Page 302 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes Government-initiated Investment
In comparison with the export-oriented and market-development types of FDI, government-initiated
type of FDI occurs through the provision of substantial incentive structures to investors by a host
country’s government. These are accepted by investors whereas market as well as cost conditions
may have precluded them from investing in the host country under normal or “no-incentive”
circumstances. For example, in South Africa the incentive takes the following forms : relaxed foreign
exchange controls, tax concessions to investors who partake in national development projects such
as Coega in Port Elizabeth, indirect subsidies through the provision of specific infrastructural
requirements by investors, ease of repatriation of investments and many other kinds of government
support services.
To protect the host country and also to make the option of providing incentives to foreign investors
efficient, such incentives are directed at specific projects or industries. Additionally, incentives are
given by host country governments in order to attract foreign investors to either less-developed
regions or regions which require improvement in certain sectors. For example in South Africa, it is
understood that the Industrial Development Corporation of South Africa has allocated investment
opportunities to each of the nine provinces.
The following illustration from Reuber seems typical of this kind of investment. A country decided
that the time had come to displace imports of synthetic rubber with those produced locally. The
country was short of hard currency and lacked the technological skills to produce competitive products.
To overcome these problems, it sought a joint venture arrangement with another country which held
only a small share of the host country’s market as an exporter to the country. This country considered
it worthwhile to supply funds and technology in order to obtain a substantial minority interest in the
venture and thereby increase its market share. The participating country continued to maintain its
own independent distributors, although subsequently the host country decided to set up its own
distributor to handle a portion of the output under a market-sharing arrangement. The plan was to
produce specialised grades locally as sales volumes rose to the point where production costs became
internationally competitive. The host country, however, pressed for local manufacture much earlier
than the participating country felt justified in doing by economic considerations. Import-displacement
investment of this kind accelerated the transfer of production and technology but at the cost of
considerably higher prices for the domestic economy. This cost was justified by the government on
the grounds that it yielded a variety of intangible non-quantifiable external effects, such as the
development of local management and technical skills, improved technology and series of beneficial
spill-over effects on the local industries.
Host-country governments have historically played an important role in attracting or excluding FDI
through subsidies, which is one of the most effective ways of stimulating the flow of FDI. Subsidies
take a number of different forms. They serve to reduce the risk premium of locating abroad and so
they may directly influence a firm’s cost structure. One example of a subsidy which affects the firm’s
risk premium would be the provision of public education to increase literacy within the country. All
firms benefit from a more educated populace. In contrast, a subsidy could be aimed at reducing a
particular firm’s or industry’s costs of providing on-the-job training. A risk-reducing subsidy, such
as the provision of social overhead capital, has direct economy-wide benefits while a cost-reducing
subsidy benefits a select firm or group of firms.
Given the framework of analysis presented above, a government-sponsored subsidy would have the
unequivocal effect of increasing the probability of a firm’s move to an investment location. Under the
cases presented above, the view by investors is that a subsidy does not in itself reduce or compensate
firms for locational risk, but does increase the risk premium for investors, i.e. a subsidy is not seen as
a positive factor in a firm’s cost structure or the "riskiness of a foreign location” decision making.
However, this does not necessarily imply that a subsidy is independent of the firm’s profit-maximising
level of output.

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