Few people would put Rwanda at the top of their list of countries likely to lead the way in ICT over the next five years. However, since 1998 the African nation has been focusing its investment promotion resources on attracting firms in the ICT industries. Is this wishful thinking or the ambitious strategy of a dynamic government?

Researchers from Oxford, Harvard and Yale Universities, working on behalf of Oxford Investment Research (OIR), recently surveyed the targeting practices of 122 national investment promotion agencies (IPAs) to explore such questions related to the practice of industry targeting. The results of this study have led to the development of a model designed to bring a more rigorous and analytical approach to industry targeting than has previously been employed.

Advertisement

Attracting firms

What is industry targeting and why is it important? It involves IPAs focusing their efforts on attracting firms from a small group of industries which have been selected for a variety of reasons. The initial OIR survey revealed that targeting is widespread in investment promotion; it is used by more than 70% of national promotion agencies. For IPAs, investor targeting offers the opportunity to use scarce resources efficiently by focusing marketing efforts and facilitation services on the most responsive sectors, or on sectors which have been identified as being potentially the most valuable to the economy.

In the 1980s, for example, Costa Rica’s investment promotion agency, CINDE, directed almost all of its efforts at electronics, an industry which was deemed to be both responsive to promotion and of high value to the local economy. For investors in target industries, this extra attention can mean that bureaucratic barriers are smoothed, that they gain access to experts and government officials, and, in some cases, obtain generous incentive packages.

A recent study of 30 countries showed that, after controlling for other determinants, FDI in targeted industries grew at an average of 2% faster than in other industries. Over five years this is a 10.4% increase compared with the others.

Best laid plans

So where do industry targeting strategies tend to go wrong? Although the process may let IPAs get more bang for their buck, effective targeting is challenging. There are as many opportunities for failure as for success.

Building and implementing a successful strategy requires much more than simply advertising the IPA’s choice of preferred industries.

The benefits of targeting derive from greater focus on and knowledge of key industries. To fully realise these gains, IPAs’ daily operations – such as direct marketing, attendance at trade shows, facilitation services, etc – should be organised around target industries. For example, CzechInvest built its organisation structure around target industries to develop specific expertise among its staff, a successful model adopted by many other IPAs.

Another common problem affecting IPAs is the articulation of targets in terms of overly broad and nebulous labels. For example, Spain includes “new technologies” and “R&D intensive industries” among its current targets. While these terms make clear what benefits the country is looking for from captured FDI, their breadth make them less able to be translated into increased expertise and efficiency within the IPA.

A more immediate challenge for IPAs is choosing the right industries. If an IPA picks one which is not suited to the host economy, there are costs both in terms of wasted promotion resources and lost opportunity to attract valuable industries. There are also potential costs to corporations who relocate on the basis of over-optimistic targeting programmes. Misjudging the value of a new site can be costly to both the multinational corporation and the host country if operations become unprofitable and workers lose their jobs.

Followers of fashion

Several IPAs in the OIR survey appear to have fallen into the trap of choosing fashionable industries rather than those likely to bring the greatest realisable economic benefits. While a focus on a new-technology industry might make an IPA’s strategy appear cutting-edge, promotion agencies – particularly in poor countries – should ponder whether the development of a high-tech cluster around a particular industry represents a realistic or even desirable goal. The survey revealed that this temptation to select buzzword industries over more traditional types is widespread.

Biotechnology, for example, might be touted as an industry of the future, but this quality alone doesn’t recommend it as a target for most countries. Even in the US, the largest biotech market in the world, it represents less than one-hundredth of 1% of total output and employment. Yet countries as diverse as Hungary, Estonia, New Zealand and Cuba have selected biotechnology as one of their targets. If these nations want to attract foreign investment to increase employment and build industry clusters, their investment promotion budgets might be better spent on larger industries, or those in which they already have a comparative advantage.

The survey confirmed that a few prize industries are monopolising the attention of IPAs. Manufacturing accounts for the largest fraction of target industries worldwide. Competition for FDI is most intense in the electronics, machinery and food-related products industries, which are each targeted by more than 40% of IPAs (see chart 1). In the service sector, ICT and tourism are the most popularly targeted. On the other hand, IPAs appear to have ignored a large group of industries.

 

 

879.photo.jpg

 

 

Intense competition implies that, for FDI, some industries are inherently more desirable than others. However, desirability is not the only relevant criterion for choosing a target. Without some existing comparative advantage which makes the industry fit in well with the economy, IPAs will struggle to attract targets, even with generous incentives. And without some long-term potential comparative advantage, the economy may never succeed in building a cluster around the target.

Choosing the target

What is the best way to choose a target industry? OIR’s survey asked IPAs to explain their choices. It showed a wide variation in their methodologies, but a quote from one IPA executive summed up many of the approaches: “We go after industries where we think we can get quality and quantity [of FDI].”

OIR decided to sort the IPAs’ choice criteria and formalise their objectives into a quantitative methodology. The model shows that the IPAs’ objectives and their selection of target industries are often at odds, an error that could be potentially very costly for their performance.

Working recently with the investment promotion division with the Spanish Ministry of Industry, Tourism and Trade, OIR applied the model to Spain. The coarse-grained analysis is presented here as a demonstration of how the model operates.

