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United Nations Conference on Trade and Development Investment Advisory Series Series B, number 6 Best Practices in Investment for Development How to attract and benefit from FDI in small countries Lessons
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United Nations Conference on Trade and Development Investment Advisory Series Series B, number 6 Best Practices in Investment for Development How to attract and benefit from FDI in small countries Lessons from Estonia and Jamaica UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT BEST PRACTICES IN INVESTMENT FOR DEVELOPMENT CASE STUDIES IN FDI How to Attract and Benefit from FDI in Small Countries: Lessons from Estonia and Jamaica UNITED NATIONS New York and Geneva, 2011 ii How to Attract and Benefit from FDI in Small Countries NOTE As the focal point in the United Nations system for investment within its mandate on trade and development, and building on three and a half decades of experience in this area, UNCTAD, through the Division on Investment and Enterprise (DIAE), promotes understanding of key issues related to foreign direct investment (FDI) and enterprise development. DIAE also assists developing countries in enhancing their productive capacities and international competitiveness through the integrated treatment of investment and enterprise development. The term country as used in this publication also refers, as appropriate, to territories or areas. The designations employed and the presentation of the material do not imply the expression of any opinion whatsoever on the part of the Secretariat of the United Nations concerning the legal status of any country, territory, city or area, or of its authorities, or concerning the delimitation of its frontiers or boundaries. In addition, the designations of country groups are intended solely for statistical or analytical convenience and do not necessarily express a judgement about the stage of development reached by a particular country or area in the development process. The following symbols have been used in the tables: Two dots (..) indicate that data are not available or not separately reported. Rows in tables have been omitted in those cases where no data are available for any of the elements in the row. A dash (-) indicates that the item is equal to zero or its value is negligible. A blank in a table indicates that the item is not applicable. iii A slash (/) between dates representing years for example, 2004/05, indicates a financial year. Use of a dash ( ) between dates representing years for example signifies the full period involved, including the beginning and end years. Reference to the dollars ($) means United States dollars, unless otherwise indicated. Annual rates of growth or change, unless otherwise stated, refer to annual compound rates. Details and percentages in tables do not necessarily add to totals because of rounding. The material contained in this publication may be freely quoted or reprinted with appropriate acknowledgement. A copy of the publication containing the quotation or reprint should be sent by post to the Chief, Investment Promotion Section, DIAE, UNCTAD, Palais des Nations, Room E-10078, CH-1211 Geneva, Switzerland; by fax to ; or by to Publications are available on the UNCTAD website at UNCTAD/DIAE/PCB/2010/4 UNITED NATIONS PUBLICATION Sales No. 10.II.D. ISBN Copyright United Nations, 2011 All rights reserved Printed in Switzerland iv How to Attract and Benefit from FDI in Small Countries PREFACE The Investment Advisory Series provides practical advice and case studies of best policy practice for attracting and benefiting from foreign direct investment (FDI), in line with national development strategies. The series draws on the experiences gained in, and lessons learned through, UNCTAD s capacity-building and institution-building work in developing countries and countries with economies in transition. Series A deals with issues related to investment promotion and facilitation and to the work of investment promotion agencies (IPAs) and other institutions that promote FDI and provide information and services to investors. The publications are intended to be pragmatic, with a how-to focus, and they include toolkits and handbooks. The prime target audience for series A is practitioners in the field of investment promotion and facilitation, mainly in IPAs. Series B focuses on case studies of best practices in policy and strategic matters related to FDI and development arising from existing and emerging challenges. The primary target audience for series B is policymakers in the field of investment. Other target audiences include civil society, the private sector and international organizations. Series B was launched in response to a call at the 2007 Heiligendamm G-8 Summit for UNCTAD and other international organizations to undertake case studies in making FDI work for development. It analyses practices adopted in selected countries in which investment has contributed to development, with the aim of