage by
investing abroad.
· locational advantages: (Vernon, 1966.) these arise in part from the fact that, for many
products, there is a production cycle involving several stages, with new technology first
being produced and used in the home country and, once standardized, shifted abroad
because either nearness to the final market or lower factor costs make this advantageous.
33
However, even if one were to accept the characterization of technological stages in this
theory, the theory does not explain why a firm has to establish its presence abroad rather
than license its technology or products.
· internalization advantages: Buckley and Casson (1976) attempted to fill the gap in the
locational advantages theories by calling attention to advantages which may accrue to a firm
from "internalization", i.e. engaging in foreign production itself, rather than sub-contracting
or licensing it to a foreign firm. These authors drew on the general "transactions costs"
theory of Williamson (1975) which provides a rationale to explain why it may be more
advantageous to concentrate certain activities within the firm, rather than rely on the market
mechanism to achieve the same objectives, say, by licensing or sub-contracting. The basic
idea here is that there are transactions costs of various kinds involved in operating through
the market mechanism. When such costs are greater than those arising from carrying out
activities within the firm, internalization, that is, establishing an overseas subsidiary, will be
preferred.
These mainstream theoretical approaches are not mutually exclusive; nor are they
comprehensive. They do however encompass most of the practical reasons why firms may
invest abroad (for example, access to markets, labor costs, proximity to raw materials, a
more lax approach to the environment, and fiscal incentives). There are, however, other
theories which explain multinational investment in rather different terms, such as
oligopolistic rivalry between firms at the global level, the empire-building motives of
managers of large corporations in advanced countries, or strategic entry deterrence, that is,
the build-up of overseas capacity in order to stop potential rivals from entering any specific
market or markets. Such theories may be better than the mainstream theories in explaining
some of the observed facts concerning FDI, notably the existence of FDI surges.
2.2.4 Eclectic Paradigm
The theory, developed by John Dunning, is called the Eclectic Paradigm. It is called a
paradigm because it is a framework for integrating other theories that explain the activities
of multinational enterprises. The Eclectic Paradigm consists of three advantages:
34
Ownership Advantages. This helps explain the "why," or motivation, of multinational
enterprise activities. Ownership advantages are defined as the degree to which a firm
possesses sustainable ownership-specific advantages over other firms in the market. Some
examples of these advantages are innovative capacity, access to financial resources, and
organizational and marketing systems.
Location Advantages. This helps explain the "where," or location, of multinational
enterprise activities. These advantages are specific to the country. Some examples are
natural resources, labor force (availability and quality), and societal structure (legal systems,
political structure).
Internalization Advantages. This helps explain the "how," or the manner, of multinational
enterprise activities. Internalization is the degree of ownership and control. At one end of the
spectrum is no control or ownership. Transactions are made at arm's length or through the
market. At the other end of the spectrum is full control. The firm "internalizes" the market
transactions by owning or controlling the other firm. The transactions are not arm's-length.
A multinational enterprise's degree of foreign direct investment (and other foreign valueadding activities) depends on four conditions being present. These conditions form the basis
of the Eclectic Paradigm:
The extent to which a firm possesses ownership advantages over other firms in the particular
market.
The extent to which a multinational enterprise believes that it is in its interest to exploit the
ownership advantages rather than sell them to another firm. Examples of transferring these
ownership advantages would be the licensing of a technology or the franchising of a
business concept.
The extent to which there are location-specific advantages of a certain country that increase
the value of the ownership advantages over the location advantages of other countries.
The extent to which the foreign direct investment is consistent with the long-term strategy of
the firm.
35
The Eclectic Paradigm has attempted to draw together a number of related theories
explaining MNE activity. Business scholars disagree over the value of this paradigm.
However, most agree that it is a useful framework for evaluating the attractiveness of
foreign direct investments.
Initially it has been stated that the existence of each ownership, locational and
internationalization advantages is a necessary and the simultaneous existence of them is a
sufficient condition for FDI to occur. More recently it has been argued that locational
advantages of a potential host country could be a both necessary and sufficient condition for
FDI (Stehn 1992). FDI may be undertaken even without firm specific advantages on part of
the foreign investor if the potential host country's locational advantages are large enough to
(over)compensate for only small or even lacking firm-specific advantages. This argument
has important implications for economic policy towards FDI.
2.2.5 Macro-economic Theories
In addition to these micro-economic theories of FDI, there is an older literature which
contains macro-level theoretical approaches and "broad-brush" accounts which attempt to
explain why foreign investment takes places. These include various theories of economic
imperialism, based on different interpretations of the workings of the capitalist system.
Some are simple "rate of profit" theories which can quite easily be accommodated within the
neo-liberal framework sustaining the idea of unfettered flows of capital on a global level.
Others which focus on the "vent for surplus" have greater political content in that capital
export is seen as a necessity under certain (low) wage conditions and some of these theories
predict a cataclysmic end to the capitalist system.
Governments, too, (particularly of the rich advanced countries) make substantial efforts to
encourage overseas investment by their enterprises, with a view to ensuring access to natural
resources or increasing potential exports of capital goods (including military equipment),
while at the same time generating inflows of profit remittances benefiting the balance of
payments. Such efforts sometimes correspond to a geopolitical strategy to "tame" through
indirect influence the policies of governments in countries with the actual or potential
political and economic power to exert a regional or global influence.
36
2.3 Motivational studies and Risk in Decision process
2.3.1 Motivational studies
Within the context of motivational studies for foreign direct investments, authors investigate
the initiating forces of FDIs. One can generally differentiate between two main groups,
market-oriented vs. cost oriented strategies.
Behavioral studies, which may also focus on decision-making processes, often concentrate
on the motives for FDI. One of Aharoni's goals, for example, was to analyze in detail why
companies wanted to invest in the relatively small market of Israel and not somewhere else
(Aharoni 1966: 9). It is important to know the motives for the investment abroad, to know
what type of information needs to be searched, and what types of problems might have to be
confronted during the decision process. More detailed motives for foreign investment will
be discussed in the next section of the paper
2.3.2 Motives for FDI
The difficulties in providing a general theory of FDI also stem from the observation that the
motives are differing considerably between the different markets in which foreign investors
are engaged (Agarwal, 1991). The traditional literature has focused on market access as the
main motive for FDI. It states that there is an optimal timing for starting FDI: a company
should have reached a certain market share in a foreign market by means of exporting before
becoming an investor there.
Since 1960, there are several empirical studies about the approaches of the managers to
direct investment into foreign countries with motives lists. However, it is possible that the
managers are not able to define the real motives and/or are not ready to term the real
motives, but solely say that ones, which care for their image (Rubinstein, 1975).
The Germany Industry and Trade Committee (DIHT) using inquiry of companies acquire a
detailed list of motives for direct investment into foreign countries (Kayser 2001):
37
Exhibit 5. List of Motives for direct investment
Motive
Rank
Expansion of the overseas activity onto new markets
2.87
Protection and expansion of a present market
2.38
Protection and control of the distribution in the host country
2.05
Political Stability of the host country
1.68
Export basis for products of the parent company
1.32
Overcoming of trading and export restraints
1.31
Expectation of a higher rate of return on investment
1.14
Supplier for company of the host country
1.03
Low costs of wages
1.01
Protection of the maintenance in the host country
0.97
Employment creation
0.73
Fortification of the economic autonomy of the host country
0.64
Saving of transportation costs
0.58
Government aid's arrangements of the host country for direct investment
0.53
Production for the parent company (re-import)
0.52
Realization of technologies, which were developed for the special needs of the
host country
0.51
Processing of domestic raw materials for the inland needs of the host country
0.42
Shifting rated on conditional on Exchange rate
0.42
Supplier for a domestic corporate, which likewise operate in the host country
0.41
Low prices for raw materials and utilities
0.39
Government aid's arrangements of the country (what company come from), for
direct investments
0.32
Protection and extension of the raw material basis
0.30
Other reasons
0.17
Protection of the energy supply
0.15
International Institutions' Aid's arrangements for direct investments
0.08
The relative importance of labor costs for FDI decisions, however, is not as straightforward
as it might be appear (Agarwal, 1989). Low labor costs are necessary, though not a
sufficient conditions. One factor which is reducing the importance of cheap labor as a
locational advantage is the increasing degree of automatization in most manufacturing
industries. Actually, FDI is more important in industries producing sophisticated products
(such as automotive, electrical, machinery and transport equipment) than in industries
producing standardized products. In the textile and clothing industry, e.g., foreign investors
38
prefer sub-contracting rather than FDI as these industries are not characterized by firmspecific advantages which might induce equity arrangements.
2.3.3 Risk theories
The assumed or actual risk of decisions in general, and especially that of investment
decisions in foreign countries, receives a lot of attention in the literature. "Risk" as an
expression is used widely in the literature even though authors are actually referring often to
uncertainty or even ambiguity rather than risk itself (Laverty 1996).
According to the mathematical definition, "risk" refers to the case where the probability of
every alternative is known, even though the actual outcome is not. Decision making under
uncertainty, in contrast would refer to a case where the probabilities of alternatives are not
known with certainty.
During strategic decision-making processes even the alternatives are usually not known.
This is why Mintzberg (1976, p.251) introduced the concept of ambiguity, "where almost
nothing is given or easily determined.". Thus, even if the literature or interviewees talk
about the "risk" of investing, it should be understood that the terms is used in the popular
way for expressing any condition of risk, uncertainty, or ambiguity.
The trade-off between expected value and risk plays a major role in rational decision
theories. The researchers rejecting the normative model of decision making proposed new
ways of explaining, how companies choose between alternatives. It was found that decisionmakers are usually risk averse and are influenced by many factors other than risk and
potential pay-offs (Wharton 1992).
2.4 Modes of entry strategies
FDI flows consists largely of four categories of capital account transactions (commonly
referred to as “modes of entry”), namely: “greenfield” investment (whereby an enterprise is
created essentially from scratch); mergers and acquisitions involving significant crossborder elements; earnings reinvested in foreign-owned companies; and cross-border loans
39
and trade credits between related enterprises. The latter two are not of major concern in a
development context, whereas reinvested earnings sometimes make up a significant part of
the FDI flows between mature economies.
The potential benefits of FDI summarized above apply in principle to all FDI, regardless of
modes of entry. Nevertheless, many developing country governments have expressed a
strong preference for greenfield over other types of investment, and some have voiced
concerns over the effects of M&A originating abroad. This persistent skepticism towards the
takeover of domestic enterprises by foreign investors generally has both political and
economic roots.
In political terms, host country authorities may convince their domestic constituency
relatively easily of the advantages of greenfield investment, whereas the acquisition of
entrenched national enterprises by foreigners often breeds resentment. Moreover, in cases
where host country authorities use their influence over domestic enterprises to make them
pursue aims other than the maximization of shareholder value, transferring the ownership to
foreign investors may be considered as a loss of sovereignty. Finally, where corporate
restructuring is a likely outcome of foreign takeovers, M&As, however potentially
beneficial to the broader host economy, - are often opposed by powerful interest groups.
The economic arguments most often made for preferring greenfield investment to M&As
relate to the amount of money eventually made available for productive investment in the
host economy. Except for the unlikely case where the sellers of an enterprise promptly
reinvest the entire proceeds in the domestic enterprise sector, portfolio reallocation will, at
least in the short term, divert some of the M&A proceeds away from productive investment.
This scenario is exacerbated where the host country investment climate is perceived as poor,
particularly where confidence is so low that the national authorities face problems of capital
flight. Another economic argument for greenfield investment is based on the value of FDI as
a source of stable external finance. The irreversibility of most greenfield investment makes
it a more “patient” source of capital than M&As, at least where M&As take the form of the
acquisition of listed equity on secondary markets.
A further rationale for host countries’ preference for greenfield investment could emanate
from the fact that the motivation factors surveyed above do not always apply equally across
the modes of delivery. A stylized representation is proposed in Exhibit 6.
40
Exhibit 6. Predominant motivation factors and modes of delivery
Greenfield
Mergers and Acquisitions
Resource-seeking FDI
Yes
Rare
Market-seeking FDI
Yes
Yes
Efficiency-seeking FDI
Rare
Yes
Strategic-asset seeking FDI
Rare
Yes
While no firm conclusions should be drawn from this simple categorization, it is interesting
to note how resource-seeking FDI, which is almost universally sought by countries at an
early stage of economic development, tends to take the form of greenfield investment.
Strategic-asset-seeking FDI, on the other hand, consists mainly of enterprise takeovers, and
while such investment generally benefits the host country, certain special cases continue to
raise concerns among policy makers. Technologies acquired via M&As, for example, may
be priced at market values that fail to reflect their potential future external effects, which, if
they are subsequently transferred out of the host economy, may lead to an overall economic
loss. Another example of “unwanted” M&As is the case in which foreign investors acquire
enterprises with the main purpose of increasing their market power. This may stifle
competition in the host economy.
2.5 Political environment in the context of international investment
The conceptualisation of the firm, as done in strategic management and the geography of
enterprise literatures, and discussed in the previous Chapter, leads to the question of the
boundaries of the firm: where does the firm end and the environment begin? Answering the
question is difficult. First of all, the definition of the firm's environment depends on the
approach as explained earlier in the context of different approaches to industrial geography.
Neoclassism emphasises natural resources, labour, the market, and competitors as the major
factors of the environment. Behaviourism focuses on the decision-maker's perceptual space,
while structuralism points out the labour market as the main constitution of the environment.
Furthermore, the geography of enterprise approach has adapted an institutionalist view of
the firm's environment arguing that the firm is part of a power network consisting of
external institutions, such as parent firms, subsidiaries, subcontractors, rivals, financial
institutions, and the home and host governments (Hayter 1997, 79-81). In the context of
41
FDI, especially the bargaining relation between the firm and the host government plays a
role. This perspective includes also an implicit idea that the firm is able to influence its
external environment at least to some extent.
Secondly, the internationalisation of economic activities makes the definition of the
environment hard. There are no fixed boundaries between the firm and the environment
because firms grow by internalising parts of their external environment. The scope of the
firms is continuously enlarging, which makes it difficult to decide which parts of the total
environment should be incorporated in the analysis, (cf. Wood 1981, 416). In the present
study, the use of the modified strategy-performance model defines the scope of analysis, and
determines the parts of the environment to be analysed, as well.
Thirdly, the borderline between the internal and the external is questionable as the same
resource may appear as a firm-specific or country-specific factor. For example, financial
capital may be achieved inside or outside the firm, and it may be achieved on the home
market, the host market, or a third country. Financial capital may be an existing resource of
the firm at the time of investment, but the availability of financial capital in the host country
may also be an incentive to invest. Therefore, it is important to analyse both internal and
external factors at the same time.
In the following, attention is turned to the environment of the firm with special reference to
the political environment of the firm in the host country. First, political environment of the
firm is compared with the other relevant parts of the firm's environment that are included in
the modified strategy-performance model. Then, the particular role of the political
environment of the firm in the context of FDI is scrutinised. Finally, the firm's abilities to
influence or gain from its political environment are discussed.
2.5.1 Political environment as a parts of the firm's general environment
As explained earlier in Chapter Two, a particular target market can be analysed in terms of a
general macro-environment and a specific competitive environment. The general macroenvironment is further divided into natural, demographic, cultural, political, economic, and
technological environments. Different parts of the firm's environment can be put in
hierarchical order in which political, economic, demographic, and technological
42
environments manifest the cultural environment and in which the natural environment forms
the frame environment for all other environments, as illustrated in Exhibit 7. (cf. Koivisto
1998, 75; Jwa 2002,168)
Exhibit 7. Hierarchical structure of the different macro-environments of the firm
Source: Modified fromKoivisto 1998, 75.
The classification of the environment of the firm originates from marketing literature (eg
Kotler 1980) and in the context of the FDI it has to be enlarged to cover not only the host
market but various potential resources available in the host country for the TNC. The
importance of the potential resources depends on the type of investment, whether FDI is
directed to the local or international market. In the case that the host market is not the target
market of the investor, as in the case of export-oriented investment, the potential resources
available in the host country may play a more important role for the investment decision
than the host market as such.
Starting from the natural environment of the firm, Kotler (1980, 110-112) has defined it as a
subject of challenges and opportunities related to raw materials, energy, and environmental
issues. In the context of the FDI, the natural environment is even a wider concept including
43
the physical features of the host country, such as location of the country that determines the
accessibility, climate that may dictate modifications in product or affect people as
consumers or workers, the regional structure that may divide the nation into distinct markets
or hinder transportation, and natural hazards that may require a special building code, for
example (Terpstra 1978, 68-70). It is important to include ecological aspects in the analysis,
as also done by Kotler, similar to other environmental analyses, such as STEEP, LE PEST
C, and environmental scanning.
The cultural environment of the firm in the host country cannot be understood without
referring to the whole civilisation to which it belongs. Civilisation is created by religion,
history, language, habits, institutions, and the people's identity. According to Huntington
(2003, 48-49), religion can be recognised as the most important determinant of culture. The
cultural environment of the firm forms the conceptual and normative basis for the political,
economic, demographic, and technological environments of the firm, although the latter
ones also influence the first one (cf. Koivisto 1998, 72-76). According to Kotler (1980, 122),
the cultural environment of the firm primarily shapes the values and attitudes, which in turn
have an impact on the firm's marketing. Widening this marketing oriented view to cover also
FDI, different business cultures, the level of internationalisation, tolerance of foreigners, and
equality whether a question of race, gender, ethnic or social origin, age, language, or others,
has to be considered.
The political environment of the firm is defined by Kotler (1980, 115-121) as the
determinant of the rights and responsibilities of the firm by laws and social order. This
definition refers basically to such issues as the regulation against unfair competition and
unfair consumer practises, the social costs of the production, and the pressure groups
lobbying for better consumer protection. Thus, Kotler observes exclusively the domestic
market and discusses more administrative than political aspects of the society (cf.
Boddewyn & Brewer 1994). Extending this view to the FDI, the political environment of the
firm has to include the various political factors that can affect the TNCs operation or its
decision-making in the target country (Terpstra 1978, 119), starting from the political
system of the host country to its foreign relations. In addition, it has to be extended to cover
legal systems and economic policies, including trade and investment policies in particular.
Thus, in the present study, the political environment of the firm includes the host country's
overall policy in general and economic policy in particular. These policies are shaped not
44
only by the domestic conditions in the host country, but by the world politico-economic
conditions.
The economic environment of the firm, as defined by Kotler (1980, 108-110), refers to the
purchasing power of the market. Especially, the market-seeking TNCs are interested in the
purchasing power as an indicator of the economic environment. It is a function of income,
prices, savings and credit availability. At the market level, it is normally measured by GDP.
In addition, FDI as a form of international finance makes TNCs interested in exchange and
interest rates in the host country in comparison to other countries. Altogether, in the context
of the FDI, the concept of the economic environment has to be extended to cover the
economic system that shapes the level of economic development and production structure.
The demographic environment of the firm refers to the population, which equals the market
(Kotler 1980,103-108). Further segmentation of the market requires information on the
geographical distribution of the population; density; mobility; age distribution; birth,
marriage and death rates; racial, ethnic and religious structures. All these various indicators
reflect the demographic transition of the particular country. Another universal demographic
process is urbanisation. For an investor, the extent of urbanisation in the host country tells
that there are consumer behavioural differences between people in cities and rural areas.
Moreover, in the context of FDI, the demographic environment refers also to the manpower
available for the TNC as a resource. Thus, there are many aspects related to the quality of
labour, which are interesting for the firm, such as the number of labour, wage level,
educational level, and the rate of unemployment.
The technological environment of the firm is created and adopted by individuals and
organisations, and thus, it is dependent on social processes. Technology enables creating
new products and processes, new organisational and geographical arrangements of
economic activities and new structures. (Dicken 1992, 97-98) The technological
environment of the firm can be measured through such indicators as productivity,
infrastructure, innovativeness, and the R&D level in the host country. According to Kotler
(1980, 112-115), it is subject to rapid and sometimes unpredictable changes, which may
create but also destroy industries. Basically, technological change, which has occurred
worldwide along with the industrialisation, can be divided into long waves based on a few
major new technologies. Each wave is associated with a particularly significant
technological change and a specific geographical pattern.
45
In addition to the general macro-environment, the Lahti's strategy-performance model has
placed attention to the specific competitive environment. The model states that contrary to
the general macro-environment, a firm may have an impact on its competitive environment
to some extent being part of it by itself. According to Kotler (1980, 48-49), the firm meets
its rivals in three types of competition: generic competition, product-form competition, and
enterprise competition. Lahti (1987), in his turn, emphasises the competition over the
markets or the resources, and recognises various types of competition in terms of product,
price, marketing communication, and logistics.
Finally, the prevailing market forms in the host country may have an impact on FDI. The
market form may be a monopoly, monopolistic competition (a duopoly, an oligopoly, a
heterogeneous polyopoly), or perfect competition (a homogeneous polyopoly). In the case of
a monopoly, imports are restricted, which favours direct investment. Also a duopolistic and
an oligopolistic market may favour direct investment because production within the
concentrated market offers a better basis to compete than production outside of the market.
According to Luostarinen (1982, 30-31), the more monopolistic the market in the target
country, the more it favours direct investment operations. However, the entry depends also
on the reactions of the rivals. There are also other agents, which may have an impact on the
firm's competitive environment, such as the subcontractors, suppliers, labour, governments,
and pressure groups. They may all have an impact on the firm and the market, but usually
also the firm may have an impact on them to some extent.
2.5.2 The specific role of the political environment
Kobrin (1979, 69), has explained that the political environment is different from other
elements of the firm's environment because it incorporates aims to gain, maintain or increase
power at the state level. Thus, the political environment largely determines the framework of
economic activity. Consequently, Boddewyn and Brewer (1994) have argued that the
political environment is in contrast to other elements of the firm's environment. They
explain that TNCs are used to handle differences in nature, cultures, economies,
demographies, and technologies in the home country. There, they manage these differences
through market segmentation. In the host country, however, TNCs enter a political space of
foreign sovereignty. Entering this political space is different from entering just an economic
46
space because the host government can intervene in the TNC entry, operation, and exit, as
long as the host country's territory is concerned. For example, national laws of the host
country affect many cross-border activities, such as the investment of capital, payment of
dividends to a foreign investor, and customs and duties to import. Thus, the political
environment creates a significant border for international business of a TNC. (Boddewyn &
Brewer 1994, 123-126) These arguments make it meaningful to study the political
environment separately from other relevant factors having an impact on the investment
decision of the firm.
In international business (eg Terpstra 1978, 119), the political environment of the firm is
defined widely to consist of any national or international political factors that can affect the
operations and decision-making of TNC. FDI studies define political environment through
the political risk, as the political events in a particular country influence the operation of the
TNC in that country. Political risk has been studied only since the late 1960s when the first
TNCs started to seek low-cost production locations abroad. The political risk assessment
was not considered a top prority in most TNCs before such drastic events as the first oil
crisis in 1973 and the upheaval in Iran in 1979 (Simon 1982, 66). Kobrin (1979) has
conducted a literature review of the various definitions of the political risk, and ends up
defining the firm's political risk in terms of host government intervention in TNC
operations. Another approach to political risk focuses on political events, such as instability,
violence, or constraints on TNC operations. The previous definition highlights the actor,
notably the host government but also other governmental and societal actors, while the latter
puts emphasis on attitudes and actions.
From the TNC perspective, political risk is part of the firm's environmental risk. Political
risk can arise with regard to ownership, operations and transfers. The ownership risk arises
due to uncertainty about the host government's decision to change foreign investors'
ownership. If realised, the risk may take the form of domestication, or even expropriation,
confiscation, or nationalisation. Consequently, operation risk refers to uncertainty about host
government policies constraining the operations of the TNC in the host country. Policies can
be changed in terms of prices, terms of competition, taxation, or product specifications.
Finally, transfer risk is related to uncertainty about the host government's policies that may
restrict TNCs ability to transfer profits or capital out of the host country. TNCs can reduce
the political risk by negotiating with the host government.
47
Similar to studies on political risk, the present study discusses the political environment of
the firm through the actors and the actions that may have an impact on TNC. From the TNC
perspective, the host government is the most important actor, as it is able to intervene
directly in FDI. The role of the host government intervention in FDI is shaped by two major
forces. First, it is dependent on the domestic conditions including the political structure and
the economic imperatives. Second, it is subject to change according to the fluctuation in the
international politico-economic conditions. Not only the host government and its
intervention that creates the political environment of the firm in the host country, but the
external conditions outside the host country may give an impetus to the emergence of
political change. Thus, the political environment of the firm has to be considered both in
terms of internally and externally-based events (Simon 1982, 66). This kind of setting is
typical of studies focusing on the role of the host government intervening in FDI (eg
Goodman 1987, Korhonen 2001). A further distinction can be made between actions and
policies directed at all foreign firms in a particular country or selected fields of foreign
business (Robock 1971), or between governmental and societal actions and policies (Simon
1982, 66). All of these aspects have been put together by Simon (1982, 67) who has
generated a general framework for political risk assessment (viz. Exhibit 8).
Exhibit 8. A general framework for political risk assessmen
Internal
Macro
Governmental
nationalisation,
- coup d'etats
Expropriation
Societal
- revolution
- civil war
- creeping
- factional conflict
nationalisation
- ethnic or
religious turmoil
- widespread
riots
or terrorism
- nationwide
strikes, protests
or boycotts
- shifts in public
- repatriation
restrictions
- leadership
opinion
- union activism
straggle
- radical regime
change
- high inflation
- high interest
rates
- bureacratic
policies
48
Societal
- selective
terrorism
- selective
strikes
- selective
protest
- national
boycott
of the firm
Micro
Governmental
- selective
nationalisation or
expropriation
- selective
indigenisation
- joint venture
pressure
- discriminatory
taxes
- local content or
hiring laws
- industry-specific
regulations
- breach of
contract
- subsidisation of
External
- cross-national
- nuclear war
- international
guerilla warfare
- conventional
war
- border
conflicts
- alliance shifts
- embargoes or
international
activist groups
boycotts
- high external
debt
service ration
- international
terrorism
- international
- international
terrorism
- world public
opinion
- disinvestment
pressure
- foreign TNC
competition
- selective
international
boycott of the
firm
economic
instability
local competition
price controls
- diplomatic
stress
between host
and
home country
- bilateral trade
agreements
- multilateral
trade
agreements
- import or export
ternational
- foreign
government
interference
Source: Simon 1982, 67.
Since the 1980s, when Simon built his framework, the political and economic developments
have become increasingly interdependent. In addition, in the case of FDI, the investment
policies together with the more general economic policies have a central role when assessing
the political environment of the host economy. Certainly, the investment policies are not the
only actions that may have an influence on the TNC's decision making, but many changes in
the host country's overall political system may be as influential. Thus, the present study has
divided the political environment of the firm into national and international conditions
similar to Simon (1982), but also into overall policies that influence all firms in the host
country whether local or foreign, and economic policies that may be directed to certain
industries or firms (eg foreign firms only). This distinction is similar to Robock (1971).
However, the societal issues have not been separated from the governmental issues in order
to reduce the complexity of the framework. As a result, the components of the political
environment to be used in the present study are illustrated in Exhibit 9 and will be discussed
thoroughly below.
Exhibit 9. Components of the political environment
nditions
conditions
International
Overall policies
Political system of the host
country
Economic policies
Economic system of the host
country
The host government's
The host government's
49
conditions
international relations
economic relations
Source: Modified from Korhonen (2001, 48).
TNCs are interested in the impact of the political changes rather the direction of the change.
The direction of the change means, for example, that the host government may turn to be
more interventionist or less interventionist. For TNC, the direction of the change may,
however, be a positive, negative, or inconsequential factor. This is because TNC may
perceive the change as inconsequential if the intervention is not directed to FDI policy at all.