Three-step approach

OIR’s theoretical model takes a three-step approach to selecting targets. The first step uses country and industry analysis to determine how desirable and attainable industries are in terms of long-term growth, economic development and existing comparative advantage. The second plots the industries on a matrix to assess those most likely to deliver gains to the economy through FDI. The third investigates forward and backward links between potential targets to develop an integrated industry-development strategy.

In step one, the reasons for targeting industries are placed into two categories: desirability and attainability. For each, carefully weighted metrics captured key features of the choice criteria expressed by IPAs in the survey. For the Spanish industries described here, data on each of these metrics came from sources such as the Organisation for Economic Co-operation and Development and the US Bureau of Economic Analysis.

The metrics which constitute the desirability index of industries reflect that IPAs wish to attract high-quality investment. The metrics attempt to capture two main drivers of this desirability: the expected internal benefits brought by firms within the industry and the spillover, the potential benefits of the industry to the broader economy.

The metrics which constitute the attainability index of industries for Spain capture the idea that successful strategies must focus on industries which fit well with the economy. This is captured by analysing the country’s comparative advantage, the existing size of the industry in the Spanish economy, and Spain’s historical success in attracting FDI in the industry.

Mapping industries

Step two maps industries according to their attainability and desirability. This gives a visual representation of their suitability for targeting. The upper right quadrant in diagram 2 shows that national-strength industries score highly in desirability and attainability. For Spain, these are medium-tech and high-tech: energy, automobiles and other transport equipment, ICT, and food and beverages. Spain already has large and successful industries in these sectors.

Spain’s automobile sector scores particularly highly on the desirability index because of its high rank in export propensity, R&D intensity and large size of company. The sector scores highly on the attainability index because Spain is well suited to it, as measured indirectly through a method called revealed comparative advantage, where a measure of the industry’s contribution to the national trade balance is used as a proxy for the industry’s success.

ICT scores highly on the attainability index for different reasons. Spain has a high score here on the metric capturing labour productivity in this industry and has received much FDI, particularly in telecoms, over the last five years.

The upper left-hand quadrant contains potential future-goal industries which are desirable but for which Spain currently scores poorly on the attainability metrics. For example, the country has a low attainability ranking in computer-components because of this industry’s low labour productivity and high trade deficit.

Although Spain does not have existing capabilities to attract clusters in these industries, they are not necessarily inappropriate for a targeting strategy. Indeed as shown by Asia’s newly industrialised countries, a forward-looking strategy should include desirable industries where future capabilities may be developed.

Building capabilities

Step three is to choose currently attainable but less desirable industries. The idea is to build capabilities within the economy towards more desirable but currently unattainable industries. The model analyses crucial links between industries, from simple input-output relations to more complex knowledge-transfer dependencies. Where a quick-win industry is deemed to have large links with future-goal industries, it is considered a potential target. The reason is that it is a pathway industry which will, over time, strengthen the industrial capability of the economy.

For Spain, this analysis showed that future-goal sectors, such as communications equipment, pharmaceuticals and biotechnology, and industrial machinery, had crucial links with potential pathway sectors, such as rubber and plastics and construction.

Spain’s strengths

Spain’s current targets are environmental industries, renewable energies, biotech, new technologies, and R&D activities. A first pass through OIR’s model identified several different national-strength sectors, including automobiles, marine construction, and energy. The future-goal industries were identified as being potentially attainable with the development of appropriate and crucial pathway industries.

This new assessment of target industries, combined with a considerable increase in information about comparative advantage and industry potential, gives Spain’s investment promotion team the opportunity to consider whether the current allocation of investment promotion resources could be altered for increased efficiency.

While the OIR choices are a considerable shift from current targets, the next step for the model is to work with other data to test and confirm the initial output at a finer level of disaggregation. Industry profiling and sectoral reports will inform the validity of quantitative choices. Techniques to leverage existing industry knowledge help to integrate target choices with current investment promotion practices.

Future challenges

Investment promotion is an inexact science. It draws theory and knowledge from experts across fields such as economics, marketing and industrial development. Empirical research continues to attempt to judge the value of investment promotion and to pin down high-value strategies to efficiently and competitively increase beneficial FDI for countries at different stages of economic development.

Recent academic work has contributed greatly to our understanding of how targeting works within the framework of investment-generation activities. However, IPAs and inter- governmental organisations still face many informational challenges.

OIR’s model is a step towards a scientific methodology for targeting. It relies on quantitative data and qualitative industry forecasting to enable optimal targeting decisions to be made.

The next major issue to be faced by IPAs is the problem of judging the success of targeting decisions. The common practice of using FDI flow data or job creation statistics to evaluate performance is sub-optimal, given the fluctuating nature of FDI inflows and the fact that job creation is an inaccurate measure of economic benefit.

Work is ongoing on a programme to develop project evaluation tools and success measures to help IPAs assess the individual and total value of their attraction efforts. Combined with methodologies such as OIR’s targeting model, this could help to make investment promotion a more predictable tool for economic development.

Oxford Investment Research (OIR) is an FDI research group and consultancy based at Oxford University. It takes a multidisciplinary approach to investigating issues and solving problems that face IPAs and multinational companies.

Contact Nicholas Davis at:

nicholas.davis@oxfordinvestment.org.uk