WORLD TRADE WT/LDC/HL/5
13October 1997
ORGANIZATION(97-4380)
Original: English High-Level Meeting onIntegrated Initiatives for
Least-Developed Countries 'Trade Development
THEMATIC ROUND TABLE: THEME B
ENCOURAGING INVESTMENT INLEAST-DEVELOPED COUNTRIES
Note prepared bytheUNCTAD Secretariat
INTRODUCTION
1. Thereisawideconsensusamongpolicy-makersinleastdevelopedcountries(LDCs),international
development agencies andthedonor community ontheneedtopromote bothforeign investment and
private investment ingeneral inLDCs. Theprivate sector isviewed asbeing bothmore dynamic and
(incompetitive markets) amore efficient userofscarce resources thanthepublic sector. Itcanalso
mobilise finance, andother scarce resources, notavailable tothepublic sector. Foreign investment
inparticular canenhance access toscarce managerial skills, technology andmarketing channels, and
therebyprovideanimportantchannelforraisingoutput,productivityandexports(EconomicCommission
forAfrica, 1996, p.1).
2. Many LDCs haveattempted toimprove thebusiness climate forforeign anddomestic private
investmentbyimplementingbroad-basedeconomicreforms,liberalisingmarketsandimprovingincentives
forinvestors. Despite thesereforms, foreign direct investment (FDI), otherforms offoreign investment
(such asportfolio investment) anddomestic private sector investment remain atverylowlevels inmost
LDCs. Thispaper examines whyforeign investment hasremained depressed inLDCs, evaluates policy
options forboosting foreign investment, andmakes recommendations forpolicy reforms andassociated
technical assistance programmes. Itargues thattheexisting thrust towards liberal economic policies
should becontinued, thatpolicy should bebroadly neutral between domestic andforeign investors,
asthetwosetsofinvestors havethepotential tocomplement eachother, andthatarange ofpolicy
initiatives,supportedbydonors,tostrengthentheinstitutionalbaseinLDCsforpromotingandsupporting
private investment should beundertaken.
I. CURRENT LEVELS AND TRENDS INFOREIGN AND DOMESTIC PRIVATE
INVESTMENT INLDCs
3. FDIinflows toall48LDCs averaged $1.44 billion perannum during 1991-1996. Thisamounted
toonlyslightly more than1percentofthecombined GDP oftheLDCs, andonly1.1percentof
thetotalinflows ofFDItoalldeveloping countries.1Nevertheless FDIflows toLDCs haveincreased
during the1990s, albeit fromaverylowbase: inflows incurrent dollars during 1991-1996 werealmost
160percenthigher thanduring 1985-1990. Among LDCs, themajor recipients ofFDIin1996were
Angola andCambodia, which bothattracted around $300 million, andUganda, United Republic of
Tanzania, Yemen, LaoPeople 'sDemocratic Republic andMyanmar, which eachreceived between
$100millionand$200million(UNCTAD,1997,pp.303-307).Comprehensivedataonformsofforeign
1FDIinflows toalldeveloping countries amounted to1.8percentoftheir combined GDP.WT/LDC/HL/5
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investment other thanFDI(e.g.portfolio investment) inLDCs arenotavailable, butitislikely that
thelevels were negligible.
II. IMPEDIMENTS TOFOREIGN INVESTMENT
4. Many oftheLDCs haveimplemented policy reforms toimprove theinvestment climate for
theprivate sector since the1980s. Policy reforms include liberalisation ofexternal trade, foreign
exchange andfinancial markets, removal ofrestrictions onforeign investment, privatisation ofstate-
owned enterprises, andtheenactment ofliberal investment codes providing, interalia,investors with
guarantees against expropriation, fiscal incentives andrationalised approval procedures. These policy
reforms havenotyetstimulated amajor expansion inthelevelofforeign investment inLDCs, although,
asnoted above, there wasariseduring the1990s from averylowbase.
5. Foreign investment hasremained depressed inLDCs forseveral reasons. First, profitable
investment opportunities, outside oilandminerals, areverylimited because ofthesmall sizeofdomestic
economies andavariety ofsupply-side constraints oncompetitive export production, suchaspoor
infrastructure andlackoftechnical skills intheworkforce.