In the case that the FDI policy is intervened, this may lead to a more restricted or a more
liberal FDI policy. Therefore, the changes in the political environment as such are not
important, but the way how the TNC interpret them through its strategies. Thus, the impact
on TNC depends upon both the characteristics of the firm (internal factors) and the
characteristics of the environment (external factors). In addition, TNCs are interested in the
speed of the change. Certainly, it is easier for TNCs to be adjusted to gradual rather than
rapid changes. However, changes are drastic only for those who have not made scenarios for
the future, or interpreted the scenarios correctly. This is because most changes are preceded
by a recognisable development path and could have been basically predicted.
Political system of the host country. The political system of a country can be defined as a
persistent pattern of human relationship, which involves control, influence, power, or
authority (Dahl 1976, 4). The political system includes the polar cases of authoritarianism
and democracy, and all the various conditions between them. However, the political system
as such does not have an impact on the firm's investment decision as long as the system is
stable and predictable. Instead, political instability blocks the possibilities of TNCs and thus,
they tend to avoid countries with an unstable political climate (Luostarinen 1982, 35).
Instability refers usually to drastic changes in the host country's political system, such as a
coup d'etat, separatist movements, or a new reform-minded regime. However, the impacts of
change for TNCs is not straight-forward. For example, a coup d'etat can be made by a
radical government expropriating all TNCs, but also by a conservative government returning
expropriated properties of TNCs (Kobrin 1979, 70). An example of significant change in the
political system is the handing over of the sovereignty of Hong Kong from Britain to China,
which took place over night on July 1, 1997. The political change did not, however,
influence business because Hong Kong's economic and social systems were guaranteed to
50
remain unchanged for at least 50 years although it came under the communist government of
China.
The political system of the host country basically creates the prevalent attitudes toward
business enterprises whether domestic or foreign. TNC needs to take into account the overall
legal system of the country. In order to manage the various legal issues a lawyer who
understands local laws and practices is essential. In many cases, TNCs utilise multinational
law firms, which have expanded abroad, usually through mergers or other arrangements
with local firms, in order to serve their clients in foreign markets.
The host government's international political. TNCs are not independent to choose the
investment location, as they operate under a global political system composed of nation
states. TNC investing in a particular host country is always a foreign actor and thus,
involved with the host country's international relations (Terpstra 1978, 124). The host
country is a part of the international political system and its role there may vary from
isolated to integrated. TNCs have to be aware of the host country's commitment to
international organisations and agreements, regional arrangement, and bilateral relations.
Basically, the host country's integration with the world community increases its
attractiveness as an investment target, because supranational organisations have an impact
on global policy and thus, they may prevent the emergence of political risks in a certain
region or country. Entering a supranational organisation may also give additional boost to
the FDI, because the organisation may have particular uniforming requirements for its
members. Fulfilling these requirements makes the developments in the host country more
predictable and similar to other countries that belong to the same group. For example, the
Association of Southeast Asian Nations (ASEAN), which was originally, in 1967, formed to
secure political and military stability in the region, has resulted in the member countries
gradually increasing their role in the world community. Later, political co-operation has
turned to focus more on economic cooperation in the form of the ASEAN Free Trade Area
(Afta), and the ASEAN as a region has become an increasingly interesting investment target
for TNCs. Although the membership in general may increase the attractiveness of all
member countries, the risks may, however, increase in a single member country due to some
internal tensions (eg the case of Indonesia).
51
Isolation from the world community usually makes the country less attractive in terms of the
FDI, such as in the case of North Korea. However, isolation may also be an inconsequential
factor for TNCs if the situation is understandable as in the case of Taiwan, which has been
isolated against its own will from most of the international organisations due to the pressure
of mainland China, and maintains only quasi-diplomatic functions. Despite, this Taiwan's
economic position has remained strong and it is an important target of international
investments.
From the TNC perspective, a special feature of a host country's international relations is its
relationship with the home country of the TNC. If the host government dislikes the policy of
the home country, it may hinder the TNCs entry, operation, or exit in the host country. TNC
may even be attacked or boycotted along with the anti home country feelings in the host
country. Also the historical reasons may affect the relations, as between a former colonial
power and its colonies. (Terpstra 1978,124)
The host government's economic relations. The host government's relation to the
international market may vary from independent to dependent. If the country is dependent
on trade, it is also vulnerable to market fluctuations regardless of sound macroeconomic
fundamentals or any stabilisation policy. These constraints in the world economy are mostly
beyond the host government's intervention. In addition, it has been argued that due to the
globalisation process, national governments are going to lose part of their traditional
functions and power to intervene in the traditional ways. This is because globalisation is
making the world's economic system and society increasingly uniform, integrated, and
interdependent.
Joining an economic integration or organisation is likely to increase FDI in the host country
because of the increasing stability and the uniforming requirements of the organisations. In
addition, the international agreements and established practises play a role. For example,
membership of the World Trade Organisation (WTO) prevents the home country from
imposing new tariffs or non-tariff barriers, while membership of the International Monetary
Fund (IMF), the World Bank, or a development bank aids a home country's international
financial situation (Terpstra 1978, 125). The FDI is positively correlated with the host
country's integration in the world economy, because most of the world FDI takes place
among the core countries. Among peripheries, TNCs view the developing economies as
risky because of the possible politico-economic changes are likely to be more rapid and have
52
more surprising consequences for the TNCs than in the core countries, which are similar
among themselves.
Economic system of the host country. Economic policies can be defined as government
activities to promote economic development. In creating the welfare of the country, the
government aims to achieve a number of other economic objectives, such as a high and
sustained level of economic growth, full employment, low inflation, and a sound balance of
payments and a strong currency value in foreign exchange markets (Nellis & Parker 1996,
12) The role of the government in this context varies between the interventionist and noninterventionist. The free market approach demonstrates that the market mechanism
guarantees economic efficiency and thus, the less the state intervenes, the better the market
works. The governed market approach claims that the economy is inherently unstable and
requires active government intervention to achieve stability. In a governed market, TNC
needs special skills in order to convince the host government of the benefits of the FDI for
the host country.
Trade policies are closely linked with the investment policies. From the host government's
perspective, there are at least two ways how countries can combine trade and investment.
Some countries have combined liberal trade with restricted FDI and become net investors
abroad, while other countries have had an open FDI policy but restricted imports, and they
have become net importers of foreign capital. From the TNC perspective, high tariffs and
non-tariff barriers create an incentive to invest in the country. Consequently, when the trade
barriers are not significant, TNCs would rather export goods than invest in the host country.
From the TNC perspective, the host country's investment policy is the most direct
implication of the host country's political environment. The investment policy is a subpolicy of the national economic policy given it has the same ends. The host government may
treat FDI as a form of international finance: industrialisation or faster growth creates an
increased need for capital. If the domestic investment is not adequate, demand has to be
satisfied by outside capital, notably foreign loans, foreign aid, or FDI. Recently, the
worldwide share of FDI has increased in comparison to foreign aid and loans. (UNCTAD
1999) At the same time, the competition of FDI has intensified and national governments
have to ensure policies that sustain and advance national competitiveness against their
foreign competitors, namely the other potential host countries. In order to attract FDI, many
53
host governments have reduced regulations and administrative burdens they earlier imposed
on TNCs.
The government's control of FDI flows can be justified by various economic arguments,
such as the negative impacts of FDI, but also by the need to protect new domestic
technologies, the need for protective measures under the restructuring process of an
economy, or the need to control foreign capital flows across national boundaries. There are
also general political arguments for intervention in FDI, such as national security (protection
of critical industries, such as industries related to defence, telecommunications,
transportation, or those having a large effect on the balance of payments), and political
objectives (harmonising the investment policy to correspond to the agreements with
international institutions).
After weighing the costs and benefits of FDI, the host government can use various
investment policies in intervening in them. Dicken (1998, 97-98) has divided investment
policies roughly into four categories including government intervention on 1) entry, 2)
operations and 3) transfer of capital of foreign firms, as well as 4) government incentives
stimulating FDI. According to this categorisation, government intervention on entry,
operations, and transfer of capital are solely restrictive, and the incentives are added to the
list more as a curiosity. As government intervention may, however, be supporting as well as
restrictive, a categorisation by Lim (2001, 5-7), who discusses interventions in terms of
support, restriction, and communicative media, may be more useful. Under these categories,
restrictions can be further divided into prior and post-entry restrictions, similar to Dicken
(1998, 97-98), as shown in Exhibit 10.
Exhibit 10. Types of government intervention in foreign direct investment
nvestment support
Incentives (eg grants, tax
reductions, protection of the
market)
investment equity,entry
Prior to entry restrictions of
ownership levels, market entry,
ratio of foreign investment
equity, entry into certain
business sectors, and
requirements on a local content
level, minimum level of export,
technology transfer
54
investment
communication media
Overseas delegations
One-stop service (acting in a
proxy position on behalf of a
foreign investor)
Investment
seminars and
exhibitions
Consulting (advising activities
by related institutions such as
research institutions, chambers
of commerce and industry,
legal and accounting firms)
Post-entry restrictions on
certain authorisations,
notifications, registrations,
approvals, conditions of
establishment related to factory
establishment, environmental
protection export and import
procedures, marketing and
procurement, remittance of
profits, remittance of capital
Honouring foreigninvested firms
Follow-up service (monitoring
of grievances, ombudsman
system)
Source: Lim 2001, 5-7; Dicken 1998, 97-98.
Encamation and Wells (1985) have noticed that host governments may compete for
investment not only by increasing incentives, but also by creating images of an attractive
host country. In many cases, the host government has to improve the conditions of the
country in order to attract greater volumes of FDI. This can be done by supporting
expansion of the domestic market, an increase in productivity, enhancement of the
technological infrastructure, natural resource development, activities to promote investment,
and the quality of business facilitation. However, Lim (2001, 17) points out that many
economic determinants are difficult to improve by the government in the short-run and thus,
the role of investment incentives remains significant. Thus, the host government may offer
incentives in order to fill the gap between the real locational attractiveness of the country
and the degree of expectations by the TNC for a desirable investment location. Investment
incentives are the most direct way to impact investment costs and returns of the TNC (Lim
2001,4).
Despite the common trust in the incentives, many empirical studies have shown
contradictorily that incentives probably play only a marginal role. For example, Yeung
55
(1996, 1998) has shown that the investment incentives do not necessarily increase the inflow
of FDI, but they are symbolic commodities, which make an impact only in their absence. In
addition, the aim of the host government should not be to attract FDI as such, but to attract
FDI that is beneficial to the economy. In the worst case, the costs of the incentives exceed
the benefits of the FDI. Therefore, the intangible attitudes of the host government became
emphasised over the investment incentives. (Yeung 1996,256; 1998, 703) Accordingly,
Kobrin (1982) has argued that managers rank political and administrative concerns as more
important than government incentives. Also Lim (2001) has foud that the host government
policy objectives can be reached better by providing investment incentives only by
negotiations on a case-by-case basis, rather than offering overall incentives for all TNCs.
However, there are differences between the host countries, because well-developed
consumer markets or the low-cost production sites may be attractive as such without any
special investment incentives, while more unattractive economies may need to enhance their
locational attractiveness by incentives.
A host country associated with instability is not the strongest candidate in the competition
for international investment flows and the same is true with an unpredictable investment
policy. Despite this, governments do change their investment policies. According to
Globerman (1988, 42), the reasons are twofold. Firstly, deteriorating economic conditions
may force a government to modify its investment policy in order to encourage short-term
inflows of foreign capital both for balance of payments reasons and for a short-term
employment consideration. This view suggests that liberalising trends are cyclical in nature
and may be reversed when economic conditions improve. Secondly, the perceived net
benefits of FDI may have increased, either because of the evidence that FDI has more
substantial economic benefits than previously thought or because of a growing belief that
restrictions impose net costs on the host country. This view suggests that liberalising trends
are long lasting, (ibid.)
Investment policies as regional policies. In addition to national economic objectives, the
host government may aim to attract FDI in order to promote regional development.
Consequently, FDI has an impact on the regional development concerns and economic
effects of local scope (Lim 2001,18). The regional aspect of FDI calls for government
intervention, which combines the aims of investment policy with regional policy. According
to Haggett (1983, 535) there are four approaches to explain how the central government may
intervene in order to adjust regional differences within a country. First, the government can
56
pursue a laissez-faire policy with no revenue sharing to poor areas. The second approach is
called a special-area strategy, which directs special help to the problem areas. This approach
draws near to the growth pole theory, which concentrates investment on selected nodes in
order to bring about secondary growth in the hinterlands. In the third strategy, rich areas
subsidise poor areas. Finally, the fourth approach, a complete-equalisation strategy, aims at
bringing all areas up to the same income level.
The major tools of regional policy are 1) investment in the public sector (eg improvement of
basic infrastructure), 2) inducements to business in the private sector to invest in a region
(eg tax concessions), and 3) inducements to individuals and households to locate in or leave
a region (Haggett 1983, 537-538). The distribution of TNCs within a host country is
important from the viewpoint of their economic and social impact. In developing countries,
the FDI is usually concentrated on the economically most active regions, which usually
means either the major urban centres or the Special Economic Zones (SEZs). In developed
countries, TNC activities follow industrial activity in general. There, the host governments
have often attempted to direct TNCs in high unemployment areas, where TNCs can utilise
the labour pool and diminish the unemployment rate. Often this kind of regional policy,
however, reinforces prevailing locational advantages rather than directs the location of a
TNC. (Dicken 1998,219)
By definition, SEZs are industrial complexes, which are selected within a country for a
special policy purpose and designed to induce domestic or foreign companies to engage in
business activities by providing them with a series of preferred treatment measures. Thus,
SEZs are enclaves enjoying a status that does not extend to the whole territory of the
country. Usually, they provide some special treatment in terms of production, trade or tax.
SEZs have been established for 1) free trade, 2) free export trade, 3) export processing or 4)
international investment. The early SEZs were free zones focusing on trade only, while the
latter Export Processing Zones (EPZs) were established particularly for production. SEZs
have been especially an Asian phenomenon: originally SEZs referred to coastal regions of
China, which were established in 1978 along with the open door policy of the Chinese
government. Later, EPZs have been established in Korea, Taiwan, Singapore, Malaysia,
Indonesia, and the Philippines.
To sum up, some investment studies (eg Kobrin 1979, Boddewyn & Brewer 1994)
understand the political environment as superior to the economic environment in the
57
hierarchical structure of the environments of the firm (cf. Figure 9) These studies support
the idea that it is relevant to study the political environment of the firm separate from the
other parts of the firm's external environment. The political environment of the firm can be
analysed through the actors and the actions. The host government forms the most important
single actor of the political environment of the firm, because it is able to use its power and
intervene in FDI. Its role depends not only on the domestic politico-economic conditions but
also on the world politico-economic conditions. Its actions towards TNC may be channelled
directly through economic policies that may be focused on foreign firms only, or indirectly
through overall policies that influence all firms in the host country whether local or foreign.
The impact is however not only from the host government to TNC but the TNCs are able to
influence the political environment in the host country by negotiating.
2.5.3 Political relations having an impact on international investment
Traditionally, the political environment has been understood as a part of the firm's
environment, which the firm itself cannot influence. However, in the present study it is
supposed that firms do not take locations as given in the form of cost and revenues surfaces
(as suggested by the neoclassical approach), or information spaces (as suggested by the
behaviourist approach), or in relation to labour (as suggested by the structuralistic
approach), but as subject to negotiation, persuasion and bargaing (as suggested by the
geography of enterprise approach) (Hayter 1997,161). In addition, it is argued that firms are
able to bargain over the location conditions available in the host country. Firms do not only
adapt themselves to the environment but can at least partially influence their environment.
Stopford et al. (1991) calls the relationships between TNCs and the state as a triangular
nexus of interactions comprising power play among state-state, firm-firm, and firm-state
relationships. These interactions take place as bargaining among states for power and
influence, as competition among firms in the world market, and as specific bargaining
between states and firms for the use or creation of wealth-producing resources, (ibid., 32)
Starting from state-state relations, diplomatic relations between the home and the host
country set the ground for the development of economic relations. For example, after setting
diplomatic relations in 1992, trade and investment flows between China and Korea
increased within only a few years making them now one of the most important trade and
investment partners for each other.
58
Conflicting relations between the host and the home country do not necessarily prevent FDI.
For example, Taiwanese firms have invested continuously in mainland China through third
countries, especially Hong Kong, in the absence of diplomatic relations. Sometimes, the
volume of FDI may be high but affected by political disputes as in the case of Korea and
Japan that dispute over the islet of Dokdo. Countries disagree over the fishing rights in their
territorial waters, but in Korea the issue often brings up the nationalist sentiments based on
memories of Japanese colonialism and on Korea's large trade deficit with Japan. As a result,
Korean consumers sometimes simply refuse to consume Japanese products when the Dokdo
dispute or other sensitive issues come up.
In political economy literature, another form of political interaction in addition to
diplomacies has been distinguished, namely transnational relations, which refer to those
networks, associations or interactions that cut across countries and link individuals, groups,
organisations and communities. These relations do not respect national territorial boundaries
but operate beyond direct state control. (McGrew 1992, 5-7) These relations include also the
relations between the host government and the TNC. The web of global political
interdependencies emphasises the permeability of the nation state to external influences and
thus, challenges the traditional distinction between the domestic and the international.
Developments abroad may be inserted into the domestic political process and accordingly,
local actions may lead to repercussions abroad. (McGrew 1992,14)
With regards to firm-state relations, the geography of enterprise approach has incorporated
an institutionalist view of investment location, according to which, it understands the
location as a subject for bargaining between the firm and the host government. Also in the
present study, the investor and the host government are in a bargaining relation, but this
relation as such is beyond the actual scope of the study.
A TNC - host government relation includes bargaining because the parties have different
interests. These interests may be conflicting, negotiable, or complementary (Gregersen &
Contreras 1975, 48-51). The TNC's economic diplomacy aims at getting access to attractive
factors of production, financial incentives, and acceptable levels of political risks. At the
same time, the host government negotiates for investment, the transfer of technology,
exports, and employment, among others. With regard to conflicting issues, there are a large
number of studies on TNC - host government bargains over FDI (eg Gregersen & Contreras
59
1975, Bradley 1977, Doz & Prahalad 1980, Poynter 1982, Lecraw 1984, Goodman 1987,
Kobrin 1987, Moon & Lado 2000). These studies have emphasised the firm-specific and
industry-specific sources of bargaining power, but the discussion on country-specific
sources has remained scarce. The country-specific sources of bargaining power refer to a
TNCs ability to manage the political imperative, as Moon and Lado (2000) have called it.
The topic has been studied explicitly in the context of international investment by Poynter
(1982), who has argued that investors seeking out influential politicians or senior civil
servants in the host country enjoy less intervention than the other investors.
The role of firm-state relations is subject to change during the investment project. Lieberthal
and Lieberthal (2003) divide a single direct investment project into three: entry, country
development, and global interaction phases. In the entry phase, the manager of the host
country unit has to develop influential contacts in the host country, but not only at the firm
level with local partners, but also at the national level with the host government officials and
politicians. With the help of these contacts, TNC may negotiate incentives and other
beneficial conditions for the investment. In the country development phase, frequent
contacts of top corporate officials with the host government are crucial in order to initiate
new operations. They are also needed to continue the privileged treatment, because once the
investment is made, the firm's power to protect the investment erodes. Large fixed costs
become sunk and technology installed. By the time, as the subsidiary is operating
successfully, the host government may see the original terms as overgenerous. (Goodman
1987, 120). Finally, in the global interaction phase, the main emphasis of TNC turns from
the host country efforts to full integration of operations into the TNC's regional and global
efforts. However, good relations with host government should be still maintained in order to
avoid any discriminating requirements or the end of the relationship. If the TNC has
integrated to the host country and provides benefits in the form of exports or employment,
for example, conflicts are unlikely.
If the studies on country-specific sources of bargaining power in terms of the host country
have remained scarce, they are even rarer in terms of the home country. Hayter (1997, 288)
has pointed out that a TNC may increase its bargaining power by lobbying help from its
home government. Usually the demand for help comes from the TNC, but it is also possible
that the initiation comes from the home government, which encourages the TNC to invest in
a certain project or a particular host country (Goodman 1987, 23). In the present study, this
kind of help is called authority services, and it refers to the public means to promote
internationalisation of the home country industries. Authority services include the services
60
of the Ministry of Foreign Affairs, high-level business delegations preferably led by the
President or the Minister, meetings and seminars chaired by the Ambassador or Commercial
attache, and various kinds of supportive measures by trade centres and other public
institutions.
The home government, which believes that international operations of the TNCs have
economic benefits for the home country, tends to adopt a liberal outward investment policy
and promote internationalisation of the TNCs by providing a range of authority services. It
is likely to offer authority services especially for the investment projects taking place in the
host countries with which the home government has good and stable relations. Probably, the
need for authority services is highest in the case of authoritarian host countries where the
personal relations in the most high level settings may be crucial even for a rather modest
single investment project.
In addition to TNC's negotiations with the home and host governments, the bargaining may
also be extended to the intra-national level, if the local government is allowed to take it upon
themselves to encourage foreign investment (Korhonen 2001, 118). Beyond the national
level, Dent (1999, 11) has also pointed out that the TNC may even lobby help from a
regional block. For example, a European company that has invested in an East Asian
country may request the EU to remove some tariffs that are carried against the products that
the TNC produces in East Asia and exports to the EU market.
To sum up, the above-mentioned state-state relations have been studied widely in the field
of political economy and the firm-firm relations in the field of international business. The
firm-state relations that are emphasised by the geography of enterprise approach have been
studied to a lesser degree. The studies have shown that the TNCs are able to manage the
political imperative related to politico-economic institutions and systems in the host country,
but they may need to build a special policy towards the host government that is able to
intervene in entry, operations, and exit of the TNC. However, the negotiations with the host
government are not the only way to increase the TNC's bargaining power but it may also
lobby help from its home government, a fact that has gained relatively little attention in
earlier literature.
Finally, the earlier studies on TNC - host government relations give an additional support
for using Lahti's strategy-performance model in the context of FDI. There are namely
studies on the bargaining power of the TNCs that utilise a very similar setting to the present
61
study, such as Moon and Lado (2002). However, as their study belongs to the resourcebased research tradition, they emphasise firm-specific resources and capabilities over the
host country characteristics. In the present study, the fit between the firm-specific and
country-specific factors is pursued and thus, the holistic strategy-performance model is
found more suitable.
2.5.4 Summary: The role of the political environment for the firm's investment
decision
This chapter has discussed the second research task that aims to identify what is the relative
importance of the political environment of the firm among the other relevant factors having
an impact on the firm's investment decision. In the introductory part of the present study, it
was noticed that industrial geography does not take any specific view of the political
environment and thus, the political environment was discussed only through the broader
concept of the firm's environment (cf. Table 2). The geography of enterprise approach
understands the environment of the firm as a network among the TNC and the external
institutions, such as the foreign units of the TNC, subcontractors, rivals, host governments,
and others (cf. Table 3). However, it does not state any specific view of the role of the
political environment of the firm in relation to other parts of the firm's environment.
In Lahti's (1987) strategy-performance model, the political environment of the firm is part of
the firm's general macro-environment. The comparison of different parts of the firm's
environment produces a note that when applying the model to FDI studies, the contents of
the environments that have originally been defined in terms of marketing, has to be enlarged
to cover conditions relevant to FDI. However, the model as such gives no reason to
highlight the role of the political environment in relation to other elements of the general
macro-environment. Some investment studies (eg Kobrin 1979, Boddewyn & Brewer 1994)
argue that the political environment is superior at least to the economic environment within
the hierarchical structure of the environments of the firm (cf. Figure 9). Also some studies in
the field of economics understand political systems constraining all other actors in the
economy by building the legal institution (eg Jwa 2002, 168). Therefore, it is justified to
study the political environment separate from the other environments of the firm.
62
TNCs may interpret the changes in the host country's political environment as a positive,
negative, or inconsequential factor, depending on their strategies. These perceptions can be
studied by using the modified strategy-performance model. In the original strategyperformance model, the firm cannot have a direct impact on its general macro-environment,
including the political environment, although it is able to affect the competitive environment
to some extent. Differently, according to the geography of enterprise research tradition,
firms take locations as subject to negotiation, persuasion and bargaining (Hayter 1997, 161).
Firms do not only adapt themselves to the environment but can at least partially influence it.
Also some investment studies in the fields of the geography of enterprise and international
business have placed attention on the TNC -host government bargaining (eg Gregersen &
Contreras 1975, Bradley 1977, Doz & Prahalad 1980, Poynter 1982, Lecraw 1984,
Goodman 1987, Kobrin 1987, Moon & Lado 2000). Most of these studies have highlighted
the firm-specific and industry-specific sources of the bargaining power of the TNC, while
the discussion on country-specific sources has remained scarce.
In the present study, the relation of the firm and its home government is incorporated into
the triangular relationships of the firm-firm, the state-state, and the firm-state, which have
been introduced by Stopford et al. (1991). As shown in Exhibit 11, the relation between the
TNC and its home government is manifested by the authority services provided by the home
government to TNC in its efforts to internationalise through outward investment. Altogether,
the firm has many, at least indirect ways to influence its political environment in the host
country.
Exhibit 11. Relations of a political nature in the context of international investment
63
Note: TNC has to integrate the foreign unit with itself in the case of M&A. In the
case of a greenfield investment, a foreign unit is built from scratch.
In conclusion, the discussion on the second research task of the study leads first to the
argument that as there is some disagreement in the literature on the role of the firm's
political environment in relation to other parts of the firm's environment, a further analysis
of this issue is needed. The present study argues that it is justified to study the political
environment of the firm separately. The importance of the political environment of the firm
is rooted in the use of political power of the host government to intervene in FDI. Secondly,
the present study argues that TNCs are able to influence at least their political environment.
They can affect their host government not only by bargaining but also by lobbying help
from their home government in the form of authority services.
2.6 Summary of the Literature review
The attraction of foreign direct investment to a developing economy depends upon a
combination of social, political and economic factors, some of which are under the control
of host governments while others are not. Those which are not are as follows: the
determinants of foreign expansion of firms in developed countries, such as the growth of
oligopoly, technological change, competitive and marketing strategies, cost pressures; the
size and the rate of growth of the host economy (only indirectly controlled, if at all, by host
government policy); political and social (including labor) stability in the host country (again,
only indirectly controlled by host governments); and the economic, social and political
conditions in the home economies of the TNCs (Lall and Streeten, 1989).
It was shown that most prior studies on strategic decision-making processes do not
distinguish between the types of market that the company intends to operate in. It was
shown, however, that emerging markets differ significantly from stable markets. This
research therefore will fill the gap in the literature brought about by the lack of focus on
this difference. The result of this study should be a model based on past findings from the
areas of general strategic decision process research, FDI decision-making process research,
and related fields. It adds to this existing knowledge significant new insight from a
relatively large-scale field research effort.
64
This study aims to make a contribution to the FDI theory. The study is positioned to the field
of economic geography, and the geography of enterprise research tradition in particular, as
shown in Exhibit 12. Therefore, the starting point for theorising about FDI lies in the basic
statements of the geography of enterprise literature on FDI and related concepts. In order to
build a theoretical framework, the key ideas of the geography of enterprise approach have
been discussed in previous chapters in a dialogue with strategic management, international
business, and political economy literatures. The major arguments of the present study are
collected to Exhibit 12 in the next page.
