CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES White Paper for Japan’s G7 Presidency © 2023 The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of the World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the World Bank, its Board of Executive Directors, or the govern- ments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Contents Acknowledgments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v Abbreviations and Acronyms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Chapter 1. Evolving Landscape of Investment Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 FDI dynamics are changing fast in developing economies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 New opportunities are emerging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Chapter 2. Changes in FDI Rules and Policies: Latest Trends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Increased trend toward FDI liberalization across developing countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Growth in FDI restrictions, especially in developed countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Strategically calibrating and reforming investment incentives. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Derisking the investment environment by curbing investment disputes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Selected examples of multilateral, plurilateral, and regional initiatives on investment . . . . . . . . . . . . . . . . . . . 28 Chapter 3. FDI Policy Reforms: Examples from East Asia and Sub-Saharan Africa. . . . . . . . . . . . . . . . . . 32 Pillar 1: Investment attraction and facilitation through targeted reforms to seize investment opportunities in new sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Pillar 2: Investment retention and investor grievance management to retain existing investors. . . . . . . . . . . 35 Pillar 3: FDI linkages with local economies to harness FDI spillovers and benefits. . . . . . . . . . . . . . . . . . . . . . 36 Chapter 4. Policy Considerations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Appendix A. Supplementary Analysis for Chapter 1 on Evolving Landscape of Investment Flows. . . . . 46 Appendix B. FDI Trends in Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Contents | iii Appendix C. High-Level Summary of Good Practice Elements to Implement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 Corporate Tax Incentives Appendix D. Examples of FDI Policy Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Appendix E. Country Classifications. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Endnotes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 iv | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Acknowledgments This report was jointly prepared by the Interna- Ivan Anton Nimac, Eloise Obadia, Lien Anh Pham, tional Finance Corporation (IFC) and the World Ramprakash (Ram) Sethuramasubbu, Victor Steen- Bank at the request of Japan’s Group of Seven (G7) bergen, and Alexander Vanezis. Jonathan Boulle, Presidency to inform discussions at the May 11–13, Matisse Gauthier, Davide Rigo and Gianluca San- 2023, G7 meeting of finance ministers and central toni provided analytical input at various stages of bank governors (FMCBG). the report. Victoria Solan edited the report and The report was prepared by a team co-led by Nick Visscher formatted charts and illustrations. Peter Kusek (Senior Economist, World Bank) and The team is grateful to peer reviewers Fer- Alexandros Ragoussis (Senior Economist, IFC), nando Blanco (Principal Economist, IFC), Stephan under the guidance of Asya Akhlaque (Practice J. Dreyhaupt (Principal Economist, IFC), Mary C. Manager, Investment Climate, World Bank), Mona Hallward-Driemeier (Senior Economic Adviser, Haddad (Global Director, Trade, Investment, and World Bank) and Smita Kuriakose (Senior Econ- Competitiveness, World Bank), and Denis Medve- omist, World Bank). The team also benefitted dev (Senior Economic Advisor, IFC). from comments and guidance by Roumeen Islam The report team included Dilek Aykut, Shihab (Senior Adviser to the Managing Director, IFC), Ansari Azhar, Juliana Beall, Denny Mahalia Lew- Marc Schiffbauer (Lead Economist, World Bank) is-Bynoe, Gerlin May U. Catangui, Kobina Egyir and advice from Gilles Alfandari (External Affairs Daniel, Paramita Dasgupta, Elwyn Davies, Max- Adviser, World Bank) and Ross Masood (Principal imilian Philip Eltgen, Xavier Forneris, Armando Operations Officer, IFC). Heilbron, Eduardo Antonio Jimenez Sandoval, Pri- The team gratefully acknowledges financial yanka Kher, Hania Kronfol, Fantu Farris Mulleta, support from the Comprehensive Japan Trust Fund. Acknowledgments | v Abbreviations and Acronyms AfCFTA African Continental Free Trade Area ISDS investor-state dispute settlement ASEAN Association of Southeast Asian LAC Latin America and the Caribbean Nations MENA Middle East and North Africa BEPS Base Erosion and Profit Shifting MNC multinational corporation CPSD Country Private Sector Diagnostic MNE multinational enterprise CRM customer relationship management MSMEs micro-, small-, and medium-size EAP East Asia and Pacific enterprises ECA Europe and Central Asia NA North America FDI foreign direct investment OECD Organisation for Economic Co- G7 Group of Seven operation and Development G20 Group of Twenty R&D research and development GDP gross domestic product SIRM systemic investor response mechanism GMT global minimum tax STRI Services Trade Restrictiveness Index GOLSM Guinean Online Local Supplier Marketplace UNCTAD United Nations Conference on Trade and Development IFC International Finance Corporation UNIDO United Nations Industrial IFD investment facilitation for Development Organization development WB World Bank IMF International Monetary Fund WTO World Trade Organization IPA investment promotion agency IPRR Investment Policy and Regulatory Review vi | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Executive Summary Since the onset of the COVID-19 pandemic, a Capital flows to most developing coun- series of overlapping crises have brought about tries, including foreign direct investment, volatility and an uncertain outlook for the global have grown little over the past decade. economy. The number of people living in extreme Foreign capital flows to developing countries fell poverty has increased by more than 700 million, to an estimated $662 billion in 2022 from an aver- and the world is not on track to meet the Sus- age of over $1 trillion in the decade preceding the tainable Development Goals. Across the world, COVID-19 pandemic. Falling portfolio equities the increasingly severe effects of climate change and bonds accounted for a disproportionate share are putting further strain on developing countries of the global drop, as investors sought safety and and having a disproportionate impact on the poor. higher returns. Across countries, most of the de- Meanwhile, debt sustainability challenges and lim- cline was due to a fall in capital flows to China and ited fiscal space for many developing country gov- the Russian Federation, reflecting the pandemic ernments limit their ability to respond. Against this lockdowns in China and the Russian Federation’s backdrop, it is increasingly important to scale up invasion of Ukraine. private capital flows to developing countries to sup- FDI flows to developing countries followed a port private sector development and to address the less pronounced decline than overall capital flows, growing global challenges they face. and FDI to countries other than China and the This report focuses on the trends in foreign di- Russian Federation even increased slightly to an rect investment (FDI), which encompasses foreign estimated $406 billion in 2022 from $386 billion investment in new or existing firms and production in 2021. However, the importance of these flows facilities. FDI is a subset of overall capital flows, but has steadily declined over the past decade when it is perhaps the most critical because of its potential measured as a share of developing countries’ gross development impact and stability relative to other domestic product (GDP). This decline reflects not cross-border capital flows. The report provides a only weak macroeconomic prospects and geopo- granular analysis of shifts in FDI flows and policy litical tensions, combined with the lasting impact trends and suggests policy responses that develop- of the COVID-19 pandemic, but also the ongoing ing countries may consider in order to reverse the process of shifting global value chains and trans- decline in FDI and to enable more private capital to formation of investment in terms of modes of en- support their development needs. try, sources, and sectors, among other dimensions. Executive Summary | 1 Growing climate change impacts, rising interest locations. Taken together, these trends could lead rates, and policy changes in advanced countries— to fewer, larger, and more powerful foreign en- such as incentives for green investments and local- trants in developing countries’ labor and product ization of supply chains for key technologies—have markets, potentially weakening competition and also had far reaching implications for the allocation many of its benefits in destination markets. of investment across the globe. New FDI opportunities are emerging in Shifts in the composition of FDI flows risk services, the clean energy transition, and reducing their development impact. in global value chain reconfiguration. The past decade saw the emergence of several Historically, FDI in developing countries has been changes in the composition of FDI to develop- mainly in manufacturing and infrastructure proj- ing markets that risk reducing the development ects. However, during