The Significance of Foreign Direct Investment to Caribbean Development

By

Ronnie Griffith1 and Kimberly Waithe Economic Affairs Division Research and Planning Unit

Ministry of Finance, Economic Affairs and Energy

and

Roland Craigwell Department of Economics

University of the West Indies Cave Hill Campus

August 2008

1 Correspondence Address: Ronnie Griffith Senior Economist, Research and Planning Unit, Economic Affairs Division, Ministry of Finance, Economic Affairs and Energy, 3rd Floor Warrens Office Complex, Warrens, St. Michael Tel.# 310-1308. E-mail Address: ronnie.griffith@gmail.com.

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The Significance of Foreign Direct Investment to Caribbean Development

Ronnie Griffith, Kimberly Waithe and Roland Craigwell

Abstract GET RID OF THESE LINES

The paper analyses the significance of FDI inflows to the development of Caribbean

countries, with a focus on the relationship between FDI and growth. In addition, it

reviews some policy objectives, the potential costs and benefits as well as pertinent issues

relative to FDI that would assist Caribbean territories in their search for sustained

economic growth and development. Its main conclusion is that Caribbean countries must

have adequate structures and policies implemented through competent public governance

to act as a catalyst for attracting FDI inflows to their shores. However, once there is an

increase in such capital inflows careful scrutiny of the source and origin must be practice

for transparency and avoidance of any unethical incidences of money laundering, terrorist

financing and drug trafficking.

GET RID OF THESE LINES

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Keywords: Foreign direct investment, economic development GET RID OF THESE

LINES JEL classification: PUT IN THE JEL NO.

Introduction GET RID OF THESE LINES

Over the last two decades there has been phenomenal growth in Foreign Direct

Investment (FDI)2 and trade globally, driven primarily by multinational (MNCs) and

transnational corporations (TNCs). According to the SPELL OUT (UNCTAD)’s World

Investment Report (2007), global FDI inflows amounted to $1,306 billion in 2006, rising

more than 38% over the previous year and not too far from the record level of $1,411

billion reached in 2000. In addition, the stock of FDI worldwide totaled US$12 trillion in

2006. Such investment was used for the activities of 78,000 TNCs which owned 780,000

foreign affiliates. The sales, value added, and exports of these affiliates are estimated to

have increased by 18%, 16% and 12% in 2006, respectively.

In line with trends at the global level, FDI flows to the Caribbean have grown from US

$1,290 million in 1995 to US $3,797 million in 2005. In absolute terms, such flows may

appear small but are, nonetheless, quite substantial relative to the size of each island.

Traditionally, these inflows were geared towards the primary sector; however, in recent

times, the concentration has been in the tertiary sector, specifically, the services sector

with a focus on tourism, telecommunications and finance industries (Craigwell, 2006).

The greater portion of FDI flows to the Caribbean have been resource and efficiency

seeking, since the most important factor for export-oriented FDI are resource

endowments (Craigwell, 2006). Therefore, those countries that are rich in natural

2 Foreign direct investment is the principle type of foreign investment. It is the inflow of capital into and

out of a particular sector of a country and signifies direct control of an enterprise by investors. This type of investment comprise (a) settler-type investment where the investor and his/her capital moves to a country, (b) “putting-out” investment where ownership and control resides abroad but without links to other enterprises and (c) the multinational corporation as an extension of the corporation into foreign countries (Meyer, 2003).

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resources such as gold, bauxite, oil, petroleum, natural gas and alumina have attracted

larger amounts of FDI. For example, Trinidad and Tobago, one of the resource-rich

countries in the Caribbean, is among the major recipients of FDI.

In addition, the growing importance of increased production at a minimum cost has been

facilitated by the liberalization of foreign investment policy in virtually all countries

including the Caribbean. In light of this, the region has adopted policies of gradual

liberalization and deregulation which have attracted investment over the years. Strategies

of TNCs to access strategic resources and the need to reduce production cost to be

globally competitive have also contributed. Such TNCs have found themselves in

Trinidad and Tobago for its petroleum oil and natural gas, Guyana for its gold, bauxite

and timber and Jamaica for its bauxite and alumina.

It is quite obvious that the governments throughout the Caribbean understand the

necessity of FDI in the twenty-first century and have adopted different methods of

attracting it to their shores. These developing countries seek to attract FDI by offering

incentives such as tax holidays, import duty exemptions, market preferences,

infrastructure and subsidies to firms with a view that there will be spillovers in

technology, knowledge and managerial skills. Such strategies are aligned to the policies

adopted by the East Asian Tigers or the newly industrialized countries (NICs) who

recorded substantial rates of growth.3 However, growth in the Caribbean countries has

not been as strong, prohibited by their small size, open dependence on more developed

countries for financial assistance, openness to external shocks and the under-developed

nature of the capital markets.

Against the backdrop of the preceding discussion, the main objective of this paper is to

assess policy issues with respect to FDI, focusing on the Barbadian economy. However,

references would be made to Latin American and other Caribbean territories with a view

to determine the strategies that developing countries need to adopt and implement in

3 For an in depth discussion on the East Asian Miracle, see World Bank (1993).

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order to attract FDI to enhance growth and development. The Barbadian economy

presents an interesting case since it is not resource-rich like Guyana and Trinidad and

Tobago and its major sectors experience high costs of production. As such, its FDI

inflows are smaller when compared to these latter territories. In addition, this issue is of

current interest in the Barbados economy where the Democratic Labor Party’s (now the

current Government) Manifesto of January 2008 highlighted that any government

desirous of moving Barbados forward in the new international environment must seek to

increase its foreign exchange earning capacity by attracting higher levels of investment.

