# **_I. Introduction_**

## **_a. Drivers of Foreign Direct Investment_**

In Rwanda, a foreign company can freely invest in any of the 32 sectors covered in the _Foreign Direct Investment (FDI) Regulations_ database with no limitations on foreign ownership. The foreign company can then establish its subsidiary in Kigali in a mere 5 days.<sup>2</sup> By contrast, an investor trying to enter the South African market will face equity restrictions in 11 of the 32 sectors covered by the database. Moreover, the process of establishing a foreign-owned company in South Africa is one of the longest in the region and it takes on average 57 days to complete (39 of which pertain to procedures imposed exclusively on foreign companies).

Anywhere in the world, a company deciding on where to establish its next subsidiary may be attracted by large markets, natural resources, or low input prices. Beyond these factors, however, an economy’s regulatory framework can also greatly affect the investment process. There is little a government can do about its economy’s size or natural resource endowment. It can, however, create a legal and regulatory environment that makes the economy more attractive to FDI.

The openness of sectors to foreign equity ownership is one of the relevant conditions for attracting foreign direct investment. In fact, those economies with greater degrees of liberalization currently show higher levels of foreign investment (World Bank Group, 2010). The benefits of opening up sectors include increased foreign presence, access to international markets, transfer of technology and knowhow, access to finance and increased competition between foreign and domestic providers alike (Duggan, et al 2013; Javorcik and Mattoo, 2011 and Paunov, 2012). There are still a number of reasons why economies wish to protect certain industries, including national security concerns and protecting infant and domestic industries from foreign competitors, among others. However, these goals can be reached through other regulatory initiatives that do not involve closing sectors off to foreign equity participation, particularly when such restrictions are extended indefinitely and unnecessarily. The point should also be made that liberalization of FDI (that is, the elimination of discriminatory treatment between nationals and foreigners) should not be confused with de-regulation of FDI. States can always retain their regulatory powers to pursue key public policy objectives, such as protecting the environment, health, and safety, preventing fraudulent practices or protecting the stability of the financial system. In order to achieve those goals, it is not necessary (or convenient) to discriminate between domestic and foreign investors. All investors should be subject to more transparent and simpler controls and regulations in order to increase efficiency and consumers’ rights.

A large body of research has addressed the question of what determines FDI flows. One framework views FDI as being market-driven (by economy size or location), efficiency-seeking (driven by human capital or infrastructure quality and costs), strategic-advantage seeking (acquisition of distribution channels or technology) or resource-seeking (driven by natural resources or other strategic assets). Numerous empirical studies have confirmed the importance of these factors (Blonigen and Piger 2011 and Hornberger et al 2011). The absence of foreign ownership restrictions as measured by the indicators is an important but insufficient condition for attracting FDI. Aside from openness to foreign ownership, other determinants of FDI include market size, infrastructure quality, cost factors, political stability, and economic growth, actual and potential. Other factors ranging from physical security to historic cultural ties have also been found to influence FDI, reflecting the wide range of FDI determinants. Restrictions on

> 2 The establishment process referred to in this example is based on a case study that sets out assumptions that the investment is done in the light manufacturing sector. Please refer to the complete set of assumptions in Box 1 below.

3