the COVID-19 pandemic, impact of these flows. “Greenfield” FDI, which investments in those projects dried up and an- involves the establishment of new production fa- nouncements of greenfield investments in services cilities and thus the creation of many new jobs, have now surpassed those in manufacturing. Look- has been in consistent decline as a share of total ing ahead, new opportunities to attract foreign investment. While annual announcements of new direct investment are emerging in the growing greenfield projects (that is, the future pipeline of services sectors of developing countries, such as investments) averaged more than 100 percent of banking, transportation and logistics, tourism, and gross FDI flows to developing countries before health care. the global financial crisis, the ratio had dropped Investment opportunities in the clean energy to one-half of gross flows by 2020. At the same transition are growing. While investment in sec- time, cross-border mergers and acquisitions of tors classified as “green” by the European Union existing companies and project finance grew in (EU)—such as electric vehicles, battery storage, importance. Although these other types of foreign and solar panels—has been considerably lower investments can also support growth, their impact than in other sectors for most of the past two de- on employment and economic transformation cades, the gap has narrowed significantly in merg- tends to be more modest. ers and acquisitions and disappeared in greenfield Concentration of FDI flows into a smaller FDI since 2020. number of investors is also evident. Whether mea- International production networks are experi- sured as an index of concentration or as a share of encing reconfiguration that is particularly intense largest enterprises in total, concentration has been in Asia. The main motivations reported for these on the rise since the global financial crisis. This shifts by multinational enterprises are proximity to holds globally as well as for investment into de- final consumption and diversification of produc- veloping countries and for a number of important tion to protect against future shocks. The effect of source countries—China, Japan, and the United geopolitical tensions on the relocation of invest- States—and sectors such as extractives, chemi- ment also appears strong, particularly on flows cals, and energy. A parallel trend is the growing involving the Russian Federation and China. This importance of reinvested earnings and intercom- reconfiguration of investment aligns with a reloca- pany loans relative to new equity investment. The tion of more labor-intensive production to regions former are associated with the expansion of ex- like Sub-Saharan Africa and South Asia and rep- isting facilities by incumbents in established sec- resents an opportunity for job creation and eco- tors rather than expansion into new sectors and nomic transformation in the receiving countries. 2 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Reforms have generally continued to be Beyond the dynamics in national-level trade favorable to FDI, but recently some mea- and investment policy, a reenergized international sures, primarily in developed countries, investment policy agenda at global, multilateral, have become more restrictive. and regional levels shows promising signs for devel- Over the past 20 years, more developing countries oping countries. Some of the leading international have liberalized their economies and lifted many initiatives—such as the World Trade Organization’s restrictions on foreign investment. The latest evi- Investment Facilitation for Development Agree- dence from the World Bank FDI Entry and Screen- ment, regional integration initiatives such as the ing Tracker shows that since 2020, more than 24 African Continental Free Trade Area (AfCFTA), developing market and developing economies have and the agreement on the global minimum tax on eased investment restrictions by increasing foreign multinational enterprises brokered by the OECD equity ownership ceilings, further opening sectors and the Group of Twenty (G20)—have the poten- such as finance and energy to FDI, streamlining tial to play a key role for harnessing FDI for sustain- and expanding foreign worker permit regimes, and able development. To be effective, these initiatives improving land ownership rights. need to be complemented by ambitious domestic However, the lack of growth in FDI flows to reforms and strong implementation efforts. developing countries demonstrates that these types of reforms are necessary but not sufficient The evolving global environment re- to attract more private capital. For example, while quires a renewed effort by countries many reforms have focused on services, further seeking to mobilize FDI for sustainable opportunities for easing services sector restric- development. tions remain. In addition, product market reg- Adjustments in the geographic, sectoral, and struc- ulations, lack of complementary policy reforms tural patterns of FDI are increasing the urgency for in skills and technology adoption, and a dearth countries to remain nimble and adaptable to seize of investable projects hamper FDI in developing these opportunities and maintain their investment economies and should be the focus of their future climate attractiveness. Clear and transparent rules reform efforts. for FDI that are consistently and predictably en- In contrast to developing countries, restrictions forced are a core anchor of this endeavor. Besides on FDI in advanced economies have been on the attracting new investments, to foster the retention rise. FDI screening has gradually increased, moti- and expansion of FDI, governments should ad- vated by the desire to preserve host country inter- dress risks that often lead to investors withdrawing ests such as national security, critical infrastructure, investments or canceling expansion plans, such dual-use technologies, and sensitive information. as adverse regulatory changes or breaches of con- Data from the FDI Entry and Screening Tracker tracts. Facilitating links between FDI and the local show that since 2020, Organisation for Economic economy should also be a medium-term priority, Co-operation and Development (OECD) countries through the implementation of broader policies have accounted for 70 percent of all restrictive FDI to strengthen firm- and economy-level absorptive measures and 60 percent of all screening measures. capacity. In addition to the rise in screening of foreign in- This report highlights practical country exam- vestors interested in new greenfield FDI projects ples of reforms from Sub-Saharan Africa and East in specific sectors, many advanced countries have Asia to illustrate promising approaches to strength- also increased their scrutiny of foreign takeovers of ening countries’ policy responses to changing for- strategic assets and technology companies. eign investment dynamics. The reform examples Executive Summary | 3 are organized along the three main pillars of the lenges presented by the current global environment investment life cycle: (a) investment attraction and requires multilateral and international cooperation facilitation aiming at seizing new opportunities, and leadership. Given the scale of private sector (b) investment retention to decrease the probabil- financing needs for development, official multilat- ity of divestment and to foster existing expansion eral assistance should catalyze private capital and and reinvestment of retained earnings of FDI, and enable FDI. Major donors, in close coordination (c) FDI links with the local economy to increase the with international financial institutions, can play a development dividend of FDI. The examples include role in facilitating and enabling increased private successful reforms in liberalizing sectors with high capital flows through cofinancing and derisking, as investment potential, such as services in Indonesia; well as supporting domestic resource mobilization easing legal and regulatory barriers to investment and increasing the efficiency of public spending. in Ethiopia; and increasing investment attraction The magnitude and scale of the current head- through strategic reevaluation of investment oppor- winds for the global economy necessitate that pol- tunities in South Africa. Additional examples from icy makers deploy their full set of policy tools to Mongolia, Rwanda, and Viet Nam illustrate how improve business confidence and boost countries’ investor grievance management programs enhance investment competitiveness. Maintaining an open investor confidence. In addition, examples from and rules-based system, fostering global integra- Guinea and Viet Nam demonstrate how building tion and outward-looking policies, solidifying trust stronger FDI links with the local economy through among countries, and ensuring shared benefits supplier development programs and FDI linkages from FDI and global value chain participation are initiatives helps decrease information gaps for inves- key to the world’s future sustainable and resilient tors and boosts local business opportunities. growth. In addition to country-level efforts for enabling private investment, tackling the complex chal- 4 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES CHAPTER 1 Evolving Landscape of Investment Flows The mobilization of private investment in devel- Foreign direct investment to developing oping economies is essential to meet the financ- countries stagnated before the COVID-19 pan- ing gaps for sustainable development around demic and the current set of headwinds to the the world. The shortfall in annual funding for global economy has further exacerbated the lon- achieving the United Nations (UN) Sustainable ger-term