To achieve these above objectives the paper is structured as follows: following a brief

introduction, section 2 provides the theoretical background for the paper, and focuses in

particular on the relationship between FDI and growth. Section 3 reviews the appropriate

policy objectives for FDI linking these to the current strategies in the Caribbean. Section

4 looks at pertinent issues in relation to FDI. Section 5 outlines some of the potential

costs/benefits with respect to FDI. Section 6 provides a forward looking approach for the

Caribbean. The final section concludes the paper.

2. Theoretical Review

Increasingly, FDI is assuming a significant role in the development and growth strategies

of developing and emerging market countries because of inadequate resources to finance

development projects. While there is yet no consensus on the relationship between FDI

and growth, there is a growing view that FDI is positively correlated with growth.

Lewis (1954) was one of the first Caribbean economists to initiate the concept and

importance of foreign investment to small developing economies. He contended that if

there was a choice between foreign investment and domestic capital, the latter should be

preferred, perhaps to protect the sovereignty of the nation. However, in the absence of

domestic capital, Lewis argued that foreign investment, given its scarcity and competing

claims for its use, should be encouraged and incentives provided such that the net results

are favorable to the domestic economy and contribute to the development of the

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entrepreneurial, management and administrative skills of the country, the relative lack of

which has served as a constraint on development in the Caribbean.

Proponents of FDI suggest that FDI ensures the efficient allocation of resources

compared to other forms of capital inflows. Theoretically, this view has been buttressed

by recent developments in growth theory which highlight the importance of

improvements in technology, efficiency, and productivity in stimulating growth. In this

regard, FDI contribution comes through its role as a medium of transferring advance

technology from industrialized to the developing economies. For instance, Findlay (1978)

postulates that FDI increases the rate of technical progress in the host country through a

“contagion” effect for the more advanced technology and management practices used by

foreign firms. In addition, it is argued that FDI enhances economic growth through

technology spillover, creates employment, reduces dependence on accumulation of debt

as a source of development financing and strengthens human capital and entrepreneur

skills. Romer (1993, p.548) has lamented that by bringing new knowledge to their host

countries, MNEs may help to reduce ‘idea gaps’ between developed and developing

countries which are sources of growth.

The hypothesis of FDI-led economic growth is based on the endogenous growth model,

which states that foreign investment associated with other factors, such as domestic

capital, human capital, exports, and technology transfer, have significant effects in

driving economic growth (Borensztein, et al., 1995). These growth-driving determinants

might be initiated and nurtured, so as to promote economic growth through FDI. To this

extent, FDI may have a positive growth impact that is similar to domestic investment,

along with partly alleviating balance-of-payment deficits on the current account. The

prevailing economic experience of the East Asian countries, especially China and India,

has further strengthened the conviction that FDI is a critical element in narrowing the

resource gap and ensuring accelerated economic growth. Thus, in the face of their growth

challenges, a number of countries are now pursuing domestic policies that are geared

towards attracting more FDI.

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While many highlight FDIs positive effects, others blame FDI for “crowding out”

domestic investment and lowering certain regulatory standards. Agosin and Mayer (2000)

states that the most immediate externality of an MNE entry on domestic enterprises in the

industry of the entrant is negative as foreign entry erodes their market share.4 As such,

the effects of FDI can sometimes barely be perceived, while other times they can be

absolutely transformative. However, while the impact of FDI depends on many

conditions, well-developed and implemented policies can help maximize its gains.

To sum up, attracting FDI has become a key part of national development strategies for

many countries. They see such investments as bolstering domestic capital, productivity,

and employment, all of which are crucial to increasing economic growth. As such, FDI

inflows are pertinent to the small economies of the Caribbean as a means of bolstering

economic growth.

3. Appropriate Policy Objectives for FDI

Policy instruments in the form of legislation related to economic, environmental and

social policies are necessary to allow for incentives to attract FDI in the globalize

economy of the twenty-first century. The aim of such policies is to create an enabling

business environment to facilitate the growth and development of all businesses in the

market. In addition, sound regulation of these policies is a prerequisite for them to work

and achieve the required returns of investment. As a basic approach to regulation, host

governments should create an incentive structure to encourage compliance with the spirit

and letter of the laws. This is more productive than surrounding the business operations

with rules that may or may not be the best way to achieve the goals envisioned. For

instance, markets in polluted environments have proven to be an effective way to

stimulate firms to find the most efficient ways to reduce pollution.

4 For an in depth discussion on the negative externality of an MNE entry, see also Markusen and Venables

(1997).

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The following five key policies are essential for attracting FDI:

Human Capital

For domestic human capital to utilize the knowledge, skills and technology transferred by

foreign firms, a policy of developing domestic skills and knowledge is necessary to reap

the full benefits. Such a policy relies on a good health and education structure, which are

then interconnected with other commercial infrastructure that include energy,

communications, transport and finance.

The World Bank (1993) notes that the allocation of public expenditure between basic and

higher education was and still is the major public policy factor that accounted for East

Asia’s extraordinary performance with regard to the quantity of basic education provided.

