THE ROLE AND IMPACT OF PRIVATE FOREIGN INVESTMENT IN DEVELOPING COUNTRIES WITH SPECIAL REFERENCE TO KENYA

A private foreign investment is an investment made by a private individual or a private entity in a foreign country.

This type of investment differs from other investments made by a foreign public or governmental entity in another country in that it is made by an individual or a private entity. Also known as a personal foreign investment, this type of investment frequently provides economic stimulation in other countries. It is not always the case, but certain foreign investments are sometimes considered to be a type of foreign aid, especially when made in third-world nations or other struggling economies. Strict rules apply to foreign investments and may vary according to the country where a private foreign investment is being made.

Depending on the country, a personal foreign investment may include an investment for personal use or may include a commercial investment. A commercial foreign investment is one made in an industry that would be considered commercially useful as opposed to another investment involving more personal use, such as residential real estate. A personal foreign investment may include a variety of investment types depending on what is permissible by the country where an investment is being made, as well as what investments are available.

A private foreign investment is often one made in the private sector, as opposed to public exchanges, but investments are not always limited to this type. Personal investments may also be made in public entities, which are frequently referred to as a public foreign investment. Examples of a public foreign investment include those made in a foreign country’s public transportation system or in a foreign stock exchange.

Many view a private foreign investment as a sound strategy when trying to diversify an investment portfolio, as one country’s economy may be better off or worse off than another at any given time and can be leveraged in a profitable fashion. A private foreign investment is also at times useful as a hedge strategy when purchasing a different country’s currency to offset the cost of supplies or products from a country. Some also use a private foreign investment to retire in a foreign location while benefiting from equity when investing in real property. Experts warn, however, that a private foreign investment can be risky when a government is unstable or in places experiencing political disturbance.

Foreign investors look for a strong “investment climate” in developing countries. This is where society and politics are stable and there is “good governance”, such that the economy is managed well, the public service is efficient, flexible, and honest, laws and regulations are not unduly intrusive or directive, and contracts are enforced in the courts. FPI responds most to political, economic, and infrastructural features. In addition to social and political stability, it is attracted by ready markets, high rates of return, inexpensive and skilled labour, and cheap local inputs. It is deterred by inadequate or expensive infrastructure and risk. Opportunities to sell products in large or profitable markets occur domestically, in the poor country receiving the investment, or abroad, including investors’ home countries. Domestically, markets are created by a large or growing middle-class in the population or by protection such as high tariffs or heavy regulations for imported goods.

Openness to Foreign Investment

The Government of Kenya encourages foreign direct investment. Multinational companies make up a large percentage of Kenya's industrial sector. In the past, Government support for foreign investment was often implicitly conditioned on some form of joint venture whereby a related parastatal or a politically well-connected individual became the local partner. This practice is becoming less common with economic liberalization and privatization of public sector enterprises. Particularly since 1994, the Government of Kenya has sought out foreign investment through investment conferences and foreign trips by the head of state.

Foreign investment is not routinely screened. Nevertheless, investors may choose to take advantage of the one-stop office of the Investment Promotion Center (IPC), created in 1982 under the Ministry of Finance, and an independent agency since 1986. The IPC sets minimal environmental, health and security requirements for its projects. An investment code has been in the works since 1994. The code would set forth guidelines on investment, enumerate the various investment incentives and mandate that all new projects obtain IPC approval. Efforts are under way to harmonize investment regimes in Kenya, Uganda and Tanzania and, eventually, to remove all tariff barriers between the three East African countries. In addition, the three Investment Authorities are working towards harmonizing the investment incentives.

It is Government of Kenya policy to encourage investment that will produce foreign exchange, provide employment, promote backward and forward linkages and transfer technology. The only significant sectors in which investment (foreign and domestic) is constrained are those where state corporations still enjoy a statutory or de facto monopoly. These are restricted almost entirely to infrastructure (e.g., power, posts, telecommunications, and ports) and the media (e.g., radio). Even in these sectors, ongoing commercialization and economic reform is expanding the room for private business.

Foreign Private Investment (FPI) and Foreign Direct Investment (FDI) plays a big role in economic development and growth of a country especially a developing country like Kenya. The impact of these investment are both beneficial and harmful to a country. The following expounds on the impact and role  played by FPI in a country.

