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Three Key Ideas for Creating Effective Investment Policies

Roberto Echandi's picture
Attracting, promoting and retaining foreign investment is a complicated matter – especially for a developing economy. Evidence shows a compelling case for foreign direct investment (FDI): foreign investors can create jobs, bring capital and technologies, create knowledge spillovers, help local companies integrate with global value chains, and drive economic growth in general. But these potential benefits are not automatic and far from guaranteed.
Mexicali region at night
Many multinational corporations, including Honeywell and GKN Aerospace, and LG Electronics,
have built plants in Mexicali. Photo Credit: ImageShack, Creative Commons.
There are many variables at play when considering an FDI strategy and corresponding policies. Not all FDI should be treated equally: different types of investments have different impacts to consider. For instance, will the FDI rely on the extraction or processing of natural resources? Will it substitute imports by seeking a market for particular products and services? Or will the investment focus on increasing production efficiency and increasing exports? All of these affect local markets in drastically different ways.

So how can policymakers navigate these decisions and ensure that FDI is helping advance their countries and benefiting its people? They need a logical way to connect the dots between investment goals and the ultimate result of those investments.

This is why The World Bank Group developed an investment reform map, which offers three basic concepts to help governments clarify the position of their countries in the world economy, set priorities and implement a country’s long-term vision:
  • Investment policy is not about choosing between foreign and domestic investment. It is about connecting them both through local, regional and global value chains. This means regulatory reform should not only focus on domestic laws but also pursue coherence between the latter and international investment agreements which are increasingly governing domestic and international production.
     
  • An investment is not a transaction; it is a relationship. An investment policy strategy needs to go beyond attracting initial investments – this is just one small part of the story. The real benefits to the state come later on in the relationship, when a country successfully retains investment and builds strong linkages with domestic businesses.
     
  • Not all types of investment are the same. Different types of investment have different effects on socio-economic development, and thus require different policies.
Countries who can apply this framework to their investment policies and vision will have a logical backbone for implementing an investment strategy that could lead to measurable results. For instance, Mexico’s aerospace industry was essentially non-existent in the year 2000, but now has grown to a $5 billion export industry that employs around 31,000 people. The Ministry of Economy is coordinating a national plan based on the strengths of particular regions in the country. This enables Mexican companies, which make components like airplane interiors and seats, to grow alongside the major global firms such as Cessna, who makes electrical components, and Honeywell, who makes jet engine components. In addition, state universities are ramping up their aerospace design and engineering programs: Mexico now graduates 100,000 engineers annually, providing a skilled population of potential employees to power the businesses. Mexico also has privileged access to the U.S. market – which captures 59% of the world’s aerospace and defense market. With 20% annual growth in the sector since 2004, hopes are high that Mexico will reach its goal of exporting $12 billion in aerospace products by 2020.

There is no one-size fits all solution to developing effective investment policies. An approach that works within one country for one type of investment at one particular time may need to be continually revised, revamped, and reworked to take into account the changes or unique circumstances in an economy. By using and adapting a framework such as the investment reform map, governments can develop policies that work for their own countries. In an increasingly globalized world, there is no doubt that foreign investment has a huge role to play in propelling developing economies forward and connecting with larger markets. The only question is how governments can use it strategically to bridge the gap in global inequality and maximize the benefits for its people.

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