Table 1 shows the allocation of the education budget in 1985. The share of public

expenditure on education allocated to basic education has been consistently higher in East

Asian countries than elsewhere. By giving priority to expanding the primary and

secondary bases of the educational pyramid, East Asian governments have stimulated the

demand for higher education, while relying to a large extent on the private sector to

satisfy that demand (World Bank, 1993).

Table 1: Allocation of Education Budgets, 1985

Economy Public expenditure on education as a percent of GNP

Pubic expenditure on basic education as a percent of GNP

Percent of education budget allocated to higher education

Percent of education budget allocated to basic education

Hong Kong 2.8 1.9 25.1 69.3

Indonesia 2.3 2.0 9.0 89.0

Rep of Korea 3.0 2.5 10.3 83.9

Malaysia 7.9 5.9 14.6 74.9

Singapore 5.0 3.2 30.7 64.6

Thailand 3.2 2.6 12.0 81.3

Source: World Bank (1993)

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In terms of human resources, Braveboy-Wagner et al. (1993) notes that educational

achievement in the Caribbean is well above the average for countries at a similar level of

development. These Caribbean countries attained universal primary education earlier, if

not at the same time as the four East-Asian tigers5 and secondary school enrollment is

above average for middle income countries. However, tertiary education is below that of

the East Asian countries like Hong Kong and Singapore. The remarkable difference

between the two groups was that in East Asia educational achievement has led to

significant production growth unlike in the Caribbean. This is due to three important

reasons: firstly, the ability to produce comes from employment, and in this regard, the

Caribbean has been at a disadvantage since structural unemployment has been around 10-

13% (Rajapatirana, 2001). Rajapatirana (2001) further argues that the earlier

implementation of inward-oriented trade policies as well as restrictions on FDI and work

permits may have prevented increased access to both technical and management know-

how. Thirdly, the quality of education appears to have declined.

Another important point to highlight is the impact of the brain drain on Caribbean

territories. The region has recorded the highest emigration rates in the world (Docquier

and Marfouk, 2005). Figure 1 shows that most Caribbean countries rank in the top 20 in

the world in terms of skilled emigration rates (skilled are defined as those with 12 or

more years of schooling). The migration rates by schooling are quite substantial. For

example, 70 percent of the tertiary-educated labor force has migrated from the Caribbean

to the Organization for Economic Co-operation and Development (OECD) member

countries.

Table 2 reveals the breakdown of emigrants from the Caribbean by their skills (education

groups). It is observed that Guyana, Grenada, Jamaica, and St. Vincent and the

Grenadines have the highest tertiary emigration rates in the region, followed by Haiti,

Trinidad and Tobago, and St. Kitts and Nevis.

5 The four East Asian Tigers are Singapore, Taiwan, Hong Kong and South Korea.

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An important cost that emigration imposes on source countries is the public expenditure

on the education of migrants. This social cost is particularly high for the tertiary-educated

migrants in developing countries like Barbados, Jamaica, and Trinidad and Tobago

(Mishra, 2006).

Table 2: Percent of Labor Force That Has Migrated to OECD Member Countries, 1965–2000 (By Level of Schooling)

Primary Secondary Tertiary

Antigua and Barbuda 9 64 67

Bahamas, The 3 10 61

Barbados 18 28 63

Belize 7 58 65

Dominica 19 67 64

Dominican Republic 6 33 22

Grenada 25 71 85

Guyana 18 43 89

Haiti 3 30 84

Jamaica 16 35 85

St. Kitts and Nevis 32 42 78

St. Lucia 12 21 71

St. Vincent and the Grenadines 18 33 85

Suriname 39 74 48

Trinidad and Tobago 8 22 79

Average 15 42 70

Source: Docquier and Marfouk (2005)

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Figure 1: Top 20 Countries in the World with the Highest Emigration Rate to the OECD Member Countries, 1970-2000

Source: Docquier and Marfouk (2005).

Note: Educated labor force is defined as having 12 or more years of completed schooling.

Openness to Trade

Since the mid-1980s, many Caribbean countries have undertaken economic reforms

aimed at increasing the openness of their economies to trade and investment. The

liberalization of the FDI regime featured involved the removal of barriers to entry for

foreign investors as well as extending national treatment and Most Favored Nation

(MFN) status to foreign investors. For instance, in Jamaica, the Foreign Exchange

Control Act, which imposed restrictions on capital outflows and prohibited foreign

operators in certain industries and sectors, was revised in the 1980s, making the country

more conducive to foreign investment.

In recent times, FDI inflows have been prominent in the services sector. This has been

buttressed by the General Agreement on Trade in Services (GATS) of the World Trade

Organization (WTO). However, although many Caribbean countries have accepted

commitments to liberalize their services sector, they still maintain numerous restrictions

on market access and national treatment across services sectors and mode of supply

(ECLAC, 2003).

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Trade liberalization, especially through the Common External Tariff (CET), and

privatization have also been vital in attracting export-oriented FDI. For example, FDI

directed to the telecommunications sector in the region has been in response to the

privatization and deregulation of that sector.

Additionally, the establishment of trade and investment liberalization agreements

between the Caribbean, other countries, and within the WTO framework has been a key

determinant in attracting FDI inflows. For example, Caribbean countries have made

several strides in organizing bilateral investment treaties with other countries along with

establishing the CARICOM Single Market and Economy (CSME), which is expected to

influence investment, especially intra-regional investment flows (ECLAC, 2003).

Legal System

In association with the policies discussed above there must be a reliable legal system to

ensure that agreements and arrangements are honored. A reliable legal system promotes

transparency with respect to the rules and the expected requirements of all investors.

