Transparency for FDI

Financial, Fiscal and Enterprise Affairs Directorate (DAF)

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Investment is partly about taking risks, though not just any risk. In fact, transparent systems where the judicial framework is efficient and corruption is low tend to receive more investment.

By its nature, transparency cannot be easily quantified, nor can it be isolated from other policy aspects that impinge on foreign direct investment (FDI). Owing to the links between the regulatory structure of a country and the transparency of its policies, the focus needs to be both on the nature of the rules applying to foreign investment and on the extent of transparency in their implementation.

Studies indicate that business environments often remain non-transparent even after governments have moved to enact clearer policies, simply because those measures are not actually implemented. However, except in cases where the host government maintains an outright prohibition on market access by foreign firms, the implementation of relevant legislation is likely to be more important in shaping investors’ perceptions than is the actual legislation itself. National treatment, for instance, may be enshrined in legislation in many countries, but if foreign firms are effectively discouraged through discretionary decisions of the relevant national authorities, they will perceive such arbitrariness as being just as restrictive as an outright prohibition on foreign investment.

This point is brought out clearly in a major study of 55 developed and developing countries, which found that “better functioning legal systems and governance and better enforcement appear to be more important than legal origins per se in terms of their impact on development” (S. Ahn and J. Chan-Lee, see references). This study, path-breaking in many respects, of the informational quality of financial systems and economic development, constructs indices for various aspects of transparency for 55 countries. Of particular relevance in the context of FDI is the measure of institutional governance (see graph).

There are wide variations in inflows even for countries with the same institutional governance rating – as one would expect given the multiplicity of factors behind the investment decision – but overall the relationship between the quality of institutional governance and the level of inflows is clear and positive. Thus, countries where the rule of law prevails and is enforceable, the judicial system is efficient, corruption is low and ownership is less concentrated, receive more investment.

One of the most interesting national cases relates to China, whose policies toward foreign direct investment have been quoted in literature both as examples of the virtues of raising transparency, and to point to areas where problems remain (see box).

Russia arguably provides one of the clearest examples of a divergence between regulation and implementation. A recent OECD survey of the investment environment in Russia found that the otherwise adequate rules-based legal and regulatory environment was consistently being undermined by failures in implementation and enforcement (see references).

There is no unified economic space, no “level playing field” for businesses in Russia, because of the multitude of administrative barriers and obstacles encountered by investors, particularly at regional level, often in contravention of federal legislation and regulation. As specific examples of unpredictable hurdles to be surmounted by investors at federal level could be mentioned sudden withdrawal of frequencies from telecommunication companies, or sudden unavailability of previously posted railway freight tariffs which served as a basis for feasibility calculations. At the regional level, examples abound in the form of unforeseen licensing or permission requirements, license fees in excess of what is legally required, tax payments that are negotiable rather than statutory, “voluntary” contributions to extra-budgetary funds, etc. In addition, the general burden of licensing and other policy-induced start-up difficulties at regional level is so onerous that firms specialising in helping new businesses to manage this process are becoming a new growth industry.

These manifest problems with transparency are almost certainly one of the main reasons why Russia, despite having a large domestic market, abundant raw materials, an educated workforce and geographical proximity to Europe, does not rank even in the world’s top 30 destinations for FDI. Significantly, both foreign and domestic investment are low in Russia, suggesting that local investors are as discouraged by the lack of transparency as are foreign ones.

*This is extracted from a new OECD book, Foreign Direct Investment for Development: Maximising Benefits, Minimising Costs. For more on this subject, e-mail daf.contact@oecd.org 

References

•Ahn, S., and J. Chan-Lee (2001), Informational Quality of Financial Systems and Economic Development: An Indicators Approach for East Asia, Working Paper, Asian Development Bank Institute, Tokyo, June.

•OECD (2001), Investment Environment in the Russian Federation: Laws, Policies and Institutions, Paris.

©OECD Observer No 234, October 2002




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