6. Second, theimplementation ofreforms hasbeeninconsistent oronlypartial insome countries:
forexample, some important restrictions onforeign investment remain inplace, investment applications
entail bureaucratic procedures, privatisation hasbeenslowtogetofftheground, andthemacroeconomic
environment isstillverydifficult, withhighinflation, largegovernment deficits, andsluggish growth
rates.
7. Third,manyLDCslackanadequateinstitutionalframeworkforprivateinvestment:forexample,
thelegalframeworkrequiredtoenforcefinancialcontractsisoftenweak,whichimpedesthemobilisation
offinance bytheprivate sector.
8. Fourth, many LDCs areperceived asbeing high-risk locations forinvestment, because of
economic andpolitical instability, thelegacy ofpastpolicies whose consequences wereoftendetrimental
totheprivate sector, and,especially inAfrica, thefearthatevenpeaceful countries might infuture
beaffected bythetypeofinternal conflicts which afflict many countries intheregion. These factors
haveimpeded domestic private investment aswellasforeign investment. Theweakness ofthedomestic
private sector itself hasserved todeter foreign investment.
III. POLICIES TOENHANCE INFLOWS OFFDI
9. IfLDCs aretoattract significant levels offoreign investment, arange ofpolicy reforms will
beneeded. Policy reforms should aimtostimulate bothforeign anddomestic private investment, as
there arelikely tobeimportant complementarities between thetwo(Lall, 1997). Investments often
havepositive externalities: onefirm'sinvestment canprovide amarket fortheoutput ofananother
firmorcanprovide itwith production inputs. Aflourishing domestic private sector provides
opportunities forforeign portfolio investment. Inaddition, foreign companies arereluctant toinvest
incountries where thedomestic private sector itselfisunwilling toinvest, asthissends negative signals
about theattractiveness ofthebusiness climate. Policies which benefit domestic private investment
aretherefore alsolikely tostimulate foreign investment.
10. Probably thesingle mostimportant prerequisite forboosting private investment istosustain
robust economic growth ratesoveraprolonged period. Most empirical work onthedeterminants of
private investment indicates thatthemaindeterminant, attheaggregate level, isgrowth inoutput, oftenWT/LDC/HL/5
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referred toastheaccelerator theory ofinvestment (Greene andVillanueva, 1991; Oshikoya, 1994).
Growth-enhancing policies willinclude, interalia,lowinflation, lowfiscal deficits andcompetitive
exchange rates, anopentradepolicy withminimum barriers toimports, theavoidance ofpolicy-induced
distortions, restrictions anddisincentives toproduction (especially inagriculture andtheexport sectors),
andincreasedpublicsavingsmobilisation(Hadjimichaeletal,1996;Goldsbroughetal,1996).Sustaining
economic growth inLDCs willalsorequire enhanced financial support fromdonors, inparticular to
enable countries tomaintain expenditure andimport levels inthefaceofnegative external shocks.
IV. REGIONAL INTEGRATION
11. Given theverysmall sizeofmost LDCs 'domestic markets, enhancing regional integration
among LDCs andtheirnon-LDC neighbours would greatly expand therange ofprofitable opportunities
available forinvestors, allowing themtorealise economies ofscalewhich would notbepossible were
theytoproduce onlyforasingle country market. Anumber ofregional trading arrangements involve
LDCs(e.g.ECOWAS,SADCC),butbothinstitutionalandphysicalbarriersimpedetradeflowsbetween
themembersofthesegroupings.Effectiveregionaleconomicintegrationrequiresthefullimplementation
ofregional accords todismantle non-tariff barriers andreduce tariffs between members, tointroduce
more efficient customs procedures atborders, andtoimprove thetransport infrastructure. Inaddition,
regionalagreementscanimproveconditionsforforeigninvestmentbyharmonisinginvestmentregulations
between different member countries.
V. REDUCING THE RISKS OFINVESTMENT
12. There hasbeenagrowing awareness among academic economists ofthesensitivity ofprivate
investment decisions toriskanduncertainty (Rodrik, 1991). Tocompensate forrisk,investors will
demand much higher expected rates ofreturn, andmany feasible investment projects willnotbe
undertaken inarisky business environment. Theriskpremiums demanded byinvestors arelikely to
besohighinmany cases thatGovernments cannot easily offset theirimpact byoffering investment
incentives suchasfiscal concessions. What isneeded isthecreation ofabusiness environment inwhich
avoidable risksareminimised.
