FDI takes place because the interests of the three principal parties involved in the investment process overlap: multinational enterprises (MNEs) undertake investments abroad because they seek to strengthen their international competitiveness by establishing a portfolio of locational assets; host countries permit incoming FDI and even facilitate it because they expect it to advance their economic development; and home countries allow (and even facilitate) outward FDI by their firms because they expect to benefit from successful firms being headquartered in their territories. It follows that, if one of the parties is no longer satisfied with the manner in which its interests are being met, they will change their policies toward FDI.

This article looks at this issue from the perspective of host countries. Its premise is that, if host countries do not benefit sufficiently from incoming FDI, they will – at least over the longer run – not encourage it and, ultimately, even pursue policies that restrict it. 

Advertisement

To be sure, so far changes in host country policies are still mostly in the direction of making the investment climate more welcoming for foreign investors. But there are signs that this is changing. Unctad’s World Investment Report 2021 reports that, in 2020, the proportion of more restrictive or more regulatory new policy changes implemented in 67 countries was the highest since 2003. At the same time, governments put more emphasis on facilitating not only more FDI, but more sustainable FDI, i.e. investments that, while being commercially viable, involve best efforts toward making a reasonable contribution to the economic, social and environmental development of host countries, and take place in the context of fair governance mechanisms. This suggests that host countries are no longer fully satisfied with the current distribution of benefits associated with FDI. This, in turn, should be of concern to all parties involved in the investment process and interested in an open investment regulatory framework.

There are of course many areas in which adjustments in the distribution of benefits can be made to ensure that the interests of the three principal parties in the investment process are met in a satisfactory manner. It is in fact a process that is already underway, as reflected in the agreement on the reform of the international tax system reached just this year. 

This article outlines, by way of example, three concrete policy areas for which it should be relatively easy to enhance the distribution of benefits associated with FDI in favour of host countries, without deterring foreign investors or, for that matter, antagonising home countries, to arrive at a new equilibrium in the distribution of benefits associated with FDI that is satisfactory for all. These three policy areas are:

• for foreign investors, helped by host countries, to create stronger linkages between their foreign affiliates and domestic firms in host countries, to make the former less dependent on potentially vulnerable supply chains while strengthening the domestic enterprise sector of host countries;

• for home countries to support host countries, through the provision of independent assistance, in the negotiation of contracts between host country government entities and foreign investors, to arrive at mutually satisfactory, and hence more stable, contracts; and 

• for host and home countries to work together on a multilateral investment facilitation framework, to encourage not only more FDI but more sustainable FDI. 

Investment promotion agencies (IPAs) have a role to play in each of these policy areas.

Fostering linkages

Backward linkages between foreign affiliates and domestic firms are one of the most effective avenues through which domestic firms can benefit from the tangible and intangible assets of foreign affiliates. A few countries have established linkage programmes through which governments support the upgrading of domestic firms to make them ‘linkage-ready’, i.e. help them reach the standards that international investors expect from their suppliers to supply them with the quantity and quality of goods and services they need. Strengthening and deepening linkages is a win-win proposition for foreign investors and host countries. 

The issue then becomes: how can one encourage the creation and deepening of linkages? For instance, establishing ‘Linkage Forums’ in host countries that bring together various stakeholders in public dialogues on linkage creation and deepening would be a good starting point. Governments can build and maintain databases of local enterprises to help investors identify potential subcontractors and ensure that enterprises in the databases are linkage-ready through a certification step, so that the databases are trusted and used. Special incentives could be given to foreign affiliates seeking to enhance their sustainability characteristics. IPAs in developed countries (which increasingly also support outward FDI) could assist IPAs in developing countries in developing linkage programmes, with funds made available in the context of official development assistance, to help their own outward investors. 

There are many other actions host countries can take to help foreign affiliates source locally and, in the process, advance the development of their economies.  

Supporting contract negotiations

Investment contracts between host country governments and foreign investors typically govern the exploration and exploitation of minerals and oil, the development of infrastructure and the acquisition of agricultural land. Such contracts are necessary, as natural resources are generally owned by the state, and infrastructure often requires the taking of land or the granting of monopolies. As the demand for raw materials (as part of the post-pandemic recovery) rises, investors seek to acquire land for food production and the substantial need for infrastructure in developing countries is being addressed, getting these contracts right will become increasingly important. 

This is so, because the contract terms have important implications for years – if not decades – to come for the three principal parties of the investment process: for host countries, because they determine the benefits they obtain from FDI and, hence, their development impact; for MNEs that often invest billions of dollars in these projects, because their long-term survival may depend on the performance of these projects; and for home countries, because their economies may depend to a certain extent on the output of these projects and, in any event, the successful performance of their international investors. Well-negotiated contracts that seek a fair distribution of the benefits associated with the projects they cover are likely to be more stable and therefore in the interest of all parties.  

