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The Significance of Foreign Direct Investment to Caribbean Development By Ronnie Griffith1 and Kimberly Waithe Economic Affairs Division Research and Planning Unit Ministry of Finance, Economic Affairs and Energy and Roland Craigwell Department of Economics University of the West Indies Cave Hill Campus August 2008 1 Correspondence Address: Ronnie Griffith Senior Economist, Research and Planning Unit, Economic Affairs Division, Ministry of Finance, Economic Affairs and Energy, 3rd Floor Warrens Office Complex, Warrens, St. Michael Tel.# 310-1308. E-mail Address: [email protected]. The Significance of Foreign Direct Investment to Caribbean Development Ronnie Griffith, Kimberly Waithe and Roland Craigwell Abstract GET RID OF THESE LINES The paper analyses the significance of FDI inflows to the development of Caribbean countries, with a focus on the relationship between FDI and growth. In addition, it reviews some policy objectives, the potential costs and benefits as well as pertinent issues relative to FDI that would assist Caribbean territories in their search for sustained economic growth and development. Its main conclusion is that Caribbean countries must have adequate structures and policies implemented through competent public governance to act as a catalyst for attracting FDI inflows to their shores. However, once there is an increase in such capital inflows careful scrutiny of the source and origin must be practice for transparency and avoidance of any unethical incidences of money laundering, terrorist financing and drug trafficking. GET RID OF THESE LINES 2 Keywords: Foreign direct investment, economic development GET RID OF THESE LINES JEL classification: PUT IN THE JEL NO. Introduction GET RID OF THESE LINES Over the last two decades there has been phenomenal growth in Foreign Direct Investment (FDI)2 and trade globally, driven primarily by multinational (MNCs) and transnational corporations (TNCs). According to the SPELL OUT (UNCTAD)’s World Investment Report (2007), global FDI inflows amounted to $1,306 billion in 2006, rising more than 38% over the previous year and not too far from the record level of $1,411 billion reached in 2000. In addition, the stock of FDI worldwide totaled US$12 trillion in 2006. Such investment was used for the activities of 78,000 TNCs which owned 780,000 foreign affiliates. The sales, value added, and exports of these affiliates are estimated to have increased by 18%, 16% and 12% in 2006, respectively. In line with trends at the global level, FDI flows to the Caribbean have grown from US $1,290 million in 1995 to US $3,797 million in 2005. In absolute terms, such flows may appear small but are, nonetheless, quite substantial relative to the size of each island. Traditionally, these inflows were geared towards the primary sector; however, in recent times, the concentration has been in the tertiary sector, specifically, the services sector with a focus on tourism, telecommunications and finance industries (Craigwell, 2006). The greater portion of FDI flows to the Caribbean have been resource and efficiency seeking, since the most important factor for export-oriented FDI are resource endowments (Craigwell, 2006). Therefore, those countries that are rich in natural 2 Foreign direct investment is the principle type of foreign investment. It is the inflow of capital into and out of a particular sector of a country and signifies direct control of an enterprise by investors. This type of investment comprise (a) settler-type investment where the investor and his/her capital moves to a country, (b) “putting-out” investment where ownership and control resides abroad but without links to other enterprises and (c) the multinational corporation as an extension of the corporation into foreign countries (Meyer, 2003). 3 resources such as gold, bauxite, oil, petroleum, natural gas and alumina have attracted larger amounts of FDI. For example, Trinidad and Tobago, one of the resource-rich countries in the Caribbean, is among the major recipients of FDI. In addition, the growing importance of increased production at a minimum cost has been facilitated by the liberalization of foreign investment policy in virtually all countries including the Caribbean. In light of this, the region has adopted policies of gradual liberalization and deregulation which have attracted investment over the years. Strategies of TNCs to access strategic resources and the need to reduce production cost to be globally competitive have also contributed. Such TNCs have found themselves in Trinidad and Tobago for its petroleum oil and natural gas, Guyana for its gold, bauxite and timber and Jamaica for its bauxite and alumina. It is quite obvious that the governments throughout the Caribbean understand the necessity of FDI in the twenty-first century and have adopted different methods of attracting it to their shores. These developing countries seek to attract FDI by offering incentives such as tax holidays, import duty exemptions, market preferences, infrastructure and subsidies to firms with a view that there will be spillovers in technology, knowledge and managerial skills. Such strategies are aligned to the policies adopted by the East Asian Tigers or the newly industrialized countries (NICs) who recorded substantial rates of growth.3 However, growth in the Caribbean countries has not been as strong, prohibited by their small size, open dependence on more developed countries for financial assistance, openness to external shocks and the under-developed nature of the capital markets. Against the backdrop of the preceding discussion, the main objective of this paper is to assess policy issues with respect to FDI, focusing on the Barbadian economy. However, references would be made to Latin American and other Caribbean territories with a view to determine the strategies that developing countries need to adopt and implement in 3 For an in depth discussion on the East Asian Miracle, see World Bank (1993). 