Investing for development: The Policy Framework for Investment
Private investment is a dominant force driving globalisation. Cross-border investment flows have tripled over the last decade alone and foreign capital stocks are now twice the size of global GDP. Private investment is acting as a powerful catalyst for growth and, as emerging economies from Asia to South America have shown, is one of the surest ways to sustained poverty reduction. But this requires having the right policies in place.
Not every country is reaping the full potential of higher investment. Flows of international capital to developing countries are concentrated in a handful of economies, with Africa virtually absent as an investment location. In 2003, five non-OECD countries accounted for more than a quarter of the total value of OECD country investment outflows.
There are several reasons for this geographic imbalance. For a start, there is intense competition to attract investment. Issues like market size or geography matter but, by and large, countries with a poor-quality business and investment environment lose out the most. Even where standards are relatively high, authorities wishing to draw investment must be properly prepared to observe and effectively apply these standards.
Nor is there a single policy instrument to boost inward investment. As any inward investment agency will testify, easy fixes such as subsidies alone will eventually run aground if, for instance, bureaucracy is too costly. In other words, as OECD experience and analysis suggest, the most effective way to realise the full potential of investment is to put in place a range of conditions needed to attract and sustain those investments in the long term.
That means encouraging high standards in terms of transparency, procedural fairness, openness and corporate responsibility. To help achieve this, the OECD with non-OECD governments, the World Bank and other organisations are developing a Policy Framework for Investment (PFI). Quite simply, it aims to support governments’ efforts to attract and to reap the benefits of global investment. What is it, how does it work and who can use it?
First it is necessary to place the PFI into context. Attracting investment is not an end in itself, but rather a means to sustain growth and development. The development community too has recognised the crucial role of private enterprise within any strategy aimed at reducing poverty. This common ground led to 182 governments adopting the United Nations Monterrey Consensus in 2002, and this September, the UN World Summit renewed its commitment to mobilising private investment, both domestic and foreign, for advancing economic development and as a way to achieve the goals of the Millennium Declaration.
Against this background, the PFI is an initiative designed to advance implementation of the Monterrey Consensus through a whole-of-government approach. Just as a narrowly defined investment policy is not the best way to attract business investment, a poorly conceived investment attraction strategy may create incentives which distort business decisions, and in some cases even deter private investors. Providing tax concessions, for instance, will have a limited impact, or indeed do more harm to the business climate, if these are compensated by other new taxes, or draw funds away from education.
Ironing out such conflict reinforces the need for coherent policies for investment and for good business promotion and facilitation policies. These must be aimed at correcting for market failures and developed in a way that can leverage the strong points of a country’s investment climate.
Building a coherent framework for investment is precisely what distinguishes the PFI. It is best described as a tool that can assist different types of countries to benchmark their strategies against broadly accepted international practices. It highlights ten domains that, beyond stable macroeconomic conditions, have a strong bearing on the investment environment. These are: investment policy; investment promotion and facilitation; trade policy; competition policy; tax policy; corporate governance; corporate responsibility and market integrity; human resource development; infrastructure development and financial services; and public governance.
Each of the policy areas considered under the PFI comes with a series of probing questions to test for quality and coherence, based on OECD and non-OECD experiences, as well as the established principles embodied in international agreements. For example, questions in the investment policy chapter relate to the broader benefits for domestic and foreign investors alike of regulatory transparency, property rights protection and fair treatment for all investors.
The PFI’s emphasis on comprehensive and coherent government policies for investment takes into account the broad interests of the community in which investors operate, particularly with respect to the policy domains that indirectly influence the investment climate. For instance, the PFI asks whether trade policies that restrict imports act as an obstacle to investment in both the host and home countries by increasing the cost of doing business and by shrinking the size of markets. In the field of competition policy, it tests whether the principles in operation are used in support of the broader investment strategy.
The PFI also helps to support integration of policy regimes across countries. A host country may, for example, have an exemplary domestic tax system, but the lack of a well established tax treaty network between host and home countries of investors may result in unintended double taxation of investment returns, discouraging investment activity. In short, the questions seek to tease out and make more transparent the opportunity cost of structural policy choices from an investor perspective.
The PFI does not propose policy prescriptions. Rather its strength lies in providing a reference point which governments will be able to use to guide the formulation of policy standards in all areas bearing on the investor climate. Secondly, governments could use the PFI in self-evaluation or mutual assessments among countries in different regions, as well as in multilateral discussions. And thirdly, the PFI can help donor agencies to design more robust capacity-building programmes. All of these uses would facilitate a speedier consensus towards good policy practices and help to create more even, transparent and more attractive destinations for investment.
More than 50 OECD and non-OECD countries are, through a taskforce of government representatives, involved in the development of the PFI. Thanks to this collaborative approach, based on extensive regional consultation in every continent, the PFI can be adapted and made relevant to the specific economic, legal and cultural circumstances that exist in countries at different levels of development.
In May this year a joint conference between the OECD and the New Partnership for Africa’s Development (NEPAD) held in Entebbe examined the PFI in the African context, and in October 2005 an OECD conference, organised in partnership with the World Bank and hosted by the Brazilian government in Rio de Janeiro, strengthened the developing country dimensions of the PFI and considered how it can be best used by governments and stakeholders.
Version one of the PFI is scheduled to be launched in mid 2006. Already it has attracted wide interest from many governments as well as regional organisations and initiatives that work with these countries, such as ASEAN, SEE, NEPAD and APEC. This is encouraging, as clearly the tool needs to be actively used if it is to grow and succeed. After all, it is a “living” instrument that must evolve with circumstances and experience to remain practical.
The PFI must be seen in the broader context of multilateral efforts, including the Doha Development Agenda and the Johannesburg World Summit on Sustainable Development Declaration, to strengthen the international and national business environments. Directed to governments, it complements instruments addressing good corporate practices, such as the OECD Guidelines for Multinational Enterprises.
The Policy Framework for Investment is an innovative response to the policy challenges raised by globalisation. If governments and development communities use it to assess different situations and to formulate and–most importantly–implement adequate policy responses, then the full potential of investment, as envisioned in the Monterrey Consensus, can be harvested. That means gains for sustainable development and the fight against poverty as well.
OECD (2005), International Investment Perspectives, Paris.
OECD (2005), Investment for Development: 2005 Annual Report, Investment Policy Co-operation with non-OECD Economies.
OECD (2005), Corporate Responsibility in the Developing World, Annual Report on the OECD Guidelines for Multinational Enterprises.
© OECD Observer, No. 251, September 2005
For more on the October 2005 conference in Rio, please click here
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