13. Many business risksareoutside thecontrol ofpolicy-makers (such astheterms oftrade), but
there aresome strategies which Governments canadopt toreduce risksforinvestors. These include
pursuing macroeconomic stability, preventing keyprices, suchasinterest ratesandexchange rates,
frombecoming seriously misaligned (which would create theriskofsharp corrections inthefuture),
andtheavoiding frequent changes inpolicies, andinparticular policy reversals.
14. Risks canalsobereduced through theenactment ofappropriate regulations. Investment codes
which provide guarantees against expropriation, guaranteed rights torepatriate profits, etc,cangive
foreign investors some degree ofassurance against future changes inpolicy which would bedetrimental
totheirinterests (seebelow).
VI. INVESTMENT INSURANCE
15. Toenhance theircredibility, LDCs should aimtojoinmultilateral bodies which offerinvestors
insurance against certain types ofriskandtoenterbilateral investment agreements withpotential source
countries forforeign investment. Inaddition, multilateral andbilateral investment insurance agencies
should beprepared toofferconcessional insurance ratestoinvestors inLDCs inorder toencourageWT/LDC/HL/5
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investment inthese countries, provided thattheLDC Governments meetcertain criteria withregard
topolicy andlegislation.
VII. REGULATORY ISSUES AND INVESTMENT INCENTIVES
16. Business confidence canbeenhanced bytheenactment ofaregime ofinvestment regulations
which istransparent, doesnotdiscriminate against foreign investors orparticular categories ofinvestors,
doesnotimpose restrictions onlegitimate business activities, isadministratively simple andminimizes
thescopeforarbitraryapplicationbypublicofficials.Liberalrulesonprofitrepatriation,capitaloutflows
andtheservicing ofexternal debtareessential toattract foreign investment. Foreign investment,
however, doesnotnecessarily require generous fiscal concessions (e.g. taxholidays, accelerated
depreciation allowances, dutyexemptions). There islittleevidence thatfiscal incentives achieve their
objectives ofpromoting investment inthetargeted sectors, while thenegative affects ofselective fiscal
incentives arewellestablished: these include thedistortion ofincentives between different sectors
oftheeconomy andbetween theuseofdifferent assets, often incomplex andunpredictable ways, and
thelossoftaxrevenue. Afiscal policy comprising uniform butrelatively lowcorporate taxrateswith
aminimum ofexemptions andconcessions would provide aconducive fiscal regime forforeign investors
without jeopardising government revenue. Regional co-operation isneeded toensure thatLDCs do
notcompetewitheachothertoofferincreasinglygenerousconcessionstoforeigninvestorsattheexpense
oftheirtaxpayers (Lall, 1997, p.21).
VIII. FINANCIAL MARKET DEVELOPMENT AND REGULATION
17. Thedepth andefficiency ofdomestic financial markets areimportant factors inattracting foreign
investors. Portfolio investment isclearly dependent upondomestic capital markets, while mostdirect
foreign investors willusethedomestic banking system andsome mayneedtoraisefinance ondomestic
capital markets. Foreign investors needliquid markets, adiversity ofinstruments, andasound banking
system. Theroleofpolicy willmainly betoensure thattheappropriate institutional structures and
regulations areputinplace. Ifdomestic stock markets aretoattract foreign capital, liberalised entry
andexitregulations, including theability torepatriate capital, good-quality information onlisted
companies, transparent andrigorous application ofrulestoprevent fraud andotherabuses, andefficient
trading andsettlement procedures arenecessary (Economic Commission forAfrica, 1996, pp.17-18).