4 order to attract FDI to enhance growth and development. The Barbadian economy presents an interesting case since it is not resource-rich like Guyana and Trinidad and Tobago and its major sectors experience high costs of production. As such, its FDI inflows are smaller when compared to these latter territories. In addition, this issue is of current interest in the Barbados economy where the Democratic Labor Party’s (now the current Government) Manifesto of January 2008 highlighted that any government desirous of moving Barbados forward in the new international environment must seek to increase its foreign exchange earning capacity by attracting higher levels of investment. To achieve these above objectives the paper is structured as follows: following a brief introduction, section 2 provides the theoretical background for the paper, and focuses in particular on the relationship between FDI and growth. Section 3 reviews the appropriate policy objectives for FDI linking these to the current strategies in the Caribbean. Section 4 looks at pertinent issues in relation to FDI. Section 5 outlines some of the potential costs/benefits with respect to FDI. Section 6 provides a forward looking approach for the Caribbean. The final section concludes the paper. 2. Theoretical Review Increasingly, FDI is assuming a significant role in the development and growth strategies of developing and emerging market countries because of inadequate resources to finance development projects. While there is yet no consensus on the relationship between FDI and growth, there is a growing view that FDI is positively correlated with growth. Lewis (1954) was one of the first Caribbean economists to initiate the concept and importance of foreign investment to small developing economies. He contended that if there was a choice between foreign investment and domestic capital, the latter should be preferred, perhaps to protect the sovereignty of the nation. However, in the absence of domestic capital, Lewis argued that foreign investment, given its scarcity and competing claims for its use, should be encouraged and incentives provided such that the net results are favorable to the domestic economy and contribute to the development of the 5 entrepreneurial, management and administrative skills of the country, the relative lack of which has served as a constraint on development in the Caribbean. Proponents of FDI suggest that FDI ensures the efficient allocation of resources compared to other forms of capital inflows. Theoretically, this view has been buttressed by recent developments in growth theory which highlight the importance of improvements in technology, efficiency, and productivity in stimulating growth. In this regard, FDI contribution comes through its role as a medium of transferring advance technology from industrialized to the developing economies. For instance, Findlay (1978) postulates that FDI increases the rate of technical progress in the host country through a “contagion” effect for the more advanced technology and management practices used by foreign firms. In addition, it is argued that FDI enhances economic growth through technology spillover, creates employment, reduces dependence on accumulation of debt as a source of development financing and strengthens human capital and entrepreneur skills. Romer (1993, p.548) has lamented that by bringing new knowledge to their host countries, MNEs may help to reduce ‘idea gaps’ between developed and developing countries which are sources of growth. The hypothesis of FDI-led economic growth is based on the endogenous growth model, which states that foreign investment associated with other factors, such as domestic capital, human capital, exports, and technology transfer, have significant effects in driving economic growth (Borensztein, et al., 1995). These growth-driving determinants might be initiated and nurtured, so as to promote economic growth through FDI. To this extent, FDI may have a positive growth impact that is similar to domestic investment, along with partly alleviating balance-of-payment deficits on the current account. The prevailing economic experience of the East Asian countries, especially China and India, has further strengthened the conviction that FDI is a critical element in narrowing the resource gap and ensuring accelerated economic growth. Thus, in the face of their growth challenges, a number of countries are now pursuing domestic policies that are geared towards attracting more FDI. 6 While many highlight FDIs positive effects, others blame FDI for “crowding out” domestic investment and lowering certain regulatory standards. Agosin and Mayer (2000) states that the most immediate externality of an MNE entry on domestic enterprises in the industry of the entrant is negative as foreign entry erodes their market share.4 As such, the effects of FDI can sometimes barely be perceived, while other times they can be absolutely transformative. However, while the impact of FDI depends on many conditions, well-developed and implemented policies can help maximize its gains. To sum up, attracting FDI has become a key part of national development strategies for many countries. They see such investments as bolstering domestic capital, productivity, and employment, all of which are crucial to increasing economic growth. As such, FDI inflows are pertinent to the small economies of the Caribbean as a means of bolstering economic growth. 3. Appropriate Policy Objectives for FDI Policy instruments in the form of legislation related to economic, environmental and social policies are necessary to allow for incentives to attract FDI in the globalize economy of the twenty-first century. The aim of such policies is to create an enabling business environment to facilitate the growth and development of all businesses in the market. In addition, sound regulation of these policies is a prerequisite for them to work and achieve the required returns of investment. As a basic approach to regulation, host governments should create an incentive structure to encourage compliance with the spirit and letter of the laws. This is more productive than surrounding the business operations with rules that may or may not be the best way to achieve the goals envisioned. For instance, markets in polluted environments have proven to be an effective way to stimulate firms to find the most efficient ways to reduce pollution. 4 For an in depth discussion on the negative externality of an MNE entry, see also Markusen and Venables (1997). 