trends. Using the most up-to-date evi- Development Goals exceeds $4 trillion per year, dence, this section highlights that East Asia and according to the latest UN estimates (UNCTAD Pacific and Sub-Saharan Africa are among the re- 2022). Low-income countries face particularly gions most affected by the recent developments. acute challenges: foreign capital inflows averaged These regions are highlighted throughout the re- only $2 billion per year over the period 2016–21, port both in terms of changing dynamics and pol- compared with the $3 billion during the first half icy responses. of the past decade. As a share of gross domestic A number of structural trends underscore ar- product, foreign capital flows to these countries eas of increasing relevance for the policy agenda. have fallen from an 8.6 percent peak in 2007 to Namely, greenfield investments are becoming rarer, about 1.7 percent in 2022. reinvested earnings are becoming a more critical Foreign direct investment is a critical yet in- component of new investment in developing coun- creasingly scarce component of private finance tries, and FDI projects are becoming increasingly flows to developing countries.1 Global uncertainty, concentrated among fewer investors. At the same ongoing geopolitical fragmentation, and the slow- time, new opportunities are emerging from the on- down of economic growth in major developing going reconfiguration of global and regional supply economies associated with a challenging macro- chains, as well as from the growth of FDI in ser- economic environment are all thought to have vices and green sectors. There is also potential for contributed to weak investment patterns. Moving FDI to drive job creation in Africa. forward, the structural transformation of invest- ment—including increased concentration of flows, FDI DYNAMICS ARE CHANGING supply chain reconfigurations, and shifts to activi- FAST IN DEVELOPING ties such as services—is driving change that is not ECONOMIES yet well understood, and by extension, less well Over the years, FDI has played a crucial role in framed by policy. the growth and development of economies across Evolving Landscape of Investment Flows | 5 the income spectrum, bringing new technology tal flows in both country-specific sudden stops and as well as boosting capabilities, competition, global stop episodes (figure 1.1). FDI’s resilience, and domestic productivity.2 The turn of this cen- especially its equity component, is mainly driven tury was marked by an unprecedented growth of by investors’ long-term outlook rather than cycli- capital inflows to developing countries, making cal or short-term financial market considerations. foreign investment a key topic in the Finance Foreign direct investors tend to look through for Development agenda. Growing FDI flows to the short-term fluctuations and divest only if the developing economies during the period before prospective project has lost its strategic value or the global financial crisis was to some extent the long-term attractiveness. The other two FDI com- reflection of enabling global macroeconomic ponents—reinvested earnings and intercompany conditions. This macro environment was marked loans—are more volatile. They are closely linked to by the expansion of China, favorable commod- the companies’ operational activities and are more ity prices, and a largely positive global growth dependent on the economic cycle. outlook. The procyclicality of capital flows to both de- Foreign capital flows in developing veloping and advanced economies offers some countries have been declining mainly explanation for their evolution across borders in due to components other than FDI. more recent years. Studies have shown that capital Despite their spectacular growth in the years lead- inflows tend to expand during good times and to ing to the global financial crisis in 2007–08, foreign decline during recessions (Broner et al. 2013; Ka- capital flows to developing countries have been on minsky, Reinhart, and Vegh 2005; Puy 2013). While a downward trajectory since. Foreign capital in- this pattern is documented in markets around the flows to developing countries fell to an estimated world, it appears generally stronger in developing $680 billion in 2022, marking the lowest level since markets and weaker at the lower end of the coun- 2015, following the record-breaking $1.6 trillion in try income distribution (Araujo et al. 2015; Puy 2021. Relative to GDP, foreign capital flows reached 2013). The decision to invest internationally in a a low level rarely seen the past two decades (figure specific project and location is also a decision to 1.1). Tighter global financial conditions, height- not invest those same funds domestically. Macro- ened uncertainty, and the Russian Federation’s in- economic spillovers, in other words, can also mo- vasion of Ukraine weighed on developing country tivate investment decisions. Evidence pointing to assets in most of 2022. the growth of outflows from high-income to devel- Declines in portfolio equity and investments oping economies during business cycle downturns other than FDI accounted for a large part of the reflects investors’ arbitrage among different invest- contraction in foreign capital flows. Even with ment opportunities (Levi Yeyati, Panizza, and Stein some recovery in the fourth quarter (Q4), foreign 2007). Although the strength of this pattern varies portfolio equity and debt flows reached an esti- substantially across major investing economies, it mated net outflow of $203 billion for the whole may partly explain the dynamics of foreign capital of 2022, a sharp downturn from the $225 billion to developing economies over the last decade and of inflows in 2021. International bond issuances very recent years. by developing countries slumped, accompanied Relative to other foreign capital flows, FDI has by large domestic bond sales by foreign inves- been more stable and resilient during financial tors amid the Russian Federation’s invasion of crises. FDI inflows have exhibited lower volatility Ukraine, global financial uncertainty, and con- and declined by smaller amounts than other capi- cerns about high debt. Other investment inflows 6 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Figure 1.1 | Foreign Capital Inflows to Developing Countries, 2000–22 FDI Portfolio inflows Other inflows Foreign capital inflows Russian Federation’s invasion . of Ukraine & global tightening Argentina Global Oil price collapse default financial crisis Russian Federation sanctions COVID- . Foreign capital inflows (percent of GDP) . $, trillions . . – . – e Source: IFC and World Bank staff calculations on IMF Balance of Payments (July 2023 update). Note: Inflows are net of disinvestments and sales of assets held by nonresidents. Bars represent foreign capital flows in current prices (left axis), and the trendline represents their share of GDP (right axis). Data for 2022 were estimated by IFC staff based on high-frequency FDI data for selected developing countries and the country-specific internal databases; FDI = foreign direct investment; GDP = gross domestic product; IFC = International Finance Corporation; IMF = International Monetary Fund. Note on FDI Statistics The foreign capital statistics presented within this report are derived from IMF Balance of Payments data covering all countries. The definition of direct investment used by the IMF is the same as in the fourth edition of the OECD Bench- mark Definition of Foreign Direct Investment. Data on FDI inflows and outflows are presented on net basis (capital transactions’ credits less debits between direct investors and their foreign affiliates) following the sixth edition of the Balance of Payments Manual. Net decreases in assets or net increases in liabilities are recorded as credits, while net increases in assets or net decreases in liabilities are recorded as debits. The merit of this single source lies in its consistent methodological specifications across countries and its com- prehensive coverage of cross-border capital flows beyond direct investment, such as debt and portfolio equity. Al- ternative prominent publications on foreign investment, like the United Nations’ World Investment Report (UN, 2022), or the OECD FDI Statistics, use diverse sources for selected economies, such as China and Russia. Specifically, the United Nations use reports of FDI inflows into China from the Chinese Ministry of Commerce (MOFCOM), on a gross basis, omitting debits from inward transactions. Data regarding outflows from 2003 to present originate from the same source. The OECD relies on IMF Balance of Payments data for China. Regarding Russia, both the United Nations and the OECD report FDI statistics from the National Bank of Russia, which have not been entirely aligned with IMF figures over the years. In 2022, the National Bank of Russia reported a net FDI divestment of $18 billion, as opposed to the IMF’s report of $40 billion. Evolving Landscape of Investment Flows | 7 fell significantly, even after excluding the one-off The weakness of capital inflows was driven mainly jump driven by the $275 billion of Special Draw- by the sharp fall or reversal of the portfolio equity ing Rights allocations to developing countries in flows and less by FDI inflows. The only exception 2021. was the Sub-Saharan Africa region, where portfo- In 2022, China and the Russian Federation ac- lio inflows increased due to some recovery in South counted for a disproportionate share of the global Africa. The trends were similar for the region when drop in capital flows. Capital inflows to China fell South Africa was excluded. sharply in 2022, with a 43 percent decline in FDI in- flows and large portfolio and other disinvestments. FDI inflows have been more