Download The Significance of Foreign Direct Investment to Caribbean

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
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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.
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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).
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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)
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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).
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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
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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. FDI
though seen as essential to the growth and development of Caribbean economies also
brings with it some issues that can be more costly if they are not managed properly.
Therefore, one can conclude that in every good thing there is some bad that needs to be
kept to a minimum in order to see the true benefits of that good thing.
The Caribbean Trade and Investment Report (2000), while applauding the regional
efforts, has however urged regional governments to be more pro-active towards
improving investment prospects, adding that as far as possible they should channel FDI
resources into developing appropriate regional production structures capable of
generating economic activity in accordance with the needs of the general community, and
focus specifically on fostering backward linkages within the domestic economy.
29
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