Exhibit 12. Positioning of the present study
The first research task, which aims to uncover a model that recognises the relevant factors
that have an impact on the investment decisions of TNCs, was answered in Chapter Two
with the help of a strategy-performance model developed gradually by Lahti (1983,1985,
1987) from the basis of Ansoffian strategic management. The model was modified by
incorporating the general macro-environment of the firm explicitly to the model. In the
current study, it is argued, similar to the strategic management literature, that the firm makes
its investment decision by combining the information on its internal factors with its
information on the external environment, hi other words, TNC is motivated to invest by a
stimulus both from its external environment and from its organisation. In addition, the
country-specific factors have an impact on the firm's internal factors (resources, target
market, logistics, marketing) and finally on the performance of the firm. Thus, the firm
interprets the location conditions of the host country into a special set of location factors,
65
which are crucial from its strategy perspective. With the help of the modified strategyperformance model, the firm's relative optimal location can be explained by linking the
location of the firm to the purposes of the firm: the firm invests where it can operate
successfully.
Exhibit 13. Theoretical building blocks of the present study
The aim was to identify what is the importance of the political environment of the firm
among the relevant factors that were defined with the help of the strategy-performance
model. As a result, it is argued that there is theoretical evidence of the specific role of the
political environment of the firm among the other elements of the firm's environment (eg
Kobrin 1979, Boddewyn & Brewer 1994, Jwa 2002). The importance of the political
environment of the firm is based on the ability of the host government to use its political
power in order to intervene in FDI.
66
However, TNCs may influence the host government by using their bargaining power. The
present study argues also that the TNCs may increase their bargaining power by lobbying
help from their home governments, which may provide authority services for them.
The research problem of the present study asks how the TNCs perceive and react to the
change in their political environment in the host country when making the investment
decisions. Therefore, the political environment of the firm has to be studied separately from
the rest of the firm's general macro-environment (viz. Exhibit 14). Operationalisation of the
elements will be discussed in Chapter Six on methodology.
Exhibit 14. Relevant elements having an impact on the firm's investment decision
Source: Modified fromLahti 1987,49.
67
The modified strategy-performance model takes account of various aspects of the risk in
achieving the firm's goals. The strategic risk arises from the accuracy of the investment
decision: is it a correct decision to invest in particular host country in order to enhance the
firm's objectives? The risk is high if the firm's strategy has high reliance on some internal
resource that is not currently in place or will be difficult to acquire. Accordingly, the
operational risk is high if, for example, the logistics is not functioning or if the firm fails to
use marketing communication that fits in with the local culture. Finally, the environmental
risk is high if the firm is reliant on some factor or future event in the host country that is
highly uncertain or beyond the firm's direct influence. (Atkinson 2004)
As the study focuses on realised investment cases, it is obvious that the investors have
already found the selected host country as a place where location conditions fulfil the basic
requirements of the firm that are critical in order to implement the firm strategy. In addition,
the investors have found the host country as a place where all the necessary interactions with
the market can be maintained on a competitive basis. Investors have also selected a site
within the area. (cf. Nishioka & Krumme 1973, 204-205). Using the terminology of the
strategy-performance model, the firms focus on the match of the firm's resources with its
external environment. In order to explain the specific importance of the host country for the
individual firms, location factors have to be analysed. This analysis can be done only firm
by firm. Thus, the general setting of the study is built to compare investment decisions of the
TNCs in a particular host country before and after a certain change in the political
environment of the firm, as illustrated in Exhibit 15.
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Exhibit 15. The framework of the study
The present study penetrates all the levels typical of FDI studies: macroeconomic,
mesoeconomic, microeconomic, and milli-microeconomic levels. Starting from the macrolevel, the setting of the study in the home country versus host country position represents the
macroeconomic perspective interested in national trends of FDI. The importance of location
conditions to the group of firms, or the intra-national distribution of FDI, is typical of the
mesoeconomic perspective. The emphasis on the TNCs resource deployment and location
factors represents the microeconomic perspective interested in the competitive advantage of
the firm. Finally, studying a firm's single investment project is a subject typical of the millimicroeconomic perspective.
Methodologically, the focus on the changing political environment calls for a longitudinal
analysis. However, an analysis of the FDI flows as a whole in a particular host country,
where the political environment of the firm has been under change, is not possible if also the
internal factors of every single investor are to be included. Thus, the scope of the study has
to be more focused and in the present study, Korea is chosen as the host country. In the
69
empirical part of the study, the location conditions of Korea are first discussed on the basis
of traditional regional geography, which puts an emphasis on description. This part explains
the conditions in the host country in which TNCs in general are interested in: a distinctive
combination of location conditions that a country can offer to potential investors, and a
national policy framework by which the host government can compensate for possible
deficiencies in location conditions.
The World Bank defines foreign direct investment as: "an investment involving a long-term
relationship and reflecting a lasting interest and control of a resident entity in one economy
(foreign direct investor or parent enterprise) in an enterprise resident in an economy other
than that of the foreign direct investor (FDI enterprise or affiliate enterprise or foreign
affiliate). Foreign direct investment implies that the investor exerts a significant degree of
influence on the management of the enterprise resident in the other economy. Such
investment involves both the initial transaction between the two entities and all subsequent
transactions between them and among foreign affiliates, both incorporated and
unincorporated. Foreign direct investment may be undertaken by individuals as well as
business entities." (World Development Report 1998/99 p.219).
FDI occurs "when an investor, based in one country (the home country), acquires an asset in
another country (the host country), with the intent to manage that asses" (WTO 1996). The
management of the asset is what distinguishes direct investment from portfolio investment,
such as stocks and other financial instruments. In 1983, the Organization for Economic Cooperation and Development (OECD) suggested that FDI takes place when there is a holding
of 10 percent (or more) of the shares or voting stock. A holding below the 10 percent level
refers to the portfolio investment. However, a legally required level that distinguishes the
FDI from the portfolio investment varies by country: a 20 percent benchmark exists for the
UK and France, 10 percent for the US and Japan, and 25 percent for Germany (WTO 1996).
This review will discuss those parts of the strategic decision process literature, FDI
literature, that were most relevant to the research project.
70
3 OPERATIONAL ENVIRONMENT
3.1 The General Reform Environment
3.1.1 Political Environment
Kazakhstan is a presidential republic with many political parties, a two-chamber parliament
and a network of non-governmental organisations. Strong presidential power is not
adequately balanced by the legislature and the judiciary. In the past two years the country
has undergone two sets of elections - parliamentary and presidential. As Kazakhstan has
expressed interest in the Chairmanship of the OSCE in 2009, these elections were seen as an
opportunity to demonstrate commitment to democracy. According to international
observers, both elections showed some improvement but fell short of international standards
for democratic elections in many respects. In December 2005 Nursultan Nazarbayev won
the presidential election with an overwhelming majority of 91 per cent of the votes and
secured another seven-year term in office. The succession issue will be impacting political
developments in the years ahead.
By the end of 2006 the OSCE will be deciding on the candidacy of Kazakhstan as
Chairmanship of the organisation in 2009. In this context, any progress in crucial areas such
as freedom of the media, the ability of political parties to operate freely and respect for
individual human rights would be essential elements in the decision. The country's
leadership announced the Government's strategy for becoming one of the world's 50 most
competitive countries (Kazakhstan is currently ranking 56th). This strategic vision includes
not only important economic aspects but also a strong commitment to democratic principles.
However, the latest amendments to the Media Law raised concerns as representing a setback
for media freedom in the country.
Externally, the country is doing well by successfully pursuing a multi-dimensional foreign
policy aimed at maintaining balanced relations with all its neighbours. A known proponent
of regional co-operation, Kazakhstan is active in many regional organisations, including the
Commonwealth of Independent States (CIS) of which the country has taken over
Chairmanship this year.
71
3.1.2 Regional Issues
As a land-locked country with a substantial endowment of mineral resources but with a
relatively small size of the domestic market, regional issues primarily concern trade and
transit matters. Other important regional issues concern resource management issues such as
water-energy trade and establishment of water boundaries among the five littoral countries
of the Caspian Sea. In order to address these issues, Kazakhstan has been actively seeking
both bilateral and multilateral co-operation with its regional neighbours.
In recent years, co-operation has intensified with Russia and China, the two largest regional
neighbours, regarding exploration of natural resources, transit and export issues. Russia
remains an important transit country for Kazakhstan's exports to the EU. It is also the largest
trading partner accounting for 22 per cent of total trade in 2005. In June 2006, Kazakhstan
and Russia reached an agreement for a joint development of the Kurmangazy oil and gas
field, a large field located at the disputed Caspian water boundary between the two
countries. The countries also agreed to establish a joint venture to expand existing gas
processing plant in Orenburg, Russia for the processing of gas supplied from the
Karachaganak field in Kazakhstan. The two countries have jointly established Eurasian
Development Bank (EDB) which has an authorised capital of US$ 1.5 billion, is two-thirds
owned by the Government of Russia and one-third by Kazakhstan, and will provide finances
to the members of Eurasian Economic Community (EurAsEC).
China is quickly becoming an important trading partner, already accounting for 15 per cent
of total trade. In recent years, Chinese state-owned oil companies have increased investment
in Kazakhstan's hydrocarbon sector through the acquisition of stakes sold by Western
investors. Kazakhstan has secured an important oil export route to the east when the AtasuAlashankou oil pipeline, the first pipeline linking Kazakhstan with China, opened in July
2006. In order to facilitate cross-border trade, the construction of a free trade zone at the
Khorgos border began in 2006.
Co-operation with other regional neighbours has also improved. Kazakhstan is one of the
key foreign direct investors in the Kyrgyz Republic, especially in the banking sector.
However, there has been no concrete breakthrough on the issue of water-energy trade to
avoid the release of water by the Kyrgyz Republic during the winter months which cause
72
floods in Kazakhstan. Relations with Uzbekistan have also improved with the reopening of a
rail link between Almaty and Tashkent. In the Caucasus, Kazakhstan has officially secured a
western route for oil and gas exports by reaching an agreement with Azerbaijan on the
Baku-Tbilisi-Ceyhan oil and gas pipeline project. Kazakhstan is also becoming an important
foreign direct investor in Georgia.
Kazakhstan is an active member of various regional security and economic organisations
including Central Asian Co-operation Organisation (CACO), EurAsEC, CIS, Shanghai Cooperation Organisation (SCO) and the Single Economic Space. The effectiveness of these
regional organisations in addressing regional economic issues has so far been limited.
CACO members have agreed to merge this organisation with EurAsEC when Uzbekistan
joined EurAsEC in 2006.
3.1.3 Social conditions
Robust economy in recent years has improved overall social conditions of the country. Per
capita income at current prices has increased from US$ 1,132 in 1999 to US$ 3,813 in 2006.
The percentage of population living below the subsistence minimum income declined from
19.8 per cent in 2003 to 9.8 per cent in 2006. Life expectancy at birth increased from 64.4
years in 1999 to 66.7 years in 2005. School gross enrolment rate increased from 93.3 per
cent in 2003 to 95.4 per cent in 2006. Labour market conditions are also improving with
unemployment declining from 13.5 per cent and 8.8 per cent in 1999 and 2003, respectively
to 8.1 per cent in 2006. The Gini co-efficient2 has declined from 0.315 in 2003 to 0.304 in
2006 indicating that there has been a slight decline in the extent of inequality during the
period. Despite these positive developments, availability of qualified skilled labour, and of
basic infrastructure (drinking water, sewage systems, health and education services) are a
major problem for Kazakhstan.
There are also important regional disparities. The degree of variation in terms of income,
poverty incidence, unemployment, social sectors (health and education) and infrastructure.
The extent of variation is measured by the coefficient of variation, a statistical measure of
variance defined as standard deviation divided by the mean and the higher the coefficient,
the higher the degree of regional variation. The largest degree of variation within
Kazakhstan is found in poverty incidence, access to health service and several essential
73
infrastructure services such as sewerage, clean water and central heating. The lower
variation is found in unemployment, gross school enrolment rate and access to electricity
supply.
It is difficult to explain the reasons for regional divergence, but it is clear that the effect of
transition within Kazakhstan has been uneven. Bringing the benefits of strong economic
growth to the regions has become an important transition challenge.
3.1.4 Environment
Kazakhstan's national priorities and commitments are stated in its National Environmental
Action Plan, National Biodiversity Strategy and Action Plan and Conception of
Environmental Safety for 2004-2015, approved by Presidential Decree on 03 December
2003. The main areas of concern are the Aral Sea, the Semipalatinsk Nuclear Testing Area,
desertification and land degradation, biodiversity protection, forestation in East Kazakhstan
and in Pavlodar and Karaganda Oblasts.
Environmental issues associated with exploitation of natural resources are connected with
the intensive development of the Caspian Sea oil shelf. Metallurgical industries and power
generation cause significant air pollution, resulting in eight of the ten mostly contaminated
cities being Balkhash, Temirtau, Ekibastuz, Aksu, Pavlodar, Zhezkazgan and UstKamenogorsk. Surface water protection programmes concentrate on Irtysh, Ili, Syrdarya,
Ishim, Tobol, Ural, Turgai, Chu rivers, Balkhash Lake, and the Caspian and Aral seas. Soil
and groundwater protection programmes are under consideration. Industrial and domestic
waste disposal is a countrywide problem and special attention is needed for radioactive
waste management at Semipalatinsk and Karachaganak.
3.1.5 Legal
While in recent years Kazakhstan has introduced notable reforms to its legal system, the
country continues to face considerable challenges in entrenching the rule of law and related
institutions upon which its successful transition to a market-orientated economy will depend.
74
Kazakh commercial laws have improved significantly in recent years and are considered on
a par with many other CIS countries. The improvements in recent years extend to securities
legislation (including the creation of new unified financial sector regulator in 2004),
concessions (in particular the adoption of the new concessions law in 2006) and insolvency
(including the 2006 amendments to insolvency legislation). However, Kazakh commercial
laws still fall short in certain respects of standards that are generally acceptable
internationally. It should be noted that Kazakhstan remains one of the Bank's countries of
operation that is yet to approve and implement the AML and anti-terrorist financing laws.
An analysis of key commercial laws that contribute directly to creating a favourable
investment climate in Kazakhstan, such as secured transactions, bankruptcy laws, and
regulation of financial markets, shows that even relatively good laws often suffer from poor
implementation. This implementation gap both undermines the utility of the specific laws in
issue and diminishes the confidence that both Kazakhstan and foreign investors and traders
have in the legal system as a whole, in particular in its ability to uphold contractual rights.
Kazakhstan's poor record of upholding political freedom and civil liberties is also of
concern, given the continuing large and unchanging gap between the adoption of new laws
and their effective implementation. The President constitutionally holds a vast amount of
power, not only over the legislative, but also over the executive branch. The judiciary as
well remains under the control of the President and the executive branch.
There is a concern that the level of the country's economic progress is not matched by
similar progress in legal reform. Because of the inter-dependence of these two pillars of
transition, and given that experience has shown that in transition countries these pillars are
mutually reinforcing, Kazakhstan will only be able to maximise its long-term economic
potential provided its efforts to advance economically are matched by a commitment to legal
reform.
The FIC, set up in 2000 as a consultative body comprising major foreign investors in the
region and chaired by the President, shapes further improvements to the legislative
environment. As such the Legal Working Group of the FIC has successfully contributed to
the strengthening of judicial independence (e.g. increase of judges' salary, reforms aimed at
independence of judiciary from local authorities, etc.), creation of Specialized Economic
Courts, and drafting laws on maritime, investment, arbitration, etc. The challenge facing
Kazakhstan in 2006 and beyond is to further enhance the quality and competence of the
75
judiciary, tackle corruption, upgrade its commercial laws to standards that are generally
acceptable internationally and make those laws fully effective through a strengthening of the
court system and the rule of law.
3.2 Progress in Transition and the Economy's Response
3.2.1 Macroeconomic conditions for Bank operations
The economy has remained robust during the strategy period. Fiscal prudence has been
underpinned by further accumulation of assets by the NFRK - a vehicle to save and invest
part of fiscal revenues abroad when commodity prices are high. Monetary policy is based on
inflation targeting but, in recent years, the rate of inflation overshot policy target rates. As a
natural resource based economy, medium and long-term macroeconomic challenge is to
adopt an appropriate policy mix that will maintain the diversification of the economy and
insulate itself from commodity price volatility. Recent tightening of regulations in the
financial sector to restrain externally financed credit growth should relieve pressure on the
foreign exchange and decelerate the growth in domestic demand. However, further
strengthening of banking regulation is needed as the sector is increasingly vulnerable to
shocks. Fiscal policy should also move towards non-oil revenue deficit targeting and
consider tightening if inflationary pressures persist.
Real economy: The economy grew by 9.6 per cent in 2004, 9.4 per cent in 2005 and 9.4 per
cent in the first half of 2006. The share of hydrocarbon sector has remained at around 15 per
cent of gross domestic product (GDP) in 2003 prices as growth was primarily driven by the
non-oil sector. The income and wealth effects from high oil prices have benefited the nonoil sector - the construction and financial services sector in particular, while real growth in
hydrocarbon output slowed due to constraints in export capacity. The rate of unemployment
has declined steadily from 8.8 per cent in 2003 to 8.1 per cent in 2005. However, as the
domestic demand has been boosted by strong credit growth and higher public expenditures
on pensions and public sector wages, inflationary pressure in the economy rose. Consumer
price inflation picked up from 6.4 per cent in 2003 to 7.6 per cent in 2005 and exceeded 8
per cent by June 2006. Policy target for inflation was in the range of 4.9-6.5 per cent in
2006.
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Economic policies: The general government surplus widened in recent years (reaching 6 per
cent of GDP in 2005) while accommodating a sharp increase in fiscal expenditures on
pensions and public sector wages as well as various tax cuts. Rising oil prices have boosted
revenues from the oil sector which increased from 6 per cent of GDP in 2003 to 7 per cent
and 11 per cent in 2004 and 2005 respectively. NFRK had accumulated US$ 8 billion (14
per cent of GDP) by the end of 2005 and US$ 11.5 billion by 31 August 2006. The budget
for 2006 projects the overall fiscal position as a percentage of GDP to remain similar to that
of 2005 and fiscal surplus of 5.6 per cent of GDP is expected in 2006. In July 2006, the
NFRK was fully integrated with the budget. Under this new arrangement, all oil revenues
will accrue to the NFRK which will then transfer part of the funds to finance investment and
programmes for human capital development. The new arrangement should improve fiscal
management through targeting of budget deficit excluding oil revenues.
Monetary policy primarily focused on stemming inflationary pressure through monetary
tightening and by allowing nominal appreciation of the Tenge against the US dollar. Bank
lending primarily funded through external borrowing increased sharply and domestic credit
outstanding more than tripled between 2003 and 2005. The NBK gradually increased the
refinancing rate from 7 per cent at the end of 2003 to 9 per cent by July 2006, and extended
the coverage of liabilities for which banks were required to provide minimum reserves.
Higher reserve requirements for foreign liabilities compared to domestic liabilities were also
introduced in 2006 in order to stem the growth of external borrowing by commercial banks.
The NBK also allowed the Tenge to appreciate against the US Dollar in nominal terms in
the first half of 2006 through less intervention in the foreign exchange market. Real
effective exchange rate appreciated by 23 per cent between end-2003 and mid-2006.
External sector: The current account recorded a small deficit of 1 per cent of GDP in 2005.
A record trade balance surplus of 18 per cent of GDP due to high commodity prices was
more than offset by a sharp increase in income payments associated with FDI in the
hydrocarbon sector and an increase in imports of services, also linked to investments in the
hydrocarbon sector. The current account returned to surplus during the first quarter of 2006.
International reserves and NFRK assets amounted to US$ 22 billion, more than 9 months of
imports of goods and services at the end of first half of 2006. Total external debt as a
percentage of GDP remained constant at 74 per cent in 2005. While the share of intercompany loans associated with FDI in the hydrocarbons sector in total debt declined, the
77
external liabilities of Kazakh banks increased and accounted for 36 per cent of total external
debt at end-2005.
3.2.2 Transition success and transition challenges
The previous strategy highlighted the importance of a diversified economic structure which
will be resilient to oil price fluctuations in line with the objectives of "Industrial-Innovation
Development Strategy of the Republic of Kazakhstan for 2003-2015" and the challenge to
develop a competitive private sector. In the strategy period, the authorities have
demonstrated a great capacity for institutional innovation and adaptation, e.g. through the
establishment of the two state holding companies Samruk and Kazyna. While
acknowledging the potential of these initiatives to contribute to sustainable development, the
difficulties and risks should also be recognised. Institutional experience is not easily
transferred across countries and, once established, dysfunctional organisations are not easily
phased out.
In the forthcoming strategy period, the authorities should continue to focus on addressing
challenges identified in the previous strategy:
•
Reduce bureaucratic red tape, address the issue of corruption and create fair and
competitive
environment
for businesses
in
order
to
foster
innovation
and entrepreneurship;
•
Increase openness to foreign trade and investment in order to strengthen
competition and competitiveness of enterprises;
•
Improve corporate governance of enterprises in order to enhance access to longterm debt and equity capital;
•
Attract private sector investment in infrastructure services in order to reduce
infrastructure bottlenecks and narrow inter-regional gaps in service quality.
Progress in transition. Kazakhstan has made some progress and continues to be a lead
reformer in the CIS (Exhibit 16). However, reform efforts have clearly lagged behind
advanced transition economies in Central and Eastern Europe and the Baltic States (CEEB).
In the past two years, progress was most noticeable in the deepening of structure and the
extent of provision of market services in infrastructure sub-sectors (telecommunications and
railways) as well as in securities markets andNBFIs.
78
Exhibit 16. Reform progress in Kazakhstan, compared to CIS and CEEB
Source: EBRD Transition Report 2006
•
Market liberalisation and small-scale privatisation: Kazakhstan has reached close
to the level of advanced market economies in early years of transition. However, it
is yet to become a member of the WTO and the key challenge is to accelerate the
accession process. This will not only improve access to world markets, which is
particularly important for non-oil and gas sectors, but also improve the investment
climate for potential foreign investors as it will demonstrate the country's
commitment to international rules and obligations.
•
Financial sector reforms: Kazakhstan has been one of the most advanced
reformers in the banking sector in the CIS with the strongest regulatory and
supervisory frameworks. In order to curb rapid loan growth predominantly
financed by external funding in recent years, reserve requirements has been
tightened to increase the costs of external borrowing by banks. Regulation on open
foreign currency position has also been tightened. Consolidated supervision was
introduced to improve regulatory oversight over related party loans and further
efforts are being made to improve ownership transparency of commercial banks.
79
However, as the sector is increasingly vulnerable to shocks, the key challenge is to
further strengthen regulation and supervision with a focus on risk management. In
securities markets and non-bank financial sector, the regulatory framework is
generally in line with international standards, and the challenge is to further
strengthen the enforcement capacity of the regulator to ensure rigorous disclosure
standards are adopted in practice. Pension legislation should also be modified in
order to allow more flexibility in asset allocation.
•
Large scale privatisation, enterprise restructuring and competition policy:
Progress in reform has been relatively slow in the enterprise sector. Large-scale
privatisation has been put on hold for some time. Recently, a national holding
company, Samruk, was established in order to improve the governance of largescale state-owned companies. It is expected that the holding company, the
supervisory board of which consists of independent members as well as
government representatives, will be more effective in managing state-owned
companies. Improvement in corporate governance and transparency of private
enterprises has been limited to date, although all joint stock companies are now
required to produce their financial statements in accordance with IFRS and also to
appoint independent directors to their respective boards. The successful raising of
capital through IPO in the overseas market by several Kazakh companies could
lead to more companies seeking such avenues to raise long-term funding,
improving governance and transparency in the process. The least progress was
made in the competition policy. A new competition law that became effective in
July 2006 raised the threshold of asset and share acquisitions which require prior
approval by the competition authorities. The new law also set a unified definition
of a dominant position - a company with a share in the relevant market exceeding
35 per cent. While the new law will relieve small and medium enterprises from
ex-ante regulatory approval, given that an increasing number of enterprises
perceived anti-competitive behaviour to be an obstacle for businesses (see below),
further changes in the legal framework are required in order to promote new
business entry and ease exit.
•
Reforms of infrastructure: In infrastructure, progress has been mixed. While
overall regulatory framework for network infrastructure tariffs setting has
improved, the extent of market liberalisation and new entry has differed across
80
infrastructure sub-sectors. The most advanced is the electric power sector
followed by railways and telecommunications. The least advanced is water and
waste water and road sectors. The extent of regional divergence in access to
infrastructure services may be explained by the extent of reforms in infrastructure
with less regional divergence in those sectors where reforms are more advanced
(electricity and telecommunications). It is important that further efforts are made
to advance road sector and municipal infrastructure reforms. In the former, key
challenges are to prioritise investment and to separate regulatory functions from
project planning and execution functions which could facilitate private sector
participation. In the latter, the revenue raising and project implementation capacity
of local governments to undertake investment programmes need to be
strengthened.
Investment climate. The development of investment climate in recent years has been
mixed. The table below (Exhibit 17) is based on EBRD/WB BEEPS and it shows a
percentage of firms reporting a minor, moderate or major problem in a number of
dimensions that affected businesses in Kazakhstan in 2002 and 2006. Business environment
as perceived by surveyed firms has improved in some areas but deteriorated in others. The
deterioration was most pronounced in access and title/leasing of land, availability of skilled
workers and labour legislation, and anticompetitive practices.
81
Exhibit 17. Problems in the Business Environment
Source: EBRD/WB BEEPS 2002 & 2006
The WB's Doing Business ranking of Kazakhstan also provides a mixed picture. While the
overall ranking has improved from 82nd place among 175 economies in 2005 to 63rd in 2006,
this was largely because of a significant improvement in access to credit. In areas such as
dealing with licenses, trading across borders and closing a business, businesses in
Kazakhstan incur significantly more time and costs compared to other countries in the
survey.
82
Kazakhstan has taken steps to enhance transparency of revenues that accrue from oil and gas
sectors. In 2006, the country has officially endorsed the principles of the EITI. The objective
of the initiative is to ensure that contractual payments reported by companies match
revenues received by the Government. A memorandum of understanding was signed by
various stakeholders, including the Government and 28 companies in October 2006. Under
this initiative, all revenue flows from oil, gas and mining companies to the Government will
be disclosed to the public.
According to BEEPS, corruption is regarded as more of a problem in 2006 compared to
2002 (Exhibit 16). However, the quantitative survey in BEEPS indicates that corruption has
declined both in terms of frequency and level. The Corruption Perceptions Index (CPI) score
of Kazakhstan published by Transparency International (on a scale ranging from 10 to 0, 0
being highly corrupt) increased from 2.2 in 2004 to 2.6 in 2006, indicating a perception of
decreased prevalence of corruption. These results may reflect the effectiveness of anticorruption measures introduced in 2003 when amended anti-corruption law was adopted and
a new Agency for Fighting Economic and Corruption Crimes was established. There has
been little progress in enhancing the transparency of financial interests of public sector
officials who are in positions where there could be conflicts of interest with their private
interests.
The investment climate for foreign investors has generally remained stable in the past two
years although regulatory changes have strengthened the state's control over the oil and gas
sector. FDI remains predominantly directed towards oil and gas and related service
industries. However, reflecting relative shortage of supply, FDI began to flow into nontradable sectors such as wholesale and retail trade, utilities and the financial sector. This is
positive both from the perspectives of knowledge and skill transfers and maintaining a
diversified economy. In order to further attract FDI in non-oil and gas sectors, early
accession to the WTO is imperative as it will demonstrate the country's willingness to
commit to international rules and obligations.