resilient The decline in inflows was mainly due to the pol- than other capital flows against adverse icies that came into effect during the COVID-19 conditions. pandemic, heightened geopolitical tensions, slow The pandemic reversed a long-term trend of de- growth, rising borrowing costs, and curbs on foreign veloping countries accounting for an increasing listings. Similarly, as a result of the Russian Feder- share of global FDI. Whereas in 2019 more than ation’s invasion of Ukraine, the Russian Federation 40 percent of global FDI flows went to developing experienced close to $130 billion of foreign capital countries—a historical high—in 2021 this share fell disinvestments in 2022. back to 35 percent. Despite experiencing a gradual The year 2022 also marked the reversal of decline, FDI inflows to developing countries have China’s growing role as a source of capital flows to been less volatile than flows to high-income econo- other developing countries.3 The growth of Chi- mies (see figure A.2). na’s outward investment into both advanced and China and the Russian Federation accounted developing markets has been a salient feature of for a disproportionate share of the fall of inflows, the global economy in the past 15 years. In 2020, whereas in the rest of the developing countries, at the onset of the pandemic, China overtook for FDI increased slightly to an estimated $406 bil- the first time both Japan and the United States to lion in 2022, from $386 billion in 2021. Flows were become the world’s largest direct investor, with supported by several recent developments, such as outflows surpassing those of any other country. If high energy prices leading to investment in the ex- sustained, the recent contraction of Chinese for- tractive sectors and renewables, a few large privat- eign investment may weigh onto the future out- izations in Latin America and the Caribbean, and look of investment into developing countries. progress in investment reforms in countries such The 2022 decline of capital flows into devel- as India. Egypt and Morocco seemed to have at- oping countries other than China and the Russian tracted investors to renewable energy sectors, given Federation has been less pronounced (see figure the recognizable jump in cross-border investment A.1 for aggregate flows excluding China). Inflows announcements throughout 2022. Similarly, there totaled an estimated $816 billion in 2022, compared were large investment announcements in the semi- with $848 billion the previous year. Overall, foreign conductor sector in Malaysia, Mexico, and Viet capital inflows declined moderately across all de- Nam. veloping regions except in Latin America and the Latin America and the Caribbean and South Caribbean and South Asia (figure 1.2). The Middle Asia were the only regions that experienced an East and North Africa was the most affected, with increase in FDI inflows in 2022. Sub-Saharan Af- inflows only reaching an estimated $8 billion com- rica experienced a significant, yet moderate, con- pared with $30 billion in 2021. Other regions expe- traction driven partly by year-over-year declines in rienced a reduction of about 20 percent in inflows. South Africa. In addition to Mauritius—a financial 8 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Figure 1.2 | Foreign Capital Inflows to Developing Regions, excluding China and the Russian Federation, 2018–22 ($, billions) Sub-Saharan Africa South Asia Middle East and North Africa Latin America and the Caribbean Europe and Central Asia (excluding Russian Federation) East Asia and Pacific (excluding China) e Source: IFC and World Bank staff calculations on IMF Balance of Payments (July 2023 update). Note: Data for 2022 were estimated by IFC based on high-frequency FDI data for selected developing and country-specific internal databas- es.; FDI = foreign direct investment; IFC = International Finance Corporation; IMF = International Monetary Fund. center with volatile investment flows—FDI inflows accounting for 75 percent of capital inflows, much declined in Mozambique and Ghana. There were higher than the other regions. In addition to recent also large divestments in oil-exporting countries global headwinds, including the pandemic and the such as Angola and Nigeria. Overall, FDI to GDP Russian Federation’s invasion of Ukraine, more fell from over 30 percent to 11 percent during the medium-term factors such as the secular economic second half of the past decade (figure 1.3). The slowdown in developing countries, lower profit- Latin America and the Caribbean region bucked ability of investment, volatile commodity prices, the global negative trend in capital inflows, with deglobalization policies, and geopolitical uncer- upturns supported by significantly higher FDI tainties are all thought to have contributed to these inflows compared with 2021. Interestingly, the trends in the past decade. region’s portfolio inflows were already lower in re- The outlook for FDI to developing coun- cent years compared with the early 2010s, with FDI tries is generally not optimistic. Overall invest- Evolving Landscape of Investment Flows | 9 Figure 1.3 |  FDI Inflows to Sub-Saharan Africa, excluding South Africa and Mauritius, 2000–22 (Value $ and Share of GDP) FDI inflows FDI percent of GDP $, billions percent e Source: IFC and World Bank staff calculations on IMF Balance of Payments (July 2023 update). Note: FDI = foreign direct investment; GDP = gross domestic product; IFC = International Finance Corporation; IMF = International Monetary Fund. ment, including FDI, in developing economies tries. For example, in 2022 alone, more than 2 is expected to remain subdued in the short million jobs were generated by greenfield FDI glob- term (World Bank 2022a). The deviation from ally, based on data on the announcement of green- pre-pandemic trends is expected to remain sub- field investments.4 Beyond the creation of new and stantial, owing to slower growth, uncertainty, often better-paid jobs in the formal sector, these and rising borrowing costs in developing coun- benefits also include capital formation, transfer of tries. Because advanced economies are the major technology and managerial expertise, and a long- source of FDI in the developing world, changes term commitment of presence.5 in macroeconomic policies in the United States Over the past two decades, greenfield invest- and the European Union, and growing trade and ment has become a smaller share of overall FDI geopolitical fragmentation combined with the (figure 1.4, panel a). In the early 2000s, capital ex- risk of financial fragmentation, will affect the in- penditure in future greenfield projects that were vestment decisions of multinational enterprises announced in a given year exceeded total FDI (MNEs) (see box 1.1). inflows, reflecting a positive outlook and a more interconnected global economy. However, for Greenfield investment has shrunk most of the past decade, expenditure in greenfield relative to other modes of entry. projects stabilized at a level lower than current Greenfield investment, that is, the creation of new flows. By the onset of the COVID-19 pandemic, production facilities in host economies, can sup- announcements of future greenfield investments port growth and job creation in developing coun- represented only one-half of current investment 10 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Box 1.1 | Geo-economic Fragmentation of Capital Flows and Investment The April 2023 World Economic Outlook published by the International Monetary Fund (IMF) describes three com- pounding layers of developments that shape expectations for the global economy in the short and medium term. The first layer is the continuation of major forces that shaped the world economy in 2022, including high debt levels, geopolitical tensions, and the COVID-19 pandemic, with changed intensities. The second is the policy adaptation to the context of those crises, with stubbornly high inflation, monetary tightening, and the recent financial sector turmoil, resulting in banking sector vulnerabilities. The third layer concerns the medium-term effects of ongoing geo-economic fragmentation on capital flows and investment. Of particular interest is the analysis of geo-economic fragmentation, which can be summarized in the following findings: First, foreign direct investment (FDI) flows are increasingly concentrated among countries that are geopolit- ically aligned. Although new in neither direction nor intensity, the role of geopolitical alignment as an FDI driver has increased since 2018, with the resurgence of trade tensions between the United States and China. Second, empirical analysis undertaken at the IMF suggests that, on average, developing market and developing economies are more vulnerable to such FDI relocation than advanced economies. Sub-Saharan Africa and Asia are among the regions substantially affected, though there is considerable heterogeneity within continents in terms of sectoral specialization and the corresponding availability of alternatives to investors. Several large developing markets, such as India and Brazil, show high vulnerabilities in that respect, despite records of growing investment into these locations, indicating that the fragmentation scenario is a risk for more than just a few countries. Third, a further contraction in FDI and a shift in its geographic distribution would likely have large negative effects on host countries via lower capital accumulation and technological deepening, ultimately affecting growth. Source: IMF 2023. flows. This decline can be attributed to a less fa- from protracted uncertainty, among the array of vorable outlook and the growth of other types of structural and macroeconomic changes that may entry, such as cross-border