7 The following five key policies are essential for attracting FDI: Human Capital For domestic human capital to utilize the knowledge, skills and technology transferred by foreign firms, a policy of developing domestic skills and knowledge is necessary to reap the full benefits. Such a policy relies on a good health and education structure, which are then interconnected with other commercial infrastructure that include energy, communications, transport and finance. The World Bank (1993) notes that the allocation of public expenditure between basic and higher education was and still is the major public policy factor that accounted for East Asia’s extraordinary performance with regard to the quantity of basic education provided. Table 1 shows the allocation of the education budget in 1985. The share of public expenditure on education allocated to basic education has been consistently higher in East Asian countries than elsewhere. By giving priority to expanding the primary and secondary bases of the educational pyramid, East Asian governments have stimulated the demand for higher education, while relying to a large extent on the private sector to satisfy that demand (World Bank, 1993). Table 1: Allocation of Education Budgets, 1985 Economy Public expenditure on education as a percent of GNP Hong Kong Indonesia Rep of Korea Malaysia Singapore Thailand 2.8 2.3 3.0 7.9 5.0 3.2 Pubic expenditure on basic education as a percent of GNP 1.9 2.0 2.5 5.9 3.2 2.6 Percent of education budget allocated to higher education 25.1 9.0 10.3 14.6 30.7 12.0 Percent of education budget allocated to basic education 69.3 89.0 83.9 74.9 64.6 81.3 Source: World Bank (1993) 8 In terms of human resources, Braveboy-Wagner et al. (1993) notes that educational achievement in the Caribbean is well above the average for countries at a similar level of development. These Caribbean countries attained universal primary education earlier, if not at the same time as the four East-Asian tigers5 and secondary school enrollment is above average for middle income countries. However, tertiary education is below that of the East Asian countries like Hong Kong and Singapore. The remarkable difference between the two groups was that in East Asia educational achievement has led to significant production growth unlike in the Caribbean. This is due to three important reasons: firstly, the ability to produce comes from employment, and in this regard, the Caribbean has been at a disadvantage since structural unemployment has been around 1013% (Rajapatirana, 2001). Rajapatirana (2001) further argues that the earlier implementation of inward-oriented trade policies as well as restrictions on FDI and work permits may have prevented increased access to both technical and management knowhow. Thirdly, the quality of education appears to have declined. Another important point to highlight is the impact of the brain drain on Caribbean territories. The region has recorded the highest emigration rates in the world (Docquier and Marfouk, 2005). Figure 1 shows that most Caribbean countries rank in the top 20 in the world in terms of skilled emigration rates (skilled are defined as those with 12 or more years of schooling). The migration rates by schooling are quite substantial. For example, 70 percent of the tertiary-educated labor force has migrated from the Caribbean to the Organization for Economic Co-operation and Development (OECD) member countries. Table 2 reveals the breakdown of emigrants from the Caribbean by their skills (education groups). It is observed that Guyana, Grenada, Jamaica, and St. Vincent and the Grenadines have the highest tertiary emigration rates in the region, followed by Haiti, Trinidad and Tobago, and St. Kitts and Nevis. 5 The four East Asian Tigers are Singapore, Taiwan, Hong Kong and South Korea. 9 An important cost that emigration imposes on source countries is the public expenditure on the education of migrants. This social cost is particularly high for the tertiary-educated migrants in developing countries like Barbados, Jamaica, and Trinidad and Tobago (Mishra, 2006). Table 2: Percent of Labor Force That Has Migrated to OECD Member Countries, 1965–2000 (By Level of Schooling) Primary Secondary Tertiary Antigua and Barbuda 9 64 67 Bahamas, The 3 10 61 18 28 63 7 58 65 19 67 64 6 33 22 Grenada 25 71 85 Guyana 18 43 89 3 30 84 Jamaica 16 35 85 St. Kitts and Nevis 32 42 78 St. Lucia 12 21 71 St. Vincent and the Grenadines 18 33 85 Suriname 39 74 48 8 22 79 15 42 70 Barbados Belize Dominica Dominican Republic Haiti Trinidad and Tobago Average Source: Docquier and Marfouk (2005) 10 Figure 1: Top 20 Countries in the World with the Highest Emigration Rate to the OECD Member Countries, 1970-2000 Source: Docquier and Marfouk (2005). Note: Educated labor force is defined as having 12 or more years of completed schooling. Openness to Trade Since the mid-1980s, many Caribbean countries have undertaken economic reforms aimed at increasing the openness of their economies to trade and investment. The liberalization of the FDI regime featured involved the removal of barriers to entry for foreign investors as well as extending national treatment and Most Favored Nation (MFN) status to foreign investors. For instance, in Jamaica, the Foreign Exchange Control Act, which imposed restrictions on capital outflows and prohibited foreign operators in certain industries and sectors, was revised in the 1980s, making the country more conducive to foreign investment. In recent times, FDI inflows have been prominent in the services sector. This has been buttressed by the General Agreement on Trade in Services (GATS) of the World Trade Organization (WTO). However, although many Caribbean countries have accepted commitments to liberalize their services sector, they still maintain numerous restrictions on market access and national treatment across services sectors and mode of supply (ECLAC, 2003). 11 Trade liberalization, especially through the Common External Tariff (CET), and privatization have also been vital in attracting export-oriented FDI. For example, FDI directed to the telecommunications sector in the region has been in response to the privatization and deregulation of that sector. Additionally, the establishment of trade and investment liberalization agreements between the Caribbean, other countries, and within the WTO framework has been a key determinant in attracting FDI inflows. For example, Caribbean countries have made several strides in organizing bilateral investment treaties with other countries along with establishing the CARICOM Single Market and Economy (CSME), which is expected to influence investment, especially intra-regional investment flows (ECLAC, 2003). Legal System In association with the policies discussed above there must be a reliable legal system to ensure that agreements and arrangements are honored. A reliable legal system promotes transparency with respect to the rules and the expected requirements of all investors. Transparency allows foreign firms to plan without being discriminated against by any political regime. Justification for