disseminating best practice experiences to developing countries and countries with economies in transition. The analysis forms the basis of a new technical assistance work programme aimed at helping countries to adopt and adapt best practices in the area of investment policies. v For Series B, UNCTAD s approach is to undertake case studies of a pair of developed and developing or transitional economies that exhibit elements of best practices in a selected issue. Country selection follows a standard methodology, based primarily on the significant presence of FDI and resulting positive outcomes. The Investment Advisory Series is prepared by a group of UNCTAD staff and consultants in the Investment Policies Branch, under the guidance of Joerg Weber and Chantal Dupasquier. This study of the Series B was prepared by Stephen Young, Marek Tiits, Noel Watson and Rory Allan. Fact-finding missions were undertaken in Estonia and Jamaica in late 2007 and early The report was finalized by John Kline, Ioanna Liouka and Cam Vidler. Contributions and comments were received from Torbjörn Fredriksson, Thomas Westcott, Hans Baumgarten and Antje Watermann. The report has also benefited from views of current and former Government officials, the domestic and foreign private sector and academics. The programme receives financial support from the Government of Germany. Geneva, July 2011 vi How to Attract and Benefit from FDI in Small Countries CONTENTS NOTE... ii PREFACE...iv ABBREVIATIONS... viii I. INTRODUCTION...1 II. POLICIES AND METHODS...7 A. Overview of Estonia and Jamaica...7 B. Attracting FDI to small economies...16 C. Maintaining FDI inflows...30 D. Maximizing contributions from FDI...37 III. POLICY PRACTICES AND LESSONS FOR SMALL COUNTRIES...63 IV. CONCLUSION...83 REFERENCES...87 SELECTED UNCTAD PUBLICATIONS ON TRANS- NATIONAL CORPORATION AND FOREIGN DIRECT INVESTMENT QUESTIONAIRRE... 99 vii Boxes Box II.1. Incentives in the tourism sector in Jamaica...23 Box II.2. Shifting from apparel to ICT...42 Box II.3. Size matters in tourism...46 Box II.4. Hansabank and the Swedbank Group...50 Box II.5. FDI in Jamaican bauxite...52 Box II.6. Telecom liberalization and TNC upgrading...54 Box II.7. Example of an Estonia-founded firm that internationalized...57 Figures Figure I.1. Estonia - FDI inflows, outflows and inward FDI stock as % of GDP...2 Figure I.2. Jamaica - FDI inflows, outflows and inward FDI stock as % of GDP...3 Figure II.1. Estonia - FDI inflows by region of origin...11 Figure II.2. Sectoral distribution of inward FDI in Estonia Figure II.3. Jamaica FDI inflows by region of origin...14 Figure II.4. Sectoral distribution of inward FDI in Jamaica...15 Figure II.5. Estonia s goods exports by region of destination Figure II.6. Jamaica s goods exports by region of destination...30 Figure II.7. Estonia s export structure...39 Tables Table II.1. Estonia s and Jamaica s Percentile Rank on Governance Indicators Table II.2. Education in Estonia Table II.3. Outsourcing Companies in Jamaica Table II.4. Ownership structure in Jamaica s bauxite industry... 53 viii How to Attract and Benefit from FDI in Small Countries ABBREVIATIONS BCDP Bauxite Community Development Programme BIT bilateral investment treaty BPO business process outsourcing CARICOM Caribbean Community CEE Central and Eastern Europe CET common external tariff CIS Commonwealth of Independent States EU European Union FDI foreign direct investment FTA free trade agreement FZ free zone GDP gross domestic product ICT information and communication technology IDB Inter-American Development Bank IMF International Monetary Fund IPA investment promotion agency IPR intellectual property rights JBI Jamaica Bauxite Institute JCCP Jamaica Cluster Competitiveness Project JTI Jamaica Trade and Invest M&A merger and acquisition MFA Multi-Fibre Arrangement NAFTA North American Free Trade Agreement NIP National Industrial Policy (Jamaica) PSDP Private Sector Development Programme R&D research and development RHQ Regional Headquarters SME small and medium-sized enterprise TNC transnational corporation UNESCO United Nations Educational, Scientific and Cultural Organization USITC United States International Trade Commission WTO World Trade Organization ix Estonia Jamaica KEY FACTS TABLE Estonia Jamaica Population (millions)* Annual GDP growth (%) GDP per capita ($)* GDP by sector (%) Services Industry Agriculture FDI inflows (annual average) ($ million) FDI outflows (annual average) ($ million) FDI inflows ( % of GDP) FDI inflows (% gross fixed capital formation) Exports of goods and services (% GDP) Imports of goods and services (% GDP) Source: UNCTAD, FDI/TNC database and GlobStat database. * Data are for 2000, 2006 and 2010 only. I. INTRODUCTION Small countries defined in this study as those with a population of less than 3 million face particular challenges in attracting foreign direct investment (FDI), and in maximizing its benefits for economic development. This study selects two small economies that have demonstrated success over the last two decades in overcoming the