The message emerging from this paper is that FDI inflows benefit developing host countries in many ways. In particular, evidence on positive externalities associated with FDI suggests that policy intervention in the form of investment promotion may be warranted. But let us be very clear: we are not advocating tax breaks or subsidies for foreign investors because such policies are unlikely to be value for money[1]. Rather we are suggesting investment promotion efforts aimed at reducing the costs of FDI by providing information on business conditions and helping foreign investors deal with bureaucratic procedures. Such investment promotion activities include: advertising, investment seminars, participation in trade shows, direct marketing efforts, facilitating visits from prospective investors, matching prospective investors with local partners, helping investors obtain permits and approvals, preparing project proposals, conducting feasibility studies, and servicing investors whose projects have already become operational (see Box 1 for more details). Investment promotion stands out among industrial policies because it does not involve large outlays and does not introduce price distortions - the worst thing that can happen is that no FDI will come.
The evidence presented by Harding and Javorcik (2011) suggests that investment promotion is an effective way of attracting FDI to developing countries. To examine this question, the authors rely on the fact that the majority of investment promotion agencies (IPAs) target particular sectors in their efforts to attract FDI. Sector targeting is considered best practice by investment promotion professionals, as it is believed that more intense efforts concentrated on a few priority sectors are likely to lead to greater FDI inflows than less intense across-the-board attempts to attract FDI (Loewendahl 2001, Prokcsh 2004). If investment promotion is effective then one would expect to see priority sectors experience an increase in FDI inflows after targeting starts relative to non-priority sectors during the same time period. In other words, if investment promotion works, one would expect to see that countries receive relatively more FDI of the type they are actively pursuing.
Harding and Javorcik (2011) use detailed information on priority sectors and the timing of FDI targeting activities in 56 countries combined with data on US FDI flows, disaggregated by country and sector. Their analysis indicates that priority sectors receive more than twice as much FDI as non-priority sectors. While the magnitude of the effect may seem large, it is not implausible. Considering positive flows of US FDI to developing countries, the median sector-level flow was equal to $11 million in 2004. Thus, the estimated effect of investment promotion translates into an additional annual inflow of $17 million for the median sector-country combination. A quick look at the amounts that multinational corporations actually invest in developing countries reveals that FDI inflows of that magnitude are not uncommon. Importantly, these authors find that offering tax holidays or subsidies does not increase the effectiveness of investment promotion efforts.
Given that information provision and assistance with administrative requirements are crucial components of IPA activities, investment promotion should be more effective in settings where obtaining information and complying with bureaucratic requirements is more difficult. The findings of Harding and Javorcik (2011) confirm this view: investment promotion appears to be more effective in countries where English is not an official language and in countries which are more culturally distant from the US. Investment promotion also works better in countries with less effective governments, higher corruption, and a longer time period required to start a business or obtain a construction permit.
An effective investment promotion policy requires a high-quality IPA. Harding and Javorcik (2013) find a positive relationship between IPA performance and FDI inflows. The authors use data on 156 countries, collected by the World Bank’s Foreign Investment Advisory Services through the 2012 Global Investment Promotion Benchmarking (GIPB). GIPB data capture how well IPAs perform in facilitating site selection by providing potential investors with information needed to determine the location for their project. GIPB assesses two aspects of IPA facilitation. The first is the quality of the agency’s website, which is rated based on its content, architecture, design, and promotional effectiveness. Websites are judged on whether they contain relevant, clear, and credible information presented in an attractive and user-friendly way. The second rating focuses on the way IPAs handle direct project inquiries from investors. This rating, collected through a "mystery shopper" exercise, captures competence and responsiveness of the agency’s staff, including timeliness, quality, and credibility of informational content.
The results of GIPB 2012 reveal huge differences in the performance of various IPAs. As discussed by Harding and Javorcik (2013), the websites of only three IPAs have received close to perfect scores (95- 97%). While the top 50 websites received scores above 80%, 24 IPAs received a positive score below 30% and 13 agencies obtained a zero score (indicating no online presence). Websites also received low scores if they were not available in English, which is generally recognized as the language of international business. The quality of responses to project inquiries received much lower ratings. The top two scores were 81 and 88%. The vast majority of agencies received a rating below 50%, which means they are of limited assistance in providing the information that foreign investors need. In many cases, IPAs could not be contacted by the researcher posing as a foreign investor. Interestingly, IPAs with highly rated websites vary widely in how well they handle inquiries. There are quite a few agencies whose website obtained a score above 80% but received a score below 40% (or even 20%) for inquiry handling.
Harding and Javorcik (2013) find a positive and statistically significant relationship between the average inflow of FDI during the years 2000-10 and the average quality of the national IPA, controlling for the average level of GDP per capita, GDP growth, population size, inflation, and political stability of the host country during the period considered. The magnitude of the estimated effect is also economically meaningful: a country with the IPA quality score of 60% received on average 25% higher FDI inflows than a country with an IPA score of 45% (controlling for the country-specific characteristics mentioned above). In other words, a one unit increase in the GIPB score was associated with a 1.5% increase in FDI inflows. Thus, for example, holding everything else equal, countries with agencies with the average GIPB performance score of the Latin America and Caribbean region received 40% more FDI than countries where the GIPB score was the average for Sub-Saharan Africa. These conclusions are robust to focusing just on developing countries, controlling for various aspects of the business climate, or instrumenting for the IPA quality.
In summary, investment promotion (excluding fiscal incentives) may be a cheap and effective way of encouraging knowledge inflows. However, successful investment promotion requires professionalism, effort, and commitment to customer service. It requires maintaining an up-to-date, attractive, and user-friendly website that includes relevant and useful information for an investor’s site selection process. Providing the necessary data to support this decision process makes a huge difference.
Box 1. How inward investment promotion worksInvestment promotion can affect the choice of foreign investment site at all stages of the decisionmaking process. The process of site selection usually starts with drawing a long list of potential host countries (typically 8 to 20), which can be classified into three groups: (i) the most popular FDI destinations worldwide, (ii) countries close to the investor’s existing operations, and (iii) emerging FDI destinations (non-conventional destinations that the investor may not be initially very serious about). The third category presents an opportunity for IPAs to increase their chances of being listed via advertising, trade shows, or pro-actively contacting potential investors. The long list is then narrowed down to about 5 potential sites based on the trade-off between costs and the quality of business environment. As shortlisting is usually done without visiting the sites under consideration, the information accessibility about potential host countries plays a crucial role. IPAs can increase the chances of their countries being shortlisted by providing up-to-date, detailed, and accurate data on their websites, and preparing detailed answers to investors’ inquiries. The next step in the process, the investor’s visit to the host country, gives IPAs the opportunity to emphasize the advantages of locating in their country, show off potential investment sites, and facilitate contact with the local business community. IPAs can also play a role in the final stage of the process by providing information on investment incentives and offering help with the registration process.Source: Harding and Javorcik (2011).
[1] For instance, Haskel, Pereira, and Slaughter (2007) examine within-sector productivity spillovers associated with FDI using data from the UK and conclude that the value of these spillovers per job created by foreign investors was equal to about 2,400 USD in 2000 prices (4,300 USD). This is a much smaller amount than what is typically offered to attract foreign investment, which suggests that it is quite easy to overpay when extending fiscal incentives to foreign investors.