3.3 Access to Capital and Investment Requirements
Kazakhstan's access to capital has improved substantially in the past two years. Reflecting
buoyant economy underpinned by high commodity prices and prudent macroeconomic
83
policies, all international credit rating agencies rate Kazakhstan's sovereign foreign currency
rating at investment grade. It is currently rated "BBB-" by Standard & Poor's, "Baa3" by
Moody's and "BBB+" by Fitch. Although the Government has not raised funds from
international capital markets in recent years and adopted a policy of repaying maturing debt
instead of refinancing them, improvement in sovereign credit rating had beneficial spillovers on the credit ratings of domestic banks and corporates.
In the past two years, Kazakh issuers (primarily domestic banks and state-owned companies
in natural resources and infrastructure sectors) have raised over US$ 6 billion in
international capital markets with maturities of up to 20 years. Major banks (KKB, BTA,
BCC and Alliance Bank) were also able to raise a total of US$ 750 million in perpetual
bonds that would count as their capital base. Similarly, access to international loan markets
has also improved raising more than US$ 7 billion in the past two years. The tenor available
in the syndicated market has also lengthened with KKB, BTA and BCC raising syndicated
loan for up to 3 years. The pricing of BTA's 3-year syndicated loan raised in September
2006 was 65 basis points over London inter-bank offered rate (Libor).
Several Kazakh private companies were also successful in raising equity capital through
overseas listing in 2005. Kazakhmys, a copper mining company, raised £600 million
through an IPO on the LSE and was subsequently included in the FTSE 100 index of leading
shares. KazakhGold, a gold mining company, raised US$ 196.5 million through an IPO of
GDRs, also on the LSE. In October 2006, KazMunaiGas Exploration and Production, a
subsidiary of KazMunaiGas (a national oil and gas company) raised over US$ 2 billion
through IPO in London and Almaty. Further IPO plans have been made by other Kazakh
companies and banks to boost their equity base.
Kazakhstan continues to attract one of the highest levels of FDI per capita in the CIS
countries. FDI remains predominantly directed towards the oil and gas industries. However,
in recent years, non-tradable sectors such as business services - predominantly related to oil
and gas sector, wholesale and retail trade, utilities and financial sector have been attracting
more investments.
84
Exhibit 18. Sectoral Distribution of gross FDI
Source: National Bank of Kazakhstan
85
3.4. Investment Opportunities in Central Asia and Transcaucasus
Economic development of the newly independent states of Central Asia and the
Transcaucasus, their regional interaction, and cooperation with Russia and other countries is
key to formation of a Commonwealth unified economic area. The region includes eight out
of the 12 CIS countries.
Clearly, integration of Central Asian and Transcaucasian countries is a high priority in
promoting effective economic cooperation in the Commonwealth as a whole. Meanwhile,
successful economic relations are contingent on a sound investment policy.
The relevance and topicality of the subject has to do with the complexity of problems
brought about by the breakup of the Soviet Union. Rupture of economic, technological,
infrastructural, commercial, social, and information links created an altogether different
reality in the post-Soviet area.
The Economic Council of CIS Member States arose from their understanding of the need to
continue economic interaction in order to preserve, at the transitional stage, the economic
and technical potential and the infrastructure of their respective countries. One key aspect of
effective interaction between the CIS countries, crucial for overcoming the economic crisis
and stabilizing and rebuilding the national economies, is development of interstate
investment activity. The protracted investment crisis has become the main brake on
development and restructuring of their economies.
Investment activity in each of the Central Asian and Transcaucasian countries is ultimately
predicated on the resources and behavior of domestic investors. At the same time,
considering the annual need for foreign direct investment—which, according to expert
estimates, is worth about $9 billion—it is extremely important to study and tap the
experience of international cooperation.
All attempts to resolve the deep systemic economic crisis through financial stabilization
failed to produce successful results. Decline in production and investment activity was
stopped at a critical point.
86
Investment support for pilot projects in the real sector of the economy could become a key
line of new economic policy, leading to stabilization and revival of industry and agriculture.
These problems are of a strategic character and are common to all countries in the region
despite their specifics that always need to be reckoned with.
3.5. Investment Opportunities in Kazakhstan
3.5.1. Investment key: Comparative Study
For understanding the economy and investment climate in Kazakhstan and comparison with
Uzbekistan, Azerbaijan, Russia and Ukraina were taken follow parameters: unemployment
rate, FDI net annual inflow, Growth in real GDP, Inflation rate, public revenue, currency,
private savings, financial sector and indebtedness (ITIC).
Exhibit 19. Investmrnt key
Unemployme
nt rate (%)
FDI net
annual inflow
US$ millions
Growth in real
GDP (%
change)
Inflation rate
CPI (Change
end-year %),
1999
Public
revenue
Kazakhstan Russia
4.1
12.4
Ukraine
3.7
Uzbekistan
0.6
Azerbaijan
19.3
1,300
1,100
700
170
1,077
-2.5
-4.6
-1.7
2
10.1
1.9
84.5
20
40
-7.6
Low tax
collection.
The 1999
budget was
passed by
Parliament
in April
with tax
code
amendment
s that are
designed
Poor tax
collection
especially
after the peak
of the
financial
crisis AugustSeptember of
1998.
Expenditure
cuts and
budgetary
reforms
contributed
to a sharp
decline in the
budget
deficit in
1998. The
stock of tax
arrears has
Relatively
good tax
collection
owing to
utilization
of the
banking
system, e.g.
deduction
of taxes
from
accounts.
Low tax
collection.
The state
relies on
large stateowned firms
to contribute
the bulk of
its tax
revenue,
which
narrows the
87
Currency
primarily
to meet
these years'
revenue
requiremen
ts.
Full
currency
convertibili
ty. In April
1999, the
Kazakhstan
Governmen
t
announced
that the
Tenge
would be
allowed to
float
"within
rational
expectation
s" against
the US$
risen to over
13 % of GDP
by end 1998.
Full currency
convertibility
. After the
Russian
financial
crisis in 1998
the Rouble
fell sharply
against US$.
Russia has
officially
assumed the
obligations
of Article
VIII of IMF's
Charter,
which is the
first step to
full currency
convertibility
. However,
due to the
above
financial
crisis Russia
had to
introduce
limitations
on the list of
cases when
roubles can
be converted
into dollars
Full currency
convertibility
. The Russian
crisis placed
pressure on
the Ukrainian
Hryvnia,
which
devalued by
about 35%
between
August and
early
September
1998. This
forced the
introduction
of a new
trading band
with the
dollar, i.e.
2.5-3.5 UAH
to the dollar.
There are
new
restrictions
on currency
trading,
aimed at
minimizing
future
instability,
e.g. exchange
controls to
help support
the Hryvnia.
The new
Hryvnia/doll
ar rate was
exceeded in
late 1998 and
the
88
tax base
Som
imperfectly
convertible
.
Convertible
in principle
for current
account
transaction
s. Multiple
exchange
rates, i.e.
official rate
for central
bank
transaction
s,
commercial
bank rate,
unofficial
market
rate. Large
"spread"
between
official and
unofficial
rates. Has
officially
assumed
the
obligations
of Article
VIII of the
IMF
Charter but
range of
controls on
utilization
of foreign
currency.
Currency not
fully
convertible.
The impact
of
development
s in Russia of
autumn 1998
led to
pressure on
the exchange
rate. Through
intervention
and a
tightening of
liquidity, the
Azerbaijan
National
Bank
succeeded in
holding the
exchange
rate and
restoring
confidence;
as a result of
strong
foreign
currency
inflows, the
Manat has
gradually
appreciated.
Foreign
exchange
reserves
remain at
four month
of goods
imports.
Private
savings
In light of
the
devaluation
of the
tenge,
depositors
have been
guaranteed
US$
conversion
at the old
rate for
maintainin
g their
tenge
savings.
Willingness
to make
savings in
hard
currency,
primarily in
US$. Lack of
confidence in
the national
banking
system.
Transfer of
savings into
the state
owned banks.
There is no
official
information
on how much
Russian
people keep
in cash.
Financial
Sector
The
banking
sector is
highly
concentrate
d with
about 6065% of all
banking
assets in
the hands
of four
banks. A
reform
program is
in place for
the banking
Crisis of the
national
banking
system
caused by
actual default
of Russia on
the internal
state
securities
market and
significant
debt of major
Russian
banks on
hedging
contracts
Government
has
announced a
new currency
corridor of
UAH 3.4-4.6
to the US$
The banking
sector
remains
underdevelop
ed. Lack of
confidence
towards the
banking
system.
Depositors of
the Savings
Bank are
covered by a
formal
deposit
insurance
scheme.
However,
there is no
general
deposit
insurance on
private
savings
Two-tier
banking
sector, which
comprises
214 banks.
All
Ukrainian
banks have
been obliged
to present
their
accounts
according to
International
Auditing
Standards.
Loss-loan
89
To attract
individual
savings,
no-name
individual
bank
accounts
were
introduced
in 1998.
Majority of
household
deposits held
at the stateowned
Savings
Bank. No
official
information
on total
private
savings.
Two-tier
banking
sector with
34
commercial
banks. The
state banks
are
undercapita
lized and
illequipped to
satisfy
legitimate
enterprises
funding
requiremen
The banking
sector
remains
underdevelop
ed and is
dominated by
four Sovietera state
banks - these
control
around 6570% of the
banking
system's
assets. Three
of the four
have serious
sector. The
ultimate
target for
all
commercial
banks is to
achieve
internation
al
standards
in terms of
capitalizati
on,
liquidity,
asset
quality,
manageme
nt
standards,
accounting
practices
and IT. The
Kazakhstan
stock
exchange
(KASE)
was
launched in
September
1997.
Turnover
on the
KASE
almost
doubled in
1998,
however,
the market
remains
highly
illiquid
with
turnover
reaching
barely 2%
of market
capitalizati
on.
against
rouble
devaluation.
The Central
Bank of
Russia
(CBR) and
special
reconstructio
n agency
have
prepared
reconstructio
n programs
which
prescribe
financial
assistance for
certain banks
and
bankruptcy
for the
others. CBR
takes
measures to
introduce
strict control
in the
Russian
banking
system, for
example,
CBR
increased
mandatory
reserves. As
for the
securities
market, after
the crisis it
was nearly
frozen but at
the end of
1998 it
started to
show signs of
stability.
Trade
provisioning
has been
introduced
and a deposit
insurance
law enacted.
By late 1998,
an estimated
30-35% of
loans were
nonperforming.
Ukraine has
four stock
exchanges.
The largest
and most
significant is
Kyiv (95% of
all trading).
Kyiv is the
fifth largest
emerging
equity
market in
Eastern
Europe and
the CIS.
90
ts.
Foreign
banks
present, but
stateowned
National
Bank of
Uzbekistan
dominates.
Range of
services
provided to
clients is
limited.
However,
inter-bank
settlement
system is
well
developed.
Internation
al Auditing
Standards
in force for
audits
carried out
by all
Uzbek
banks.
Financial
markets are
in the early
stages of
developme
nt. The
stock
exchange
(created in
1995), set
new listing
requiremen
ts in 1998.
asset and
liquidity
problems.
Restructuring
programs for
the four state
banks are
designed to
prevent any
further
banking
crises from
emerging.
The private
banking
sector
consists of
over 70
commercial
banks.
Lending risks
remain high.
Azrbaijan
has no
official stock
market
although the
government
is now
addressing
the need for
ist future
development.
In December
1998 a
securities
commission
was
established.
Further
progress in
strengthening
the
regulatory
framework
for the
issuance,
registration
volume is
approximatel
y US$100200m a
month.
Indebtedness
Kazakhstan
's total
external
debt was
estimated
at the end
of 1998 at
US$7.543b
n, having
increased
over the
year by
26.7%. The
country
faces the
prospect of
a rise in
debt,
owning to
its
widening
external
borrowing
requiremen
ts.
Kazakhstan
's foreign
and local
currency
issuer
credit
ratings
were
downgrade
d to B+ in
September
1998.
Moody's
rating is B1
while
Thompson'
External debt
amounts to
more than
USD 130bn.
Internal debt
of the federal
government
amounted to
more than
RUR 400bn
and after 17
August 1998
was
restructured.
There exist
significant
mutual debts
of the
enterprises.
Not
infrequently
mutual
liabilities are
covered by
barter and
offset against
mutual
indebtedness.
Credit rating
of Russia is
B3 according
to Moody's
and SD
(selective
default)
according to
Standard &
Poor's.
Negotiations
are
continuing
Indebtedness
in Ukraine is
increasing,
with public
debt totaling
US$14.9bn
in October
1998.
Foreign debt
totaled
US$11.5bn at
end 1998, of
which
US$2.4bn
was to
international
financial
organizations
. During
1998, the
debt grew by
around
US$2bn.
Moody's
foreign
currency
rating is B3;
Thompson's
is B-.
91
The stock
of external
debt stood
at
US$2.8bn
at the end
of 1998,
representin
g 20% of
GDP.
Uzbekistan'
s ability to
run up
external
imbalances
is limited
by the fact
that it has
not
received
support
from the
IMF since
December
1996.
Uzbekistan
has no
credit
rating but
the
Governmen
t is holding
discussions
with
Standard &
Poor. It is
expecting a
rating of
BB-. A
large
proportion
and trading
of corporate
securities is
planned
under the
IMF program
in 1999.
External debt
amounts to
more than
$704 million.
The stock of
debt is
projected to
peak in 1999
(17% of
GDP) and
decline
thereafter. In
1997, an
agreement
was reached
with Russia
to cancel all
mutual
outstanding
debt
obligation,
and a loan
from the EU
was fully
repaid in
September
1997.
Azerbaijan's
external
public debt
consists
mainly of
concessional
long-term
debt and
derives
largely from
bilateral and
multilateral
lenders.
Thompson
s is B
with IMF.
of
sovereign
debt is
guaranteed.
Financial
BankWatch
gives a B
rating for
foreign
currency. No
other ratings
are available.
There are about 1400 Joint Ventures in Kazakhstan founded by partners from 61 countries.
There are after-effects from the Russian crisis, as trade with Russia accounts for 30% of
Kazakhstan exports. The tenge devaluation in 2000 has made Kazakh exports competitive
"vis-a-vis" other countries in the region, but due to restructuring, the economy is forecast to
contract slightly in 2006. However, the Kazakh government was swift to respond with fiscal
tightening and an acceleration of privatization.
3.5.2. Investment Activities in Kazakhstan
Investment activities in Kazakhstan are aimed at revival of the process of reproduction at the
expense of both foreign and domestic sources of funding. The State works towards all
possible attraction of foreign capital, towards creating an entire set of favorable factors.
President Nursultan Nazarbayev of Kazakhstan firmly adheres to this policy particularly
emphasizing that "our cardinal objective is to present Kazakhstan in the eyes of the world
community as a fairly attractive object of investments in major industries".
Many representatives of foreign companies and firms, certain businessmen express their
appreciation of the investment climate in Kazakhstan. Apart from rich natural resources,
agrarian and industrial potential, competent personnel and a relatively qualified and cheap
manpower, beneficial geopolitical location, they particularly make notice of stable political
situation, stable inter-ethnic relations.
On announcing attraction of foreign capital as its topmost strategic priority Kazakhstan
consistently implements all requisite moves which would lead to creating a civilized
legislative basis for integration into world economy and transition to an open economy.
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There has been passed Laws "On foreign investments", "On state support sustained in favor
of direct investments". On top of these, President Nursultan Nazarbayev of Kazakhstan
issued Decrees "On approving the list of priority economic sectors of the Republic of
Kazakhstan meant for attraction of direct foreign investments" and "On approving the
Regulation on the system of benefits and preferences and on the procedure of granting
thereof when concluding contracts with investors".
In 1997 the package of legal standard acts of the Republic on legal regulation of investment
relation on both national and international levels was supplemented with Laws of the
Republic of Kazakhstan "On state support in favor of direct investments", "On securities
market", "On registering transactions with securities". Besides there has been concluded
quite a number of interstate agreements on enhancing and reciprocal protection of
investments. On the whole, at the moment more than 20 legislative and standard legal acts
govern the procedure of attraction and protection of foreign capital.
According to the above, foreign investments in Kazakhstan can be made practically in any
facility and variety of activities in all authorized organizational-and-legal forms - up to
creating foreign firms (i.e. those completely owned by foreign investors), branches and
representations thereof or joint ventures with partial ownership of respective property.
Foreign investors are guaranteed - within their own discretion - use of revenues received
from their activities for reinvestment in the Republic, for purchasing goods and such other
purposes.
Taking into account sheer expediency of attracting large-scale investment resources in the
economy of the country, rational and effective use thereof, by virtue (of the Presidential
Decree there has been set up a single specially authorized body - State Committee of the
Republic of Kazakhstan for Investments.
Certain activities are underway in the Republic to advertise attraction of direct investments
into priority sectors of the economy. Within the framework of the official visit of the
President of the Republic of Kazakhstan to the United States of America at the Washington
University Gallodet there was conducted a conference "Trade and investment opportunities
in Kazakhstan and its geo-strategic significance" with the participation of major American
and transnational companies.
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The recently adopted legislative acts and a number of organizational measures are sure to
enhance the influx of foreign investments in Kazakhstan economy. Today nearly 40
countries invest their assets in Kazakhstan economy. Worth notice is, though, that today the
State tends to favor attraction of direct investments.
Escalation in investment activities promotes ever rising growth of economy. Rise in the
combined amount of investments in the fixed capital of Kazakhstan economy has been
gained at the expense of investments in oil and gas industries with the latter's share within
the general scope of investments amounts to 43%, housing construction - 12%, ferrous and
non- ferrous metallurgy - 8% and transport - 7%.
In terms of attraction of direct foreign investments, international fiscal agencies qualified
Kazakhstan as one of the leading countries among other transition economies of Eastern
Europe.
Basic guidelines of national social and economic policy to be pursued in 1998 provide for
ever further implementation of the investment policy based on the following principles:
•
national (state) support granted to enterprises at the expense of centralized
investments when transferring center of gravity from non-payable funding to
crediting on a retrievable, paid basis. Non-repayable budget financing would be
preserved mostly for socially significant objects of non-commercial, unprofitable
nature which cannot afford funding sources of their own;
•
substantial expansion of practices of joint (share-wise) state-and-commercial
funding of investment facilities (projects) including those which imply attraction
of foreign capital. Such practices add to meeting the lack of centralized assets
meant for implementation of state programs of capital construction;
•
use of a part of centralized (credit) investment assets for implementing particularly
effective and quick-recoupable investment projects and small-business facilities
irrespective of their branch affiliation property form to accelerate structural
transformation of industries;
•
improving standard basis aimed at boosting the influx of domestic and foreign
capital in the sphere of investments;
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•
toughening of state-exercised control over the purposeful spending of the
Republican budget assets allocated in investments in the form of non-repayable
funding and crediting.
There are no limits to amounts of foreign commercial credits independently (i.e. without
being granted government guarantees) attracted by banks and other business entities of the
Republic of Kazakhstan.
Assets of the Republican budget are meant primarily for construction and reconstruction of
group water pipelines and custom check-points, implementation of housing construction
programs in certain regions, construction of particular facilities of medicare, education,
transport and communications, power supply, machine-building and the like.
Particular emphasis would be given to the development to the leasing business as one of the
most promising guidelines in stepping up investment processes and an effective motive
force in technical re-equipment of industries. It is in this context that they contemplate
adopting Laws "On introducing alterations and amendments to the Laws of the Republic of
Kazakhstan "On foreign investments" and "On financial leasing", and "On introducing
alterations and amendments to the law-effective Decree of the President of the Republic of
Kazakhstan "On Licensing".
3.5.3 Attractiveness for foreign investors
Kazakhstan merits serious consideration as a location for foreign investment. After
consideration of motives' list shown above, the reasons that can be called as positive factors
for investment into Economy of Kazakhstan for foreign Investors today are:
•
A foreign policy designed to keep effective relationships with its neighbors and
with the leading world economies;
•
An internationally-orientated economy with under-exploited energy and mineral
resources;
•
An economy, which has come through the most painful period of transition, and
now has the prospect of steady growth;
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•
An early opportunity to establish market share in a market of sixteen million
people, which hitherto has not attracted much attention from foreign companies
outside the energy sector.
•
An effective central bank which has demonstrated its ability to pursue independent
policies to get inflation under control;
•
A stable political environment
Of course, all of the positive factors for foreign investors in Kazakhstan can not be
considered without definition the risks factors, which will be discussed in the next section of
the paper.
3.5.4. Risk for Investors
Investing in emerging markets is not necessarily a hugely risky task, as not investing may be
even more risky for the company if the market develops as forecast and most competitors
take advantage of investment opportunities. Focusing on the alleged high risks involved in
investing in an emerging market like Kazakhstan, as done, for example by Fowler may
therefore blur the analysis rather than enrich it.
There are follow risks for foreign investors in Kazakhstan at the moment:
•
underdeveloped infrastructure;
•
national economy susceptible for raw material price fluctuations;
•
political pressure on investors increases;
•
corruption widespread;
•
relatively small domestic market and low purchasing power.
3.5.5. Foreign investment law
The foreign investment law defines the fundamental legal and economic principles upon
which foreign investments should be drawn in the economy of Kazakhstan. It also
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establishes guarantees of the protection of foreign investments, and defines the legal forms
of foreign investments.
Under the foreign investment law, a foreign capital investor can be a legal foreign
personality, a foreign citizen, a citizen of Kazakhstan who is permanently a local resident
outwards of Kazakhstan, a foreign government or an international organization. Investments
can flow in in movable and immovable property, shares, bonds, mental property and by
government granted licenses. (F.A.Z. institute in 2005)
3.6. Foreign experience of engaging and the use of international capital and
investments
As against countries CIS, less developed countries of far abroad have accumulated much
more experience in engaging and use the of international credit and enterprise capital and
investments. And, alongside with widely known experience of countries of Latin America
and countries of Southeast Asia, interest is represented with practice of other countries
which were not achieving so impressing results in economic development, but, at the same
time which experience is rather cognitive and interesting to countries CIS. Any privileges
and endorsements are not capable to compensate these factors (Ospanov, 2004).
The investment climate in Egypt is characterized by follow positive moments.
1. A transparency of country for international investments. The government of Egypt
has as a whole opened the way for direct foreign investments also encourages the actions
activity of private sectors in the majority of the sectors of the economy.
As a part of the obligations under the agreement on the World Bank loan, the Egyptian
government has started in 1991 the program on expansion of a role of a private sector in a
national economy basically through realization of investment plans. To the middle of 1991
the government has substituted a permit system under investments with a system of
selection in which investments are approved automatically if the sector of the economy is
not introduced in a so-called "negative list" of projects. The "Negative" list includes
(Ospanov, 2004):
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•
Military production and branches connected to their manufacture;
•
Tobacco and tobacco production;
•
Investments on Sinai (except for an oil, gas and mineral raw material).
2. Laws and the norms regulating foreign investments. The law on foreign investments is
passed in 1998 and is the basic legal document allowing foreigners to have 100 % of the
property of the founded companies. The law guarantees the right to operate in Egypt and to
transfer abroad profit and a fixed capital. The companies established on the basis of the
given law, are subject to regulation on the part of General Authority for Investment and Free
Zones (GAIFZ).
The law limits investments in some regins of country. Investments can be realized in
relation to tourism, housing construction, development of various forms of real estate,
service of a petroleum industry, medical services, repair of motor vehicles, construction of
pumping stations, services in the field of transport and advisory services in various branches
of the economy and business. GAIFZ has offered on consideration of government conditions
to the law on the market of capitals where it is offered to grant the sanction to investments
for securities administration.
The law on investments defines discrepancy between internal investments and investments
in a free zone. Activity of free zones is adjusted by the law on investments. They are open
for any kinds of branch investments. The companies are released of taxes and any taxes,
annually 1 % from cost of the goods imported and exported from a free zone, or from the
gross profit received as a result of accomplishment of projects, not claiming importation or
removal of the goods however pay (Ospanov, 2004).
Agreements on concessions, in particular in the field of petroleum, a natural gas, also are
considered as areas of a free zone. Each agreement on concessions strikes root separately
and qualifies as obligatory approval of the bodies of legislation of country.
Under other major law of Egypt - the companies’ act, foreign incorporated companies can
have foreign, the property in the size up to 51 % from a total cost. Provided that at least 49
% of shares should be offered to Egyptians, under the law 159, in the end the company can
have 100 % of the shares belonging to foreigners.
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Foreign direct investments in Islamic republic Iran are permitted only by means of
participation foreign persons in the share capital of the existing and new Iranian companies.
The maximum share of foreign participation in the joint companies constitutes 49 %,
however this share will be defined depending on character of investment object.
The law on engaging and protection of the foreign investments provides legal frameworks
for approval of all foreign investments in Iran.
The procedure of approval of foreign investments will consist of several stages (Ospanov,
2004):
1.
A choice of the suitable Iranian partner.
2.
Receiving of “the basic consent”.
3.
The circulation concerning realization of investment object.
4.
Consideration of the application “the Supervisory council on engaging and
protection of foreign investments ".
5.
The decree of Council of Ministers of Iran. The decree is the official sanction to
the foreign investor to start to take of a measure on importation of the capital to
Iran. After official registration the capital of the foreign investor is protected by
the Iranian Law.
6.
Creation of the joint company.
After the announcement the Supervisory council of the positive decision or after acceptance
of the decree of Council of Ministers of Iran, local or foreign investors of the capital can
create the joint companies for the beginning the investment activity.
As we can see, a procedure of the sanction and the admission of the foreign investor on
territory of Iran is very difficult.
Especial interest represents experience of the developed countries on creation of special
investment structures. Consider one of such structures - the German financial - consulting
structure DEG encouraging private business in Africa, Asia, Latin America, and also in
countries Central and the East Europe (Ospanov, 2004).
•
DEG finances risk assets in these regions.
•
DEG renders consulting services to the businessmen realizing foreign investments.
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•
To partners DEG refer prosperous national and the foreign firms interested in
long-term cooperation or already participating in business life of indicated
regions.
•
Work of DEG is based on principles of private business.
DEG participates in all kinds of activity of a private sector. Realized DEG financial
investments are profitable, they will be agreed accepted norms on preservation of the
environment and promote economic development of corresponding countries.
The form and volume of financing, as a rule, are specially selected so that to satisfy with
requirement of the enterprise for country of investment.
DEG finances both starting, and the developing enterprises, and also investment in
perfecting and modernization of manufacture realizes. Commitments of finance usually
constitute from 5 million up to 20 million DM on the project.
DEG grants loans for market conditions. As a security for the loan the property of the
enterprise included in the project in country of investment usually serves. Thus financial
contribution DEG is, as a rule, in a reasonable ratio with volume of planned investments:
•
For the starting enterprises usually - up to 35 %;
•
For the developing enterprises - up to 100 %.
Other financial services can be if necessary organized at the expense of national and
international business banks and development banks DEG (Ospanov, 2004).
Experience of countries of Latin America represents for us interest from the point of view
of that engaging and use of the foreign capital and investments has received ambiguous
estimations, has yielded in them various results and passed in conditions, as a rule, an
economic crisis. All this gives to experience of these countries, from the point of view of
analogousness to domestic conditions and problems, the big value and interest.
After the first wave of investments in these countries in 60-70 years and after long calm,
interest of investors to the given market has again increased. Cumulative foreign
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investments for the last 5 years in these countries are evaluated by the sum from above 100
billion dollars.
Primary factor of inflow of the foreign capital and investments in economy of Argentina
were its successes in financial stabilization.
What underlies the Latin American phenomenon of engaging of investments?