Enhance growth of domestic

FDI also has potential to enhance growth of domestic firms through complementarity in production and productivity spillovers (Borensztein et al., 1998). Phillips et al. (2001) found that FDI stimulates domestic investment, with a 1% increase in the FDI/GDP ratio followed by as much as a 0.80% increase in future domestic investment/GDP ratio in Africa. They conclude that FDI provides positive externalities and spillovers that make private domestic investment more profitable. In a survey, they found that nearly all interviewed business leaders in Kenya favoured foreign investment and recognized that it offered them economic opportunities.

Impact of foreign investment on the economic system

In fact, foreign investment has served as a model for policies diffusing into the wider society. This is apparent in the economic system in innumerable ways, including in the reform of the banking system; the break-up of the monopolies of state-owned import–export companies, with respect to cross border trading rights; the opening and the reform of stock markets creating a culture of stock ownership; and the expansion of private housing. Domestic private equity and venture capital investments are also developing. Private Foreign Investment has therefore played a significant role in the major changes experienced in these sectors.

Corporate social responsibility

With respect to social consciousness, foreign investment has inspired a rise in awareness of and commitment to corporate social responsibility. Foreign investment has also inspired the formation of business interest groups such as those with a mission of social betterment, such as the Chamber of Commerce, Export Promotion Council, Export Processing Zones Authority where majority of businesses are owned by foreign investors. Foreign business interests have also been approaching these organizations to ask them to take a prominent role in proposing changes to legislative issues of common concern that would foster a friendly economic environment to invest.

Fostering the development of society

n addition to continuing to grow, albeit in newer and often more sophisticated forms than FDI, foreign investment is responsible for fostering the development of society. Foreign Direct Investment into Kenya has brought with it several international private firm to invest in Kenya. Most of these business firms stand for better quality life of their employees and the community around the business. Kenya native business management have taken the same course and are advocating for better working conditions of their employees, investing heavily on Corporate Social Responsibility  projects etc. Companies like Safaricom Ltd, Kenya Commercial Bank, Equity Bank Ltd are giving quite an amount of resources to support such projects as clean water, scholarships for financially needy students. Firms with their parent companies overseas like Biersdolf East Africa, Colgate and Palmolive, Nestle were able to attract the best experience and qualified personnel due to packages and opportunities they offered their employees and the community around them. Kenyan firms have slowly followed suit.

Technology transfer and Progress

FDI increases the rate of technological progress in the host country through a contagion effect from the more advanced technology and management practices used by the foreign firms (Findlay, 1978). This is through either copying the technology used by the foreign firms or accessing the latest technology. Such technology transfers may take place as a result of demonstration effects. Local firms may adopt technologies introduced by foreign firms through imitation or reverse engineering; as a result of labour turnover whereby workers trained by foreign firms transfer technological knowledge to local firms or they start their own firms; and through demand linkages whereby foreign firms provide services or inputs to local firms. Technology transferred from foreign investment projects improves the efficiency of local firms as well.

Integrate domestic markets into the global economic system

PFI can serve to integrate domestic markets into the global economic system far more effectively than could have been achieved only by traditional trade flows. The benefits from Private Foreign Investment will be enhanced in an open investment environment with a democratic trade and investment regime, active competition policies, macroeconomic stability and privatization and deregulation. Under such conditions, FDI can play a key role in improving the capacity of a country to correspond to global economic integration and future national developmental strategies. In practice, the greater the openness and freedom toward FDI, the more economic reforms and potential benefits that receiving countries will reap. The country is generally perceived as the Eastern and central Africa's hub for Financial, Communication and Transportation services due to continued stability, foreign investment incentives offered by the Kenyan Government like the EPZ.

Growth and development

Besides the addition to macroeconomic resources in developing countries like Kenya, PFI is believed to make other important contributions to growth and development. First, it can raise tax revenues, create employment, and open new markets for exports. In practice, though, performance in these areas does not always meet expectations. Poor and developing countries often compete to offer tax holidays as a way to attract investment. Employment may actually be lost, if foreigners buy and re-structure inefficient existing enterprises, often previously owned by the state. For instance, the government sold a large stake in Telkom Kenya to Orange, a UK telecommunication Firm. A sizebale number of employees were retrenched in order to get back Telkom Kenya on the profit path. PFI however has been know to create more jobs and increase incomes of the poor. In turn, this generates the revenues that governments need to expand access to health, education and infrastructure services and so help improve productivity. The Kenya annual budget for 2012/2013 will hit one trillion Kenya Shillings the highest ever in the Eastern Africa. This budget will highly be supported PFI projects in Kenya.