Transparency allows foreign firms to plan without being discriminated against by any

political regime. Justification for discriminatory measures consists of an appeal to the

need for consumer protection, national control over some sectors of the economy for

policy reasons, and the familiar infant-industry argument. Transparent policies permit

investors to move their capital freely in and out of the host country. If these policies are

not evident then foreign firms will be reluctant to invest.

Export Processing Zones

Export processing zones (EPZs) are designated in the host country to attract investment

by offering favoured treatment that include the absence of import controls, exemptions

from domestic taxation, the provision of infrastructure and industrial regulations. The

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establishment of EPZs requires substantial public investment by the host country.

Economic activities within these zones are typified by labour intensive industries such as

electronics assembly and garment manufacture (Warr, 1990). The objective behind

establishing these zones is to raise foreign exchange earnings, increase employment and

encourage the transfer of technology and management skills. There are also trade related

investment measures or TRIMs that influence multinationals to invest in the host country.

Many Caribbean countries have attracted TNCs through granting incentives to foreign

affiliates in EPZs. Generally, incentives included the following: exemption from import

licenses and custom duties on capital goods and raw materials and favourable labour

legislation. Some of the countries that have been active in promoting FDI through EPZs

are the Dominican Republic, Jamaica, Saint Lucia and Haiti (ECLAC, 2003). The

Dominican Republic, in particular, has had more success with EPZs than the CARICOM

countries. It is noteworthy that production in exports from EPZs has diminished in the

early and mid-1990s when compared to its growth in the 1980s.

Caribbean territories have also actively sought to attract FDI inflows by providing fiscal

incentives to foreign investors. These have been used extensively in Belize, Barbados,

Jamaica and the OECS countries. The latter group of countries provides the most

generous fiscal incentives of all the CARICOM countries, probably compensating for the

disadvantages linked with the small size of these territories (ECLAC, 2003).

Good Governance

Good governance is the door to all other policies. It reflects policies that epitomize a

stable macroeconomic environment, which projects a confidence that allows investors to

operate in relative certainty in developing financial markets.

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The Caribbean has been known for its relatively stable economic climate. The Barbados

economy, in particular, continued to perform well, expanding by 4.0% in the first-quarter

of 2008, 1.4 percentage points above the rate of growth experienced in the corresponding

period of 2007 (Central Bank of Barbados, 2008). Other fundamentals such as a fall in

the unemployment rate are also evident.

4. Some Issues Related to FDI

FDI does not only affect the economy it also impact on important social, political and

environmental conditions. Therefore, in this chapter issues such as poverty, inflation,

quality of life as it relates to health care systems and the environment, political systems

and their ethical practices, capitalism, terrorism and money laundering are discussed in

parallel with the desire to solicit FDI.

Inflation

High inflation negatively influences investment since it indicates the inability of the host

government to balance its budget and the failure of the respective Central Banks to

conduct appropriate monetary policy (Schneider and Frey, 1985), requirements necessary

to sustain high economic growth and employment, price stability, and sustainable

external accounts. If investors do not perceive a level of certainty with respect to returns

on investment then they would feel that the risks are too high. For instance, if a high

level of inflation due to mismanagement persists there could be an escalation of hardship

on the citizens of a country that may result in social disturbances. In the Caribbean

inflation rates have varied substantially, however, they have managed to remain

moderately low. Even with inflationary pressures on these small economies, as a result of

the steadily increasing oil prices since 2001, the Caribbean has been able to maintain its

inflation rate within single digits in 2006 (see Figure 2).

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Figure 2: Inflation Rates for Selected Caribbean Countries, 2001-2006

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0

2001

2002

2003

2004

2005

2006

Period

Annual Change (%

)Bahamas

Barbados

DominicanRepublic

Guyana

Jamaica

St. Lucia

Trinidad andTobago

Source: Latin America and the Caribbean: Selected Economic and Social Data 2007

Health Care Systems

The quality of life and the adequacy of health care systems are also issues that concern

investors, who see these systems as components of their social development and of their

associated personnel with whom they do business. These systems, therefore, must be

reliable and of good quality.

Political System

The political system and the ethics of the host government must be hospitable to foreign

capital in terms of property rights and civil liberties. Widespread government financial

corruption imposes difficulty for the effective conduct of business. For instance, the East

Asian economies have welcomed technology transfers in the form of licenses, capital

goods imports and foreign training. Openness to direct foreign investment has influenced

the speedy technology acquisition in Hong Kong and Singapore. However, FDI policies

in the Caribbean such as those related to foreign ownership of firms, the right to buy land,

the right to borrow locally and work permits, have been restrictive.

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Capitalism

Capitalism and the application of new innovations cause FDI to flow to new territories in

search of new markets and new consumers. The drive to technical progress make

capitalists search for cheaper sources of raw materials in distant countries.

Money Laundering

Money laundering and the threat of terrorism continued to be of serious concern

worldwide and it is imperative that financial institutions implement measures to combat

such crimes. Money laundering is any process used by criminals in an attempt to conceal

the true origin and ownership of proceeds of criminal activities, for example drug

trafficking. With the drive to attract FDI, developing countries can become conduits for

money laundering, and for persons wishing to finance acts of terrorism through financial

services.

Money laundering comprised of three stages: (a) placement (b) layering (c) integration.