constraints of size, thus achieving a strong record of FDI attraction and associated benefits. Since 1990, Estonia and Jamaica have managed to outperform many other small countries in attracting foreign investors. At the end of 2008, FDI stock as a share of gross domestic product (GDP) was close to 70 per cent in the case of Estonia and 72 per cent for Jamaica, well above the equivalent level for small developed countries (with which Estonia is compared) and small developing countries (with respect to Jamaica) (figures I.1 and I.2). The large flows of FDI have provided direct and indirect economic benefits to both countries. The objectives of this study are to compare and contrast: first, Estonia s and Jamaica s approach to setting objectives relating to inward FDI; second, the methods in the form of policy instruments used to achieve these objectives; and third, the results and impact. This study draws out the characteristics of policies that illustrate best practices, and identifies policies that were not as effective, with the aim of distilling policy lessons for small countries in attracting and benefiting from FDI. Estonia and Jamaica are interesting cases to compare because of their different policy approaches. Jamaica s emphasis on State planning contrasts with Estonia s pro-market reform strategy. Thus, this study does not seek to identify which approach is best for small countries in all circumstances, but more about how to adapt general policy lessons to unique national contexts. 2 How to Attract and Benefit from FDI in Small Countries Figure I.1. Estonia FDI inflows, outflows and inward FDI stock as % of GDP 80% % % 50% 40% 30% 20% % 500 0% Estonia Inward FDI Stock (%GDP) Small Developed Economies Inward FDI Stock (%GDP) FDI Inflows ($ million) FDI Outflows ($ million) Source: UNCTAD, FDI/TNC database. Challenges faced by small economies There are 67 small developing and transitional economies with less than 3 million people. These countries face three main challenges with respect to attracting and benefiting from FDI. The initial challenge, from the demand side, is to overcome the small domestic market and limited purchasing power that may discourage certain market-seeking FDI. Solutions to this include emphasizing other features of the economy, such as natural resources, human skills or geographic location. Market size can also be expanded through policies that seek to increase access to foreign export markets. Estonia and Jamaica, through a combination of these tools, have managed to attract remarkably high levels of FDI. Chapter I 3 Figure I.2. Jamaica FDI inflows, outflows and inward FDI stock as % of GDP 80% % 60% 50% 40% % 20% 10% % Jamaica Inward FDI Stock (%GDP) Small Developing Economies Inward FDI Stock (%GDP) FDI Inflows ($ million) FDI Outflows ($ million) Source: UNCTAD, FDI/TNC database. The second challenge is on the supply side and concerns the pressures associated with significant FDI inflows into small markets. Labour, skills and infrastructure shortages must be addressed in order to maintain investment attractiveness. An important finding identified in the case studies was that both Estonia and Jamaica did not identify and anticipate some supply-side challenges, nor did they necessarily address these issues in an optimal way. Consequently, while the case studies demonstrate model practices in many areas, important lessons are also derived from policy shortcomings. Third is the challenge of designing policies that maximize the contributions of FDI to economic growth. Conventionally, FDI brings with it benefits including capital, employment and 4 How to Attract and Benefit from FDI in Small Countries technology. This commonly leads to the introduction of new management practices, improvements in product and services quality, cost and innovation, and leads to positive impacts on productivity and wage levels. These can be categorized as either direct or indirect contributions. Direct contributions refer to (a) FDI effects on capital formation; (b) trade and the balance of payments; (c) employment and human resource development; (d) technology and innovation; and (e) market structure and expansion. On the other hand, small countries must be aware of the potential for dominant foreign enterprises to negatively affect the balance of payments, crowdout local firms, or engage in anti-competitive behaviour. In their own right, Estonia and Jamaica have managed to secure significant direct benefits from FDI in their economies, although they have not entirely avoided the problems associated with large-scale FDI projects in such small markets. With respect to indirect contributions of FDI, these can often be more important in the long run. The indirect contributions of FDI to economic growth relate to benefits in the form of spillovers due to close interaction with the local economy. It is in the interest of host countries to encourage foreign affiliates to embed themselves in the local economy and to increase, upgrade, and diversify their operations, including by using the host