Bridge investment thresholds

FDI  and FPI can help breach investment thresholds. In poor countries especially, where government revenues are small or the domestic financial system is shallow, foreign companies may be the only ones to invest in projects with a high minimum financing threshold, such as infrastructure or natural resource extraction. For instance Oil Exploration in Northern part of Kenya, Titanium mining at the Kenyan coast and coal mining in Eastern Province. All these projects are being handle by Private Foreign Investors. PFI can also help start an investment and growth dynamic that attracts further domestic and foreign investment.

Lift productivity and competitiveness

FDI and FPI can lift productivity and competitiveness by adding to the stock of capital equipment in the economy, introducing new technology in production and new organizational structures and management methods in companies, and training employees. Orange (UK) management took over Telkom Kenya and introduced some of the best technology in telecommunication industry in voice, data and mobile money transactions.

Tend to concentrate on one or few areas

FDI tends to reinforce existing patterns of economic structure. It concentrates in one or a few sectors, often in industries with few linkages to the rest of the economy, such as natural resources or light manufacturing (behind protective tariffs) for the domestic market. FDI also concentrates in regions which already have the best infrastructure and human capital. The agricultural sector and rural areas are particularly neglected. This results in neglect of rural areas where the efforts are concentrated on investment areas like the urban centres. This has been the case for a couple of decades but the country management is opening up the rural areas by building roads and expanding electricity to tap into the rich agricultural production in the area.

Putting non-used resources to work

FDI also boosts investment in other industries "by putting nonused resources to work, by encouraging local suppliers to act as suppliers and distributors for foreign corporations, and by helping disseminate efficient foreign product techniques and management styles to local businesses" (John M. Rothgeb, Jr. 1989, pp. 82-3). Non-used deposits of coal in Eastern Province and Titanium in Kwale county are some of the resources that were lying idle. The resources will be put into productive activities therefore benefiting the community and the country. FDI and FPI directed at heavy intermediate or capital goods industries are more likely to facilitate additional investment than FDI directed at specific consumer goods industries.

Supplements domestic savings

Foreign investment supplement domestic savings and harnesses them to secure a rapid rate of growth.  It serves as a stimulant to additional domestic investment in the recipient country.  By increasing the rate of capital formation in the country, it goes a long way in removing the capital deficiency which is the main hurdle in the economic growth.

Improves the balance of payments

FDI improves the balance of payments and current account substantially if it is

directed towards the production for exports or import replacement (Peter Hess and

Clark Ross, 1997, p.496). The government budget balance also improves through

high tax revenue from corporate profits, salaries of employees, and Value Added Tax (VAT) on

finished goods and services. Nestle are large exporters of manufactured and processed foods. Foreign investors are now oncentrating on the service industry in Kenya like the tourism and hotel industry. This attracts foreign earnings that are much needed to improve the balance of payments.

Some studies have concentrated on the adverse effects of FDI on economic growth (Harry G. Johnson, 1970; R.E. Caves, 1971; K. Griffin, 1972; H. Magdoff, 1976; V. Mahler, 1980). Among the many criticisms of FDI and FPI that have been mentioned are the following:

    (i).displacement of domestic resources and discouragement of local entrepreneurship;

  (ii).the creation of a foreign enclave with little or no economic contact with the local economy;

 (iii).the inadequate effort made to train and develop local managerial and technical talent and draining off to other countries the best talent that is developed;

(iv).the failure to participate more actively in community development, or alternatively, participating too actively in local matters;

  (v).the lack of co-operation with host governments and a failure to co-ordinate investment and production policies with the development priorities of the country;

(vi).the creation of less competitive markets in the long-run within the host country;

(vii).and an inappropriate demonstration effect in consumption.