1. These are global tendencies in the region, connected with common liberalization of a
financial field, minimization of interference of the state in pricing, interest rates. Today the
states of Latin America are more and more integrated and unified on conducted economic
policy, in countries there were advanced market financial technologies and tools.
2. Creation of an effective state policy of engaging of the foreign capital. Such policy has
been based on the following preconditions:
•
Essential reduction of budget deficit in all countries at the expense of changes in
the taxation, pricing and current account policy;
•
Improvement of internal structure of the prices;
•
Structural reorganization with the purpose of stimulation of the offer and
liberalization financial market.
As a result of reforms, for example, in Argentina budget deficit was essentially reduced, the
labor efficiency has sharply grown, inflation has decreased.
The important step for engaging foreign investments and the capital was removal of
limitations on export of the profit. It stimulated increase in manufacture and the profit.
3. Creation of legal base for engaging the foreign capital and investments. In countries of
Latin America to the given factor attaches special significance. Today there are no
limitations on investment activity, encumbrances for removal of dividends and the profit are
removed, and procedures of registration of investors are simplified.
4. Stabilization of investment process. Each of the Latin American countries faced to the
same dilemma which faces to countries CIS. On the one hand, engaging of foreign
investments was necessary for stimulation of an aggregate demand. However, thus it was
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necessary to avoid such collateral destabilizing effects, as complication of realization of
monetary policy and revaluation of monetary unit.
As the basic protective measure against differences in volume of foreign investments their
"sterilization" realized in the form of loans of the Central bank at business banks, transfer of
government deposits from business banks to Central Bank, increase of the interest rate under
assets and liabilities of the Central bank was applied. The sterilizing effect also was
achieved by sale of governmental liabilities. As investments were stabilized, governments of
the majority of countries weakened a degree of sterilization.
The majority of countries attempts to adjust undertook inflow of investments with the help
of the taxation, toughening of reserve requests to bank deposits, credits from abroad, and
changes of commissions at external economic operations. For example, the Central bank of
Chile in 1991г. has entered new reserve requests - 20 % for all new credits from abroad
except for trade. Then these requests were distributed to all other external credits, and in
1993 reserve requests have been increased up to 30 %.
The Mexican government has established the new order limiting a share of currency
liabilities of the majority of banks up to 10 % of their general extra portfolio, thus of 15 %
of this sum should be placed in высоколиквидных valuable papers (Ospanov, 2004).
The program of liberalization of foreign investments is the constituent of wider policy on
stimulation of the private initiative and, first of all, national businessmen. The given aspect
is important in the sense that as shows experience of countries CIS, and Kazakhstan in
particular, engaging industrial and the banking capital is considered frequently as a separate
problem. It results to that foreign investors as a result of tax, investment privileges appear in
more favorable provision, that at this positive effect gives rather strong negative effect from
decrease of investment activity of national investors.
The purpose of the program of liberalization of foreign investment is general state
reorientation on replacement of bank international crediting by engaging of direct industrial
investments.
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From the point of view of world experience it would be interesting to analyze experience of
less developed countries in questions of participation of the foreign capital in privatization.
Such analysis results in the following breeding (Ospanov, 2004):
1.
Wide sharing the foreign capital in privatization is supervised only in countries
especially undeveloped, not having neither economic, nor resource potential. To
such countries it is possible to relate Ecuador, Bangladesh, Ethiopia, Maldives,
etc.;
2.
Countries with the certain economic potential conducted mass privatization in
usual sectors of economy and rather selective - in the branches having strategic
significance.
So, for example, such countries as Argentina, Mexico, Brazil, India, etc. have chosen as
priority those or other branches and these branches became branches with strict state control.
In some countries in view of absence of natural stocks or advanced Industry (at availability
even natural resources) as priority could choose, for example, biotechnology, fibred-optical
technique, etc. spheres of economy.
This experience, unfortunately, is not taken into account at realization of privatization
("transfers to management") in some countries CIS.
Thus, experience of countries of far abroad is rather diverse both under the content, and by
the received results. Countries CIS in this plan should take those methods which have
appeared the most effective on arms and have brought appreciable results in short time.
4 CASE STUDIES
4.1 Chevron in Kazakhstan
In Kazakhstan, fewer than 17 million people populate an arid swath of Central Asia four
times the size of Texas and larger than Great Britain, France, Germany, Spain, Austria,
Holland, and Denmark combined. It's a land of harsh winters and parched summers,
expansive deserts and remote mountains. It's also a land rich with natural resources: prior to
gaining independence in 1991, Kazakhstan produced seventy percent of the Soviet Union's
lead, zinc, magnesium, tin, and titanium; sixty percent of its silver and molybdenum; thirty-
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five percent of its copper; and considerable amounts of its gold, uranium, and coal
(Dosmukhamedov, 1993).
Today, Kazakhstan's most precious asset is its oil. Though it developed petroleum resources
throughout the Soviet era, Kazakhstan retains a significant quantity of both proven and
potential reserves. It produces more oil - over half a million barrels per day -than any other
former Soviet republic except Russia. Nearly half comes from three major onshore fields:
Tengiz, Uzen, and Karachaganak. Potential offshore reserves in the Caspian Sea are much
larger, estimated at upward to 30 billion barrels, with proven reserves of over 15 billon
barrels. Though many uncertainties remain, oil development is certain to generate
substantial wealth for Kazakhstan. Nurlan Balgimbayev, the former Prime Minister and
current chief of Kazakhoil, has estimated that offshore oil and gas revenues alone could total
$700 billion over the next 40 years.
Kazakhstan has much in common with Azerbaijan. It too is in the midst of an oil boom and
looks to multinational oil companies to participate in developing its resources. Yet like
Azerbaijan, Kazakhstan has only partially established representative government, respect for
human rights, and the rule of law. President Nazarbayev largely controls the judicial and
legislative branches, ruling at times by decree. His term in office was extended in January of
1999 by an election that fell short of international standards. The government harasses and
monitors citizens through Committee for National Security (the successor to the KGB,
which reports directly to the President) and the Interior Ministry Police; both organizations
have arbitrarily detained, tortured and killed citizens. The government resists and hampers
outside monitoring of human rights, while the courts have prevented the public from
observing trials of government officials. (U.S. Department of State, 2000)
The economic situation in Kazakhstan is somewhat brighter than in Azerbaijan. Oil
production has already generated substantial revenue; Kazakhstan led the former Soviet
Bloc in foreign investment for much of the 1990s, accounting in 1996 for approximately
fourteen percent of all foreign investment in the former Soviet Union. The official GDP per
capita, adjusted for purchasing power parity, is approximately $3,200 (WFB, 2000). While
Kazakhstan was hurt by the Asian financial crisis and Russia's economic woes, it has
recently devalued its currency and benefited from recent rises in oil prices. As in Azerbaijan,
however, corruption flourishes while socioeconomic inequality increases. Likewise,
Kazakhstan's Soviet legacy of environmental pollution - much of it related to oil production
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- is dismal. Polluted groundwater, open pools of oil scum burning out of control, and rusting
equipment left abandoned are common in Kazakhstan's western oil fields.
Foreign oil companies at work in Kazakhstan thus face many of the same situations, dealing
with a government that does not fully serve the interests of the people or maintain the
institutions of a democracy. The principal difference between Kazakhstan and Azerbaijan is
that in Kazakhstan, large-scale oil production is already underway. Chevron has been a
leader in this effort, beginning with its historic $20 billion agreement with the Kazakh
government in April of 1993 to redevelop the Tengiz oil field. The agreement established a
joint venture, called Tengizchevroil, owned in equal portions by Chevron and the Kazakh
government. With production set to reach 340,000 barrels per day by 2002 (ultimately
peaking at 750,000 barrels per day by 2010), Tengizchevroil is by far the biggest oil
producer in Kazakhstan.
Tengizchevroil represented the first major step in a development process that currently
involves nearly every major multinational oil company in one or more of over fifty joint
ventures and/or exploration agreements. These range from minor natural gas projects to the
Offshore Kazakhstan International Operating Company's (OKIOC) exploration of the
Kashagan block of the Kazakhstan's Caspian holdings, which are estimated to contain
structures with up to 40 billion recoverable barrels of oil. OKIOC, which was created with
the Kazakh government in 1997 and began drilling test wells in 1999, has caught the
attention the entire industry: results of its tests promise to offer an indicator of the Caspian's
total reserves.
As the first and most active foreign oil company in the country, Chevron plays an important
role in determining the shape of future foreign oil development in the country. The
following sections assess its performance in environmental and social aspects of oil
development
4.1.1 Environmental Issues
Tengizchevroil operates in Kazakhstan under terms spelled out in its Production Sharing
Agreement (PSA) with the Kazakh government. According to Tengizchevroil's Manager of
Government Relations, the consortium operates under a Code of Conduct that is "basically
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the same as it is everywhere - protecting people and the environment." Environmental
standards are included in the consortium's PSA. While Tengizchevroil will not disclose the
contents of the agreement, it claims the environmental standards follow the standards set
forth in Kazakhstan's environmental legislation.
Kazakh environmental law relevant to oil production is found in three main sources: the Law
on Environmental Impact Assessment, the Law on Specially Protected Natural Territories,
and the Law on Environmental Protection. The "central executive organ for state control of
the environment and natural resource use" is the Ministry of the Environment and
Bioresources (MEB). Environmentalists note that while MEB is allowed broad jurisdiction
in environmental inspection, it has the exact same status as other ministries in the Republic;
the MEB can inspect, but not enforce. The current status significantly reduces the
effectiveness of the MEB's activities and permits influential ministries, departments, local
authorities and private businessmen to ignore its decisions and requirements to a significant
degree.
The principal legislation guiding oil development is the 1992 Code of the Republic of
Kazakhstan on Subsoil Resources and Processing of Minerals (hereafter "Subsoil Law"), as
amended in 1999, and the amended Edict of the President of the Republic of Kazakhstan
Concerning Petroleum (hereafter "Petroleum Law"). The Subsoil Law "shows signs of
having been drafted from an economic perspective," especially in defining subsoil as "a part
of the natural environment which can be used for satisfying economic and other needs
through the separation of its components or for the location of underground installations,
confinement of toxic substances and wastes of industry, and the discharge of sewer waters."
Recent amendments to the Petroleum Law place most oversight of foreign oil companies
directly in the hands of Kazakhoil, the state oil company formed in 1997. Specifically,
Kazakhoil has the right to:
•
participate in the development of a strategy for increasing petroleum production;
•
represent the State in petroleum operations by means of mandatory share
participation in PSA's;
•
participate in organizing tenders for petroleum operations in Kazakhstan,
including sectors of the Caspian and Aral Seas; and
•
prepare and implement new projects related to petroleum operations.
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The amendments eliminate license requirements in favor of contract provisions that state
agreed-upon terms. Foreign oil companies therefore no longer have to separately negotiate
both a license and a contract. The introduction of new procedures regulating commercial
discoveries, compensation for exploration costs, requirement for work programs, and
contractor claim resolutions place Kazakhoil at the center of oil operation management in
Kazakhstan.
Regarding environmental protection, the amendments state that contractors must receive
written permission of the "State Body" to conduct petroleum operations at sea. (While the
amendments are unclear regarding who the "State Body" is, it appears to be under the
authority of Kazakhoil.) Contractors operating at sea must are obliged to use the best
available methods to protect the marine environment. Such contractors are strictly liable for
harm to individuals or to legal entities resulting from the pollution of the sea as a result of
oil operations.
The amended law also limits the types of provisions that can be in oil contracts, stipulating
that the law of the Republic of Kazakhstan is the exclusive law applicable to any oil
operation in its territory as well as to any offshore oil operations. Specifically, oil contracts
cannot stipulate application of foreign law, with the exception of offshore oil operations
conducted on bordering deposits where the law of an adjacent state can be applied if
expressly stated by an international agreement with Kazakhstan.
Tengizchevroil, according to it representative, has no difficulty complying with this
regulatory framework. It views the evolution of Kazakh environmental law favorably,
calling the new set of environmental laws "more realistic" than what came before. It will not
disclose specific standards, but affirms that "daily monitoring ensures compliance with
environmental regulations" and takes pride in its environmental record. The consortium
"hasn't really had a big problem with fines or inspectors" and considers the state monitors
"well-trained and well-equipped."
Though positive in its assessment of its compliance, Tengizchevroil pays a substantial
amount in fines for violations. The number and size of fines have steadily increased; in 1998
they amounted to more than 238 million tenge (US$2.7 million). Emissions, especially from
gas flaring, are a particular point of concern. Tengiz oil contains up to 25% broad fraction
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high-sulfur liquefied petroleum gas, methane and hydrogen sulfide that are separated in
processing trains. The petroleum gas, with a much higher sulfur content than is allowed by
U.S. and U.K. regulations, only meets so-called "CIS specifications." According to
Tengizchevroil, this is because many of the hydrocarbon products produced at Tengiz are
intended for local, rather than European markets - hence the lower standard. The consortium
admits that it has had difficulties handling the emissions and states that sometime within
next two to three years it will install LPG equipment and other facilities to curb flaring.
Kazakh authorities are also concerned about what Tengizchevroil will do with the over 2.3
million tons of hydrogen sulfide it currently stores in six pyramids. This amount will
increase if Tengizchevroil installs a processing train to remove hydrogen sulfide sometime
in the spring of 2000 as it plans to do. Regional authorities have pressed the consortium to
invest in sulfur granulation equipment, with little success. Some environmental groups and
local authorities suspect the consortium is reluctant to invest in additional equipment
because it is cheaper simply to pay environmental fines.
Tengizchevroil's representative states that the consortium and the Ministry of Ecology and
Natural Resources "agree on a yearly basis the level of emissions that we will pay for" and
have negotiated agreements for emissions monitoring Unfortunately, environmental groups
are excluded from the agreements and neither the government nor the oil companies will
provide them with copies of the agreements Tengizchevroil's spokesperson and Kazakh
government officials state they cannot release these agreements, even though they are public
laws.
While local authorities have pressured Tengizchevroil to reduce emissions, environmental
groups retain the impression that "large issues are decided by the central government, and
they chose oil money over environmental concerns." Though central government officials
dispute this characterization, oil companies and environmental group s agree that monitoring
and regulatory practices in Kazakhstan are flawed - and that everyone, especially Chevron,
would benefit from independent, third party monitoring.
Effective third party monitoring does not exist. According to Imangali Tasmagambetov,
governor of the Atyrau region, Tengizchevroil and the regional government contribute to a
Regional Ecological Fund, which conducts what he describes as "independent
environmental audits" around Tengiz However, Tengizchevroil has taken issue with some of
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the monitoring methods after a dispute with regulators and now appears to support the
establishment of an independent monitoring system. According to its spokesperson, the
consortium "sometimes" supports the idea, believing it would benefit the consortium by
increasing local confidence in its environmental performance. There is presently no legal
mechanism by which the consortium can request a third-party assessment.
Environmental and community groups believe the Kazakh government and foreign oil
companies should demonstrate their willingness to protect citizens and the environment by
publicizing and improving regulatory practices. International petroleum advisors agree,
noting a widespread desire among foreign oil companies to see Kazakhstan modernize its
regulatory system and re-train many of the health, safety, and environmental inspectors.
According to one petroleum analyst, Kazakh regulatory agencies need to refashion their
concept of regulation to "recognize the difference between performance-based regulations
and regulations for regulations' sake, and train their inspectors to make more informed,
comprehensive assessments of health, safety, and environmental factors, rather than "simply
checking regulatory boxes without regard for the overall operations."
Additionally, some Kazakh community groups are concerned that Kazakhstan's Tengiz
venture with Chevron has set unfortunate precedents for future development. They believe
that since the Tengiz deal, government officials have rapidly pursued similar deals at the
expense of the environment. In particular, environmental and community groups see the
massive signing bonuses typically offered by foreign companies as inimical to careful
consideration of potential environmental impacts.
Environmental groups point out that shortly after the government negotiated the Tengiz deal
with Chevron, it decided to essentially withdraw the protected status of the northern Caspian
to allow exploration by OKIOC, which has established a joint venture involving tens of
millions of dollars in signing bonuses. In August of 1999 OKIOC drilled its first well in the
Kazakh sector of the Caspian Sea, described as possibly one of the "largest undeveloped
oilfields in the world." While the Kazakh government sold its stake in OKIOC in 1998 to
help reduce budget deficits, still stands to reap 80 percent of the profits under the terms of its
PSA with OKIOC.
Kazakh environmental groups, citizens in the region, and scientists have grave concerns
about how this drilling and potentially enormous amount of extracted oil will affect the
109
area's delicate ecosystem. The northern part of the Caspian is extremely shallow, with
depths of only two to nine meters. Among its abundant wildlife are three-quarters of the
world's sturgeon, which produce caviar, another expensive commodity. Environmental
scientists fear that even a small accident could ruin the delicate balance of this shallow part
of the Caspian. The Caspian Nature Group, a regional NGO, recently demanded
(unsuccessfully) that the Kazakh government ban marine drilling to protected valuable
marine and bird habitat on the shallow sea shelf. Realizing it could not convince the
government or oil companies to preserve the protected status of the northern Caspian, the
group pressured oil companies to purchase additional insurance to compensate for any
negative environmental impacts.
As a result of this campaigning, OKIOC has taken out a $1 billion ecological insurance
policy to cover drilling of the first exploration wells. It has also spent more than US$100
million to adapt its drilling barge, and flown a group of Kazakh journalists to Louisiana to
show them how oil is produced in shallow waters of the Gulf of Mexico. The consortium
maintains that it will apply collection technology and environmental research performed in
the gulf to its operation in the northern Caspian. Environmental groups and local residents
remain skeptical, however, arguing that the consequences of an accident in the shallow,
enclosed Northern Caspian would be far worse than in the deeper Gulf of Mexico, where
currents are better able to flush out and disperse pollutants.
Despite pressure from environmental groups, OKIOC drilling began before the Kazakh
government had developed a National Oil Spill Response Plan. This contradicted earlier
promises made by the government and its western advisers that such a plan would be in
place before drilling began. OKIOC s claim that it has developed its own spill response plan
has not appeased everyone - the Minister of Natural Resources also sought (unsuccessfully)
to postpone drilling until after a national plan was adopted. According to one of the
government's petroleum advisors, OKIOC simply didn't want to wait.
Taken together, these areas of concern suggest that Tengizchevroil and other foreign
ventures are operating in a situation where standards are murky, regulation is limited and/or
inadequate, and where the potential for government revenue threatens environmental
protection. The presence of foreign companies such as Chevron may
ultimately help to create a more effective and accountable framework for environmental
stewardship, but this has not yet happened.
110
4.1.2 Social Issues
Many of the individuals interviewed for this report express concern regarding
Tengizchevroil' s performance on social issues, particular labor relations, human rights, and
community development.
Regarding labor issues, observers generally agree that Tengizchevroil standards are
significantly higher than those which prevailed under the Soviets. The consortium will not
disclose specific standards and/or Codes of Conduct, but claims its policy is guided by a
number of goals, which include:
•
increasing the amount of employee training and educational assistance programs;
•
assigning more overseas assignments to local workers;
•
increasing employee compensation;
•
offering housing loans to employees; and
•
increasing the percentage of Kazakh citizens working at the consortium.
The consortium has maintained high health, safety, and labor standards. In 1998,
Tengizchevroil achieved 5 million consecutive man-hours without a lost time incident. As of
September 1999, the consortium had reached 3 million man-hours for 1999, while their
contractors had reached 5 million.96 Kazakh citizens now hold 71% of Tengizchevoil' s staff
positions, compared with 55% in 1993. Investment in employee training has risen from
approximately $1.8 million in 1994 to approximately $6.2 million in 1998, as has the
investment in educational assistance programs (approximately $320 million in 1998,
compared to $25 million in 1994). The consortium has sent over 130 local employees on
overseas training assignments in the United States and the United Kingdom, tripled average
employee compensation over the last 4 years, and awarded more than 1,000 employees
housing loans in the same time period.
The consortium's relationship to unions is reportedly more ambivalent. Tengizchevroil
claims not to disfavor union membership; there is an independent labor union at the
consortium, of which approximately 500 of the 3,200 employees are members. According to
the consortium's spokesperson, it has never struck or threatened to strike. Conflicts that have
arisen have been ostensibly been due to "different perceptions of business practices." The
111
consortium holds town hall meetings once per month in order to maintain a dialogue with
the union members and avoid disputes over these "differences in perception."
Union observers agree that Tengizchevroil treats its workers very well, providing them with
better pay and better health, safety, and labor conditions than workers at local oil companies
enjoy. However, some observers dispute Tengizchevroil's claim not to
disfavor union membership, particularly membership in national trade unions. They claim
the foreign companies don't want trade unions and would rather not employ trade union
members; faced with the existence of separate oil unions, the companies now encourage
them because they are easier to control than the larger, stronger, national unions.
A Kazakh union leader further alleges that foreign companies don't always abide by Kazakh
law, especially in disregarding requirements for advance notices of dismissal and the use of
short-term contracts that are illegal because they provide no provisions for future
opportunities. In addition to violating labor laws, the same union leader claims, foreign
companies have been a driving force behind the weakened social and economic protections
afforded by the new Labor Law, which does not require companies to pay over-time or to
notify unions of increased work hours or reductions in compensation.
Labor law has changed significantly in recent years. In September of 1999, the Kazakh
parliament replaced the old labor code with the new Labor Law, which, according to a
lawyer who was a member of the working group, contains provisions that affect trade unions
and the right to strike. The new law makes it clear that unions may choose to be independent
(local) or centralized. At present, there are two major trade unions in Kazakhstan: the
Federation of Trade Unions, and the Confederation of Free Trade Unions of Kazakhstan.
Smaller trade unions exist at individual companies such as Tengizchevroil.
Tengizchevroil disputes the claim that it skirts labor laws. It claims to have been vindicated
by the courts, citing a recent case in which it decided to outsource some of its service
business to newly created companies and offered jobs at these new companies to drivers
who had previously been employed by the consortium. When the drivers refused the
positions, the consortium dismissed them; the drivers sued in local court and won an order
for reinstatement. However, Tengizchevroil appealed the case all the way to the highest
court in Kazakhstan, which ruled in the consortium's favor.
112
The extent of corporate compliance with labor laws is difficult to measure, but it seems to be
generally good. More vexing for labor leaders is the consortium's seeming unwillingness to
communicate directly with unions. This lack of communication is illustrated by the fact that
the trade unions are not privy to the companies' Code of Conduct or any other statements
defining business practices. Union representatives thus cannot evaluate whether Chevron or
Tengizchevroil' s practices accord with such statements or codes.
Tengizchevroil's hands-off approach to unions is mirrored by a seeming disengagement
from the political situation of the country. As a newly independent nation undergoing
painful transition, Kazakhstan struggles with only weakly established democratic
institutions, a poor human rights record, widespread and rising poverty, and endemic
government corruption.
Since 1991, Kazakhstan has been a democracy, with elected legislative and executive
branches and an appointed judiciary. However, power is heavily concentrated in the person
of the president, Nursultan Nazarbayev, who can legislate by decree and largely control the
judiciary. Presidential and parliamentary elections, as well as the 1995 referendum leading
to the adoption of the constitution, were all marred by irregularities and fell short of
international standards.
The 1995 constitution establishes and guarantees basic human rights such freedom of
speech, religion, and association. By just about any standards, however, Kazakhstan's
human rights record is poor. According to Kazakhstan's leading human rights lawyer, the
Kazakh government routinely curtails the right to free speech and media, the right to
freedom of assembly and association, and the right to free and fair elections. He notes that
while the situation has improved somewhat since 1996, "there is no political debate in this
country." In 1998, for example, an independent, outspoken newspaper was firebombed and
denied access to printing houses. Following this incident and the prosecution of several large
cases by the state against media organizations, most of the independent media succumbed to
self-censor ship.
There is also evidence to widespread government interference in the individual's right to
participate in civil society and politics. A Presidential Decree of 1995 enables the
government, in contravention of the Universal Declaration of Human Rights, to penalize a
citizen for participating in non-registered public associations. The government also harasses
113
political figures, such as former prime minister (and a key opposition figure) Akezhan
Kazhgeldin. At the request of the Kazakh government, Russian police detained Kazhgeldin
on September 12, 1999. The Kazakh government subsequently barred Kazhgeldin from
running against President Nazarbayev in the January 1999 elections, using a new law
prohibiting anyone charged with even minor administrative violations from seeking the
presidential office. Kazhgeldin's ban occasioned considerable criticism from human
organizations and members of Kazhgeldin's People's Reople's Republican Party, who have
launched a hunger strike after being arrested and fined for protesting the ban. The OSCE has
refused to recognize the elections. In a similar case, the government banned a former
political prisoner, Labor Movement leader Madel Ismailov, from running for Parliament. He
had served one year in prison for insulting the President; an April 1998 provision of the
election law disqualified from running due to his conviction.
Despite this evidence of widespread human rights infringment, Tengizchevroil claims have
"never seen anything that looks like a human rights violation in Kazakhstan. Nothing of that
kind has raised its head." The consortium's representative contrasted this to the situation in
Azerbaijan, where he witnessed some disturbing events involving the police; he also
contrasted Kazakhoil to Azerbaijan's state oil company, SOCAR, in a similarly favorable
manner, claiming it did not exert a negative influence on the human rights situation in
Kazakhstan.
Tengizchevroil also seems untroubled by the endemic government corruption which,
according to a recent report from the Open Society Institute, is growing rapidly and
weakening the rule of law. According to its representative, the consortium faced some
corrupt practices by regional customs officials early on but refused to pay; the situation has
since improved. The representative argued that Tengizchevroil is relatively immune from
government corruption because of its importance.
In the face of Kazakhstan's poor human rights record and manifest corruption,
Tengizchevroil believes "the best thing the company can do is act by example, and conduct
good business." This includes bypassing potentially corrupt government officials to offer
local assistance to the Atyrau region, in which the Tengiz operations are located. The
consortium administered $50 million in development funds for the region, overseeing the
construction contracts for building and bridges directly, rather giving the money to the go
vernment. The company also assigned someone from the financial department to track the
114
funds and ensure they were put to good use. Additionally, in 1998, Chevron started a
program to support small and medium-sized business enterprises in Atyrau. The
Chevron/UNDP Business Center, using funds from Chevron and the rule of law state, but it
doesn't believe that they will see a law-abiding government and society in their lifetimes.
Corruption is everywhere in this country. It is at such a level, even in the judiciary, that I
cannot say that there is even one judge who is operating in a non-corrupt manner."
European Bank for Reconstruction and Development, have granted loans to small businesses
in the areas of food processing, trade, and manufacturing.
While many of the NGO and community representatives acknowledge that Tengizchevroil is
active in community development efforts, they express frustration at what they see is the
consortium's unwillingness to confront the government over difficult issues such as human
rights. They believe foreign oil money reinforces corruption and the government's disregard
for its citizens, while the consortium's positive efforts are mainly token or opportunistic,
such as giving money to charities headed by the president's wife. They believe
Tengizchevroil should accept liability for its partnership relationship with the government,
support NGOs and public associations that the promote democratic principles, and use its
contacts with the government to express concerns about undemocratic and corrupt practices.
Whether or not Tengizchevroil can be realistically expected to take such a proactive role in
reforming Kazakhstan's political institutions is questionable; however, environmental
activists point out that Tengizchevroil and other foreign partnered ventures could "at least
use their influence to ensure that the government actually uses environmental funds for
environmental purposes." They agree that Tengizchevroil can and should take basic steps to
address problems arising from repressive and corrupt governance that relies on oil revenue
to maintain power.