Placement is the placing of “dirty money” or unlawful cash proceeds into the financial

system via deposits, purchases of cheques and money orders. Layering is the separation

of criminal proceeds from the source by the creation of layers of transactions designed to

disguise the audit trail and provide the appearance of legitimacy. Some of these

transactions include purchasing investment instruments, insurance contracts, wire

transfers, money orders and letters of credit. Integration occurs when illicit funds enter

the legitimate economy by way of investment in real estate, luxury assets and business

ventures, until the laundered funds are eventually disbursed back to the criminals.

It is the responsive duty of financial institutions to ensure that preventative measures are

in place to reduce money laundering. In the case of Trinidad and Tobago, its Central

Bank revised the 1995 Anti-Money Laundering Guidelines to prevent illegal money from

losing its criminal identity and appearing to be legitimately acquired. Table 3 below

shows statistics on money laundering activities related to commercial real estate within

an international economy that is inclusive of the Caribbean. Real estate investment has

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the highest percentage of total occurrences of money laundering, while mortgage

investment has the lowest.

Table 3: Money Laundering Activities related to Commercial Real Estate

Entities potentially

involved in money

laundering

Reported

incidences

Percent of total

occurrences

Real estate investment 21 30.9

Property Management 20 29.4

Realtors 10 14.7

Individuals 7 103

Construction companies 6 8.8

Title 1 1.5

Mortgage 1 1.5

Source: Financial Crime Enforcement Network (2006)

Terrorist Financing

Terrorist financing can be defined as the provision or collection of funds, either directly

or indirectly, with the intention of them being utilized to undertake the unlawful use of

force against persons or property to intimidate or coerce a government, the civilian

population or any segment thereof, in the furtherance of political or social objectives

(Levis, 1979). Therefore, financial institutions have to be very vigilant with respect to

the financial services they offer, not to encourage or aid terrorist financing or suspicious

transactions. Although these institutions may want to assist the flow of FDI they still

have to exhibit proper evaluation of compliance with due diligence, risk management

procedures, record keeping and reporting requirements. Table 4 below indicates some

incidences of terrorist acts that occurred throughout the Caribbean between 1968 and

2006. As shown in the table, Barbados has 2 recorded instances of terrorist acts which are

very low, relative to Haiti (23), Puerto Rico (21), Cuba (19), Jamaica (8), and Guyana

(4). This is a good sign for encouraging FDI inflows into a host country.

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Table 4: Incidences of Terrorist Acts 1968-2006

Country No. of Incidences

Bahamas 2

Barbados 2

Guadeloupe 2

Guyana 4

Jamaica 8

Cuba 19

Haiti 23

Puerto Rico 21

Grenada 1

Trinidad and Tobago 1

Martinique 1

Source: Memorial Institute of the Prevention of Terrorism Knowledge Base (2006)

Trade

The link between FDI and trade in goods and services is of significant importance to

economic growth and development. Early theoretical approaches to trade such as the

Hecksher-Ohlin (HO) model examined the relationship between FDI and trade. The HO

model purports that a country which is well-endowed with capital will produce and

export capital-intensive products, while a country that is relatively well-endowed with

labour will specialize in and export labour-intensive goods. Empirical evidence has

confirmed that developed countries have been investing in developing countries’

industries in which they do not have a comparative advantage, especially labour-intensive

activities, and this had resulted in increased two-way trade (ECLAC, 2003).

In the Caribbean, FDI has contributed importantly to the evolution of value added and

exports in the services sectors, through the heightened performance of services trade

globally, the greater inclusion of services chapters in trade agreements and

concomitantly, the region’s focus on the inclusion of a services regime in the CARICOM

Single Market and Economy. Total export of services within CARICOM, including

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government services, averaged $5.6 billion (11 percent) from 1992 to 2000 (ECLAC,

2003). This dynamism reflects rising specialization in the services sector from the

traditional activities, such as tourism, banking, insurance and trading services, to

electricity, telecommunications and distribution which have been influenced by active

policies geared towards trade liberalization, privatization and deregulation. Foreign

investors have been attracted to these latter areas because of the improved capacity for

capturing economic rent and the increasingly favorable investor climate.

FDI in the services sector (excluding offshore financial centers) for Latin America and

the Caribbean has expanded by an estimated 8% in 2006. In Jamaica, services exports

averaged US$1.52 billion between 1990 and 2000. The surplus on trade in services grew

by 2.6% over the period. Tourism has remained one of the more dynamic sectors of the

Jamaican economy. However, liberalization has attracted FDI in areas such as financial

and telecommunication services. In the Dominican Republic, the majority of its FDI

inflows have been directed to the services sector, especially transportation, storage and

telecommunications, which accounted for approximately 40.2% of FDI during the period

1990 to 2000 (ECLAC, 2003). FDI has also fostered transformation in the services sector

of economies such as Barbados and the OECS.

5. Benefits and Costs of FDI

The importance of FDI in the economies of Caribbean countries is illustrated in Table 5,

with inward flows growing from US$1,290 million in 1995 to US$3,797 million in 2005.

The largest recipients have been Trinidad and Tobago, Dominican Republic and Jamaica.

According to the Caribbean Trade and Investment Report (2000), CARICOM's

performance in attracting FDI inflows can be considered to be well above average, given

its relatively small population and national income, with several countries being ranked

worldwide between 5 and 21 for FDI flows per US$1000 of gross domestic product

(GDP) and between 10 and 29 for FDI flows per capita. This growth has been bolstered

by the active policies of liberalization and deregulation, which have been embraced by

virtually all the Caribbean territories.

