Dirk Willem te Velde1
Governments in developing countries are increasingly looking for best-practice policies towards Foreign Direct Investment (FDI). 2 Renewed confidence in the positive benefits of FDI has led many countries that were restricting FDI in the 1960s-1980s to be more open towards FDI in the 1990s (Safarian, 1999) and beyond. Governments are liberalising FDI regimes as they associate FDI with positive effects for economic development in their countries (e.g. Borensztein et al., 1998; Lall, 2000a). Of course, in actual practice objectives to attract FDI differ by country (e.g. technology, market access, growth and poverty alleviation) and the effects of FDI may not always be desired (neglect of local capabilities, environmental damages, inequality between individuals or regions).
Increased liberalisation and technological advances have led to a rapid growth in FDI flows over the last three decades. FDI increased as a ratio of domestic investment and GDP in many countries (UNCTAD, 2000). However, while some countries attracted large FDI flows, others were less successful, even though they had liberalised FDI regimes. Intensified competition for FDI (Oman, 2000) has led many organisations to look for benchmarks of policies towards attracting FDI (see e.g. IPAP (2000) in the Asia-Europe meetings; CBI (1999) in the case of African countries). Countries are forced to be more open towards FDI in the emerging environment (including WTO rules and the importance of technology transfer) where it is difficult to build up an industrial capacity behind closed doors.
Whilst for some countries there is concern about the quantity of flows, there is a shift in other countries towards the quality of FDI. The term quality usually refers to high value-added FDI and/or to FDI with positive linkages and spillovers effects for the domestic economy. Countries that have had successful development based on FDI need to continue to upgrade FDI, either by encouraging existing multinational affiliates to develop into strategic independents, or by targeting higher value-added FDI. With WTO rules limiting domestic policy options we will look at what policies a government can still use.
Relying on high quality FDI does not guarantee (and sometimes prevents) the improvement of local capabilities. We review whether FDI has positive spillovers for the local economy in terms of growth and productivity. Theoretical developments