firm acquisitions or collectively explain weaker investment moving international project finance. forward. Capital expenditures in greenfield projects A declining proportion of greenfield projects announced in developing countries have failed to in total FDI alters expectations of job creation and grow consistently over time in value, effectively de- new technology transfer from foreign investment, clining in real terms (see figure A.3). While green- although brownfield investment—that is, involv- field FDI had experienced a remarkable surge in ing a change of ownership in existing production certain developing regions (such as Latin America facilities—can still have significant medium-term and the Caribbean and Sub-Saharan Africa) over effects on productivity and employment (Ragoussis the past decade, the COVID-19 pandemic shock 2020). Variation in development impact expecta- was rather indiscriminate across regions (see figure tions should not serve as a reason for discrimina- 1.4, panel b). East Asia and Pacific, in particular, tion around investor motivations or mode of entry, experienced the largest contraction in announce- but rather should serve as a call to action to adopt ments, reaching levels not seen in the past two de- policies that will best harness the benefits of all in- cades. Countries in the region have yet to recover vestment for development. Evolving Landscape of Investment Flows | 11 Figure 1.4 | Greenfield FDI as a Mode of Foreign Entry, 2003–22 a. Ratio of capital expenditure announced to current FDI flows b. Number of projects announced by region Sub-Saharan Africa South Asia Middle East and North Africa Latin America and the Caribbean Developing World Europe and Central Asia East Asia and Pacific 3.0 3,000 Collapse at 2.5 2,500 the onset of the pandemic 2.0 2,000 Ratio Ratio 1.5 1,500 1.0 1,000 0.5 500 0 0 e Source: IFC-World Bank staff calculations using Financial Times fDi Markets database. Note: Data referring to announced greenfield investments do not constitute official FDI statistics and are not comprehensive. FDI = foreign direct investment. FDI concentration is rising in developing decade. This pattern of increasing concentration countries. holds across different measures, source countries, There is growing evidence that markets are becom- and sectors.6 It is worth noting that the share of the ing more concentrated, particularly in the United largest enterprises in aggregate greenfield invest- States and Japan, as large enterprises consolidate ment (both globally and in developing countries) market power (Gutierrez and Philippon 2017; has been increasing since its post–global financial OECD 2018). This trend has the potential to un- crisis low point, rising especially rapidly in the past dermine the positive effects of FDI, as fewer and two years (figure 1.5, panel a). FDI into all regions larger MNEs announce new facilities or proceed has experienced higher concentration over the last with acquisitions in developing countries. Evi- decade, independently of the dynamics of aggregate dence directly linking rising FDI concentration to flows which have in several regions grown during development impact is lacking. However, existing that period. Combined, these observations suggest literature on so-called “superstar” MNEs explores a pattern of larger individual investment projects why positive spillovers to domestic firms may be by fewer multinational firms. Concentration of in- lower in the context of fewer foreign entrants and vestment has been particularly pronounced in the rising labor and product concentration in destina- extractives, chemicals, and energy sectors, suggest- tion markets (Vrolijk 2022). ing a potential connection to investors’ motiva- Greenfield FDI as well as mergers and acquisi- tions. The fact that efficiency or resource-seeking tions have become more concentrated in the past investments are experiencing these dynamics more 12 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Figure 1.5 | Greenfield FDI Concentration in Developing Countries a. High-income and developing countries b. By major source economy United States Great Britain High income Developing Japan Germany China 60 2.0 Concentration ratio (5 largest investing MNEs) 55 Concentration ratio (5 investing MNEs) 50 1.5 45 40 1.0 35 30 0.5 2003 2006 2009 2012 2015 2018 2021 2010 2012 2014 2016 2018 2020 2022 Source: IFC-World Bank staff calculations Ragoussis, Rigo and Santoni, 2023. Note: Concentration ratios are calculated using Financial Times fDi Markets database of greenfield investment projects. The ratios for country groups are the weighted average of each country’s concentration ratio, corresponding in turn to the share in total capital expenditure of the 5 largest investing MNEs. Countries with less than 10 investing MNEs per year on average are excluded from this analysis. Countries are consid- ered as developing if they are low-income, lower-middle income or upper-middle income according to the World Bank classification of 2022 (see Annex E). The robustness of the analysis is tested by considering different thresholds for calculating the concentration ratio and the Herfindahl– Hirschman index (HHI). Data referring to announced greenfield investments do not constitute official FDI statistics and are not comprehensive. intensely warrants further investigation. Concen- for technology transfer, or lower returns to R&D tration has also been notable in investment coming for domestic firms. from the United States, Japan and China as well as the other major foreign investment source coun- Reinvested earnings are becoming a tries (figure 1.5, panel b), suggesting a link with more critical source of new investment market concentration experienced within these in developing countries. economies. FDI consists of equity investment, reinvested earn- If sustained, these patterns may result in fewer, ings, and intercompany debt transactions. Reinvested larger, and more powerful foreign entrants, which earnings refer to profits that are not distributed as could dampen the effects of foreign investment on dividends but are instead reinvested in the company competition in destination economies. This could to generate further growth. While the equity compo- happen through multiple channels such as monop- nent of FDI is relatively more stable than the other sony power in bargaining over wages or domestic components and reflects long-term strategic behav- inputs. Entry of fewer foreign companies into a ior, intercompany loans and reinvested earnings are more limited set of destination markets and sec- often used to adjust FDI exposure and are therefore tors may also limit opportunities for innovation, important components of new FDI and drivers of re- through lower worker mobility which is essential silience (Aykut et al. 2009). Evolving Landscape of Investment Flows | 13 Figure 1.6 | Fluctuation in Weight of FDI Components to Developing Economies, 2003–20 Reinvested earnings Intercompany loans Equity $, billions Source: IFC-World Bank staff calculations based on IMF Balance of Payments data. For the past 20 years, developing countries Although the resilience of reinvested earnings have relied less on reinvested earnings than have and intercompany loans is a positive sign that reflects advanced economies. This difference may be confidence of investors, it may also erode competi- due to factors such as a lower financial matu- tion and the potential for technology transfers. Orig- rity, slower regulatory compliance processes that inating from the existing investing companies, these make less sense for smaller investments, or vola- flows are typically expected to grow facilities of in- tile market access opportunities. While reinvested cumbents in existing sectors without necessarily in- earnings did increase significantly in developing volving the transfer of new technologies. If sustained, countries through 2011, they were overshadowed their prevalence as a source of new investment can by equity investment trends that drove a signifi- be associated with strengthening of existing FDI pat- cant surge, and then a decline, in FDI flows to terns rather than pioneering investment and the in- developing countries before and after the global novation it entails. More generally, past investment in financial crisis. host economies is likely to be a greater determining The relative weight of reinvested earnings in FDI factor of new investment moving forward. to developing countries has been changing. Toward the end of the last decade, equity investment consol- NEW OPPORTUNITIES ARE idated significantly, which resulted in a higher share EMERGING of intercompany loans and reinvested earnings in Services FDI is growing relative to other aggregate FDI (figure 1.6) that accounted for nearly sectors. one-half of FDI flows to developing countries, ac- In many developing economies, the services sec- cording to the latest estimates. tor is growing faster than the manufacturing sec- 14 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES tor. In 2019, the services sector accounted for 55 gradual, following the structural transformation percent of GDP and 45 percent of employment in of developing economies (figure 1.7, panel b). developing economies (Nayyar, Hallward-Drie- Foreign enterprises’ mergers and acquisitions in meier, and Davies 2021). Services-led develop- services had already exceeded those in manufac- ment is therefore increasingly driving economic turing in 2017, that is, well before the outbreak transformation, enabling income gains, and cre- of the COVID-19 pandemic. The increasing pre- ating new job opportunities. Moreover, the use dominance of services in both categories of FDI of digital technologies and the possibilities for was mainly driven