country as a base for operations in other countries. While these developments are essential for sustaining the competitiveness of the affiliate within the transnational corporation (TNC) group, they make spillovers more likely and are thus crucial to continuing productivity growth and innovation in the host country, and to moving local business activity up the value chain. A key objective is for small economies to progress to what can be described as a second generation growth phase, where domestic firms and foreign affiliates generate outward FDI to expand into other markets. It is difficult to assess the extent to which Estonia and Jamaica have benefited from indirect effects. Chapter I 5 Although there are strong examples of their occurrence in both cases, there is also evidence of missed opportunities. In sum, policies to create a positive investment climate for attracting FDI per se are likely to generate certain direct contributions to economic development. However, other dimensions of Government policy have an important role in maximizing the contributions from FDI, especially those of an indirect nature. The following case studies reflect the experiences of Estonia and Jamaica in addressing challenges relating to both FDI attractions and contributions. II. POLICIES AND METHODS A. Overview of Estonia and Jamaica Estonia became independent in 1991 following the break-up of the Soviet Union. It experienced considerable uncertainty and volatility in the immediate aftermath of the break-up and embarked on policy reforms in Perhaps taking advantage of the opportunity presented by this disruption, Estonia achieved almost complete investment and trade liberalization very quickly after independence. In Jamaica, liberalization began in the 1980s but took place much more slowly against the background of that country s foray into democratic socialism in the 1970s. Jamaica also undertook significant reforms in the early 1990s with substantive trade reform in , and the removal of exchange controls and the adoption of a floating currency in Economy Estonia was under the rule of neighbouring powers for much of the period since the Middle Ages, with brief periods of independence. Following the end of Soviet control in 1991, Estonia experienced a severe transition crisis leading to a per cent decline in GDP. It responded with a strong and continuing promarket reform agenda, supported by a bipartisan political consensus. The rapid reform process involved early price liberalization, full currency convertibility, a legal requirement for a balanced budget, large-scale privatization targeting foreign investors, low taxation and an emphasis on high-quality economic governance. Rapid economic growth followed the stabilization of the economic environment in the mid 1990s and, by 2002, Estonia regained its 1989 level of GDP per capita. Economic growth continued at a remarkably high rate for most of the decade: real GDP growth was 7 8 per cent for , per cent in 2005 and 2006, then slowing to 6.3 per cent in 2007 before sliding into recession. Exports also grew strongly between 1993 and Estonia has been committed to prudent macroeconomic policies, 8 How to Attract and Benefit from FDI in Small Countries regional integration and liberal economic institutions, joining the World Trade Organization (WTO) in November 1999 and becoming a member of the European Union (EU) in Estonia was quickest among new European Union members to meet the EU s financial convergence criteria. However, the last decade of remarkable growth also led to rapid wage increases, eroding labour cost competitiveness, and to inflation above the threshold set under the EU Maastricht Treaty for the adoption of the euro. Plans to join the Euro Zone within the European Union, initially scheduled for , were delayed until at least The recent financial crisis has further complicated these plans as Estonia s economy contracted by 3.6 per cent in 2008 and around 13 per cent in However, the country has maintained a responsible budgetary policy, with a public sector deficit of about 4 per cent of GDP, and the recession appeared to be easing as of late Jamaica was colonized by Spain and subsequently the United Kingdom, before becoming independent in Since then, there has been a well-established parliamentary democracy and relative political stability. The post-war boom years of the 1950s and 1960s represented a period of liberal trade and industrial development. In 1972, the new Government took a different approach, promoting self-sufficiency, import substitution and nationalization. The country s experiment with democratic socialism was associated with capital flight, a large exodus of skilled Jamaicans and a decline in tourism. Beginning in the early 1980s, there was a return to a generally liberal economic policy and an emphasis on policy continuity despite changes in Government. Trade liberalization was instituted following a World Bank Structural Adjustment Agreement in This led to the removal of all quantit
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