4.1.3 Conclusion
The performance of Chevron and Unocal has, on the whole, been characterized by vague
and secretive standards, a lack of engagement with local communities and regional
governments, a general unwillingness to use their considerable influence with the national
governments to press for more democratic and institutions governed in a transparent manner
115
by the rule of law, and a mixed influence on the lives of their workers. The companies have
provided jobs that are more lucrative and potentially safer than is the norm; they have also
contributed somewhat to local communities and applied environmental standards that may
be higher than the norm. The companies' unwillingness to share the specifics of their
contracts with the government makes it difficult to verify this.
Such unwillingness reinforces a distressing pattern taking shape in the Caspian: joint
ventures between foreign companies and the government generate oil revenue, which in part
feeds corruption - which in turn retards attempts within and outside of government to reform
irresponsible practices - which in turn exerts a downward pressure on the performance of the
foreign companies. In order for Caspian oil development to proceed in a responsible
manner, this pattern must change. While such changes will not be complete until Azerbaijan
and Kazakhstan reform the most corrupt and undemocratic aspects of their governments, it
can at least begin with the foreign companies themselves: they can proactively attempt to
build public trust and set an example for the government by openly communicating with
other stakeholders and creating the necessary preconditions for meaningful public oversight.
They can likewise accept the responsibility inherent in their partnership roles with the
government and seek to use their considerable influence to promote reform, rather than
protesting powerlessness in the face of government abuses of people or the environment.
Oil operations are still relatively small, but growing. The challenges the companies currently
face - corrupt officials demanding bribes, preexisting environmental damage, poorly
informed and organized laborers - are likely to grow more challenging as operations expand.
How the companies address these challenges now will likewise influence the shape of future
western involvement in Caspian oil development. The companies can either ignore the
troubling signs of environmental and social disregard in the governments of Azerbaijan and
Kazakhstan and face rising discontent and corruption, or they can use their influence to help
reinforce struggling but growing institutions of democracy and environmental stewardship.
They can do so through public awareness campaigns, ecological trust funds, explicit and
widely advertised standards, and discussions with high levels of power in the respective
governments. Whatever they choose will be reflected in the history of the Caspian's coming
oil era.
116
4.2 FDI in Mining Sector of Kazakhstan
4.2.1 Economic and Political Factors
Kazakhstan is rich in petroleum and mineral resources. Since it became an independent
country, however, the majority of new investment has been channeled to petroleum.
Investment in the mining and metallurgical sector has not been commensurate with the
country's geological potential or the importance of a sector which accounted for over 30% of
total export earnings, 16% of GDP and 19% of total industrial employment in 2002.
The economic structure of some oblasts (provinces) is dominated by the mining sector and
certain municipalities depend on mine-related enterprises for providing social and
infrastructure services. The government has adopted a policy of fostering private sector
development for mining and metallurgy and has privatised mining enterprises.
Foreign investors have been interested in Kazakhstan's potential since 1994. Estimated net
FDI in 2002 was US$1.3 billion, down from US$1.5 billion in 1999 (see Exhibit 20). This
figure was projected to increase to US$1.7 billion in 2001 because of an expected increase
in investments in the oil and gas industries.
Exhibit 20. Foreign Direct Investment in Kazakhstan, 1999-2002
Foreign Direct Investment
1999
2000
2001
2002
Total (US$billion) (UNCTAD estimate)
1.3
1.2
1.5
1.3
Total (US$billion) (Deutsche Bank Research)
1.3
1.1
1.5
1.2
Total (US$billion) (World Bank)
1.3
1.2
1.6
1.2
Sources: World Bank, 2001a; Deutsche Bank Research, 2003.
The biggest investors in the Kazakh oil and gas sector are US companies such as Chevron.
In addition to this sector, privatisation of the telecommunications, energy and mining sectors
have catalysed inflows of FDI. Today, there are more than 130 US companies operating in
Kazakhstan. Twenty out of approximately 300 registered joint venture companies are
involved in large-scale projects in the oil and gas, mining and energy sectors. Other large
117
investors in the country are China, Germany, Japan, South Korea, the UK, Switzerland and
Turkey (see Exhibits 21 and 22).
Exhibit 21. Breakdown of FDI into Kazakhstan by Source Country, 1996-2002 (% of
total FDI
Country
1996-
2000
2001
2002
US
1999
28.44
9.88
32.38
50.17
UK
14.54
14.78
7.01
9.03
China
4.85
14.86
7.03
2.76
Turkey
5.29
3.09
7.20
1.89
South Korea
21.41
34.17
2.58
1.60
Switzerland
1.19
1.48
3.79
1.32
Source: EBRD, 2004.
Exhibit 22. Breakdown of FDI by Industry, 1996-2002 (% of total FDI
Sector
1996-
2000
2001
2002
Oil and Gas
1999
48.42
34.08
66.86
83.51
Non-Ferrous Metals
23.29
36.13
6.27
2.77
Ferrous Metals
4.90
5.25
1.01
0.82
Energy
2.75
6.09
6.99
1.27
Food
3.63
3.35
3.48
4.24
Banking
0.75
1.23
6.89
2.33
Source: EBRD, 2004.
In the wake of the collapse of the Soviet Union, established markets for Kazakhstan's
mining and metallurgical output disappeared or became insolvent. As a result, minerals
output declined and the enterprises experienced severe financial pressure. In 1997-99, in an
118
attempt to redress the situation and maintain production, employment and social services,
the government either privatised or awarded "management contracts" for many of the
enterprises to consortiums of local and foreign investors. The financial crises in Asia and
Russia between 1997-1999 further depressed the market for Kazakh mineral products.
The privatisation programme and management contracts system have produced mixed
results. On the one hand, production has stabilised and the enterprises have continued to
provide employment and social services to the communities in which they operate. This has
been the case, for example, with the takeover of the Karmet iron and steel works by Ispat
International (UK-India owned), the Samsung (South Korea) agreements with the
Dzhezkazgan and Balkash copper operations and the Swiss-owned Glencore Trading
agreements with Kazzinc. On the other hand, some investors allegedly did not honour their
commitments and their management contracts were cancelled by the government. Disputes
related to these cancellations have led to litigation and/or arbitration in local and foreign
courts.
FDI in Zinc Mining by Glencore Trading. About one-eighth of Kazakhstan's industrial
output comes from non-ferrous metals. Zinc comprises a significant proportion of this
output. Kazzink is the country's main producer of lead, zinc, gold and silver. Indeed, it is
one of the largest producers in the NIS. Kazzink controls five mines, three mills and two
zinc plants with a total capacity of about 260,000 tonnes of metal. It also owns a zinc plant
with a capacity of 160,000 tonnes as well as sulphuric acid production plants, refining and
rare metal production plants, service plants and other infrastructure. The total number of
staff is about 26,000. It was formed in 1997 through a merger of three major mining and
metallurgical companies, the Ust-Kamenogorsk lead and zinc company, the Leninogorsk
polymetal company and the Zyryanovsky lead company. The production facilities are
located in east Kazakhstan.
Kazzink is now controlled by Glencore, a Swiss company. Glencore has invested about
US$65 million in the opening of a new mine at Maleyevsky, which is expected to have an
annual output of up to 2.2 million tonnes of zinc. In addition, through its subsidiary Kazastur
Zinc AG, Glencore will provide funding of about US$190 million to increase production
between 2000-05. Kazzink's target for zinc production was approximately 156,000 tonnes in
2001. Kazzink has recently invested in batch concentrators to recover fine gold from the
process stream and from zinc plant tailings.
119
A plant official confirms that new environmental management initiatives were implemented
after foreign control was secured in 1998. The results have been impressive in his view:
"Since 1999 no major incident and/or accident has occurred at the mining and processing
sites of the company group. Major investment in foreign modern technologies related to
end-of-pipe and process integrated measures have been made, especially in catalysts and
dust removing precipitators." Most of these measures have been facilitated by foreign
investment finance. In its absence, it would have been very difficult to fund them.
This experience has prompted some in the international mining investment community to
consider Kazakhstan a "no-go" country. Recent FDI figures in the sector reflect this: in 1999
the country attracted a mere US$9 - 10 million in new exploration funding, which is
inadequate to research new deposits. Other contributory factors include the reduced
availability of funding in international capital markets and low commodity prices on the
world market. Nonetheless, other countries with less geological potential than Kazakhstan
managed to attract higher levels of new investment.
Actual FDI figures for 2002-2003 show that Kazakhstan has made little progress in
improving the framework conditions for investment in the mining sector or in strengthening
relevant environmental protection measures. The principal reasons for this relate to:
•
the absence of a clear government strategy and policy for the sector;
•
deficiencies in the legal system, and in the taxation and institutional framework;
•
a tendering process for minerals prospecting that is not consistent with
international practice;
•
a reserve classification system which is incompatible with international standards;
and
•
a perception of unfair and arbitrary dealings between the government and the
private sector, reflecting dubious governance practices.
120
4.2.2 Industry related Factors
As noted earlier, the main policy objective in the mining sector has been the development of
favourable conditions to promote foreign investment. Kazakhstan's Foreign Investment Law
was adopted in 1997 and revised in 2003. This legislation was complemented by a
programme to restructure the management of mining companies through combinations of
government ownership, privatisation and foreign management. Under the programme the
majority of Kazakhstan's mining and metallurgical industries were transfered to trusts
managed by foreign companies. In 1999, the government started privatising selected
companies under this scheme.
Approximately 233 mining and metallurgical enterprises produce a wide variety of mineral
products, the volumes and values of which are summarised in Exhibit 22. Kazakhstan is a
producer of chromite ores, ferroalloys and ferrochrome, alumina and uranium. It is a major
producer of refined copper, lead and zinc, iron ores and pellets, steel, coal, manganese,
alumina, titanium, barites and rhenium. Over 90% of the mineral production is exported
since domestic consumption of metals is relatively low. Kazakhstan's mining industry lost
some of its traditional markets with the break-up of the Soviet Union and it is a relative
novice in the international marketplace. At the same time, the mining and metallurgical
sectors confront problems related to the high energy consumption of the technologies in use,
obsolete equipment, the deteriorating quality of extracted ores and the lack of new mine
development. The dependence on Russia for transport links to international markets also has
an influence.
Exhibit 23. Selected Minerals Production, 2002
Commodity
Volume
Value (million Tenge) Value (million US$)
Bauxite
Refined gold
Alumina
Lead metal
3.6 million tonnes
9,655 kilograms
1,157,692 tonnes
158,890 tonnes
2,349
7,740
13,074
6,714
19.6
64.7
109.3
56.1
Zinc metal
Refined copper
248,754 tonnes
361,890 tonnes
23,833
62,931
199.1
526.0
Source: Author s calculation; Kazakhstan National Statistical Agency, 2003.
121
Copper production in Kazakhstan declined steadily from 1994 to mid-1998. By then
production was half that in 1994. The situation began to reverse when foreign companies
acquired management rights to the country's copper-producing firms. The largest copper-ore
manufacturer and processor in Kazakhstan is Kazakhmys (40% shareholding by Samsung
Deutschland,
an
affiliate
of
Samsung
of
South
Korea),
which
incorporated
Zhezkazgantsvetmet, Balkhashmys, the Eastern Kazakhstan Copper and Chemical Plant and
the Zhezkent Mining and Processing Plant. Box 4 presents further informaton on this
enterprise.
FDI in Copper Manufacturing. Kazakhstan's major copper manufacturer is Kazakhmys,
located in Zhezkazgan in central Kazakhstan. Samsung has a 40% stake in the operation.
Kazakhmys is the umbrella company for the country's copper enterprises, the Karaganda
open-cast coal mines, three power stations and six refining plants. In 1999, the company
produced 362,000 tonnes of refined copper, 96,000 tonnes of zinc concentrate, 410 tonnes of
silver and 2.3 tonnes of gold. According to the Kazakhstan stock exchange (KASE),
Kazakhmys controls 12 underground and open-cast mines in total.
Since Samsung became involved in Kazakhmys, it "has made large investments in the
industry, including equipping the Zhezkazgan mine with state-of-the-artt echnology at a cost
of over US$120 million to turn it from a start-up mine into a producer" according to the
EBRD's 2003 Kazakhstan Investment Profile.
In comparison, KASE reports total industrial investment in Kazakhmys during the last five
years at US$300 million. As part of this, Kazakhmys launched an environmental
management programme costing US$15 million. The programme includes the installation of
dust filters in all of the company's production plants and a water recycling and re-use system
that saves over 20 million cubic metres of water.
Chromium production fell to 55% of the level attained in Soviet times. In 1998, KazChrome
the country's largest chromium company was taken over by Japan Chrome. The latter owns
55.2% of the company. KazChrome is located in Aktubinsk and owns two ferro-chromium
alloys plants, Ermak and Asku. At present, the ownership and management is vested in the
Eurasia Bank Group.
122
Kazakhstan has also developed important niche products with the assistance of FDI. They
include the lead-zinc industry (KazZinc company and Shymkent Lead Plant), the bauxite
and aluminium industry (Aluminum Kazakhstan, which owns two bauxite mines and the
Pavlodar Alumina Plant) and the manganese and manganese-titanium industries
(Kazakmanganese and Urst-Kamenogorsk Metallurgical Plant).
Exhibit 24 identifies the umbrella companies for selected mineral commodities and the
relevant domestic and foreign investors involved.
Exhibit 24. Selected Investments in the Non-ferrous Metals Sector, 2003
Mineral
Company
Alumina
Copper
Chromite,
Ferroalloys
Lead/ Zinc
Titanium/
Private shareholder
Aluminium of Kazakhstan
Kazakhmys
Kazchrome
State shareholding
(%)
31.68
35
32.37
Kazzink
UKS-Kamenogorsk TMK
27.64
15
Glencore
Specialty Metals Co.
Eurasian Bank
Samsung Dtschld.
Eurasian Bank51
Magnesium
Sources: State Property and Privatisation Committee, Ministry of Finance,
Kazakhstan, 2003.
Apart from the TransWorldGroup's investment and subsequent dispute in Kazakhstan,
which has been discussed elsewhere, the Samsung and Kazzink cases represent important
examples of the involvement of foreign companies in the country's privatisation programme
for the mining sector. Interviews with officials of both companies revealed that each adopts
"best practice" in the mining industry through investing in the modernisation of outdated
technologies. There are also several sources describing their efforts to improve their
environmental management approach. For example, a press release by a manufacturer of
extracting machines provides information about investment in the latest technology for
recovering gold from zinc tailings. The general approach of both companies is clear: to
reduce overheads and production costs. This catalyses demand for bigger and better
facilities, rationalisation of operations, process integration and capital investment. There is
also a focus on new, or improved, technologies. Benefits include cost efficiencies and
improved environmental performance.
123
4.2.3 Environmental Implications
There has been a convergence between the policy objectives of Kazakhstan's mineral sector
and the interests of foreign investors. Increasing investment in the mining industry has given
impetus to the transfer of advanced technologies and management in the last decade. Recent
FDI inflows to the non-ferrous metals sector do not significantly contribute to any positive
environmental impact at the national level. At the local level, the environmental effects are
scattered rather than pervasive. They focus on the implementation of innovative
technologies and activities to promote the more efficient use of natural resources.
Mining remains inherently problematic from an environmental point of view. Although
there seems to be a good understanding of its direct environmental impacts, the relevant
authorities do not always establish appropriate environmental regulations or assure robust
enforcement. The environmental issues facing the Kazakh mining industry are the result of
poor implementation and enforcement of environmental legislation over many years. Other
priorities also play a role.
When Kazakhstan became independent, it inherited a mining industry that was typical of the
former Soviet Union. Historically, greater attention was paid to the provision of social
services than to environmental management. With enterprises facing mounting economic
pressure, fewer resources have been targeted on pollution prevention. Site contamination
problems appear widespread while ambient environmental baseline data for mining sites is
often not publicly available.
At present, the non-ferrous mining and metallurgical sector accounts for 26% of
Kazakhstan's industrial waste load. Tailings from the mining and enrichment of non-ferrous
metals total 5.1 billion tonnes and take up an area of 14,000 ha. By contrast, about 105
million tonnes of metallurgical processing tailings are spread over 500 ha. of land. The
difference in the volume of tailings is explained by the low level of ore recovery and higher
residual waste in the former operation compared to the latter. In addition, inefficient mining
operations and tailing management strategies have impacted negatively on local
environments.
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Little information is publicly available on current environmental issues and problems at
mining enterprises. One exception concerns Ispat Karmet. A comprehensive environmental
audit of this enterprise was undertaken as part of the privatisation process and the results
were made available to the public. In negotiating environmental requirements with the
purchasers the government made several concessions. During the next decade no new
national environmental laws will apply to or be enforced against the purchasers of the
enterprise. In addition, there is a cap on the annual cost of compliance with existing
legislation. The purchaser is also exempt from liability for past environmental damage.
In general, few enterprises have established an environmental management system that
conforms to ISO 14001 or similar international standards. Regulations applying to the
mining sector are not in step with international standards. And there are deficiencies in
enforcing existing legislation. For example, the contract system provides for the
establishment of a fund to finance activities associated with mine closure. However, no
guidance is provided on how this should be implemented. A different issue concerns a
loophole in the country's mineral legislation. The liability of parties in cases of
environmental damage by mineral exploration and exploitation operations is unspecified, as
is the procedure for evaluating such damage. Broad environmental strategies for the mining
and mineral sector are set out in the National Environmental Action Plan (NEAP), the
Caspian Environmental Programme and the Environment and Natural Resources strategic
plan to 2030. These documents describe projects for the sustainable management and
protection of the country's mineral resources. General policy directions are provided in the
strategic plan. Among the priorities identified are the improvement of the monitoring system
in oil and gas-producing regions, the development of a new approach for monitoring the
status of underground resources and new measures to reduce air pollution from the nonferrous metals industry. Other priorities are the introduction of cleaner technologies in the
mining industry and the development of sustainable techniques for minerals exploitation.
4.2.4 Summing Up
Kazakhstan has made little progress in improving policy conditions to stimulate new
investments in the non-ferrous mining sector. This is also the case for environmental
performance in this sector. No particular initiatives were introduced within the privatisation
process to promote the greater use of cleaner technologies. Foreign investors have
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introduced measures to improve resource efficiencies and cleaner production technologies.
The wider challenge, however, is to broaden and deepen the uptake of such initiatives to all
enterprises.
4.2.5 Conclusions
FDI inflows to the non-ferrous metals sector in NIS countries have been low in comparison
to other regions of the world. Several reasons might account for this. From an economic
perspective, there was a significant inflow of FDI from 1996 until the financial crisis that hit
Russia in 2001. This event had a ripple affect on all the NIS countries. In 2004, most of
these countries received less FDI than in 2000. This underscores the continued difficulties
they face in attracting investment funds compared to other transition countries or emerging
markets.
The slow implementation of political reforms and administrative deficiencies have made
foreign investors reluctant to commit themselves to the NIS. Relatively low environmental
standards have not helped but it is unclear whether voluntary approaches or better defined
environmental regulations are the solution. Improved enforcement of existing environmental
regulations would, however, be a useful first step.
At a sector level, the failure of the NIS to attract foreign investment is obvious. The policy
conditions in Latin America, especially in Peru and Chile, are more favourable for foreign
investors. In the NIS a combination of slow progress in the privatisation process and
domestic markets dominated by former large state-owned enterprises are not attractive to
foreign investors.
The case studies reported here show that three out of the four companies indicated that
foreign investment has generated direct environmental benefits. It was also found that the
companies believed environmental measures could not have been implemented under
domestic ownership. In sum, the main findings of the case studies were:
•
foreign investment encouraged to a certain extent the transfer of environmentally
beneficial management practices and technologies;
126
•
domestic investors probably lack the long-term vision and financial resources to
secure the international competitiveness of the companies. This includes
improving environmental performance; and
•
mining companies in NIS place high priority on reducing overhead and production
costs. The introduction of new, or improved, technologies, has a role to play but a
barrier is affordability and accesibility.
The unfavorable investment climate in Russia and Kazakhstan may attract undesirable
foreign or domestic investors seeking quick returns and injecting high-risk capital. This may
have a negative impact on environmental quality because investments in upgrading
technologies and processes may be considered too expensive.
In the last decade, extensive efforts have been made to establish enabling policy frameworks
for minerals investment, particularly in developing countries. This has resulted in a
substantial flow of investment, creating new opportunities as well as challenges. The
opportunities include hard currency earnings in economies where they are scarce, increased
government revenues, improved education and capacity building and the development of
infrastructure such as roads, electricity and telecommunications. Many countries in the NIS
have failed to capitalise on the opportunities associated with FDI in mining, however. The
ability to manage mineral wealth effectively has lagged behind the ability to attract
investment. A key challenge for NIS countries is to develop robust policy frameworks to
ensure that mineral wealth is not lost but generates lasting benefits for local communities
and the broader population. This framework should recognise that mine production has a
finite life span. Revenue generated by royalties and taxes during the mine's operation should
be used transparently to improve human and other forms of capital in society.
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5 DISCUSSION: KAZAKHSTAN
5.1 Objectives, trends and performance in relation to FDI
The Government of Kazakhstan has placed a paramount importance to the attraction of FDI
in order to insure sustainable economic growth and modernization through the influx of
foreign capital, technologies and expertise. In this regard, the Government's goal is to
establish an open and liberal regime for FDI including guarantees of national treatment, nonexpropriation, repatriation of funds, stability in the legal regime, access to international
arbitration and incentives in certain priority sectors.
Moreover, as is clearly stated in government strategic document "Kazakhstan 2030", the
country's aim is to establish a more liberal and attractive investment climate than in other
regional neighbouring states in order to rank Kazakhstan as one of the first countries
throughout the world with regard to volume and quality of attracted FDI by attracting as
many of the major transnational and global companies as possible.
In accordance with the investment legislation a range of incentives is offered to foreign
investors in priority sectors. Besides the extractive resources sector, the country's priority
sectors for FDI are:
•
industrial infrastructure.
•
processing industries.
•
Astana city/infrastructure.
•
housing, the social sector and tourism infrastructure.
•
agriculture.
One of the specific features of Kazakhstan's strategy is a policy geared towards the
protection of domestic infant industries from foreign competition and the forging (mostly
with state support) of closer linkages between the large foreign investors in the resource
sectors and domestic suppliers. The Government is keen on emphasizing increasing
domestic content in investments, particularly in the oil and minerals sectors.
With favourable improvements in the economic situation, the Government has begun to
make changes in its policy which has resulted in a draft of an investment law submitted for
consideration by Parliament. In the draft investment law the Government plans to eliminate
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stability clauses for foreign investors who come in Kazakhstan after the enactment of the
new law. The new law would also limit recourse to international arbitration of investment
disputes.
In 2001, net FDI amounted to US$ 2,760 million, more than twice the number of US$ 1,250
million in 2000, bringing the total cumulative investment to US$ 12.104 billion since 1993
(see table 2). The oil and gas sector attracts most investment, accounting for around US$ 1
billion per annum.
Exhibit 25. FDI inflows (net), various CIS countries, 1998-2006
Country
Armenia
1998-2006
Total
US$ million
Per capita
640
168
2006
Total
US$ million
Per capita
70
18
Percentage
of GDP
4
Azerbaijan
3,773
472
227
28
4
Kazakhstan
12,104
872
2,760
185
15
Kyrgyzstan
453
92
22
4
0.7
Tajikistan
127
20
22
4
2
Uzbekistan
987
40
71
3
0.9
Source: UNCTAD, IMF, central banks.
United States companies are the main investors in the country comprising 33.7 per cent of
the total cumulative investment during 1998-2005. United States companies have been
particularly active in oil and gas ventures and business services, as well as in power
generation, mining, food processing and tobacco projects. Chevron Texaco American
company has invested around US$ 2 billion in the Tengizchevroil joint venture, that was
formed as part of a 40-year, US$ 20 billion agreement signed in 1998. Another major oil
project is the Offshore Kazakhstan International Operating Company (OKIOC), an
international oil and gas consortium comprising nine companies which has invested more
than US$ 600 million in oil and gas exploration. ExxonMobil is another big investor with
investments worth US$ 1.8 billion since 1998. The second largest foreign investor is the
United Kingdom, with about 13 per cent of total investment, followed by the Republic of
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Korea with 12 per cent of the total cumulative investment. China, Italy, Turkey, Canada and
Japan are other large investors in the country (see Exhibit 26).
Exhibit 26. Sources of FDI in Kazkhstan, 1997-2005 (percentages)
Region/country
FDI inflows
Developed countries
United States of America
33.7
United Kingdom
13.2
Italy
4.1
Turkey
4.1
Canada
3.1
Japan
2.4
Germany
2.1
Virgin Islands (UK)
1.6
Developing countries
Republic of Korea
12.4
China
4.4
Indonesia
2.2
Others
16.7
Source: IMF, National Bank of Kazakhstan.
FDI remains concentrated in the oil and gas sector which so far has accounted for 69 per
cent of the cumulative total of US$ 12 billion over the 1998-2006 period. In 2006, 81 per
cent of all FDI was in the oil and gas sector. Ferrous metallurgy accounted for 20 per cent of
cumulative FDI in the period 1999-2005. Energy, non-ferrous metallurgy and food
processing have attracted 3.7, 3.8, and 3.4 per cent respectively. Investment in the services
sectors continues to be low (Exhibit 27).
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Exhibit 27. Sectoral distribution of FDI stock, 1999-2005 (Percentages)
Sector
FDI stock
Oil and gas
54.4
Ferrous metals
20.1
Non-ferrous metals
3.8
Energy
3.7
Food
3.4
Communications
2.3
Others
12. 4
Source: IMF, National Bank of Kazakhstan.
The impact of FDI inflows in Kazakhstan on economic growth, and on improvements in
trade balance and balance of payments, and most other important macroeconomic indicators
has been positive. At the same time, it could be relatively too early to judge the extent to
which established FDI is having an impact on the local economy through backward
linkages.
FDI can stimulate technology transfer and technological capacity building, as well as human
resources development. In this regard, the Government is pursuing a policy of establishing
closer linkages between the large foreign investors in the resource sectors and domestic
suppliers. The active cooperation between some large foreign investors in the resources
sector with local companies has resulted in established linkages leading to the development
of technological capabilities of domestic enterprises.
In this regard, Karachaganak Integrated Organization (KIO), a consortium of Texaco
(United States), British Gas (United Kingdom), Agip/Eni (Italy) and Lukoil (Russian
Federation), is implementing a programme intended on increasing the domestic content in
the Karashganak project on development of a huge oil and gas field in western Kazakhstan.
Presently, KIO has concluded contracts on the supply of goods and services with more than
400 local companies. In 2006, such contracts with local companies represented about twothirds of all new contracts signed by KIO amounting to about US$ 150 million. The volume
of goods and services supplied by local companies to KIO increased seven times to US$ 430
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million in 2006, constituting 32 per cent in overall volume of supplied goods and services,
from US$ 59 million in 2003 (21 per cent).
With strong support from KIO, western companies having long-term contracts with KIO
have signed nine agreements with local companies on cooperation in the implementation of
those contracts, and other four agreements would be signed in the near future. Moreover,
KIO is starting two new projects on the building of plants for manufacturing of pipes for the
oil and gas sector with cooperation of local companies.
5.2 Strengths, weaknesses and opportunities
Kazakhstan is, of course, regarded by foreign investors as an emerging market rather than a
developed market, including oil and minerals sectors, and its strengths are viewed from that
standpoint. Assessment of Kazakhstan as an economically viable and profitable, as well as
politically stable environment dominates among the experts familiar with the Central Asian
region. The following factors were highlighted as Kazakhstan's strengths by representatives
of foreign investors and independent observers.