by the scarcity of new manu- remote delivery allow service providers to access facturing FDI, rather than by an outsized growth larger markets and spread benefits as upstream in services, and the relative resilience of services enablers and downstream complements for man- foreign investment. These patterns point to higher ufactured goods (Nayyar, Hallward-Driemeier, relevance of certain categories of policies related and Davies 2021). to services trade and market access, as well as the The growth of FDI in the services sector is a need for targeted reforms that can unleash the po- natural outcome of structural transformation and tential of the services sector in driving growth and the expansion of the services economy in devel- job creation in local economies. They also high- oping economies. Although many restrictions are light the importance of investment in infrastruc- still in place, this investment has been supported by ture, technology adoption, and skills development the gradual liberalization of the services sector (see that can enable the services sector to thrive. subsequent sections) and the growing need for ser- vices among manufacturers operating in develop- International production networks ing countries in international production networks are experiencing reconfiguration—in (Nayyar, Hallward-Driemeier, and Davies 2021). Asia, the reconfiguration is particularly One corollary of the latter is the strong growth in intense. payments for intangibles—including data, soft- Although discussions regarding the reconfigu- ware, and licensing fees for the use of intellectual ration of global production networks due to the property—which has continued its upward trajec- COVID-19 pandemic have been prevalent, sup- tory over the past decade. The structural transfor- porting evidence is only now emerging. Findings mation of developing economies combined with from a recent World Bank survey (which included stronger emphasis on global climate action gener- more than 1,000 global business executives from ate new opportunities for investment also in green large firms in both developed and developing sectors (box 1.2) countries) suggest that a considerable number of Remarkably, the number of greenfield FDI companies are expected to relocate their invest- projects in services has closely mirrored the trend ments both within and across regions (World Bank of the overall investment in developing countries. 2020a). East Asia and Pacific stands out as the re- Until 2019, the drop in announcements of new gion likely to experience strongest intraregional manufacturing establishments by MNEs and the relocation of investment, with many firms diversi- resilience of the services economy led to the num- fying production to markets outside of China (fig- ber of services projects surpassing those in man- ure 1.8 and figure A.5 by sector of main activity). ufacturing (figure 1.7, panel a). The pandemic has The main motivations reported for these shifts accelerated this trend, notably with greater de- by MNEs are proximity to final consumption mar- mand for digitalization. The growth of services kets and diversification of production to protect FDI from mergers and acquisitions has been more against future shocks. However, the effect of geo- Evolving Landscape of Investment Flows | 15 Box 1.2 | New Opportunities in Green Sectors Multinational enterprises have a crucial role to play in global climate action through their investments and technolo- gies. Direct investment in renewable energy activities such as solar panels, waste management, and environmental technologies can advance these objectives in terms of both scale and the technology needed to support climate transition. A classification of sectors into “polluting” and “green” on the basis of their industrial classification and a subsequent allocation of investments into those categories allows for a closer examination of structural shifts of foreign direct investment (FDI) over time to more climate-friendly activities. Although investment in polluting sectors has been considerably higher than investment in green activities for most of the past two decades, the gap narrowed significantly in mergers and acquisitions, and it disappeared in greenfield FDI during the COVID-19 crisis (figure B1.2.1). Several factors can explain this growth of green sectors in investment into developing countries, including declining costs of renewable energy, pressures from governments and investors to engage in lower-carbon activities, and possibly a greater pricing in of carbon risk premiums by shareholders. Figure B1.2.1 | Investment in Green Sectors in Developing Countries a. Greenfield announcements b. Mergers and acquisitions Polluting sectors Green sectors Polluting sectors Green sectors 300 500 250 400 200 300 $, billion $, billion 150 200 100 100 50 0 0 Source: IFC-World Bank staff calculations using Financial Times fDi Markets database and Refinitiv database Note: Sectors are classified into polluting and green according to the European Union Taxonomy. The data referring to announced greenfield investments or mergers and acquisitions do not constitute official FDI statistics and are not comprehensive. political tensions on the relocation of investment result, a significant gap emerged, with strategic FDI appears strong, particularly to and from Asia. In going to Europe about twice as much as that going to strategic sectors, such as the semiconductor indus- Asian countries (IMF 2023). The lack of recovery of try, the flow of FDI into Asian countries started to FDI flowing into China is partly due to fragmenta- decline in 2019 while investments to the United tion in these activities. Asia has been losing market States and Europe have proved more resilient. As a share vis-à-vis almost all other regions likely due to a 16 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Figure 1.7 | Growth of Services FDI, Greenfield and Mergers and Acquisitions, 2003–22 a. Greenfield FDI projects announced in developing countries (Total projects) Manufacturing Services , , , , , East Asia & Pacific South Asia Sub-Saharan Africa , b. Mergers and acquisitions in developing countries ($, billions) Manufacturing Services East Asia & Pacific South Asia Sub-Saharan Africa Source: IFC-World Bank staff calculations using Financial Times fDi Markets database and Refinitiv database Figure 1.8 | Expected Relocation of Production from Largest Investors, by Region (share of firms, percent) Region of increase By share of firms (percent) EAP SAR MENA SSA ECA LAC NAM East Asia and Pacific (EAP) 56% 16% 5% 0% 13% 2% 8% South Asia (SAR) 40% 13% 15% 5% 15% 2% 11% Middle East and North 26% 3% 5% 15% 33% 3% 15% African (MENA) Sub-Saharan African (SSA) 16% 7% 19% 35% 9% 3% 12% Europe and Central Asia 21% 12% 7% 1% 41% 5% 13% (ECA) Latin America and the 23% 15% 2% 1% 11% 8% 41% Caribbean (LAC) United States and Canada 33% 15% 0% 3% 18% 15% 18% (NAM) 0% of relocation > 50% of relocation Source: 2021 Global Investment Competitiveness Survey (World Bank 2020a). Note: The diagonal of the table from upper left to lower right shows relocation within the region. The survey comprised 1,060 business execu- tives in global and regional headquarters. The surveyed firms accounted for 33 percent of total sector revenues globally based on 2019 data. combination of geopolitical, financial, and structural the weakening in recent years of the mediating role drivers that came into effect at the same time. of human capital and financial depth in strength- In the same context, a significant portion of ening the relationship between FDI and growth the global value chain (GVC) reconfiguration plans (Benetrix, Pallan, and Panizza 2022). This finding concern relocation from China to India in the com- has been associated with a number of hypotheses. ing years (see figure A.4). Many firms invested in While the GVC revolution reduces requirements in China are diversifying their operations by expand- terms of domestic production and technology to ing to other cost-competitive locations, such as In- receive FDI, the segmentation of production—that dia, Indonesia, Malaysia, the Philippines, and Viet is, whereby high-skill, high-tech segments of pro- Nam. Meanwhile, India is turning into an increas- duction remain at home—can reduce the positive ingly attractive destination of foreign capital, with spillovers associated with FDI (Antras 2020). In a a high share of surveyed firms globally reporting context of geopolitical fragmentation and stronger plans to increase investment in the market. vertical motivations for investment, technologi- Overall, these shifts mark a divergence from cal transfer stands to weaken in this process. New preexisting trends in global production and invest- technologies are also changing costs across global ment, signaling potential restructuring of GVCs, as value chains in ways that are fundamentally hard to well as changes in the strength of FDI in supporting predict (Lund et al. 2019). While there is still scarce growth and job creation in lower-income econo- evidence regarding the many potential drivers of a mies. The shifts are particularly meaningful in light weaker association between FDI and growth, the of new evidence highlighting an unstable relation- current context offers vast areas for relevant debate ship between FDI and economic growth, as well as and analysis. 