IX. INVESTMENT PROMOTION
18. With strong competition from countries throughout theworld toattract foreign investment,
LDC Governments needtogreatly improve themarketing oftheircountries assuitable locations for
foreign investment, withinvestment promotion agencies inLDCs taking amore proactive marketing
andpromotional role. Promotional strategies should gobeyond general marketing (e.g.attradefairs)
toselective targeting ofpotential foreign investors. Investment promotion agencies inLDCs should
identify themainstrengths oftheirowncountries aslocations forforeign investment, andthentarget
specific foreign investors which aremostlikely tobeattracted bythesestrengths. Thestrategies adopted
bysomeofthemostsuccessfulinvestmentpromotionagenciesintheworld(e.g.theMalaysianIndustrial
Development Agency) provide potentially important lessons forLDCs (Tillet, 1996). Aswithmany
other components oftheinstitutional structure inLDCs, however, investment promotion agencies face
severe constraints interms ofhuman andfinancial resources.WT/LDC/HL/5
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X. RECOMMENDATIONS,INCLUDINGELEMENTSOFINTERNATIONALBESTPRACTICE
INATTRACTING FOREIGN INVESTMENT TOLDCs
19. Thefollowing summarises therecommendations forpolicy reforms andtechnical assistance
programmes tostrengthen theinstitutional, policy andlegislative frameworks forforeign investment
inLDCs.
(i) LDCs should establish clear, straightforward, administratively simple and"investor friendly"
investment codes. These should notdiscriminate between different categories ofinvestors
(e.g.foreign anddomestic), should minimize government interference inlegitimate business
decisions andprovide asetofbasicguarantees toinvestors inrespect ofproperty rights, foreign
exchangetransactions,etc.Donorsandinternationalagenciesshouldprovidetechnicalassistance
where necessary.
(ii) LDCs should enactcomprehensive legislation andestablish supervisory frameworks forcapital,
money andbanking markets. Theregulatory framework should focus onprudential rather
thaneconomic regulation; i.e.promoting prudent management offunds, proper accounting
standards, transparency infinancial transactions, prevention offraud andinsider abuses, and
competition infinancial markets. Technical assistance tostrengthen financial system regulation
andsupervision willbeneeded. International agencies should assist LDCs without national
stockexchanges toundertake research ontheviability ofestablishing theirownstockexchanges,
oralternatively ofestablishing exchanges onaregional basisorjoining analready established
stock exchange intheregion.
(iii) LDCs should setupinvestment promotion agencies (IPAs), adopting the"best practices" of
successful IPAs around theworld, toformulate investment promotion strategies, market the
country asaninvestment location, andtarget specific foreign investors. International agencies
suchasUNCTAD, UNIDO, MIGA andtheWorld Association ofInvestment Promotion
Agencies (WAIPA), should collaborate tofacilitate theexchange ofnational experiences in
investment promotion andtoencourage theadoption of"best practices" byLDCs.
(iv) LDCs should seektostrengthen regional integration inorder toexpand thesizeofthepotential
market available toforeign investors. Thisshould entail thefullimplementation ofexisting
agreements toremove trade barriers among neighbouring countries andfurther liberalisation
oftrade andinvestment within regional groupings.
(v) LDCs should provide allinvestors withlowbutuniform taxrateswithaminimum ofselective
taxexemptionsandconcessionsandotherincentives.LDCsshouldseektoharmoniseinvestment
incentives within theregional groupings ofwhich theyaremembers inorder toavoid pressure
tocompete against theirneighbours byoffering generous fiscal incentives. LDCs should sign
"double taxation" agreements withallcountries fromwhich foreign investors arelikely tobe
based. Donors andinternational agencies should provide technical assistance toLDCs toassist
them toevaluate andrationalise investment incentive schemes.
(vi) Donors andinternational agencies should provide comprehensive capacity building programmes
fortheagencies within LDCs responsible forinvestment promotion andregulation andfor
financial system development andregulation. Capacity-building should include training of
staff, study visits tomore established IPAs, stock exchanges, regulatory bodies, etc,and
provision oftechnical advisors.WT/LDC/HL/5
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(vii) Multilateral andbilateral investment insurance should beextended toforeign investors inLDCs
atpreferentialrates,providedthatLDCGovernmentsmeetspecifiedminimumconditionsrelated
tothepolicy andlegislative framework.
(viii) Donors andinternational agencies should establish programmes toenhance thetechnical and
managerial skills ofdomestic private sector investors; e.g.bystrengthening technical training
institutions andproviding technical assistance totrainkeypersonnel indomestic firms.WT/LDC/HL/5
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Monetary Fund.
Greene, Joshua, andDelano Villanueva, (1991), "Private Investment inDeveloping Countries", IMF
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Hadjimichael, Michael etal(1996), "Adjustment forGrowth: TheAfrican Experience", Occasional
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