discriminatory measures consists of an appeal to the need for consumer protection, national control over some sectors of the economy for policy reasons, and the familiar infant-industry argument. Transparent policies permit investors to move their capital freely in and out of the host country. If these policies are not evident then foreign firms will be reluctant to invest. Export Processing Zones Export processing zones (EPZs) are designated in the host country to attract investment by offering favoured treatment that include the absence of import controls, exemptions from domestic taxation, the provision of infrastructure and industrial regulations. The 12 establishment of EPZs requires substantial public investment by the host country. Economic activities within these zones are typified by labour intensive industries such as electronics assembly and garment manufacture (Warr, 1990). The objective behind establishing these zones is to raise foreign exchange earnings, increase employment and encourage the transfer of technology and management skills. There are also trade related investment measures or TRIMs that influence multinationals to invest in the host country. Many Caribbean countries have attracted TNCs through granting incentives to foreign affiliates in EPZs. Generally, incentives included the following: exemption from import licenses and custom duties on capital goods and raw materials and favourable labour legislation. Some of the countries that have been active in promoting FDI through EPZs are the Dominican Republic, Jamaica, Saint Lucia and Haiti (ECLAC, 2003). The Dominican Republic, in particular, has had more success with EPZs than the CARICOM countries. It is noteworthy that production in exports from EPZs has diminished in the early and mid-1990s when compared to its growth in the 1980s. Caribbean territories have also actively sought to attract FDI inflows by providing fiscal incentives to foreign investors. These have been used extensively in Belize, Barbados, Jamaica and the OECS countries. The latter group of countries provides the most generous fiscal incentives of all the CARICOM countries, probably compensating for the disadvantages linked with the small size of these territories (ECLAC, 2003). Good Governance Good governance is the door to all other policies. It reflects policies that epitomize a stable macroeconomic environment, which projects a confidence that allows investors to operate in relative certainty in developing financial markets. 13 The Caribbean has been known for its relatively stable economic climate. The Barbados economy, in particular, continued to perform well, expanding by 4.0% in the first-quarter of 2008, 1.4 percentage points above the rate of growth experienced in the corresponding period of 2007 (Central Bank of Barbados, 2008). Other fundamentals such as a fall in the unemployment rate are also evident. 4. Some Issues Related to FDI FDI does not only affect the economy it also impact on important social, political and environmental conditions. Therefore, in this chapter issues such as poverty, inflation, quality of life as it relates to health care systems and the environment, political systems and their ethical practices, capitalism, terrorism and money laundering are discussed in parallel with the desire to solicit FDI. Inflation High inflation negatively influences investment since it indicates the inability of the host government to balance its budget and the failure of the respective Central Banks to conduct appropriate monetary policy (Schneider and Frey, 1985), requirements necessary to sustain high economic growth and employment, price stability, and sustainable external accounts. If investors do not perceive a level of certainty with respect to returns on investment then they would feel that the risks are too high. For instance, if a high level of inflation due to mismanagement persists there could be an escalation of hardship on the citizens of a country that may result in social disturbances. In the Caribbean inflation rates have varied substantially, however, they have managed to remain moderately low. Even with inflationary pressures on these small economies, as a result of the steadily increasing oil prices since 2001, the Caribbean has been able to maintain its inflation rate within single digits in 2006 (see Figure 2). 14 Figure 2: Inflation Rates for Selected Caribbean Countries, 2001-2006 Bahamas 60.0 Barbados 40.0 30.0 20.0 Dominican Republic 10.0 Guyana 0.0 20 06 20 05 20 04 20 03 -20.0 Jamaica 20 02 -10.0 20 01 Annual Change (%) 50.0 St. Lucia -30.0 Period Trinidad and Tobago Source: Latin America and the Caribbean: Selected Economic and Social Data 2007 Health Care Systems The quality of life and the adequacy of health care systems are also issues that concern investors, who see these systems as components of their social development and of their associated personnel with whom they do business. These systems, therefore, must be reliable and of good quality. Political System The political system and the ethics of the host government must be hospitable to foreign capital in terms of property rights and civil liberties. Widespread government financial corruption imposes difficulty for the effective conduct of business. For instance, the East Asian economies have welcomed technology transfers in the form of licenses, capital goods imports and foreign training. Openness to direct foreign investment has influenced the speedy technology acquisition in Hong Kong and Singapore. However, FDI policies in the Caribbean such as those related to foreign ownership of firms, the right to buy land, the right to borrow locally and work permits, have been restrictive. 