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Table 5: Inward foreign direct investment flows to the Caribbean (US $ millions)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Anguilla 18 34 21 28 38 43 35 38 34 92 103

Antigua and Barbuda 33 23 24 27 64 67 112 80 179 91 129

Bahamas 107 88 210 166 149 250 102 153 190 274 360

Barbados 12 13 15 16 17 19 19 17 58 -12 159

Belize 21 17 12 19 54 23 60 24 -1 128 107

Dominica 55 19 22 9 19 20 18 18 30 25 27

Dominican Republic 414 97 421 700 1,338 953 1,079 917 613 758 899

Grenada 23 19 36 50 43 39 61 62 91 55 28

Guyana 74 93 52 44 46 67 56 44 26 30 77

Haiti -2 4 4 11 30 13 4 6 14 6 10

Jamaica 147 184 203 369 524 469 614 481 721 602 601

Montserrat 3 0 3 3 8 2 1 1 2 3 1

St. Kitts and Nevis 23 38 26 33 60 99 90 81 78 53 50

St. Lucia 35 21 51 86 87 58 63 57 112 … 112

St. Vincent and

Grenadines 31 43 93 89 57 38 21 34 55 66 34

Trinidad and Tobago 296 356 1,000 732 643 680 835 791 808 1,001 1,100

TOTAL 1,290 1,049 2,193 2,382 3,177 2,840 3,170 2,804 3,010 3,172 3,797

Source: Latin America and the Caribbean, Selected Economic and Social Data 2007

UNCTAD’s Transnationality Index6 shows that in 2004 (the latest year for which the

index was compiled), the importance of international production rose in most host

economies (developed and developing as well as transition). The Caribbean, in particular,

performed well with regards to this index, with Trinidad and Tobago, Jamaica, The

Bahamas, Dominican Republic and Barbados ranking 3rd,6th,16th,19th and 28th

respectively, among developing countries. In addition, the top 20 rankings of countries by

UNCTAD’s Inward FDI Performance indices showed significant improvement in the

6 The transnationality index is based on the average of the share of FDI inflows as a percentage of gross fixed capital formation for the last three years; FDI inward stock as a percentage of GDP; value added of foreign affiliates as a percentage of GDP and employment of foreign affiliates as a percentage of total employment.

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economies of The Bahamas and Guyana. In 2005, The Bahamas and Guyana ranked 21st

and 32nd, however, in 2006, they moved up the index to 18th and 20th, respectively.

Nonetheless, as noted in the Caribbean Trade and Investment Report (2000), these

indicators highlighted the dependence on external resources to finance and sustain growth

and development in the region. Such dependence should be carefully managed to prevent

short-term fluctuations based on extra-regional economic developments from derailing

the development process in member states.

Barbados has a number of registered Real Estate Agencies from which data were sought

to analyze the level of investment in condominiums and real estate (inclusive of land)

over the last four years. In 2004, one local agency recorded direct investments in

condominiums and real estate property by returning nationals and foreigners of $2.4

million (see Figure 3). Investments in this category increased over the next three years by

90.6%, 3.7% and 16.1% in 2005, 2006 and 2007, respectively (see Figure 4). It can be

assumed that these increased investments were prompted by the required provision of

additional accommodation leading up to the staging of the ICC Cricket World Cup in

2007.

Furthermore, it is also evident that improved access to and ownership of properties in

Barbados have been in the form of domestic and foreign investments in large concrete

houses, hotels and condominiums that push up the value and resale prices of these

properties and surrounding areas. Understandably, from an economic stand point, an

injection of foreign currency through the sale of land to foreigners can only be of benefit

to the economy. However, with these benefits also come some negatives in that, both on

the south and west coasts, these parcels of land referred to as “windows to the sea” are

sold at very high prices, at a time when there are increasingly turbulent external pressures

on small economies such as Barbados.

22

Figure 3: Investment by Returning Nationals and Foreigners In Condominiums and Other Real Estate Properties In Barbados

0

0.5

1

1.5

2

2.5

2004 2005 2006 2007

Year

Total Investment($BDS millions)

Source: A Local Real Estate Agency 2008

Figure 4: Annual Percent Change in Investment by Returning Nationals in Condominiums and Other Real Estate Property in Barbados

90.6

3.716.1

2005

2006

2007

Source: A Local Real Estate Agency 2008

In order for a domestic economy to maximize the benefits and minimize the costs of FDI

within a host country, there must be policies implemented to attract FDI. This would

serve as a catalyst for the overall effect on macroeconomic growth inclusive of welfare

enhancing processes. Developing countries, such as those in the Caribbean, also need to

reach a certain level of development in education, technology, infrastructure and health

care before being able to benefit from FDI presence in their market. Additionally,

financial markets must be fairly well developed to allow the host countries to reap the full

benefits of FDI.

23

Studies (World Bank, 1993) have shown that FDI triggers technology spillovers and

contribute to factor productivity and income growth. FDI also assists in human capital

formation, contributes to international trade integration, helps create a more competitive

business environment and enhances enterprise development. Positive contributions are

also associated with the environmental and social conditions by transferring cleaner and

more environmentally friendly technologies that lead to more socially responsible

corporate policies. These benefits are very potent tools for alleviating poverty in

developing countries.

As a result of foreign firms transferring their knowledge and managerial skills to

domestic firms, great benefits are derived. This allow firms to be more competitive in the

globalize market with respect to being efficient and productive through the reduction of

costs and development of new revenue generating activities.