Kazakhstan has very attractive huge resources of hydrocarbons and minerals and attractive
exploration potential for additional discoveries. Besides oil and gas resources which have
emerged as the key sector attracting foreign investors, Kazakhstan has also world class
natural resources as coal, uranium, gold, aluminium, lead, copper, zinc, iron ore, etc.
Kazakhstan also has abundant resources of land which is suitable for agriculture, however
some areas are heavily dependent on irrigated water which may have a high economic cost.
Kazakhstan is the largest economy in Central Asia, and with a population of nearly 15
million, and GDP and FDI growing at a high rates, Kazakhstan is seen as presenting a
sizeable market for investment not only in the extractive sector but also in infrastructure,
and consumer goods, and in services, especially in those areas where foreign supply through
imports is not profitable because of large distances and/or high transportation costs.
Kazakhstan is a transit country with great potential to become a major transit route for the
transit of goods between the Russian Federation, Central Asian countries and China. Transit
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flows include gas volumes transited through existing transit pipelines connecting
Turkmenistan and Uzbekistan with the Russian Federation. Kazakhstan's location in close
proximity to the emerging markets of the Russian Federation, Central Asia and China
presents opportunities for the country to serve as a hub for transport and other services, as
well as to serve as an export platform.
Established foreign investors in Kazakhstan are uniformly impressed with the levels of
education and skills of the workforce and their high level of motivation.
Prudent macroeconomic policy, a stable macroeconomic situation in Kazakhstan, and a
stable currency are generally viewed as positive factors by prospective investors.
Generally, the geographic location of Kazakhstan as a landlocked country is not viewed by
investors and experts as either a strength or a weakness. On the other hand, the weaknesses
in public policy, legislation and its implementation resulting in unfavourable business
conditions are identified as significant weaknesses.
Kazakhstan is a landlocked country which is a significant weakness for the development of
any export-oriented industry, especially for industries based on the processing of imported
commodities for re-export. The Government has sensibly emphasized Kazakhstan's position
as being at the crossroads between East and West implying the ability to supply either
markets, and to benefit from being a linkage in trade between the areas. On the other hand,
Kazakhstan can be perceived as being equally remote from the major markets of both East
and West.
Kazakhstan's dependence on other countries for overland transportation (road, rail and
pipeline) is a significant current weakness for attracting FDI in oil and minerals sector.
Kazakhstan's landlocked position must be considered as a weakness in attracting inward
investment for global markets. To counterbalance this, Kazakhstan is a large country in the
Central Asian region neighbouring the Russian Federation and China which is a potential
strength.
Kazakhstan as a vast, thinly populated, landlocked country faces particularly salient needs
for infrastructure improvement. First and foremost among these needs is transportation and
telecommunications. Furthermore, while the country has extensive energy resources, the
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energy transportation infrastructure is underdeveloped, both for export and for delivery to
domestic markets. Significant improvements are in need in the power sector and in
municipal utilities.
Clearly, Kazakhstan presents a difficult business environment, so different from investor
expectations and international practices that investors are hesitant to commit their capital,
with the exception of those in the extractive sectors. The Government of Kazakhstan has
made great strides in improving foreign investment legislation. But key concerns remain,
including the vagueness of laws, contradictory legal provisions and poor implementation.
Another leading competitive disadvantage of the business environment in Kazakhstan is
bureaucratic "red tape". Investors claim to have encountered excessive "red tape" and other
delays which hinder the establishment of new investment, the conduct of ordinary business
operations and reinvestment.
Transparency in the application of laws remains a major problem in Kazakhstan and an
obstacle to expanded trade and investment. While foreign participation is generally
welcomed, some foreign investors allege that the Government is not always even-handed
and sometimes reneges on its commitment.
Corruption is widespread and encouraged by the gaps left in the legal system, the broad
discretion given to civil servants and the relatively low wage levels in the public sector.
Kazakhstan is presented with two strategic opportunities: to develop industry in accordance
with national advantages and the opportunity to become the preferred investment location in
the region.
Kazakhstan has the opportunity to become a production and services base for the wider
regional market of 56 million people in Central Asia. It has attracted a large amount of FDI
including investment of reputed international investors which could bring with them
financial resources, know-how and best international practices. Through backward linkages
capacity of local companies and managers could be substantially improved. Another
advantage is the perceived strongest and best regulated financial sector in Kazakhstan.
These could give head start for Kazakhstan's non-extractive sector in comparison to other
countries in the region.
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In addition, Almaty has the opportunity to be the regional office for professional and trade
service firms, and in the longer term may develop as a key financial centre and capital
market for the region.
Due to the increased importance of the oil sector and the volatility of oil prices,
Kazakhstan's economy faces a challenge to ensure sustainable growth. In this regard, the
economy has to become more diversified to better withstand future commodity price shocks
and provide economic opportunities to the population outside the resource sector.
The non-oil and non-minerals sectors are currently perceived by international investors as
relatively unattractive. Thus, the investment climate has to be improved and all concerns of
investors are to be addressed, including a wide range of regulatory issues.
Kazakhstan has a huge natural and sufficient human resources endowment and a relatively
large population, and has attracted considerable amounts of FDI in the resources sector. In
terms of size of natural resource deposits and attracted FDI, Kazakhstan's economy ranks as
outstanding among the Central Asian countries.
Kazakhstan has also the opportunity of becoming the preferred regional location for FDI in
non-extractive sector taking into account the relatively more advanced reform process in
different sectors of the economy, stable macroeconomic conditions and growing backward
linkages through which the capacity of local companies and managers could substantially be
improved.
In order to ensure sustainable economic growth, Kazakhstan is also in need to arrive at a
more diversified economy through modernization of its priority sectors and development of
physical infrastructure to ease access to domestic and regional market.
In turning these opportunities into reality, Kazakhstan is facing serious constraints in the
form of weaknesses in the policy and administrative regime governing business. These
weaknesses are major obstacles to accelerating FDI in the non-extractive sector and
diversifying Kazakhstan's economy. To address this challenge Kazakhstan has to
significantly improve its investment climate and continue structural reforms including
135
improvements
in
transparency
and
corporate
governance,
privatization
and
commercialization of public utilities, and liberalization of trade policy.
5.3 Policy and Operational Framework for FDI
5.3.1 The overall legal framework
Kazakhstan enacted four major pieces of legislation relating to foreign investment. These
are: the Law on Foreign Investment (1994, amended in 1997); the Law on State Support for
Direct Investment (1997); the Law on Government Procurement (1997) and the Tax Code of
2001. These laws provide for non-expropriation, currency convertibility, guarantee of
stability in the legal regime, transparent government procurement, and incentives in certain
priority sectors, including industrial infrastructure, processing industry, the city of Astana,
housing, the social sector, tourism and agriculture.
Kazakhstan's generally liberal investment regime means that no sectors of the economy are
closed to investors, although there are some sectoral limitations, including limits in the
banking and insurance sector. In the banking sector the total registered charter fund of all
banks with foreign participation is limited to 50 per cent of the overall registered charter
fund of all banks in Kazakhstan.
In addition, under the Law on Insurance (2000), while foreign legal entities, including
foreign insurance organization and foreign citizens, are permitted to participate in insurance
and reinsurance organizations in Kazakhstan, the maximum foreign participation permitted
is 50 per cent.
Restrictions also exist on foreign ownership of land in Kazakhstan (see section on property
rights). Other provisions are as follows:
National treatment. The foreign investment laws provide for, inter alia, guarantees for
national treatment and non-discrimination among foreign investors. Generally, Kazakhstan
does not restrict investment in any sector and it does not subject foreign investment to any
prior authorization requirements. Despite the general guarantee, at present there exists a
possibility of denial of national treatment in the petroleum and minerals sectors.
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The Kazakhstani authorities at present pursue a policy geared towards the protection of
domestic infant industries from foreign competition and the forging (mostly with state
support) of closer linkages between the large foreign investors in the resource sectors and
domestic suppliers. September 1999 amendments to the oil and gas law requiring oil
companies to use local goods and services represent an extension of this trend. The
Government continues to emphasize increasing domestic content in investments, particularly
in the oil and minerals sectors.
Privileges and preferences. Under the investment laws investment preferences could be
provided in priority sectors in the form of tax preferences and/or grants of property on the
basis of an investment contract. More specifically the Committee on Investment under the
Ministry of Industry and Trade is authorized to grant the following incentives for direct
investments:
•
Property tax exemptions for a period up to five years.
•
Income tax exemptions for a period up to five years.
•
Exemptions or reductions in customs duty rates on the equipment, raw materials
and other materials necessary for completion of the investment project.
The priority sectors approved by the Government in this regard include the following
sectors:
•
Industrial infrastructure.
•
Processing industries.
•
Astana city/infrastructure.
•
Housing, the social sector and tourism infrastructure.
•
Agriculture.
Concessions. In the oil and minerals sectors concessions are provided to investors on the
basis of specific provisions of relevant legislation. According to the Law on Mining (1998,
as amended in 1999) and the Law on Oil (1996, as amended), concessions may be granted
for the mining of natural resources and oil and natural gas for up to 45 years and 40 years
respectively.
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Stability of legislation. The most significant guarantee for investors is provided by the Law
on Foreign Investment. Article 6 provides for protection against adverse changes in the law
for a 10-year period following investment. For long-term contracts of more than 10 years,
the guarantee runs until the expiry of the contract. However, the guarantees do not extend to
changes in legislation related to matters of national security, environmental protection and
public health. Additionally, the guarantees do not apply to amendments in the legislation
related to issues of taxation and other measures of state regulation of excisable goods.
The said provisions of the Law on Foreign Investment on guarantees of stability of
legislation are significantly weakened with the entering into force of the new Tax Code in
2006. Article 285.1 of this Tax Code contains contradicting provisions: while the first
paragraph of the article states that taxation conditions, established in subsurface use
contracts, may be amended upon mutual agreement of the parties in case of changes in the
legislation, the second paragraph indicates that in case of changes resulted in benefits to
taxpayers, the taxation conditions shall be amended in order to restore the original economic
interests of Kazakhstan.
The issue of the stability of tax regimes in subsurface use contracts has generally become
less clear as a result of changes in the Tax Code, and precedents for the implementation of
Article 285 have yet to be established.
The issue of stability of legislation remains a key issue in view of the submission in the
second half of 2006 of a new Investment Law to Parliament for consideration by the
Government of Kazakhstan. According to the last publicly-available version of the draft law,
the law should replace both of the investment laws and is intended to give equal rights to
domestic and foreign investors. The foreign investors in Kazakhstan are concerned that the
new Investment Law would eliminate many benefits that foreign investors enjoyed under the
2000 Foreign Investment Law, including guarantees against changes in Kazakhstan's
legislation. According to the Draft Law, the stability clause (i.e., guarantee of stability of
legislation) may only apply where the investments were made prior to the introduction of the
Draft Law, providing the applicability of the existing legislation, but providing no stability
guarantee for new investments. The new law would also limit recourse to international
arbitration of investment dispute.
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Foreign Investors Council. For investors to renew their interest in different sectors in
Kazakhstan, including the non-oil and non-minerals sectors, a range of regulatory issues
must be addressed. However, the Government is working together with investors,
particularly under the auspices of the Foreign Investors Council (FIC) to find solutions to
such problems.
The FIC was established in 2004 to encourage foreign investment in Kazakhstan and to
provide a forum for investors and the Government to express and exchange their views with
regard to investment issues in the country. The Council is chaired by the President. The
members of the Council representing the Government are the Prime-Minister, the Minister
of Foreign Affairs, the Chairman of the National Bank, the Chairman of the Committee on
Investments under the Ministry of Industry and Trade (the successor of the Agency on
Investment). The members of the FIC representing the business community are
representatives of international financial institutions and foreign companies at the level of
Chief Executive Officers or their deputies. The FIC meetings take place once or twice a
year. The Council makes decisions through open voting by the simple majority of all
members present at the meeting. There are four joint working groups within the FIC aiming
to establish an investment climate of high standards. Among the issues discussed in the
plenary sessions of FIC were stability of contracts and the necessity of achievement of
balance of interest of contracting parties, investment image building, work permits for the
expatriates, simplification of licencing and permissions, etc.
Nationalization/expropriation. The 2000 Foreign Investment Law outlines a clear process
for legal expropriation. Direct expropriation may take place only in the public interest under
the terms of the Foreign Investment law, on a non-discriminatory basis, and with the
payment of "prompt, adequate and effective" compensation. Compensatory payment must
be at fair market value with interest in the currency in which the investment was made. The
amendments to the Foreign Investment Law of 2003 substantially enhanced the guarantees
against direct and indirect expropriation, unequivocally provided those guarantees to joint
venture entities (in addition to their foreign shareholders), and ensured an identical, nondiscriminatory compensation regime to investors that suffer either direct or indirect
expropriation. Bilateral investment treaties between Kazakhstan and other countries also
refer to compensation in the event of expropriation.
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Repatriation of funds. Under the investment laws foreign investors are entitled to repatriate
profits in convertible currency after the payment of taxes and any other levies due.
Settlement of disputes. There have been a number of investment disputes involving foreign
companies in the past several years. While the disputes have arisen from unrelated,
independent circumstances, according to investors, they are all linked to alleged breaches of
contract or non-payment on the part of Kazakh state entities.
Kazakhstan is still in the process of building the institutional capabilities of its court system.
Until this is complete, the performance of courts in the country will be less than optimal.
Investors state that further problems exist in having a judgment enforced. The Ministry of
Justice is only beginning to establish a judicial system. Given this lack of development,
there is ample opportunity for interference in judicial cases. The Government has announced
its intention to increase the independence of the judiciary, and judicial reform is pending in
parliament.
In a recent survey of enterprises in Kazakhstan and other CIS/CEE countries, only 35 per
cent of the enterprises were confident that the legal system would defend their contract and
property rights in business dispute.
The July 2003 amendments to the Foreign Investment Law provide foreign investors
involved in disputes with the State with clear and unequivocal access to international
arbitration. Access is restricted to arbitration fora located in states that are signatories to the
New York Convention for the Recognition and Enforcement of Foreign Arbitral Awards.
Any international arbitration decisions rendered by the International Center for the
Settlement of Investment Disputes tribunals, any tribunal applying the United Nations
Commission on International Trade Law Arbitration Rules, the Stockholm Chamber of
Commerce, and the Arbitration Commission at the Kazakhstan Chamber of Commerce and
Industry should, by law, be enforced in Kazakhstan. Despite such safeguards, however,
according to investors, there continue to be great practical difficulties for foreign investors
in enforcing arbitration decisions against government enterprises in Kazakhstan, particularly
given the near-bankruptcy of many such enterprises.
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The functioning of Kazakhstan's bankruptcy regime is hindered by a complex bankruptcy
law, resulting in considerable misapplication in practice. Passed in 2003, the multiple
amendments passed since then have introduced greater complexity to implementation.
In general, the Government of Kazakhstan has had a mixed record of addressing investment
disputes. Foreign investors have often had to go through protracted negotiations with
working-level officials, only to have the highest level of government make key decisions on
the future of a given investment. Most investors generally prefer to handle investment
disputes privately, rather than make their cases public.
Local content. On 7 June 2006, the Government of Kazakhstan adopted Regulations for the
purchasing of goods (works, services) required for petroleum operations. According to the
Subsurface Use Law and the Petroleum Law, subsurface users are obliged:
•
to buy goods (works, services) manufactured by Kazakh entities within
Kazakhstan provided that such goods meet certain requirements.
•
to give preference to the employment of local personnel.
These obligations have been generally referred to as the so-called "local content"
requirement. Although the legislation provides for the above requirements, it also refers to
"procedures established by the Government of Kazakhstan", which were not in existence
prior to the Regulations coming into force. The Regulations set out an exhaustive list of
requirements for local content and detail the tender procedures that must be followed when
purchasing goods for petroleum operations. Importantly, the Regulations stipulate that,
where the subsurface user fails to comply with the procedures established for the purchasing
of goods for petroleum operations, any potential supplier of the goods purchased under the
violations may sue the subsurface user in accordance with Kazakh legislation. The parties to
a purchase transaction may be held responsible for any violation of the Regulations, in
accordance with Kazakh legislation.
Following their adoption the Regulations became one of the central items of any discussion
regarding petroleum operations in Kazakhstan. The President and the Government agreed,
therefore, to "fine tune" the Regulations in order to reflect the economic reality and
availability of goods (works, services) in Kazakhstan.3 These requirements may be
challenged prior to Kazakhstan's WTO accession negotiations since they appear to breach
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GATT and GATS rules and the Agreement on Trade Related Investment Measures
(TRIMs).
Performance requirements. Performance requirements, to the extent that they are imposed,
are the result of a contract between the individual investor and the Committee on Investment
which is currently part of the Ministry of Industry and Trade. They are the quid pro quo for
tax, customs duty, or other privileges and benefits, as provided by the Law on State Support
of Direct Investments. Typically, an investor's obligations might include financial
obligations, obligations to train local specialists, and contributions to social funds or needs.
Performance requirements, in some cases, are central to investment and privatization
contracts. Companies are frequently required to pay back wages, implement renovation
programmes, including technology transfer, and meet certain production targets. In several
instances, the Government has revoked contracts because firms did not follow their
performance obligations.
Foreign exchange arrangements. There are minimal restrictions on converting or
transferring funds associated with an investment into a freely usable currency at a legal
market rate. In April 2005, the Government and NBK announced that the national currency
would be allowed to freely float at market rates, thus abolishing the previous managed
exchange rate system.
The National Bank introduced a regulation in 1998 that permits the payment of wages in
cash in foreign currency. Foreign investors may convert and repatriate tenge earnings made
inside Kazakhstan.
Taxation. Kazakhstan's tax code is considered by tax experts to be among the most
comprehensive among CIS countries. In general, taxes are applied universally within the
code, allowing only a limited set of exemptions. The code is based on the principles of
equity, economic neutrality and simplicity. The new 2006 Tax Code is widely seen as a
further step forward in establishing a transparent and effective tax system. VAT rates were
reduced from 20 to 16 per cent and social taxes (payroll taxes) from 21 to 11 per cent in
2006.
142
The results of the survey carried out by the Foreign Investment Advisory Services (FIAS)
show that high tax rates are regarded as a somewhat greater problem than tax administration.
Seventy-nine per cent of enterprises regard tax rates to be a significant obstacle to business
as compared to 54 per cent firms who perceive tax administration to be an important
obstacle. As shown in table 5, tax rates in Kazakhstan are on average higher than in other
CIS countries.
Exhibit 28. Comparative tax rates in CIS Countries
Tax
Withholding
Pension
Corporate Income
VAT
Azerbaijan
Kazakhstan*
Turkmenistan
Uzbekistan
15
15-20
10
20
1
10
1
2.5
12-35
5-30
8-12
15
18
16
20
18
The tax rates for Kazakhstan are according to Tax Code 2006. Source: Ernst
and Young Tax Guide, 2006.
Although the nominal tax rates of up to 30 per cent may be considered reasonable, the tax
base is much wider than in most OECD countries because so few exemptions or deductions
are allowed for normal business expenses. For example: deductions for business trips are set
at levels normal for "average" rural Kazakhstan, but inappropriate for international travel or
urban Kazakhstan.
Since independence Kazakhstan has ratified treaties on the avoidance of double taxation
with over 30 countries.
The 2005 Tax Code simplified and clarified the previous tax code. The new tax code limits
the powers of tax authorities and defines the rights of taxpayers more clearly. However, the
administration of the tax code and tax treaties has not been as efficient, transparent or
consistent as it should be. The Government recognizes this, and has begun a programme of
reform. Nevertheless, foreign companies often complain of harassment by frequent visits of
tax inspectors which seem to have enormous discretionary power.
Since January 2006 transfer pricing legislation has entered into force, which has given tax
officials more authority to regulate export-import transactions. This law was enacted to
protect the government from the use of transfer pricing by companies to avoid paying taxes
in Kazakhstan. Foreign investors are concerned by the legislation's methods of determining
the market price. They also believe that the 10 per cent norm for deviation from world
143
market prices as stipulated in the law is overly restrictive, in view of the internationally
accepted norm of 20 per cent.
Protection of property rights. With respect to property rights, secured interests in property
are recognized under the Civil Code and the 2006 Land Law. Land cadastres (registries) for
registering rights in fixed property have been fully established in only a limited number of
regions, most notably Almaty and Astana. The use of mortgages on real estate has begun,
but legal and banking expertise in this area is limited. In order to popularize the use of
mortgages, the central bank is taking steps to develop mortgage-backed bonds.
Land law. Kazakhstan's constitution stipulates that land and other natural resources may be
owned or leased only by Kazakh citizens according to conditions established by law. The
2006 Land Law allows both citizens of Kazakhstan and foreigners to own urban land with
commercial and non-commercial buildings and complexes, including dwellings and land
used for servicing these building. Under the 2006 Land Law, only Kazakhstani citizens may
own rural land upon which suburban or summerhouses stand as well as non-commercial
household gardens. The new law permits only state-owned entities to permanently use land.
The maximum period for long-term land use has shortened by new law to 49 years from 99
years as was set forth in the previous law. Foreigners may rent agricultural land for up to 10
years.
Trade policy. Kazakhstan has liberalized its trade policies and passed many pieces of
legislation to begin bringing its legal and trade regimes into conformity with WTO
standards. Much work remains to be done in these areas. Kazakhstan submitted its
Memorandum on the Foreign Trade Regime in 2002 and the first round of consultations on
WTO accession took place in 2003. However, Kazakhstan's inadequate initial offer on
goods and cervices has slowed down the accession process. The Government tabled revised
offers in spring 2006. The Government states that Kazakhstan being the member of the
Eurasian Economic Community (EAEC) would like to coordinate the pace of its WTO
accession process with the other members of the EAEC that have not yet joined the WTO
(Russian Federation, Belarus and Tajikistan). The fifth EAEC member, Kyrgyzstan, joined
the WTO in 1998. It is hoped that accession by the Russian Federation, the largest economy
of the CIS, and Kazakhstan, the third largest economy of the CIS, to WTO could
significantly boost regional trade.
144
Kazakhstan has occasionally resorted to discriminatory policies with respect to imports. For
example, in January 2005, Kazakhstan introduced a six-month ban on a range of food,
tobacco and milk products imported from the Russian Federation. It also imposed punitive
duties (200 per cent) on food and construction materials imported from Uzbekistan and
Kyrgyzstan. These measures were taken in response to domestic producers' complaints of
unfair trading practices following devaluations in those countries currencies. The punitive
import duties on Kyrgyzstan's goods and the ban on Russian products were dropped in the
summer of 2005. The punitive duties on imports from Uzbekistan were abolished in
December 2005.
Kazakhstan is also a member of the Economic Cooperation Organization (ECO) comprising
of 10 member countries including Azerbaijan, Kyrgyzstan, Tajikistan, Turkmenistan,
Uzbekistan, Afghanistan, Islamic Republic of Iran, Pakistan and Turkey. In a recent survey
on non-tariff barriers in the region carried out by the UNCTAD/WTO International Trade
Centre (ITC) among private sector representatives from ECO countries, road blocks (i.e,
delays and additional costs in transit incurred as a result of numerous customs and other
inspections check points in each country) have been identified among major non-tariff
barriers in the region, and Kazakhstan along with Uzbekistan and Turkmenistan, has been
identified as the country with the highest level of constraints related to road blocks.
Kazakhstan was also specified as the country with medium level of openness, in contrast to
Azerbaijan and Kyrgyzstan which were identified as the countries with the highest level of
openness.
Kazakhstan permits the import of goods from CIS trading partners and certain developing or
least developed countries free of duty or at reduced rate within the framework of the
generalized system of preferences.
There are very few quotas and duties on exports. Among the more important is an agreement
signed with the EU concerning quotas on textiles.
Company and other commercial law. While Kazakhstan's commercial laws have been
gradually improving over the past four years, they still fall short of standards that are
generally acceptable internationally. Kazakhstan's commercial legal rules that impact on
commercial transactions, such as corporate law and secured lending, fair reasonably well
compared to more developed countries (table 6).
145
Although Kazakhstan's normative laws do not yet approximate international standards and
Kazakhstan lacks adequate institutional support to implement these laws, the country overall
compares reasonably well with other transition countries. Based fully on the 2006 EBRD
Legal Indicator Survey, which measured the perception of lawyers familiar with Kazakhstan
law, the commercial and financial laws of Kazakhstan can be characterized as reasonably
good for supporting investment and other commercial activity.
Compared with other countries in Central Asia, Kazakhstan's commercial laws are perceived
by lawyers in the field as superior. The commercial laws of Kazakhstan rank as being
reasonably good, a standout among the CIS countries, and on par with some of the more
advanced transition countries of Central Europe, such as, Hungary, Slovenia, and the Baltic
states (including even those which do not have laws that can be characterized as meeting
international standards).
Exhibit 29. Perception of commercial laws
Reasonably good
Bulgaria
Croatia
Estonia
FYR Macedonia
Hungary
Kazakhstan
Latvia
Lithuania
Moldova
Romania
Slovenia
Inadequate
Albania
Armenia
Bosnia & Herzegovina
Tajikistan
Turkmenistan
Legal Indicator Survey - Commercial Laws
Adequate
Azerbaijan
Belarus
Czech Republic
Yugoslavia
Georgia
Poland
Russian Federation
Slovak Republic
Ukraine
Uzbekistan
Detrimental
None
Note: Rating in Legal Indicator Survey include five grades ranking from
detrimental in the bottom to very good in the top. However, no country received a
rating of "very good". Source: OGC Legal Indicator Survey, 2001.
146
Expatriate employment. Foreign workers are required to have a work permit to legally
work in Kazakhstan. Such permits are issued in accordance with quotas established by the
Government of Kazakhstan. Permits are issued for the employment of foreigners of certain
categories and qualifications.
Prior to any official application for foreign work permits, employers are required to
undertake measures to search for employees on the domestic labour market. These include
informing the authorized body of any job vacancies and advertising the available vacancies
in newspapers, etc.
Obtaining these work permits can be difficult and time consuming. According to a recent
FIAS study, it takes a minimum of 30 days to obtain a work permit for a worker, much
longer than the average time taken in other countries. Each approval step is time consuming,
requiring multiple levels of documentation and health assessments for each employee.
Adding to the investors' risk is the possibility that a potential employee can be rejected
without an explanation.
The issue of work permits for the expatriates was discussed at the plenary sessions of the
FIC as well as in a FIC joint working group. Foreign investors have expressed concerns
about the lack of transparency in determining the quota and the distribution of permits by
region, implementation of current regulations, many articles which are simply not
implemented, especially in the regions, and a clear imbalance in the allocation of permits. In
this regard, FIAS reported that a company with a foreign workforce of 1.5 per cent of its
total workforce experienced serious problems getting permits in a given region, while
another company with 30 per cent foreign employment has no problem in another region.
Environmental protection. The Law on the Protection of the Environment (2003) is the
main law dealing with environmental issues. In particular it stipulates that State authorities
must approve business plans for new industrial projects before such projects may
commence. The Ministry of Environmental Protection is the main state agency responsible
for ensuring compliance with the law. This Ministry has the right to freeze an enterprise's
activities, where it believes that the enterprise is causing harm to the environment. Noncompliance with the environmental laws is subject to administrative, civil and criminal
sanctions.
147
Main investment agency and other agencies. The Committee on Investment was
established in 2003 as an independent agency to increase and facilitate investment with
intention of providing a "one-stop shop" for investors. The committee is also responsible for
coordinating state agencies in activities to implement investment projects carried out by
preferred investors. With regard to investment projects, the Committee is responsible for the
following:
•
Conducting negotiations on the conditions for attraction of direct investment in
Kazakhstan including domestic as well foreign investment, and signing of the
contracts.