15 Capitalism Capitalism and the application of new innovations cause FDI to flow to new territories in search of new markets and new consumers. The drive to technical progress make capitalists search for cheaper sources of raw materials in distant countries. Money Laundering Money laundering and the threat of terrorism continued to be of serious concern worldwide and it is imperative that financial institutions implement measures to combat such crimes. Money laundering is any process used by criminals in an attempt to conceal the true origin and ownership of proceeds of criminal activities, for example drug trafficking. With the drive to attract FDI, developing countries can become conduits for money laundering, and for persons wishing to finance acts of terrorism through financial services. Money laundering comprised of three stages: (a) placement (b) layering (c) integration. Placement is the placing of “dirty money” or unlawful cash proceeds into the financial system via deposits, purchases of cheques and money orders. Layering is the separation of criminal proceeds from the source by the creation of layers of transactions designed to disguise the audit trail and provide the appearance of legitimacy. Some of these transactions include purchasing investment instruments, insurance contracts, wire transfers, money orders and letters of credit. Integration occurs when illicit funds enter the legitimate economy by way of investment in real estate, luxury assets and business ventures, until the laundered funds are eventually disbursed back to the criminals. It is the responsive duty of financial institutions to ensure that preventative measures are in place to reduce money laundering. In the case of Trinidad and Tobago, its Central Bank revised the 1995 Anti-Money Laundering Guidelines to prevent illegal money from losing its criminal identity and appearing to be legitimately acquired. Table 3 below shows statistics on money laundering activities related to commercial real estate within an international economy that is inclusive of the Caribbean. Real estate investment has 16 the highest percentage of total occurrences of money laundering, while mortgage investment has the lowest. Table 3: Money Laundering Activities related to Commercial Real Estate Entities potentially Reported Percent of total involved in money incidences occurrences Real estate investment 21 30.9 Property Management 20 29.4 Realtors 10 14.7 Individuals 7 103 Construction companies 6 8.8 Title 1 1.5 Mortgage 1 1.5 laundering Source: Financial Crime Enforcement Network (2006) Terrorist Financing Terrorist financing can be defined as the provision or collection of funds, either directly or indirectly, with the intention of them being utilized to undertake the unlawful use of force against persons or property to intimidate or coerce a government, the civilian population or any segment thereof, in the furtherance of political or social objectives (Levis, 1979). Therefore, financial institutions have to be very vigilant with respect to the financial services they offer, not to encourage or aid terrorist financing or suspicious transactions. Although these institutions may want to assist the flow of FDI they still have to exhibit proper evaluation of compliance with due diligence, risk management procedures, record keeping and reporting requirements. Table 4 below indicates some incidences of terrorist acts that occurred throughout the Caribbean between 1968 and 2006. As shown in the table, Barbados has 2 recorded instances of terrorist acts which are very low, relative to Haiti (23), Puerto Rico (21), Cuba (19), Jamaica (8), and Guyana (4). This is a good sign for encouraging FDI inflows into a host country. 17 Table 4: Incidences of Terrorist Acts 1968-2006 Country No. of Incidences Bahamas 2 Barbados 2 Guadeloupe 2 Guyana 4 Jamaica 8 Cuba 19 Haiti 23 Puerto Rico 21 Grenada 1 Trinidad and Tobago 1 Martinique 1 Source: Memorial Institute of the Prevention of Terrorism Knowledge Base (2006) Trade The link between FDI and trade in goods and services is of significant importance to economic growth and development. Early theoretical approaches to trade such as the Hecksher-Ohlin (HO) model examined the relationship between FDI and trade. The HO model purports that a country which is well-endowed with capital will produce and export capital-intensive products, while a country that is relatively well-endowed with labour will specialize in and export labour-intensive goods. Empirical evidence has confirmed that developed countries have been investing in developing countries’ industries in which they do not have a comparative advantage, especially labour-intensive activities, and this had resulted in increased two-way trade (ECLAC, 2003). In the Caribbean, FDI has contributed importantly to the evolution of value added and exports in the services sectors, through the heightened performance of services trade globally, the greater inclusion of services chapters in trade agreements and concomitantly, the region’s focus on the inclusion of a services regime in the CARICOM Single Market and Economy. Total export of services within CARICOM, including 18 government services, averaged $5.6 billion (11 percent) from 1992 to 2000 (ECLAC, 2003). This dynamism reflects rising specialization in the services sector from the traditional activities, such as tourism, banking, insurance and trading services, to electricity, telecommunications and distribution which have been influenced by active policies geared towards trade liberalization, privatization and deregulation. Foreign investors have been attracted to these latter areas because of the improved capacity for capturing economic rent and the increasingly favorable investor climate. FDI in the services sector (excluding offshore financial centers) for Latin America and the Caribbean has expanded by an estimated 8% in 2006. In Jamaica, services exports averaged US$1.52 billion between 1990 and 2000. The surplus on trade in services grew by 2.6% over the period. Tourism has remained one of the more dynamic sectors of the Jamaican economy. However, liberalization has attracted FDI in areas such as financial and telecommunication services. In the Dominican Republic, the majority of its FDI inflows have been directed to the services sector, especially transportation, storage and telecommunications, which accounted for approximately 40.2% of FDI during the period 1990 to 2000 (ECLAC, 2003). FDI has also fostered transformation in the services sector of economies such as Barbados and the OECS. 5. Benefits and Costs of FDI The importance of FDI in the economies of Caribbean countries is illustrated in Table 5, with inward flows growing from US$1,290 million in 1995 to US$3,797 million in 2005. The largest recipients have been Trinidad and Tobago, Dominican Republic and Jamaica. According to the Caribbean Trade and Investment Report (2000), CARICOM's performance in attracting FDI inflows can be considered to be well above average, given its relatively small population and national income, with several countries being ranked worldwide between 5 and 21 for FDI flows per US$1000 of gross domestic product (GDP) and between 10 and 29 for FDI flows per capita. This growth has been bolstered by the active policies of liberalization and deregulation, which have been embraced by virtually all the Caribbean territories. 