18 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Figure 1.9 | Job Creation in Announced Greenfield Projects, by Region , , , , , , , , Sub-Saharan Africa , , , , , , , , South Asia , , , , Middle East and , , , , North Africa , , , , , , , , Latin America and the Caribbean , Europe and Central , , , , , , , Asia (excluding Russian Federation) , , , , , , , , East Asia and Pacific (excluding China) , , , , , , , , China Source: IFC-World Bank staff calculations using Financial Times fDi Markets database. Note: The data referring to announced greenfield investments do not constitute official FDI statistics and are not comprehensive. FDI-linked employment shifts to Africa large pools of unskilled labor (Qiang, Liu, and Steen- show renewed momentum. bergen 2021). The ongoing reorganization of global Labor-intensive greenfield projects and jobs are value chains has resulted in a substantial increase shifting to Sub-Saharan Africa and South Asia. in jobs announced by MNEs in greenfield projects The cost and availability of labor has always been in the two regions (figure 1.9). This shift presents a crucial factor in determining the configuration of an opportunity for job creation, the strength and international production in GVCs, as MNEs have reach of which remains to be materialized in the sought to optimize their production costs by out- coming years. Adding to the increasing cost of la- sourcing labor-intensive activities to regions with bor in traditionally cheaper production hubs, such Evolving Landscape of Investment Flows | 19 as China, and the growing sophistication of their structure both in the rest of Asia and Sub-Saharan production, the trend toward establishing more la- Africa. An array of multilateral and regional initia- bor-intensive facilities in lower-income regions has tives that are discussed in the next section aim spe- been supported by extensive investment in infra- cifically at these enabling conditions. 20 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES CHAPTER 2 Changes in FDI Rules and Policies Latest Trends The past few years have witnessed more restrictive 2.1). This chapter reviews some of the recent and foreign direct investment policy measures being more salient trends in domestic policies as well as adopted by advanced economies while many de- international rules for investment. It zeroes in on veloping countries have continued to adopt mea- policies affecting investor entry and establishment, sures that facilitate or even liberalize FDI (figure corporate tax incentives, investment disputes, and Figure 2.1 | Share of New National Policies Less Favorable to FDI, by year, 2011–22 Percent Source: UNCTAD 2023. Note: Per latest data released in July 2023, in 2022 the share of policies less favorable to FDI decreased to 28 percent, reflecting a relative rise of favorable policies intended to stimulate investment and promote economic growth in the face of unprecedented challenges posed by the current global crises (UNCTAD 2023c). Changes in FDI Rules and Policies | 21 Figure 2.2 | World Bank FDI Entry and Screening Tracker—FDI Measures by Type Sub-Saharan Africa South Asia Middle East and North Africa Latin America and the Caribbean Europe and Central Asia East Asia and Pacific OECD member Screening mechanism—national security sectors Screening mechanism—only healthcare sector Screening mechanism—bordering countries Screening mechanism—net benefits Other sectoral screening mechanism Restriction on hiring foreign workers Restriction on land ownership Reducing foreign capital ownership 0 5 10 15 20 25 30 35 40 Opening closed sector Increasing foreign equity ceiling Streamlining foreign workers permits Streamlining land ownership Other 0 5 10 15 20 25 30 35 40 Source: World Bank 2023c. Note: Measures were captured from February 2020 to February 2023. EAP = East Asia and Pacific; ECA = Europe and Central Asia; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa; OECD = Organisation for Economic Co-operation and Development; SAR = South Asia; SSA = Sub-Saharan Africa. investment conflict prevention. It also highlights INCREASED TREND TOWARD the renewed momentum in investment rulemaking FDI LIBERALIZATION ACROSS at the regional, international, and multilateral lev- DEVELOPING COUNTRIES els by spotlighting recent initiatives of the African Many developing countries have eased invest- Union, the Organisation for Economic Co-opera- ment restrictions. Data from the World Bank tion and Development, the Group of Twenty, and FDI Entry and Screening Tracker7 show that the World Trade Organization. The collective aim many developing countries have eased invest- of these policy efforts is not only to facilitate in- ment restrictions by increasing foreign equity creased investment flows to developing countries, ownership ceilings, opening closed sectors to but also to enhance the role FDI can play in inclu- FDI, streamlining foreign worker permits, and sive and sustainable development. improving land ownership rights (figure 2.2). 22 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Box 2.1 | FDI Liberalization Examples The World Bank’s Investment Policy and Regulatory Reviews (IPRRs) present information on the legal and regulatory frameworks governing foreign direct investment (FDI) in different countries. They focus on foreign investment entry, establishment, protection and select dimensions of FDI in the digital economy. Two rounds of IPRRs were completed in 2019 and 2021 for Brazil, China, India, Indonesia, Malaysia, Mexico, Nigeria, Thailand, Türkiye, and Viet Nam. Exam- ples of reforms to liberalize FDI regimes in these countries, as captured by the IPRRs, include the following: • China (2020–22): New versions of the negative list and the encouraged industry catalogue were released, opening further sectors and activities to FDI (for example, manufacturing of new energy vehicles and satellite television ground receiving facilities, some financial services). Comprehensive pilot programs were approved on the opening of 12 services sectors to FDI in the Tianjin, Shanghai, and Chongqing municipalities and in Hainan Province. • India (2020–21): Equity ceilings in insurance companies were raised from 49 percent to 74 percent. One hun- dred percent equity ownership was allowed in coal and lignite mining, contract manufacturing, telecommunica- tions services, and single-brand retail trading. • Indonesia (2021): A new negative list was released liberalizing more than 245 business lines, including import- ant sectors such as transportation, energy, and telecommunications. • Viet Nam (2020): The Law of Investment was amended, simplifying the business registration process, redefining state-owned enterprises, providing updates on incentives, and abolishing or reducing conditions for 22 business lines, such as commercial arbitration and franchising and logistics services. Sources: Kher, Kusek, and Eltgen 2022. Notably, most FDI-friendly measures were ad- growing economic contributions of the services opted in the East Asia and Pacific region (16 sectors, restrictions on services trade and invest- measures), followed by the Middle East and ment remain high around the world, especially North Africa and Europe and Central Asia re- in South Asia and the Middle East and North Af- gions (11 and 7 respective measures). Findings rica (see appendix B).9 In contrast, Latin Amer- from the World Bank’s Investment Policy and ica and the Caribbean and North America are Regulatory Reviews (IPRRs) corroborate these relatively less restricted. Similarly, some sectors results for a set of 10 middle-income developing (for example, professional services and finance) countries (see box 2.1). have generally higher FDI barriers than others While many of the liberalizing reforms across (for example, telecommunications and distribu- the developing regions have focused on services, tion). Data also show that there has been some further opportunities for easing services restric- reduction in services restrictions over time, es- tions remain. As discussed in this report, services pecially in transport and professional services. account for an increasing share of employ- However, these reforms have been driven mostly ment, output, trade, and FDI globally (Nayyar, by high-income countries, reinforcing the need Hallward-Driemeier, and Davies 2021).8 Despite for continued reforms in developing regions. Changes in FDI Rules and Policies | 23 GROWTH IN FDI RESTRICTIONS, count for 70 percent of all restrictive measures and ESPECIALLY IN DEVELOPED 60 percent of all screening measures. In addition to COUNTRIES the rise in screening of new greenfield FDI projects, Despite the trend of liberalizing reforms in many some countries have also increased their scrutiny of developing countries, FDI restrictions in the form foreign takeovers of strategic assets and technology of FDI screening have continued to increase, par- companies. ticularly in developed economies (UNCTAD 2023). A forthcoming World Bank paper explains that the STRATEGICALLY CALIBRATING increase in investment restrictiveness is evident AND REFORMING INVESTMENT in the gradual expansion of FDI screening mecha- INCENTIVES nisms motivated by preserving host country inter- Another policy area that has seen a lot of policy ests such as national security, critical infrastructure, reform momentum concerns corporate tax incen- dual-use technologies, and sensitive information tives. Despite mixed evidence regarding their ef- (Forneris and others, forthcoming) (figure 2.3). Of fectiveness and overall economic impact, corporate the 79 new restrictions identified since February tax incentives have been used increasingly by gov- 2020 by the World Bank’s FDI Entry and Screening ernments around the world to attract FDI and pur- Tracker, more measures have been aimed at restrict- sue other policy objectives, including promoting ing FDI entry (62 percent) than at liberalizing or green growth, supporting higher value-added jobs, facilitating entry (38 percent). OECD countries ac- or bolstering the digital economy. Between 2009 Figure 2.3 | Prevalence of FDI Screening and National Security Reviews New framework Amendment to existing law Source: Forneris and others, World Bank, forthcoming. Note: Information for 2022 is until August. 