In recent years, the argument focused on the cost of attracting foreign capital. The wide range of incentives (tax concessions, supply of raw materials at subsidized prices, access to foreign exchange) that developing countries adopt to attract foreign investment have invariably led to inefficient allocation of resources. There has been efforts to withdraw licences for EPZ Film Production companies operating in Nairobi for flouting EPZA regulations therefore gaining unfair advantage over other Film Production companies.

Furthermore, the surplus of capital produced in these countries has been "drained off by foreign interests" in the form of "profit repatriation and interest payments". This has reduced their ability to marshal the domestic investment needed to promote economic growth.

Conclusion (source: African Economic Research Consortium Paper on Foreign Direct Investment in Sub-Saharan Africa: Origins, Targets, Impact and Potential)

It is generally believed, however, that FDI provides positive net benefits to the host country. As a consequence, many countries provide a range of incentives to entice FDI. Incentives typically include tax and duty concessions and guarantees against nationalization. Materials and equipment imports, for example, are often exempt from import duties. Other tax concessions include tax holidays, accelerated depreciation and exemption of investment income from the company income tax. The export processing zones in Kenya, for example, offer all investors a ten-year tax holiday, easy repatriation of profits and little regulation with regard to environment protection and labour standards.

Little research has been done on the extent to which these investment incentives are effective in attracting foreign firms, their cost in terms of forgone tax revenues and the losses incurred from competition among countries to attract favoured firms. Such a review of the incentive systems is important because of the poor responsiveness of foreign investment in many African countries. The available evidence regarding the efficacy of financial and fiscal incentives in attracting FDI is ambiguous, not least because countries find themselves in competitive bidding to their general detriment if “excessive” incentives are provided, with little impact on the total supply of investment resources, justifying the case for cooperation among these countries (Hoekman and Saggi, 1999). On the other hand, such competition may serve as a signaling device, indicating the countries where FDI is most valued and has the highest social return.

Empirical studies generally find financial and fiscal incentives unimportant once other fundamental determinants of FDI are taken into account, undermining the case for providing them, making them pure transfers to multinational firms (Hoekman and Saggi, 1999). According to Collier and Gunning (1999), while current tax rates in Africa are not particularly high, their imposition is often arbitrary. There are also so many temporary tax exemptions for new investors that the tax burden for long-standing investors is necessarily fairly high, thereby discouraging long-term investment.

FDI has not played an important role in the Kenyan economy despite the reforms that have been undertaken and the many incentives provided to foreign investors. Over 1997– 2001, FDI was about 0.6% of GDP, well below the African average of 1.9%. Since the 1980s, the country has faced a declining net inflow of FDI compared with neighbouring countries such as Uganda and Tanzania. In the early 1980s, for example, Kenya accounted for 87% of the cumulative net FDI in East Africa. By 2001, this was down to 21%, compared with 40% and 36% for Uganda and Tanzania, respectively. The country has therefore lost its competitiveness in attracting FDI to the two neighbours in the East African Community. There has been much concern among policy makers in Kenya over the decline of FDI, which they attribute to low investor confidence, resulting from insecurity, corruption, poor infrastructure, high utility costs, high real interest rates and limited legal recourse (Kenya, 2003).

References:

Lester Ross (2007), The Role of Foreign Investment in China’s Transition

The General Agreement on Tariffs and Trade (GATT, 1994)

The Multilateral Agreement on Investment (Proposed Vision, OECD, 1998)

Alexander Gerschenkron, (1966), “Economic Backwardness in Historical Perspective: A

Book of Essays;” Cambridge: Harvard University Press, 21-85.

Avi Nov, (2004), “Tax Incentives To Entice Foreign Direct Investment: Should There Be

A Distinction Between Developed Countries And Developing Countries?” Virginia

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Rodney Schmidt and Roy Culpeper, The North-South Institute, “Private foreign investment in the poorest countries” Forum held on March 24, 2003 in England

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Kenya Investment Authority Website - http://www.investmentkenya.com

Export Processing Zones Authority - http://www.epzakenya.com/

The Word Bank, International Finance Corporation - http://www.doingbusiness.org/data/exploreeconomies/kenya/

African Economic Research Consortium: Foreign Direct Investment in Sub-Saharan Africa: Origins, Targets, Impact and Potential paper - http://www.aercafrica.org/documents/books/FDI_papers_booklength_volume.pdf