19 Table 5: Inward foreign direct investment flows to the Caribbean (US $ millions) 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Anguilla 18 34 21 28 38 43 35 38 34 92 103 Antigua and Barbuda 33 23 24 27 64 67 112 80 179 91 129 Bahamas 107 88 210 166 149 250 102 153 190 274 360 Barbados 12 13 15 16 17 19 19 17 58 -12 159 Belize 21 17 12 19 54 23 60 24 -1 128 107 Dominica 55 19 22 9 19 20 18 18 30 25 27 Dominican Republic 414 97 421 700 1,338 953 1,079 917 613 758 899 Grenada 23 19 36 50 43 39 61 62 91 55 28 Guyana 74 93 52 44 46 67 56 44 26 30 77 Haiti -2 4 4 11 30 13 4 6 14 6 10 147 184 203 369 524 469 614 481 721 602 601 Montserrat 3 0 3 3 8 2 1 1 2 3 1 St. Kitts and Nevis 23 38 26 33 60 99 90 81 78 53 50 St. Lucia 35 21 51 86 87 58 63 57 112 … 112 Grenadines 31 43 93 89 57 38 21 34 55 66 34 Trinidad and Tobago 296 356 1,000 732 643 680 835 791 808 1,001 1,100 1,290 1,049 2,193 2,382 3,177 2,840 3,170 2,804 3,010 3,172 3,797 Jamaica St. Vincent and TOTAL Source: Latin America and the Caribbean, Selected Economic and Social Data 2007 UNCTAD’s Transnationality Index6 shows that in 2004 (the latest year for which the index was compiled), the importance of international production rose in most host economies (developed and developing as well as transition). The Caribbean, in particular, performed well with regards to this index, with Trinidad and Tobago, Jamaica, The Bahamas, Dominican Republic and Barbados ranking 3rd,6th,16th,19th and 28th respectively, among developing countries. In addition, the top 20 rankings of countries by UNCTAD’s Inward FDI Performance indices showed significant improvement in the 6 The transnationality index is based on the average of the share of FDI inflows as a percentage of gross fixed capital formation for the last three years; FDI inward stock as a percentage of GDP; value added of foreign affiliates as a percentage of GDP and employment of foreign affiliates as a percentage of total employment. 20 economies of The Bahamas and Guyana. In 2005, The Bahamas and Guyana ranked 21st and 32nd, however, in 2006, they moved up the index to 18th and 20th, respectively. Nonetheless, as noted in the Caribbean Trade and Investment Report (2000), these indicators highlighted the dependence on external resources to finance and sustain growth and development in the region. Such dependence should be carefully managed to prevent short-term fluctuations based on extra-regional economic developments from derailing the development process in member states. Barbados has a number of registered Real Estate Agencies from which data were sought to analyze the level of investment in condominiums and real estate (inclusive of land) over the last four years. In 2004, one local agency recorded direct investments in condominiums and real estate property by returning nationals and foreigners of $2.4 million (see Figure 3). Investments in this category increased over the next three years by 90.6%, 3.7% and 16.1% in 2005, 2006 and 2007, respectively (see Figure 4). It can be assumed that these increased investments were prompted by the required provision of additional accommodation leading up to the staging of the ICC Cricket World Cup in 2007. Furthermore, it is also evident that improved access to and ownership of properties in Barbados have been in the form of domestic and foreign investments in large concrete houses, hotels and condominiums that push up the value and resale prices of these properties and surrounding areas. Understandably, from an economic stand point, an injection of foreign currency through the sale of land to foreigners can only be of benefit to the economy. However, with these benefits also come some negatives in that, both on the south and west coasts, these parcels of land referred to as “windows to the sea” are sold at very high prices, at a time when there are increasingly turbulent external pressures on small economies such as Barbados. 21 Figure 3: Investment by Returning Nationals and Foreigners In Condominiums and Other Real Estate Properties In Barbados 2.5 2 1.5 1 Total Investment ($BDS millions) 0.5 0 2004 2005 2006 2007 Year Source: A Local Real Estate Agency 2008 Figure 4: Annual Percent Change in Investment by Returning Nationals in Condominiums and Other Real Estate Property in Barbados 16.1 3.7 2005 2006 2007 90.6 Source: A Local Real Estate Agency 2008 In order for a domestic economy to maximize the benefits and minimize the costs of FDI within a host country, there must be policies implemented to attract FDI. This would serve as a catalyst for the overall effect on macroeconomic growth inclusive of welfare enhancing processes. Developing countries, such as those in the Caribbean, also need to reach a certain level of development in education, technology, infrastructure and health care before being able to benefit from FDI presence in their market. Additionally, financial markets must be fairly well developed to allow the host countries to reap the full benefits of FDI. 22 Studies (World Bank, 1993) have shown that FDI triggers technology spillovers and contribute to factor productivity and income growth. FDI also assists in human capital formation, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise development. Positive contributions are also associated with the environmental and social conditions by transferring cleaner and more environmentally friendly technologies that lead to more socially responsible corporate policies. These benefits are very potent tools for alleviating poverty in developing countries. As a result of foreign firms transferring their knowledge and managerial skills to domestic firms, great benefits are derived. This allow firms to be more competitive in the globalize market with respect to being efficient and productive through the reduction of costs and development of new revenue generating activities. Technology transfer results in vertical linkages with suppliers or purchasers in the host country, horizontal linkages with competing and complimentary companies in the same industry, migration of skilled labour and the internalization of research and development. These foreign enterprises provide technical assistance, training and other information to raise the quality of the supplier’s products. They also assist local suppliers in purchasing raw materials, intermediate goods and modernizing or upgrading production facilities. Human capital is enhanced further through training and on-the-job learning to develop local entrepreneurs who acquired knowledge and skills from working with technological multinational