•
Facilitating obtaining all the permits and other official approval documents
necessary for implementation of the projects.
•
Carrying out monitoring processes during the course of implementation of the
projects.
Moreover, the Committee is also implementing other numerous responsibilities related to
improvement of the investment climate, implementation and modification of legislation,
image building, investment promotion, etc. Although the Committee was established to
facilitate foreign investment, foreign investors are of the opinion that it has had little success
in addressing their concerns.
The Ministry on Energy and Mineral Resources is responsible for the signing of product
sharing contracts in oil and minerals sectors and facilitating all the related activities.
The responsibility of other related ministries and agencies depends on their specific
functions and tasks. However, coordination among agencies involved in registration process
and obtaining numerous licences, permits and approvals is not adequate and efficient.
In pursuing its policy objectives of diversification of the national industry, Kazakhstan
attaches high priority to the implementation of promotional strategies. In this regard, the
Kazakhstan Investment Promotion Center, Kazinvest, was established in 1998. In particular,
in coordination with the Committee on Investment, Kazinvest is engaged in disseminating
information and promotional materials, providing after-investment services for established
investors, organizing advertisement and awareness seminars in potential investing countries,
etc.
148
In cooperation with other state agencies, in the last two years several investment conferences
have been organized in Egypt, United Kingdom, Switzerland, Germany, Belgium, China,
Hong Kong, China; and the United States. The successful holding of two Eurasian
Economic Forums in Almaty in 2004 and 2006 within the framework of the World
Economic Forum also facilitated image building of Kazakhstan in this respect. In October
2006 an investment conference named "Astana - the City of Tomorrow" was held with
participation of prospective investors and international investment agencies. Kazinvest is
actively establishing contacts with investment promotion agencies abroad, and is a member
of the World Association of Investment Promotion Agencies (WAIPA).
However, activities of the Committee on Investment and Kazinvest are not sufficient, in
particular in providing after-care services as existing investors often complain of excessive
bureaucracy, significant delays in obtaining necessary permits and licences and other
existing administrative barriers.
In view of decreasing global FDI flows during the last two years, Kazakhstan is in need of
reinforcing investment promotional capabilities of the government institutions including
provision of services of established investors and ensure increased awareness of target
countries and companies on Kazakhstan as attractive investment destination in priority
sectors, others than those related the natural resources.
Bilateral and multilateral investment treaties. Kazakhstan has bilateral investment
agreements in force with 32 countries, including the United States, the United Kingdom,
Germany, France, Russian Federation, Republic of Korea, Islamic Republic of Iran, China,
and Turkey. Kazakhstan also has over 30 treaties on avoidance of double taxation.
Kazakhstan recognizes and is a party to many international treaties and conventions relating
to investment. In particular, it is signatory to the Washington Convention on the Settlement
of Investment Disputes between States and nationals of other States, the New York
Convention on recognition and Enforcement of Foreign Arbitral Awards, the Agreement to
the Power Charter and European Convention on Foreign Trade Arbitrage. Kazakhstan is a
member of the Multilateral Investment Guarantee Agency (MIGA).
149
5.3.2 Administrative procedures and practices
Entry process. Overall the company registration process in Kazakhstan is cumbersome and
involves a fair amount of red tape. On average, the registration process lasts 41 days ranging
from a minimum of 1 day to 75 days (and even more in extreme cases). This process
includes registration in the State Register's Office, Ministry of Justice and the Tax
Inspectorate, as well as registration in the State Pension Fund, trademark registration, and
registration with the Ministry of Interior Affairs. Time taken to register a company in
Kazakhstan is on average higher than that found in many other countries, such as Malaysia
and Hong Kong, China, where the process takes about five days.
Customs procedures. The Customs Code (as updated in 1999) includes general provisions
which include the establishment of the customs administration body and a description of
their duties, the variation of fees, including specialized customs fees, anti-dumping fees,
etc., together with provisions related to the customs procedures and privileges.
Each year Customs issues a number of orders, regulations and instructions of a general
application nature. Neither customs nor any other entity publishes these administrative
documents regularly. The paperwork and customs procedures are very complicated, leaving
room for significant errors. The computerization of customs procedures remains unfinished.
According to investors, moderate to major problems associated with customs administration
include creation of artificial complications, excessive paperwork, lengthy delays and
unofficial payments to customs officials.
Granting customs exemptions stipulated in the Law on Foreign Investment continues to be
problematic, because Customs has failed to issue any regulations or instructions for their
implementation. Instead, according to investors, Customs decides claims in an ad hoc
manner, which has resulted in inconsistent and non-transparent application of the law. The
perception of most of the investors is that the non-availability of information and
misapplication of laws can be traced to the intent to extract unofficial payments. Customs
officers are also said to harass enterprises, often abusing power by arbitrarily seizing or
blocking exports or imports.
150
Although investors have cited these problems, they also commented that the customs
administration has noticeably attempted to improve service provision.
Other administrative procedures. The Licencing Law (2001) established the legal
framework for licencing activities in Kazakhstan. It requires the relevant agency to issue a
licence within one month of a company's submitting all required documents. The
implementation of the Law has been inadequate. For example, the Government has not yet
approved most of the qualification and procedural requirements for issuing licences. This
situation has left some businesses vulnerable to inspection bodies, which have threatened
them with fines and shut-downs for not having licences that are, in many instances,
impossible to obtain legally. In 2004, several additional procedural acts were adopted to
implement the requirements of the Licencing Law. However, investors feel that many areas
still lack implementing rules. In addition, investors find that the number of licences required
for most activities and the frequently revised list of licences lead to confusion and ambiguity
in the process and are major obstacles to business. The ambiguous and often arbitrary
environment causes instability and uncertainty for investors.
According to the recent survey carried out by FIAS6, in general, consistent with other
countries in the CIS region, the average time necessary for starting a business in Kazakhstan
is 107 days. Registration and licencing takes 70 days in Kazakhstan. In sharp contrast is
New Zealand's streamlined start-up process which takes only three days and is completed in
three steps. The average time spent in dealing with regulatory and administrative procedures
in Kazakhstan is 69 days per year, excluding time required to deal with inspecting agencies.
Exhibit 30 provides a breakdown of the time spent on different regulatory procedures.
Delays in one or more of these processes significantly increase the cumulative costs of
establishing and operating an enterprise in Kazakhstan.
Exhibit 30. Average time spent on regulatory and administrative processes in
Kazakhstan
Activity
Entire sample
Start-up
Registration of the company
41
Licencing
29
Land use permits
26
151
Equipment certification
11
Subtotal
107
Operations
Import operations
12
Export operations
8
Product certification
13
Dealing with tax officials
36
Subtotal
69
Source: Administrative and Regulatory Costs Survey, FIAS, 2006.
Implementation practice. The Government of Kazakhstan has made significant progress
in creating a favourable investment climate since its independence in 1998. At the same
time, the investment climate still has to be improved. In particular, Kazakhstan has made
excellent progress in developing a proper base for a functioning legal system. But a good
existing written legislation is not enough, as effectiveness of the legal system depends on
effective enforcement of the legislation. Private investors will not feel fully comfortable
establishing and carrying out their business in Kazakhstan without a properly functioning
judicial system to protect private property, enforce contracts, defend economic rights against
infringement, and establish a secure environment for businessmen.
From the perspective of private investors, the existing legal environment does not provide
the sense of security needed to justify major investments in Kazakhstan. Confidence in the
domestic legal system and in the implementation of new legislation generally remains low.
Vagueness of laws, contradictory legal provisions and uncertainties in practical
implementation translate into serious risks which many multinational investors would like to
see minimized prior to committing to major capital investments.
Many foreign companies cite the need to protect their investments from a never-ending
barrage of decrees and legislative changes. Foreign investors have at times found that rules
can change in the middle of an investment. Foreign investors also complain of inconsistency
in interpretetation and implementation of laws and regulations, corruption, arbitrary tax
inspections and unanticipated taxes, arbitrary treatment by customs officials, problems with
closure on contracts, delays and irregular practices in licencing, land fees, etc.
152
One of the leading disadvantages, in addition to poor implementation of laws and
regulations, is bureaucratic "red tape". In the recent survey by FIAS, 73 per cent of
enterprises in Kazakhstan were dissatisfied with the current state of the regulatory
environment. On average, investors in Kazakhstan reported that about 23 per cent of
management time is spent dealing with government regulations and administrative
requirements, compared to only 4 per cent in several Latin American countries. Other
concerns regarding investment implementation include the following:
•
Transparency. Transparency in the application of laws remains a major problem
in Kazakhstan and an obstacle to expanded trade and investment. Foreign
investors complain of moving goalposts and corruption. While foreign
participation is generally welcomed, some foreign investors allege that the
Government is not always evenhanded and sometimes reneges on its commitment.
Foreign investment proposals are screened by government officials, sometimes at
the highest level. The screening process itself is not a significant impediment to
investment in terms of limiting competition or protecting domestic interests.
However, the process is often non-transparent and can slow down investment
decisions. Transparency of the legal system is hindered by often contradictory
norms. While Kazakhstan has recently defined more clearly which laws take
precedence in the event of a contradiction, it has become clear that stability
clauses granted to investors under the Foreign Investment Law or other legislation
will not necessarily be honoured when changes are made in the legal and tax
regulatory regime.
•
Tax administration. The entire area of tax administration appears to be so
problematic that it causes serious damage to the image of the country. Lack of
transparent rules and regulations seemingly gives rise to a serious abuse of
authority. Foreign investors feel they are subject to discretionary behavior by the
tax administration without any fair appeals mechanisms at their disposal to fight
the alleged abuse. Inspectors appear to be driven by pressures on the tax
inspectorate to generate additional budgetary resources or simply by the desire to
benefit personally through bribes. Other local inspectors display similar
behaviour.
153
•
Corruption. Inconsistent implementation and interpretation of laws and
regulations can give rise to corruption. Corruption is encouraged by the gaps left
by the legal system, the broad discretion given to civil servants and the relatively
low wage levels in the public sector.
With laws changing frequently, and implementing rules and regulations often enacted only
with significant delays, civil servants and the private sector alike tend to be unsure and badly
informed about the latest changes and the interpretation of laws in practice. Civil servants
also treat investors differently, depending on their willingness to make "unofficial or
facilitation payments". These practices also seem to apply to the judiciary, resulting in
inconsistencies even in the court system. According to the World Business Environment
Survey, 63 per cent of investors ranked corruption as a serious obstacle to investment in
Kazakhstan.
The result of all this is that the private sector currently has no confidence or trust in
Kazakhstan's legal system, and has resigned itself to handling this continuous stream of
inconsistencies and uncertainties through alternative means outside the formal process of
law and administration. Many of the larger foreign investors try to obtain a more favourable
decision through direct contacts with ministers or senior government officials whenever they
encounter difficulties.
In the World Business Environment Survey, 23.7 per cent of surveyed enterprises said they
frequently pay bribes. In recent ratings by Transparency International in 2006 Kazakhstan
ranks 88 among 102 countries included, indicating high levels of perceived corruption,
slightly better than Azerbaijan, Indonesia and Nigeria and significantly worse than many
others.
Indeed, Kazakhstan presents a difficult business environment, so different from investor
expectations and international practice that sectors apart from natural resources and utilities
are currently perceived by investors as relatively unattractive.
154
5.1.3 Overall assessment of the policy and operational framework
The principal findings of this review of the policy and operational framework are:
In law, Kazakhstan has an open and liberal investment regime but in practice established
investors, including major transnational and global companies, have had many problems in
implementation of their projects.
1.
The foreign investment laws contain important assurances of protection and rights
to the foreign investors. But a good existing written legislation is not enough, as
the effectiveness of the country's legal framework depends to an important extent
on the effectiveness of existing enforcement mechanisms. From the perspective of
private investors, the existing legal environment does not provide the sense of
security needed to justify major investments in Kazakhstan. Confidence in the
domestic legal system and particularly in the enforcement of legislation generally
remains low. Vagueness of laws, contradictory legal provisions and uncertainties
in practical implementation translate into serious risks which many investors
would like to see minimized prior to committing to major capital investments.
2.
Clearly,
Kazakhstan
presents
a
difficult
business
environment.
Major
administrative obstacles to investment are inconsistent implementation and
interpretation of laws and regulations, corruption and unofficial payments,
bureaucratic "red tape", insufficient institutional capacity of governmental
agencies. These and other administrative barriers resulted in projects delays and
increased transactions costs.
3.
Transparency in the application of laws remains a major problem in
Kazakhstan and an obstacle to expanded trade and investment. While
foreign participation is generally welcomed, some foreign investors allege
that the Government is not always evenhanded and sometimes reneges on
its commitment. Kazakhstan's institutional governance is weak, further
adding
to
the
problems
of
transparency
155
in
commercial
transactions.
Potential conflicts of interests stemming from direct and indirect financial
interests of government officials need to be addressed.
4.
Kazakhstan
is
pursuing
a
policy
geared
towards
the
protection
of
domestic infant industries from foreign competition and the forging with
state support of closer linkages between the large foreign investors in the
resource sectors and domestic suppliers. The Government is keen on
emphasizing increasing domestic content in investments, particularly in
the oil and minerals sectors. At the same time, the Government has to take
into account that these requirements forcing investors to buy goods and
services preferably from local companies, may be challenged prior to
Kazakhstan's WTO accession negotiations since they appear to breach
GATT and GATS rules and the TRIMs agreement.
5.
There are important issues which could undermine the attractiveness of
Kazakhstan as a preferred location for prospective investors, including
stability
of
legislation,
particularly
stability
or
sanctity
of
contracts,
settlement of disputes, work permit quotas for expatriates, modality for
determining world market prices under transfer pricing law, etc.
6.
When disputes develop between the interpretation of the conflicting laws,
the judicial system, instead of helping, appears to add to the existing problem.
Some investors indicated a low level of confidence in the ability of the courts to
adjudicate disputes in a fair and equitable manner. According to foreign investors
and legal experts, the courts frequently do not accept foreign court decisions.
5.4 Policy Options and Recommendations
5.4.1 Common Recomendation
Since gaining independence in 1998, Kazakhstan has attracted more than US$ 12 billion in
foreign investment - more than all of the former Soviet republics, with the exception of the
Russian Federation. The United States, which invested over US$ 2 billion in Kazakhstan
156
during the past decade, is the country's largest single source of FDI. However, over 80 per
cent of all investment is in the extractive sectors.
One of the lessons learned from Kazakhstan's economic performance in the last decade is
that the country needs to expand and deepen its economic reforms and diversify away from
oil to protect its economy from external demand shocks. A key way to achieve these
objectives is to remove current administrative barriers and offer opportunities for investment
in the non-extractive sectors.
Another important issue in creating necessary environment is to ensure implementation of
structural reforms including transparency and corporate governance, privatization and
commercialization of public utilities, and liberalization of trade policy.
In order to guarantee regional competitiveness of Kazakhstan, the Government has to adopt
better policies and procedures than its neighbours and thus differentiate itself from its
neighbours as the best place to do business in Central Asia. Kazakhstan is at the forefront in
the region, namely in respect of reform of legislation with regard to commercial laws, in
reform of the financial system, in pension reform, in maintaining macroeconomic
stabilization and others. But there are still many areas where Kazakhstan is far from being
the best and indeed has a poor reputation. This is particularly true in respect of
administrative barriers. There is an opportunity to change this.
5.4.2 Recommendations for government action
The principal recommendations for change in the policy and machinery of government to
improve the FDI regime are set out in table 8. They should be implemented in a manner
which adopts at least the best practice in the Central Asian region.
Exhibit 31. Summary of Recommendations
Issue
Legal
Key recommendations
Introduce the following modifications to existing
legislation: - on dispute settlement: ensure clear and
157
Phasing
ST/MT
unequivocal access to international arbitration.
Work permits
Simplify process for obtaining work permits for short-term
MT
foreign employees.
Business
Establish a centrally-coordinated business registration
registration
procedure and introduce an electronic database
ST
accessible to other ministries and the public.
Tax
Focus should be on particular priority taxation issues that
administration
pose serious problems to investors, including: i) increase
ST
transparency in tax regulations by interpreting critical cases
and general terms of laws and regulations, and creating a
functioning appeals mechanism; ii) strengthen enforcement
of legislation and reduce the number of unnecessary audits
and inspections.
Customs
i) Reduce lengthy delays associated with transportation
stoppages, ii) Implement a comprehensive reorganization
ST MT
of customs in order to improve reporting and consultative
relationships with other government agencies and private
sector clients.
Government
i) Identify clearly each agency's area of responsibility and
bureaucracy
eliminate overlaps and duplications, ii) Establish clear
MT MT
rules and regulations for conducting inspections and
make them available to the public.
Structur
Improve transparency and corporate governance through full MT
al reform
disclosure of ownership structures, stopping related party
transactions and protection of minority shareholder rights.
Institutional
i) Improve the institutional capacities of investment-
framework
related bodies taking into account the world-best
practices, ii) Enhance coordination between national
and local agencies in implementing after-care services
for investors.
Regional
Reduce trade barriers for cross-border trade and transit in
cooperation
the region and enhance cooperation within regional
groupings.
* ST: short-term, MT: medium-term
158
5.4.3 Recommendations for subregional and regional cooperation
Based on the findings and recommendations in this report a medium-term programme of
technical assistance for Central Asian countries can be proposed.
The main objective of the programme would be to promote economic cooperation among
the five Central Asian countries through cooperation in investment attraction and promotion.
Taking into account present needs of regional countries, as well as the low level of present
economic cooperation in the region, main modules of the programe would be:
•
Coordination of national investment strategies of host countries.
•
Removal of administrative barriers, improvement of business environment.
•
Liberalization of trade policies including gradual removal of tariff and
non-tariff barriers in the region, and establishment of free trade area.
•
Joint capacity building in specific investment promotion policies.
•
Joint coordination of investment policies of Central Asian countries with
possible creation of common investment area in the region.
UNECE, UNESCAP, UNCTAD, UNDP, ШВ, and USAID could be proposed as potential
donors. Taking into account that regional technical assistance programmes in the area of
trade and investment in Central Asia are planned and implemented by different donor
organizations, a strategic partnership would be developed with other technical assistance
providers to ensure synergy effects and tap the experience gained by other institutions in this
field.
5.5 Conclusion
A number of investors observe that in addition to their own due diligence concerning
investment prospects in EMCs, they often rely on information disseminated by the
international financial institutions (IFIs), including in the context of their routine
surveillance of countries and during policy discussions pertaining to economic programs
supported by the IMF and the World Bank. A number of investors, especially those engaged
in the infrastructure and utilities sectors, also noted that they work closely with the World
159
Bank Group, including the International Finance Corporation (IFC), Foreign Investment
Advisory Services (FIAS), and the Multilateral Investment Guarantee Agency (MIGA), in
securing financing for various projects in EMCs.
In the context of discussions with investors on how the IFIs could best help facilitate EMCs
secure a greater share of global FDI, a number of important areas for further work were
identified:
•
Encouraging sound macroeconomic policies that promote sustainable growth
and address macro vulnerabilities. Most investors appreciated the role of the
IMF and the World Bank surveillance and program support for country policies.
In particular, the IMF's lead role in assisting countries in near-crisis and crisis
situations provided a degree of comfort to FDI investors in maintaining and
continuing a presence in emerging market countries. Like themselves, they see the
IFIs as taking a longer-run view on country prospects. Many suggested that the
IMF and the World Bank should make even greater efforts to discuss with FDI
investors, especially including investors in the nonfinancial sector, risks and
vulnerabilities associated with doing business in emerging markets and would
welcome opportunities to gain a greater understanding of IMF stabilization and
reform policies in emerging markets.
•
Focusing greater attention on analyzing FDI and equity flows and their
impact on the real economy. A number of investors note that IFIs focus too
much on monitoring trends, risks, and vulnerabilities concerning debt flows, but
way too little on understanding equity flows and their impact on the real economy.
Most of the investors emphasize the importance of governments' understanding
the benefits of FDI much more clearly, so as to enhance their commitment to
promoting greater inflows and improving the investment climate.
•
Increasing understanding and monitoring of banking and capital market
support of FDI in EMCs. A number of investors underscore that banks and
capital markets play an important role in facilitating FDI in EMCs. They note that
IFIs could improve their surveillance of disruptions to this financing chain—
reflected by wider spreads and withdrawal of subsidiaries—and the associated
impact on the size and range of financing available for FDI.
160
•
Systematic and regular assessments of investment climate issues. Most
investors note that more regular and in-depth assessments of the investment
climate in EMCs— including in the context of the IMF's Article IV consultation
discussions and the World Bank's economic and sectoral work—could be useful in
enabling investors make informed judgments about investment opportunities and
associated risks. Investors emphasize that better focusing the policy dialogue with
member countries on issues relating to the investment regime—including the legal
and regulatory framework, business environment, and the tax system—will further
help the authorities appreciate the role of equity capital in promoting sustainable
growth and facilitate a prioritization of structural reforms. Some investors
underscore that regular assessments of investment climate issues will both
promote FDI in EMCs and help reduce vulnerabilities by facilitating better risk
management by foreign investors. Almost all investors, however, indicated their
lack of familiarity with the Investment Climate Assessments carried out by the
World Bank. While periodic assessments, such as those carried out by the World
Bank, are important, investors see an urgent need for routine follow up on changes
and improvements in the investment climate. Such follow-up could, among other
things, help the private sector assess investment prospects in EMCs and formulate
their medium-term FDI strategies. A number of investors noted that the regulatory
regime, while largely liberalized, should be further reformed—including by
eliminating requirements to form joint ventures, removing restrictions on FDI in
certain economic sectors, and relaxing limits on ownership and merger and
acquisition activity.
•
Further focus and assessments of latent risks. A number of investors emphasize
that recent crises have magnified latent risks of investing in EMCs. They stress the
need for IFIs to focus a lot more attention on addressing legal and regulatory risks
with a view to promoting sustained FDI inflows, particularly in the infrastructure
and utilities sector where upfront fixed costs are large. Many investors note that
some EMCs fail to secure large amounts of well-diversified FDI because of
regulatory, legal, and taxation-related impediments and risks. Other investors
report they are cutting back their investment plans in certain countries where they
are experiencing unexpected problems in the regulatory regime. These risks, they
note, are often magnified at times of a slump in economic activity or during crises.
161
Investors observe that efforts to resolve crises often compromise the sanctity of
contracts.
Investors thus underscore the need for the IFIs to place greater
emphasis on issues relating to the sanctity of contracts, especially in the context of
IMF-supported programs and World Bank lending.
•
Greater emphasis on developing local capital markets. A large number of
investors emphasize that developing a wider range of financing sources is an
important precondition for supporting robust FDI flows and underscore the need
for IFIs to place greater emphasis on developing local capital markets in EMCs. In
addition to enabling foreign investors ring-fence currency and credit risks,
investors see significant ancillary benefits to the development of local capital
markets. They argue that the existence of well-functioning local capital markets
would help to reinforce the types of legal and stable tax setting that are crucial for
businesses. Some note that the availability of such financing would help build
greater linkages between domestic enterprises and FDI investors, including
through a strengthening of supply chains and marketing networks. Investors also
note that allowing nonbank financial institutions, such as pension funds and
insurance companies, to participate in the provision of long-term financing to
foreign investors could also enhance the acceptance of foreign participation in
economic activity and facilitate a broader consensus on the role of FDI. In this
context, some investors have expressed their willingness to work with IFIs in
helping host-country authorities develop local financial markets, including
through pilot projects in selected EMCs.
•
Promoting infrastructure and local business development in EMCs and
adapting to changing demands of investors. Investors, especially those in
manufacturing, emphasize the importance of infrastructure and local supply chains
for investing and operating in EMCs. Many stress the need for IFIs, especially the
World Bank, to further promote and participate in infrastructure and local business
development projects. Some investors note that IFIs, articularly IFC and MIGA,
are often slow in addressing the needs of investors. As a result, they are less
inclined to use their services. In this context, investors urge IFIs to improve and
adapt their services to the changing demands of FDI investors. Citing their recent
experiences in Latin America, some investors also underscore the need for MIGA
162
to revise and expand its political risk coverage to reflect the exposure of FDI
investors to a wider variety of risks in EMCs.
•
More continuous dialogue with the private sector. A majority of investors want
the IMF and the World Bank to reach out to a broad spectrum of the private sector
through various initiatives. They view the Capital Market Consultative Group
(CMCG) Working Group on FDI Flows to EMCs as a useful model. As a group,
investors value a continuous dialogue between the IFIs and the private sector and
emphasize the need for established channels of contact at both ends to discuss
issues of common interest.
163
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Appendices
Appendix 1: Oil and Gas Joint Ventures in Kazakhstan
Company
Location
Agip
Chevron Mobil Oryx
FSU Partner:
Rosneft/
British Gas
Tengiz / Novorossiisk
Tengizmunaigaz/ LUKoil/
Kazakstan/ Oman/ Russia
Amloa
FSU Partner:
Kziyl-Orda Oblast
Kuatamlonmunaigaz
Tenge field on Caspian Sea
175 miles south Tengiz
Anglo-Dutch
FSU Partner:
Mangistaumunaigaz
BMB
FSU Partner:
Siemens
Aktyubinskneft/ Tulpar
Chevron
FSU Partner:
Mobil
Aktybinsk
Aktyubinskneft
EEG
FSU Partner:
RWE-DEA
Aktybinsk
Aktyubeneftegazgeologiya
Gender Resources
FSU Partner:
Akshabulak field, central
Kazakhstan
Yuzhkazneftegaz
Elf Aquitaine
FSU Partner:
Tengiz/Korolev fields
Tengizmunaigaz
De Cisar
FSU Partner:
250 miles NE Tengiz
NW Kazakhstan
Mangistau
Mangistaumunaigaz
189
Hurricane
Occidental
Kzyl Kiya, Kzyl Orda Oblast
FSU Partner:
Yuzhneftegaz/Yuzhkazgeologia
Hydrocarbon
Ronor
FSU Partner:
Kazakstanmunaigaz
E. of Atyrau
Kauzer
FSU Partner:
Tengizneftegaz
Aktyubinskneft NW Kazakhstan
Mobil
FSU Partner:
Poisk Tulpar
Oryx Energy
FSU Partner:
Zharkyn
near Mertvy Kultuk
Mangistaumunaigaz &
Zharkamys fields
Preussag
FSU Partner:
Tulpar/Aktyubinskneft
Snow Leopard
FSU Partner:
NW Kazakstan near Uralsk
Poisk Kazakgaz
TPAO
FSU Partner:
Aktyubinsk, Atyrau,
Mangystau oblasts
KazNIGRI/ Munaigaz
North of Atyrau
Urals Trading
FSU Partner:
Akhbota/ Atyrau refinery
Atyrau
Vegyepszer
FSU Partner:
Atyrau
Embamunaigaz/ Akhbota
190
Curriculum vitae
Vladimir Sukhoruchenko
birth. at 12.12.1974
Abulkhaiyr-Khan. Pr., 83-3
463011 Aktobe, Kazakhstan
Tel.: +7 (3132) 513344
E-mail: [email protected]
Education:
2001- 2007
Doctoral study at the University of St. Gallen
(Switzerland)
1996-1998
Master of the economy, Study at the University
Trier (Germany)
1992-1996
Diploma “Economist-Manager”, Study at the
Aktobe University named after K.Zhubanov
(Kazakhstan)
1982-1992
Experiense:
1999-2007
Middle school no. 4 in Aktobe (Kazakhstan)
Vice-Dean on the faculty of Economics at the
Aktobe University named after K.Zhubanov
(Kazakhstan)
1998-1999
Lector at the Aktobe University named after
K.Zhubanov (Kazakhstan)
191