However, negotiating equitable and lasting contracts between MNEs and host country governments is a considerable challenge for many developing countries. Contracts typically involve complex negotiations requiring a range of expertise, including lawyers experienced in the negotiations of such contracts; financial analysts and modellers; environmental experts; and specialists in the international markets of, for example, the minerals covered in contracts. International investors typically have this expertise and are well-resourced; many developing countries – and especially the least developed among them – simply do not have that expertise and resources to get such contracts right. 

Arriving at well-negotiated contracts requires therefore that assistance is provided to under-resourced developing countries. Such assistance exists, but only to a very limited extent. For example, because of limited resources, the Connex Support Unit concentrates largely on extractive industry projects and related infrastructure. Beefing up contract negotiations support is therefore important, to arrive at mutually satisfactory (and therefore more stable) contracts, and countries in a position to do so should provide such support. 

Facilitating sustainable FDI

Restarting the world economy – and especially the economies of most developing countries – will require massive investment, including FDI. A multilateral Investment Facilitation Framework for Development (IFF4D) can make an important contribution in this respect. Such an agreement is being negotiated in the World Trade Organization since September 2020, focusing on concrete measures that make it easier for investors to establish themselves in host countries and operate within them, hopefully thereby increasing FDI flows that advance economic growth and development.

This approach is, of course, understandable. But it begs the question of whether it might be possible to include in an IFF4D not only measures that facilitate FDI flows, but also measures that directly help to increase the development impact of the investment that host countries receive. One way in which this can be done is to include in an IFF4D concrete measures that focus on facilitating sustainable FDI (the ITC and DIE have published a comprehensive inventory of such measures). For example, it could encourage the establishment of linkage/supplier-development programmes in host countries (for the reasons outlined earlier). It could also create the category of the Recognised Sustainable Investor and allow WTO members to let such investors benefit from additional investment-facilitation measures. Bestowing the status of Recognised Sustainable Investor on eligible foreign investors would also be an incentive that can be offered, on their own, by individual countries interested in increasing the benefits of FDI for their economies. The key of such measures is to stimulate sustainable FDI for sustainable development.  

Host countries and home countries should make a joint effort to see to it that an eventual WTO agreement helps not only to stimulate FDI flows, but also helps to increase its direct development contribution of such investment in host countries. Meeting this challenge is important not only with respect to the WTO negotiations: future investment treaties can be expected to include provisions on investment facilitation, as already seen in the Regional Comprehensive Economic Partnership Agreement and negotiations underway with African countries. 

IPAs can advance this agenda in many ways. 

Fostering linkages is part and parcel of the mandate of many IPAs, and MNEs would welcome the opportunity – especially at a time when they explore ways to make their global value chains more resilient. If the creation of supplier-development programmes should be included in an IFF4D, furthermore, IPAs would be able to count on international technical assistance when launching or strengthening such programmes.  

IPAs are also often involved, in one way or another, in realising large-scale investment projects that are implemented on the basis of investor-state contracts. They have an interest in securing such projects, and they have an interest in getting them on the basis of terms that are as favourable for their countries as possible. It is therefore in the interest of IPAs – both those responsible for attracting FDI and the increasing number of IPAs that support outward FDI – to be able to benefit from international support for contract negotiations and, hence, to encourage countries in a position to do so to support institutions that provide such support.

Finally, negotiators of the WTO IFF4D, as well of other international investment agreements that contain concrete investment facilitation measures, need the input of IPAs for their negotiations. Most negotiators of such agreements are trade negotiators and lawyers, and not many of them have the ground-level experience of the practitioners involved in facilitating FDI flows. As part of their policy-advocacy function, IPAs are in an excellent position to provide their insights on this matter. In doing so, they can also ensure that the treaties concluded on this subject cover the most important investment-facilitation measures, can make a difference when they are being implemented and, ultimately, help IPAs pursue their mandates.

Conclusions

For governments, FDI is merely a tool to advance their national economic growth and development. They need to see clearly, therefore, that allowing FDI is beneficial for them. Influencing the distribution of benefits in favour of countries is not an easy task under any circumstances, given how competitive the world FDI market is. But if countries are to benefit from FDI to the greatest extent possible, and international investors are to prosper, home countries, host countries and MNEs have to make every effort to pursue policies that make it interesting for governments to admit FDI into their economies and for investors to invest in them. 

The three actionable policy areas outlined here are only examples of how the distribution of benefits among the three principal parties to the investment process can be improved in favour of host countries. And this can be done in a manner that does not deter foreign investors or, for that matter, cause the opposition of home countries – in fact, it is in their own enlightened self-interest. 

Karl P. Sauvant (karlsauvant@gmail.com) is a Resident Senior Fellow at the Columbia Center on Sustainable Investment, a joint center of Columbia Law School and the Earth Institute at Columbia University. This article draws on his “Improving the distribution of FDI benefits: The need for policy-oriented research, advice and advocacy”, Journal of International Business Policy, 2021.

This article first appeared in the August/September print edition of fDi Intelligence. View a digital edition of the magazine here.