The impact of the global recession and financial crisis on FDI has been the immediate issue facing investment promotion agencies (IPAs) around the world. Now that FDI levels are slowly increasing again, IPAs are having to adapt to a rapidly changing and increasingly multipolar global economy, while at the same time deliver a strong return on investment and control budget expenditure.

Responding to changes in the global political economy requires a fundamental shift in the structure and activities of IPAs. What follows are five of the key challenges.

Greenfield and beyond

Attracting greenfield FDI has been the main activity of IPAs worldwide. The core focus on greenfield FDI is unlikely to change as it creates new jobs and expands output in the local economy, but IPAs have begun to examine if and how they should attract other types of FDI.

Mergers and acquisitions (M&As) have been the key driver of FDI flows. Most IPAs found it extremely difficult to promote M&As because of political and legal sensitivities, and also a lack of capability. But attitudes are beginning to change. In light of the recent economic recession, finding overseas buyers for struggling domestic companies has become essential to sustaining jobs and output. With economic recession, IPAs focused as much on protecting existing investment as attracting new investors, which increasingly involves bringing in foreign investors and capital from the rapidly growing emerging markets.

At the same time, whereas joint ventures, alliances and partnerships have for many years been a key globalisation strategy for companies, particularly those in technology industries or in emerging markets, IPAs have traditionally avoided promoting and facilitating them because of the uncertain and hard-to-quantify economic benefits. The global economic recession has put a heightened emphasis on such arrangements to enable companies to globalise, as it is a more cost-effective strategy and often a quicker route to access new markets and capabilities, compared to greenfield investment or M&As. Companies from developing countries, which are the fastest-growing source of FDI projects, are more likely to engage in joint ventures, alliances and partnership-type investments, as they lack the experience of international investment and knowledge of overseas markets, and so often look for a local partner to help their initial investment.

As IPAs recognise the benefits of M&As and other types of inward FDI, and struggle to attract the same volumes of greenfield FDI, more and more IPAs are grappling with the challenge of how to promote these types of investments.

One key shift in response to this challenge is a growing integration of trade and investment agencies. With the trade side responsible for the business expansion of domestic companies, and investment agencies attracting foreign investors, combining the two under one umbrella should, in principle, increase the capability of the agencies to promote and facilitate M&As and other types of investment – which is essentially a matchmaking process. By pooling market intelligence and overseas offices, significant cost savings should also be achieved, which is particularly important in today’s fiscal climate.

We are already seeing ambitious moves by some of the largest countries to combine trade and investment. One of the first major agencies to make this change was Scottish Development International (formerly Locate in Scotland), shortly followed by UK Trade & Investment (formerly Invest UK). In 2009, Germany announced it was bringing trade and investment under the same umbrella. Some agencies are now developing websites that explicitly or implicitly promote M&As and joint ventures, alliances and partnerships, and other agencies are building specialist units for this type of investment.

Much more research is needed on how best to bring trade and investment together, what the impact is on inward FDI results, and what the best practices are for promoting, facilitating, monitoring and evaluating the effectiveness in attracting M&As and other types of investment.

The emerging question

While most global crossborder investment still comes from large developed economies, growth is being fuelled by emerging markets. The evidence indicates they will rapidly become a major player in outward FDI.

Even though the FDI opportunity from emerging markets is still small relative to countries such as the US, UK, Germany and Japan, the structural changes in the world economy will rapidly change the sources of global investment. The fastest-growing supply of greenfield investment tends to be from developing countries. China (and India) will inevitably become major outward investors, and not just in terms of lower-level activities. China will likely become an intellectual property powerhouse. In the next few years, Chinese-based technology will start to make a global impact – Western companies are already being successfully sued for infringing on Chinese patents (The Economist, April 25-May 1, 2009). Intra-regional investment is also growing rapidly. For many IPAs from emerging markets, attracting investment from neighbouring and other emerging markets will become increasingly important.

As a result, IPAs from around the world are re-orienting their focus and service offer towards emerging markets. IPAs are establishing overseas offices in the major emerging markets, in particular China, where many IPAs from the West have multiple offices, but also in the other big emerging economies, such as India, Brazil and Turkey. Where resources and the current size of the opportunity do not justify an office, IPAs are recruiting consultants to conduct lead generation programmes.

However, attracting emerging market investment is not only about increasing resources for lead generation in these countries. Attracting their investment is often more challenging than encouraging inward FDI from the more transparent and private sector-driven developed countries.

First, the role of the government in business is typically much more pronounced in developing countries. To attract major companies to invest often requires high-level political access and negotiations. An IPA on its own may not have the political clout and will need to partner with government ministers and even heads of state to gain the required access and influence.

Second, emerging market companies are, in most cases, new to international investment. They require a much more consultative approach in terms of providing more detailed information on everything from market conditions, to how to invest and how to navigate the political system of the host country.