Technology transfer results in vertical linkages with suppliers or purchasers in the host

country, horizontal linkages with competing and complimentary companies in the same

industry, migration of skilled labour and the internalization of research and development.

These foreign enterprises provide technical assistance, training and other information to

raise the quality of the supplier’s products. They also assist local suppliers in purchasing

raw materials, intermediate goods and modernizing or upgrading production facilities.

Human capital is enhanced further through training and on-the-job learning to develop

local entrepreneurs who acquired knowledge and skills from working with technological

multinational enterprises. Competition, even although seen as a cost in terms of job losses

and closures of businesses can also be seen as a motivator to higher productivity, lower

prices and more efficient resource allocation.

Environmental concerns are usually positive. Technologies are more modern and

environmentally cleaner than local provision such that positive externalities have

occurred where local imitation, employment turnover and supply chain requirements

have led to improvements in the host country. Developing countries have also benefited

from FDI with respect to reducing the level of poverty, especially in labor intensive

24

countries in adherence with the national labor law and internationally accepted labor

standards. Studies (World Bank, 1993) have found a positive relationship between FDI

and worker’s rights since investors have great concern for their own reputation.

Under the “eclectic theory” there are additional benefits that can be exploited by the host

country. Size and diversification, access to or control over raw materials, the ability to

call on the political support of their government, access to finance on favorable terms in

foreign as well as domestic markets, and the ease with which the foreign firm can shift

production between countries are some of the ownership advantages.

Location advantages encompass things such as transport costs facing both finished

products and raw materials, import restrictions, the ease with which the firm can operate

in another country, the profitability with which the ownership advantages can be

combined with factor endowments in other countries, the tax policy in both source and

host countries, and political stability in the host country. Internalization gains focuses on

factors that allow more profitable transactions to be carried out within the firm than to

rely on external markets. The essential element of the “eclectic theory” is that all three

types of conditions are necessary, but no one is sufficient, in attracting foreign direct

investment.

Although there are some benefits to FDI there are also potential costs that are of an

economic and non-economic nature. Conversely, some potential drawbacks occur in the

deterioration of the balance of payments as profits are repatriated. Foreign firms may not

develop positive linkages with local communities and may have harmful environmental

emissions or disposals, especially in the extractive and heavy industries. Social

disruptions of accelerated commercialization and competition to domestic firms may also

result in closures and lost of jobs. With the influx of FDI, host countries must be careful

not to perceive an increasing dependence on international firms as a loss to political

sovereignty. Capital inflows to developing countries by way of foreign direct investment

overshadow official development assistance by a wide margin, highlighting the

importance of FDI as a tool for economic development.

25

6. A Forward Approach for the Caribbean in the Twenty-First Century

The new Barbados government has stated its desire to move Barbados forward in the new

international economic environment by increasing its foreign exchange earning capacity

and thereby attract higher levels of investment. As the new government continues to chart

Barbados’ path through the turbulent waters of the twenty-first century it recognizes that

the rapidly changing global economic environment poses particular challenges to small

economies. This situation begs the need for new domestic entrepreneurial and investment

opportunities in traditional and new industrial, cultural and knowledge sectors.

Proposals to avoid taxation policies that act as disincentives to investment and

productivity in the January 2008 DLP Manifesto indicate an understanding of the

importance and need for investment and greater productivity. In addition, other proposals

alluded to the improvement in the prices of financial instruments and the enhancement of

foreign exchange reserves by providing attractive investment instruments to keep capital

at home and attract capital from abroad. One important point to note is that, the sub-

region has focused significantly on competing for a larger quantity of FDI through tax

and other incentives, rather than on better quality FDI and infrastructure and institutional

development to maximize the benefits of FDI.

Instead of concentrating on offering generous tax incentives, countries in the sub-region

should focus on building strong competitive systems and institutions to encourage FDI in

high value-added activities. This would entail building comparative advantage in new

dynamic activities based on a careful strategy for human capital development,

partnerships between the private sector and training institutions and efficient public

service and supplier service networks (ECLAC, 2003).

This shift toward services, particularly information and communications services, tourism

and financial services, as a result of liberalization and deregulation will continue to have

increased benefits of FDI to developing countries. Foreign owned service companies can

26

be an important source of spillovers to the domestic business sectors, particularly

compared to the often limited linkages between extractive industries and the host

economies.

Caribbean countries in the 1960s adopted dominant anti-trade policies by relying on

import substitution as the major stimulus to growth. This development policy sought to

repress imports and encourage domestic production of substitutes for those imports.

However, this resulted in what is called the ‘double negative effect” where domestic

producers pushed up the prices on locally produced products under the import

substitution policy, thus deriving increased profits, and reduced the level of exports of

countries pursuing import substitution.

Reflecting on the policies used by the East Asian countries and the Caribbean in the

1960s, it is observed that they were fundamentally different. The Caribbean concentrated

on import substitution policies while the East Asian countries emphasized export driven

development. In addition, the East Asian countries successfully implemented additional

policies that have eluded the Caribbean in relation to strategy implementation and

intervention management. The economies of the East Asian countries have grown

significantly through foreign direct investment over a short period of time. Contrary to

this, income distribution, social conditions and environmental pollution have regressed.

