Rethinking FDI

Kazi Rahman
Published : 30 Nov 2014, 05:59 PM
Updated : 30 Nov 2014, 05:59 PM

Capital is crucial for the economy of Bangladesh to grow. In order for Bangladesh to achieve this goal, it needs access to direct capital (cash) for investment in infrastructure, education, institutional development and industrialisation; and it also needs indirect capital (technical know-how) to effectively manage these assets and create value.

But since we are a relatively poor country, the most effective way for us to obtain access to capital (direct and indirect) is to make Bangladesh attractive to talented and affluent people who would be interested in investing their money and knowledge in it and help its people prosper. So far so good.

But this isn't as easy as it sounds. Foreign investors are seriously jhanu public (very cunning individuals). A rational foreign investor will only invest in a country if the expected return of an investment in comparison to the amount of risk undertaken is sufficiently high. They will analyse all available information and make a decision, based on their assessment, whether to invest in a country or not. Rational investors will not heed the pleas and promises of any government.

Contrary to what many of us seem to believe, the primary goal of rational foreign investors is profit maximisation, not ideological proliferation. Therefore, they will invest wherever they will have the opportunity to make the highest amount of profit. These people are meticulous and they are shrewd. They have no intension of incurring loss. Their objective is to strike a bargain whereby both parties to the agreement would stand to benefit from the investment. However, the amount of benefit that each party will be able to extract from a deal depends on many factors, such as global economic conditions, negotiating abilities and relative bargaining positions.

One should keep in mind that there is another type of investor. These investors are not motivated by profit but by other objectives such as dissemination of a certain ideology. These investors would happily invest in a country which is managed appallingly, if they believe that they can use their capital to purchase influence in the recipient country to achieve a non-pecuniary goal which could lead to political and economic instability in the recipient country.

The fact is that rational investors have far more capital (direct and indirect) at their disposal then investors who are motivated by non-financial goals. Furthermore, the former group is more adept at managing assets and capital formation than the latter. Therefore, the investors who can offer the most benefit on a state are rational investors because they have far more resources at their disposal and they are not interested in creating any kind of instability in the recipient state. Rational investors, in fact, seek political and economic stability, strong infrastructure network and a reduction in arbitrary exercise of power because these provide the most favourable environment for their investments to thrive.

Although successful ventures can have many positive externalities, such as higher number of jobs, higher income and better quality of life; there is also the potential that such investors could make exorbitant profit, especially if there is an information asymmetry between the investors and a state. If it transpires that a foreign investor is able to extract an exorbitant profit from their investment, that state must keep in mind that they have to respect their agreement. Under no circumstances should they seek to unilaterally rescind a contract because that would be financially disastrous for the state. If a state acts irrationally and unilaterally breaks a contract, they would have to pay damages to the foreign investors, which would run into millions of dollars. Furthermore, it would set a very bad precedent for that state making it extremely difficult for the state to attract new investors in the future.

Investment relationships are an ongoing process. Parties to a contract must respect the terms of their agreement. To ensure that the state does not get the short end of the stick, it must develop a transparent and accessible framework for foreign investors to invest in a country so that parties are aware of their risks. Furthermore, the state should also take necessary precautions to ensure that they are not being ripped off. These could include promoting transparency for the negotiations and agreements in relation to large projects (such as infrastructure), having an open tendering process for allocating work, establishing an independent oversight committee who ensures that contractors comply with their obligations and a contingency plan.

Rational investors do not invest out of the goodness of their heart. They are business people who are making a business decision; therefore, state negotiators should keep in mind that these people should be treated with respect but with a high degree of skepticism. Foreign investors are essential for economic development, but they could just as easily turn to economic exploitation, especially if they can ensure a legal monopoly from the government which would protect them from competition and thus the need to innovate new ways for increasing efficiency.

If a government is truly interested in economic development of its citizens then it has to court these fickle rational investors. The state has to be cautious when negotiating with them because foreign investors have no allegiance to a foreign state in which they want to invest. Theywill only invest if a state can offer them favourable tax regime, strong infrastructure network, and protection and security of their employees and assets.

If a state needs FDI for its growth and prosperity, then it is up to the state to change its approach and implement changes (policy and administration) that will attract these fickle investors to its shores. Foreign investors should be treated as valuable guests who have to be very pleased by the hospitality of the state in which they choose to invest because that would encourage other investors to follow suit. However, the investors must conform to the laws of the state and should not be treated preferentially. If they fail to fulfill their end of the bargain then they should be treated in accordance with the law and the terms of their contract. As more and more investors line up to invest capital in a state, the relative negotiating position will change which will enable the state to negotiate new contracts on more favorable terms. However, it is quite likely that at the early stage of development the investors are inclined to play hardball and drive a hard bargain which means that some of the contracts may allow investors to generate substantial profit.

When a state can offer their citizens better living standard, protection from illegal violence and a better future, there is no reason for the people to oust them from power. The people will be more than happy to keep in power the people who will fight for their future. Singapore is a case in point. Singapore has had the longest serving prime minister in the world, Mr. Lee Kuan Yew, despite allegations of corruption in his government and that he used the law to squeeze his political opponents (among other things). He has singlehandedly navigated Singapore from the brink of disaster to one of the wealthiest nations in the world through foresight, shrewdness, liberal trade policy and discipline. He has successfully courted foreign investors and talented individuals through his policies and administration, and investors have been flocking to the island nation to do business and make money for over the last four decades.

Rational foreign investors are very shrewd. If they are avoiding investing in Bangladesh, then it implies that the Government of Bangladesh has not been able to create a business friendly environment. Foreign investors are still skeptical about Bangladesh, and their reservation in relation to investing in Bangladesh indicates that they think that the risk to return ratio of investing in Bangladesh is not sufficient. This should not come as a surprise to the people who are responsible for the economy. If foreign investors are not making any direct or indirect investment in Bangladesh, then the Government of Bangladesh needs to re-consider its approach and develop a solution to remedy the situation. If it does not change its approach, then these investors will keep on eluding the country.
It is interesting to note that there has been a noticeable drop in FDI as a percentage of GDP of Bangladesh in these years:1998-99 (-0.04%), 2000-01 (-0.42%), 2001-02 (-0.06%), 2005-06 (-0.18%), 2006-07 (-0.23%), 2008-09 (-0.37%), and 2009-10 (-0.06%) (Source: World Bank). Most of these dates correspond to election years or times of political instability. The most prolific and sustained rise of FDI as a percentage of GDP took place between 2003 and 2005 (1.15%), which indicates that it is possible for Bangladesh to consistently attract foreign direct investment but there is still a long way to go. It seems that the primary criterion for FDI has been political stability. Whenever that has been challenged, the economy of Bangladesh and the people have suffered.

There is no point in reinventing the wheel. Singapore has demonstrated how it is possible to maintain political stability and become a prosperous nation from the brink of disaster. Although Bangladesh is hardly similar to Singapore of 2012, there are quite a lot of similarities between Bangladesh today and Singapore in the 70s. At that time the streets of Singapore were full of rickshaws, the traffic was horrendous and people used to litter everywhere. Does that sound familiar? It is hard to imagine how far Singapore has come in such a short time. If Bangladesh wants to flourish, then the Government of Bangladesh must learn from the travails of Singapore, among other nations, and develop strategies to entice foreign investors to invest in the future of the people of Bangladesh and implement them.