Third, business and personal networks are generally even more important in emerging economies than elsewhere. The business community is often closely connected to certain families or schools where the future industry leaders meet, and these networks continue into business life. The IPA needs to be able to tap into these networks; making the right recruitment is often critical for success.

Fourth, the indigenous technology sectors in emerging markets are largely embryonic, making it hard to identify the future investors.

IPAs face new challenges in trying to attract investment from emerging markets, and may need to employ a different set of capabilities and resources in order to succeed.

Focus on growth

In tough market conditions, it is essential that IPAs focus on high-growth sectors. Research by fDi Intelligence has identified some of the key sectors that will offer continued FDI growth, despite the global recession and financial crisis. Topping the list is environmental technology, which, with continued government funding, is experiencing rapid growth in FDI, in particular in wind and solar power-related areas. IPAs from Spain and Germany have successfully penetrated this sector, achieving very high levels of FDI. Government policies in both countries have strongly supported inward FDI, and Germany, for example, offers 50% capital investment grants in areas such as solar energy. Other sectors that are generally resilient to recession include healthcare, food and beverages, infrastructure and defence.

In a fast-changing market, IPAs around the world need to ensure they have the intelligence resources to be able to identify the new growth sectors and the key investors to target in these sectors. They also need to be able to influence government policy to incentivise investors to invest in these areas, as the examples of Spain and Germany in environmental technology show. During a recession, IPAs must forge joint strategies with other government departments to ensure government legislation and funding is aligned to supporting inward FDI in the growth sectors – or face losing investment to competitor locations. It will be a major challenge for IPAs to act quickly to change their historic sector-targeting strategies, to understand the new growth industries and influence government policy to support them.

A break with tradition

The growth of private equity and venture capital funds and, in particular, sovereign wealth funds (SWFs) is challenging the traditional remit and activities of IPAs. Some of the best lessons in how to attract this new type of investor come from emerging markets, in particular the Middle East, which has been most exposed to these new investors. The Jordan Investment Board, for example, recently developed a two-pronged strategy to encourage FDI. For attracting traditional investors (ie, corporate entities establishing productive greenfield operations under their ownership, management and control) the board has drawn up sector propositions outlining the comparative advantages of investing in Jordan. For enticing new types of investors, it took a very different approach and has identified and developed concrete business cases with financials for specific projects that SWFs and other private equity-type investors (including rich individuals) can invest in. These projects could include a construction venture investing in a local company, or establishing a new operation to meet a particular need or gap in the market. The IPA is seeking to attract foreign capital, rather than a subsidiary of a company, to invest in specific opportunities in the host country, significantly broadening the type of FDI IPAs target.

As SWFs become a more important source of global investment, IPAs from other regions of the world are expected to respond and adapt the way in which they promote their locations for FDI. This will be a major challenge for IPAs. They need to change their traditional marketing approach from one of selling location features and benefits to that of defining and promoting specific, profitable projects these funds can invest in. The IPAs that get this right could generate very significant volumes of inward capital flows for their location.

Diaspora drive

The diaspora has become a valuable source of inward capital flows, most pronounced in India and China, but also of critical importance in smaller economies such as Lebanon. However, specific investment promotions to attract diaspora investment have only recently been experimented with by IPAs. Examples include certain areas of France that have developed strategies for attracting successful French citizens back to the region, targeting French players in the technology industry who had migrated to California and London. IPAs from the UK have also started to look at this area, and the Scottish agency has developed a website to encourage Scots overseas to move back and establish local businesses.

The key challenges of developing a strategy to attract diaspora investment include: establishing a reliable database of diaspora from the location; facilitating conditions for inward investment by the diaspora, including incentives and soft support services, such as provision of contacts and matchmaking; and improving information provision to the diaspora through a website, newsletters or embassy contacts.

The next phase

Entering the second decade of the 21st century, IPAs are likely to have a significantly greater remit and international operations than is currently the case. They will increasingly be promoting FDI across different types of business entities and a wider range of source markets. They are likely to become more active in encouraging crossborder M&As, partnerships and capital investments, as well as traditional greenfield investment projects.

While previous transformations in investment promotion, such as aftercare, supplier development and the promotion of services, were led by a relatively small number of IPAs from the rich countries, the new shift toward boosting all types of investment, with a much greater emphasis on emerging markets, will be more widespread in initial adoption. Indeed, given their first-mover experience, IPA best practices in this new phase of investment promotion are likely to come from developing country IPAs as much as those from developed countries. As the marketplace and opportunities for FDI become more global, so will the competition.

This is an excerpt from Foreign Direct Investments from Emerging Markets: The Challenges Ahead, edited by Karl P Sauvant and Geraldine McAllister with Wolfgang A Maschek (New York: Palgrave Macmillan, 2010)