enterprises. Competition, even although seen as a cost in terms of job losses and closures of businesses can also be seen as a motivator to higher productivity, lower prices and more efficient resource allocation. Environmental concerns are usually positive. Technologies are more modern and environmentally cleaner than local provision such that positive externalities have occurred where local imitation, employment turnover and supply chain requirements have led to improvements in the host country. Developing countries have also benefited from FDI with respect to reducing the level of poverty, especially in labor intensive 23 countries in adherence with the national labor law and internationally accepted labor standards. Studies (World Bank, 1993) have found a positive relationship between FDI and worker’s rights since investors have great concern for their own reputation. Under the “eclectic theory” there are additional benefits that can be exploited by the host country. Size and diversification, access to or control over raw materials, the ability to call on the political support of their government, access to finance on favorable terms in foreign as well as domestic markets, and the ease with which the foreign firm can shift production between countries are some of the ownership advantages. Location advantages encompass things such as transport costs facing both finished products and raw materials, import restrictions, the ease with which the firm can operate in another country, the profitability with which the ownership advantages can be combined with factor endowments in other countries, the tax policy in both source and host countries, and political stability in the host country. Internalization gains focuses on factors that allow more profitable transactions to be carried out within the firm than to rely on external markets. The essential element of the “eclectic theory” is that all three types of conditions are necessary, but no one is sufficient, in attracting foreign direct investment. Although there are some benefits to FDI there are also potential costs that are of an economic and non-economic nature. Conversely, some potential drawbacks occur in the deterioration of the balance of payments as profits are repatriated. Foreign firms may not develop positive linkages with local communities and may have harmful environmental emissions or disposals, especially in the extractive and heavy industries. Social disruptions of accelerated commercialization and competition to domestic firms may also result in closures and lost of jobs. With the influx of FDI, host countries must be careful not to perceive an increasing dependence on international firms as a loss to political sovereignty. Capital inflows to developing countries by way of foreign direct investment overshadow official development assistance by a wide margin, highlighting the importance of FDI as a tool for economic development. 24 6. A Forward Approach for the Caribbean in the Twenty-First Century The new Barbados government has stated its desire to move Barbados forward in the new international economic environment by increasing its foreign exchange earning capacity and thereby attract higher levels of investment. As the new government continues to chart Barbados’ path through the turbulent waters of the twenty-first century it recognizes that the rapidly changing global economic environment poses particular challenges to small economies. This situation begs the need for new domestic entrepreneurial and investment opportunities in traditional and new industrial, cultural and knowledge sectors. Proposals to avoid taxation policies that act as disincentives to investment and productivity in the January 2008 DLP Manifesto indicate an understanding of the importance and need for investment and greater productivity. In addition, other proposals alluded to the improvement in the prices of financial instruments and the enhancement of foreign exchange reserves by providing attractive investment instruments to keep capital at home and attract capital from abroad. One important point to note is that, the subregion has focused significantly on competing for a larger quantity of FDI through tax and other incentives, rather than on better quality FDI and infrastructure and institutional development to maximize the benefits of FDI. Instead of concentrating on offering generous tax incentives, countries in the sub-region should focus on building strong competitive systems and institutions to encourage FDI in high value-added activities. This would entail building comparative advantage in new dynamic activities based on a careful strategy for human capital development, partnerships between the private sector and training institutions and efficient public service and supplier service networks (ECLAC, 2003). This shift toward services, particularly information and communications services, tourism and financial services, as a result of liberalization and deregulation will continue to have increased benefits of FDI to developing countries. Foreign owned service companies can 25 be an important source of spillovers to the domestic business sectors, particularly compared to the often limited linkages between extractive industries and the host economies. Caribbean countries in the 1960s adopted dominant anti-trade policies by relying on import substitution as the major stimulus to growth. This development policy sought to repress imports and encourage domestic production of substitutes for those imports. However, this resulted in what is called the ‘double negative effect” where domestic producers pushed up the prices on locally produced products under the import substitution policy, thus deriving increased profits, and reduced the level of exports of countries pursuing import substitution. Reflecting on the policies used by the East Asian countries and the Caribbean in the 1960s, it is observed that they were fundamentally different. The Caribbean concentrated on import substitution policies while the East Asian countries emphasized export driven development. In addition, the East Asian countries successfully implemented additional policies that have eluded the Caribbean in relation to strategy implementation and intervention management. The economies of the East Asian countries have grown significantly through foreign direct investment over a short period of time. Contrary to this, income distribution, social conditions and environmental pollution have regressed. Caribbean countries must therefore learn from the experience of export