Saving Ethiopia from the jackals by turning to institutionalized foreign investment

1 Jul

Posted by The Ethiopia Observatory (TEO)
By Eidmon Tesfaye

While humanity shares one planet, it is a planet of two worlds – the world of the rich and that of the poor. Ethiopia is among the bottom of the underdeveloped group and poverty in the country is widespread and deep-rooted.

In this era of globalisation, investors from every corner of the world invest their money in multiple countries. The primary motive of investors is making profit. If the host country is suitable for this motive, then, foreign investors put their money in host countries. As they do in other developing countries some foreign investors invest their money in various economic sectors in our country.

Developing countries are too poor to save sufficiently for investment. They are characterised by subsistent agricultural economy, wherein production is directly used for consumption and nothing is left for saving and investment. Thus, they need finance in the form of Foreign Direct Investment (FDI), aid and concessional loans, in order to achieve the required growth.

As far as I see it, the strategy of every developing country’s government is reducing poverty and improving the living standard of the society. To achieve this, economic growth is taken as the main objective, though it is not the only solution to overcome persistent poverty. To realise growth, governments use a mix of policies and make interventions in the market. Governments of poor countries have the problem of shortage of capital to finance projects that are intended to bring about development.

In Ethiopia, for instance, the potential sources of tax revenue are minimal due to lower participation of the private sector in the economy. The tax collection system is also ineffective which results in lower government revenue and, hence, government’s underinvestment in institutional infrastructure development. To this end, the importance of foreign sources of finances is indispensable.

The ruling party, the EPRDF, proclaim that its policy is the cause for the increment of FDI in our country. For the reason of our meager economy, if we consider capital in the form of FDI only, rather than institutionalised capital, the outcome will be destructive.

Due to the absence of strong institutional infrastructure, foreigners and top officials are seen involved in the economy unlawfully. Therefore, regarding FDI, the big question for me is how we ought institutionalise it.

FDI has a positive overall effect on economic growth, although the magnitude of this effect depends on the stock of human capital available in the host economy. In contrast, the nature of the interaction of FDI with human capital is such that for countries with very low levels of human capital, the direct effect of FDI is negative.

Different types of economic distortions, however, may jeopardise the role of FDI as a means for advanced technology transfer. For example, because of protectionist trade policies, FDI may be the only way to gain access to domestic markets by firms that would otherwise have been exporters to the host country.

Similarly, governments may offer a set of incentives to foreign investors to stimulate the inflow of FDI, with the objective of increasing foreign currency reserves or of developing certain sectors considered strategic from an industrial policy point of view. These policies may result in a flow of FDI that does not respond to higher efficiency but only on profit from the opportunities created by distorted incentives.

I deem domestic firms to have better knowledge of and access to domestic markets. If a foreign firm decides to enter the market, it must compensate for the advantages enjoyed by domestic firms. Most likely a foreign firm that decides to invest in another country enjoys lower costs and higher productive efficiency than its domestic competitors. In the case of developing countries, in particular, it is likely that the higher efficiency of FDI results from the efficiency of their institutions. To, The higher efficiency of FDI would result from a combination of advanced management skills and more modern technology.

The extent and quality of a nation’s institutions and its institutional infrastructure are becoming a more important component for overall productivity and the attraction of FDI. This, in turn, reflects the belief by private corporations (both foreign and home-based) that the role played by location-bound institutions and organisations in 21st Century society is becoming an increasingly critical determinant of the successful deployment of their own ownership specific, but often mobile assets.

By institutions, we mean the formal conventions (typically called rules), as well as the informal conventions (typically called standards) of society, which individuals and organisations devise and implement. These entities comprise each of the stakeholders (firms, civil society, consumer groups, labour unions and governments) that make up a society.

The purpose of institutions is essential to define the rules by which upgrading competitiveness and attracting FDI is played, monitored and enforced. But the objective of the players is to use the institutions in a way that they will win the game.

Certainly, the institutional infrastructure of a country embraces its political institutions such as regime type, the national structure of decision making, and the judicial system. Economic institutions, such as the structure of national factor markets and the terms of access to international factors of production as well as socio-cultural factors such as informal norms, customs, mores and religions comprise institutional infrastructure.

The key feature of institutions and the institutional infrastructure of which they are part is that they are location-bound extra market instruments designed to facilitate economic activity (including inbound FDI), by reducing the transaction costs of such activity. Such transaction costs are well-known to international business scholars. They represent the ‘inconvenience’ costs of doing business, and the uncertainties arising from possible opportunism, moral hazards and incompleteness in commercial dealings.

They include search, negotiation and enforcement costs. The purpose of an effective and market facilitating institutional infrastructure is to reduce these costs, which, inter alia, include inadequate property rights, the absence of a properly regulated banking system, widespread corruption, imperfect or undeveloped financial markets and weak incentive structures; and by so doing, both enhance the trust, reciprocity and commitment among social and economic agents, and upgrade the competitiveness of firms.

Building an efficient and socially acceptable institutional infrastructure is likely to be particularly challenging in the case of transition economies unused as they are to a market based institutions; and the speed and extent to which this can be efficiently achieved with minimum social disruption, is likely to be a critical factor in influencing the capability of a country to adjust to the demands of global capitalism and to attract FDI.

Government, in seeking to devise appropriate institutions, organisations and policies to upgrade their domestic competitiveness, need to be cognisant of the evolving strategies of existing and potential foreign investors, as they seek to advances their own objectives.

Uniquely, from the past centuries, the value of time in 21st century is big. That may be why the EPRDF is overly focused on statistical data to show the increment of FDI in the country.

But, I think, the numbers indicates only size. They do not show the section of society benefiting from it.

Hence, the EPRDF must go out of the box and institutionalise FDI inflow and management in the country through building an efficient and socially acceptable institutional infrastructure in the country. To carry out this, I believe, the issue of FDI ought to be separated from the party. The era of FDI as the private agenda of top EPRDF officials ought to also end.

/Addis Fortune

*Eidmon Tesfaye Has a Masters Degree in Agricultural Economics & Rural Development.

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