Caribbean countries must therefore learn from the experience of export industrialization

promotion and industrialization by invitation as touted by Sir Arthur Lewis and practice

by the East Asian Countries, coupled with policies to protect the social growth and

development of the society as a whole. With new trading agreements and organizations

that govern international trade such as the World Trade Organization (WTO) and the Free

Trade Area of the Americas (FTAA) it is imperative that Caribbean countries integrate to

resist the threats of globalization and to maximize the benefits and opportunities it can

present. Hence, the Caribbean Single Market and Economy is seen as a strategy

implementation to combat the threats of trade liberalization and globalization in the

twenty-first century. Given the expected benefits of this integration process, the level of

27

foreign direct investment is bound to increase, thus, fuelling growth and development

since the relevant structures would be in place and functioning.

Conclusion

The main objective of this paper was to assess policy issues with respect to FDI, focusing

on the Barbadian economy. However, references were made to Latin American and other

Caribbean territories with a view to determine the strategies that developing countries

need to adopt and implement in order to attract FDI to enhance growth and development.

The evidence indicated that although the Caribbean has a relatively high

transnationalisation index (FDI/GDP ratio), FDI has not facilitated much dynamic

structural change into high value-added production and trade. Generally, the benefits of

FDI have fallen short of expectations. Systemic competitiveness has been constrained by

limited knowledge transfer in high quality downstream segments of production and weak

research and development spillovers. Burdensome terms of technology contracts created

long-term dependence on foreign suppliers for technology, secrecy and proprietary

clauses, including intellectual property rights, and prevented the use of the technology

after the contracts expired.

Moreover, as referred to by Krugman (1998), FDI which involves the transfer of

ownership during a crisis, may not lead to competitive production, since the foreign

corporation may not be taking control of domestic firms because of competence, but

because they have the cash to buy them and locals do not. A major problem with FDI in

the sub-region is that it tends to accentuate economic dualism. Whether it is investment in

petroleum in Trinidad and Tobago, bauxite in Guyana and Jamaica, or tourism in The

Bahamas, the nature of FDI coupled with the prevailing economic structure, limits the

development of competitive linkages with the rest of the economy.

The quality of institutions and supporting services must be made more effective and

efficient to reduce transactions costs in the sub-regional economy. Government policy

28

should focus on eliminating and rationalizing the approval process where bottlenecks in

investment, customs, and the legal and regulatory framework occur. Furthermore,

Government policy should aim to obtain better terms and conditions from foreign

investors where local requirements are utilized to ensure better use of domestic inputs. In

addition, benchmarks for the transfer of technology and training of local managerial and

technical staff should be adopted, as was done by the Asian NICs to facilitate the transfer

of knowledge and skills in order to ensure that prospective local entrepreneurs learn the

“tricks of the trade.” FDI inflows should also create a virtuous circle of higher wages,

increased demand and a better quality workforce due to higher wages based on improved

worker productivity.

As a result of the research done on this very important topic it is quite evident that

developing countries must have adequate structures and policies in place to act as a

catalyst to attract FDI to their shores. It is also imperative that competent public

governance is practiced for these policies and structures to be implemented, thus allowing

the benefits derived to be maximized while minimizing the costs. Sound macroeconomic

policies geared to sustain price stability, growth and development are essential in a

globalize economy when there is an initiative to influence FDI. In addition to this,

creating and maintaining effective support institutions such as investment promotion

agencies that build country image and investment destination, marketing efforts are

important as part of a strategic long-term process. Also, repatriated capital inflows as

remittances by nationals of the Caribbean living overseas have contributed significantly

to the growth and development of individual Caribbean territories and, therefore, must be

encouraged to afford these territories a more developed future. Highly skilled and trained

human capital structures and institutional capacity strengthening would assist in

determining the level of FDI into the Caribbean.

Although FDI is necessary for Caribbean countries to sustain and increase development

growth, there must also be careful scrutiny of the source and origin of the capital inflows.

Transparency of all movement of capital flows is essential to negate any unethical

practices that may arise. Caribbean countries must be cognizant of the movement and

29

origin of the capital inflows to prevent the incidence of money laundering and terrorists

financing that are usually linked to drug trafficking. These ills to society, if allowed to

fester and multiply would destroy what little progress Caribbean countries have made in

development over the years. Although these ills cannot be entirely eradicated from the

operations within a country, no matter how many preventative measures are put in place,

the responsible authorities must have structures and policies in place to control its

escalation. Regressive societal elements such as corruption can result in social issues

involving crime, health, educational and welfare dependencies that could reflect poverty

cycles. Any substantial escalation of practices of this nature can cause severe social and

economic problems for any country in the long run.

The Caribbean Single Market and Economy provides greater impetus for capital inflows

to the Caribbean, hence greater prudence and vigilance is necessary in the process of

capitalizing on the opportunities that will arise from a liberalized global economy.

Caribbean countries must show clearly that they have learned from the East Asian

countries and not let another opportunity to enhance their development go to waste. FDI

though seen as essential to the growth and development of Caribbean economies also

brings with it some issues that can be more costly if they are not managed properly.

Therefore, one can conclude that in every good thing there is some bad that needs to be

kept to a minimum in order to see the true benefits of that good thing.

The Caribbean Trade and Investment Report (2000), while applauding the regional

efforts, has however urged regional governments to be more pro-active towards

improving investment prospects, adding that as far as possible they should channel FDI

resources into developing appropriate regional production structures capable of

generating economic activity in accordance with the needs of the general community, and

focus specifically on fostering backward linkages within the domestic economy.

30

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