industrialization promotion and industrialization by invitation as touted by Sir Arthur Lewis and practice by the East Asian Countries, coupled with policies to protect the social growth and development of the society as a whole. With new trading agreements and organizations that govern international trade such as the World Trade Organization (WTO) and the Free Trade Area of the Americas (FTAA) it is imperative that Caribbean countries integrate to resist the threats of globalization and to maximize the benefits and opportunities it can present. Hence, the Caribbean Single Market and Economy is seen as a strategy implementation to combat the threats of trade liberalization and globalization in the twenty-first century. Given the expected benefits of this integration process, the level of 26 foreign direct investment is bound to increase, thus, fuelling growth and development since the relevant structures would be in place and functioning. Conclusion The main objective of this paper was to assess policy issues with respect to FDI, focusing on the Barbadian economy. However, references were made to Latin American and other Caribbean territories with a view to determine the strategies that developing countries need to adopt and implement in order to attract FDI to enhance growth and development. The evidence indicated that although the Caribbean has a relatively high transnationalisation index (FDI/GDP ratio), FDI has not facilitated much dynamic structural change into high value-added production and trade. Generally, the benefits of FDI have fallen short of expectations. Systemic competitiveness has been constrained by limited knowledge transfer in high quality downstream segments of production and weak research and development spillovers. Burdensome terms of technology contracts created long-term dependence on foreign suppliers for technology, secrecy and proprietary clauses, including intellectual property rights, and prevented the use of the technology after the contracts expired. Moreover, as referred to by Krugman (1998), FDI which involves the transfer of ownership during a crisis, may not lead to competitive production, since the foreign corporation may not be taking control of domestic firms because of competence, but because they have the cash to buy them and locals do not. A major problem with FDI in the sub-region is that it tends to accentuate economic dualism. Whether it is investment in petroleum in Trinidad and Tobago, bauxite in Guyana and Jamaica, or tourism in The Bahamas, the nature of FDI coupled with the prevailing economic structure, limits the development of competitive linkages with the rest of the economy. The quality of institutions and supporting services must be made more effective and efficient to reduce transactions costs in the sub-regional economy. Government policy 27 should focus on eliminating and rationalizing the approval process where bottlenecks in investment, customs, and the legal and regulatory framework occur. Furthermore, Government policy should aim to obtain better terms and conditions from foreign investors where local requirements are utilized to ensure better use of domestic inputs. In addition, benchmarks for the transfer of technology and training of local managerial and technical staff should be adopted, as was done by the Asian NICs to facilitate the transfer of knowledge and skills in order to ensure that prospective local entrepreneurs learn the “tricks of the trade.” FDI inflows should also create a virtuous circle of higher wages, increased demand and a better quality workforce due to higher wages based on improved worker productivity. As a result of the research done on this very important topic it is quite evident that developing countries must have adequate structures and policies in place to act as a catalyst to attract FDI to their shores. It is also imperative that competent public governance is practiced for these policies and structures to be implemented, thus allowing the benefits derived to be maximized while minimizing the costs. Sound macroeconomic policies geared to sustain price stability, growth and development are essential in a globalize economy when there is an initiative to influence FDI. In addition to this, creating and maintaining effective support institutions such as investment promotion agencies that build country image and investment destination, marketing efforts are important as part of a strategic long-term process. Also, repatriated capital inflows as remittances by nationals of the Caribbean living overseas have contributed significantly to the growth and development of individual Caribbean territories and, therefore, must be encouraged to afford these territories a more developed future. Highly skilled and trained human capital structures and institutional capacity strengthening would assist in determining the level of FDI into the Caribbean. Although FDI is necessary for Caribbean countries to sustain and increase development growth, there must also be careful scrutiny of the source and origin of the capital inflows. Transparency of all movement of capital flows is essential to negate any unethical practices that may arise. Caribbean countries must be cognizant of the movement and 28 origin of the capital inflows to prevent the incidence of money laundering and terrorists financing that are usually linked to drug trafficking. These ills to society, if allowed to fester and multiply would destroy what little progress Caribbean countries have made in development over the years. Although these ills cannot be entirely eradicated from the operations within a country, no matter how many preventative measures are put in place, the responsible authorities must have structures and policies in place to control its escalation. Regressive societal elements such as corruption can result in social issues involving crime, health, educational and welfare dependencies that could reflect poverty cycles. Any substantial escalation of practices of this nature can cause severe social and economic problems for any country in the long run. The Caribbean Single Market and Economy provides greater impetus for capital inflows to the Caribbean, hence greater prudence and vigilance is necessary in the process of capitalizing on the opportunities that will arise from a liberalized global economy. Caribbean countries must show clearly that they have learned from the East Asian countries and not let another opportunity to enhance their development go to waste. 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