24 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Box 2.2 | Sample National and European Union Measures to Address National Security Issues Triggered by the COVID-19 Pandemic Spain: Royal Decree Law 8/2020 states that the pandemic “poses a certain threat to listed Spanish companies, but also to unlisted Spanish companies that are seeing their equity value decline, many of them in strategic sectors of our economy” and that such companies have become an easy target of foreign takeovers, which poses certain risks for public order, public safety, and public health. Consequently, in numerous sectors, an ex-ante governmental approval is required for the acquisition of 10 percent or more of stock. Australia: The monetary screening threshold for foreign investments under the Foreign Acquisitions and Takeovers Act 1975 has been temporarily lowered to zero to “protect Australia’s national interest.” Also, the time frame for the screening procedures has been extended from 30 days to six months. Italy: The Italian government strengthened its special powers in sectors of strategic importance by expanding the scope of FDI screening to the financial, credit, and insurance sector and temporarily applying it also in relation to foreign acquisitions from within the European Union (EU). The government is also authorized to initiate relevant pro- cedures ex officio, even if a foreign acquisition is not notified as prescribed by law. Canada: The Canadian government published its Policy Statement on Foreign Investment Review and COVID-19, which announced “enhanced scrutiny” of “foreign direct investments of any value, controlling or non-controlling, in Canadian businesses that are related to public health or involved in the supply of critical goods and services to Cana- dians or to the Government.” This measure is a response to “opportunistic investment behavior” caused by declines in valuations of Canadian businesses as well as by investment of state-owned enterprises that “may be motivated by non-commercial imperatives that could harm Canada’s economic or national security interests, a risk that is amplified in the current context.” The new policy will apply until economic recovery from the COVID-19 pandemic. European Union: On March 25, 2020, the European Commission issued a guidance to member states urging them to make full use of existing FDI screening mechanisms to take fully into account the risks to critical health infrastructures, supply of critical inputs, and other critical sectors or to set up a full-fledged screening mechanism. India: On April 17, 2020, the government of India introduced measures to curb opportunistic takeovers and acqui- sitions of Indian companies due to the COVID-19 pandemic. The measure targets foreign investors originating from countries that share land borders with India (that is, Afghanistan, Bangladesh, Bhutan, China, Nepal, and Pakistan). These investors are required to receive governmental approval to invest in India. Romania: On February 27, 2020, the government of Romania issued an emergency ordinance amending Petroleum Law no.288/20004. The ordinance stipulated that the National Agency for Mineral Resources will serve as a com- petent authority and has the power to refuse any concession and execution of oil operations for the exploration, development, and exploitation of an oil field to a non-EU entity on national security grounds. Similarly, any transfer of a concession is only possible after obtaining governmental approval. Source: World Bank. Changes in FDI Rules and Policies | 25 and 2015, 46 percent of countries adopted new tax 1960s and 1990s (Tanzi and Shome 1992; Wade incentives or made existing incentives more gener- 1990). But the success of incentives in attracting ous (Andersen, Kett, and von Uexkull 2017). More FDI depends strongly on country-level character- broadly, there has been a trend of growing tax istics. Tax incentives are more effective in countries competition. Since the 1980s, statutory corporate with better infrastructure, reasonable transport income tax rates have continuously fallen. The larg- costs, and a policy framework favoring investment est decline has occurred in developed countries, (Bellak, Leibrecht, and Damijan 2009; Kinda 2016). where the average rate more than halved between In fact, tax incentives have been shown to be eight 1980 and 2021, from 41.8 percent to 19.9 percent times more effective in attracting FDI in countries (UNCTAD 2022). Most recently, the COVID-19 with good investment climates (James 2014). In- pandemic ushered in an expansion of corporate vestors that are more internationally mobile (such tax relief efforts, as governments sought to retain as globally oriented manufacturing and financial high-impact investments and promote sustainable services firms) have also been found to be more recovery and growth in the private sector. responsive to tax incentives (Zolt 2013). Other The growing popularity of corporate tax in- country-level factors such as political stability, reg- centives derives partly from increased compe- ulatory quality, and market opportunities are more tition to attract FDI. Policy makers are driven to critical to investors’ initial location considerations match, or even surpass, their regional neighbors compared with tax rates and incentives (Ander- by offering more generous tax concessions. Those sen, Kett, and von Uexkull 2017; UNIDO 2011). In concessions can motivate unhealthy competition general, a low tax burden cannot compensate for between states, commonly referred to as a “race to a weak or unattractive FDI environment (Göndör the bottom.” From governments’ perspective, fore- and Nistor 2012). Yet, for suitable locations, in- gone tax revenue from the reduction in firms’ tax centives can play a role in the final stage of the site liability can impose significant fiscal losses if in- selection process when investors are deciding on centives are not strategically conceived and applied shortlisted locations and wavering between similar (IMF, OECD, UN, and World Bank 2015). At the options (Freund and Moran 2017). same time, both literature and empirical evidence Policy makers often advocate for the use of tax suggest that tax incentives are often ineffective in incentives by suggesting that they are offset by the achieving their objectives and can also be very new investment, jobs, and spillovers for the econ- costly to governments. For example, an assessment omy. All too often, policy makers overestimate the of the Eastern Caribbean Currency Union from role of incentives in swaying investor decisions, 1990 to 2003 found that tax incentives had limited and in turn, their projected benefits translate into effect on FDI, though the same incentives signifi- a windfall for investors at the expense of lost tax cantly aggravated fiscal deficits and debt overhangs revenue for governments. Poor design of tax in- (Chai and Goyal 2006; James and Van Parys 2010). centives can lock countries into long-term revenue The role of tax incentives in influencing compa- losses (such as open-ended tax holidays). This is nies’ investment decisions is quite limited, although especially worrisome for lower-income countries tax incentives have demonstrated some results in that are already struggling with domestic revenue specific contexts and country-level characteristics. mobilization.10 In countries like China, the Republic of Korea, and A key policy challenge, as well as an opportu- Singapore, tax incentives have been shown to be nity, facing governments is how to use incentives part of a broader strategy that helped attract inves- effectively to motivate investments in sustainable tors and encourage industrialization between the and green sectors.11 The policy approach needs 26 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Figure 2.4 | Trends in Known Treaty-Based ISDS Cases, 1987–2022 ICSID cases Non-ICSID cases cases Cases cases Source: World Bank calculations based on UNCTAD ISDS database. Note: ICSID refers to the International Centre for Settlement of Investment Disputes of the World Bank Group. ISDS = investor-state dispute settlement. to include considerations for how investment in- government’s sphere of influence. Evidence sug- centives can be adopted strategically and imple- gests that political risks—such as breach of con- mented in a way that promotes transparency and tract, sudden and adverse regulatory changes, lack accountability and provides a level playing field for of transparency, and expropriation—and certain investors, maximizes their value for money, and operational risks, such as delays in permits and minimizes the risks (see appendix C). At the same approvals, can cause investors to divest or cancel time the recent stagnating FDI flows reported in their expansion plans (World Bank 2020). Existing Chapter 1 suggest that these types of reforms are by investors contribute a substantial amount of FDI themselves not sufficient to attract more FDI in the through reinvested earnings and are especially vul- context of prevailing global macroeconomic and nerable to those risks. These issues can lead to ex- geopolitical headwinds. pensive investor-state disputes; they are among the top causes of investor-state disputes globally. DERISKING THE INVESTMENT While investor-state dispute settlement (ISDS) ENVIRONMENT BY CURBING cases have continued to proliferate—reaching a cu- INVESTMENT DISPUTES mulative 1,190 known cases—the trend has slightly To be able to attract, retain, and expand FDI, it is eased since the 2018 high (figure 2.4).12 This metric increasingly essential for countries to take con- only records known cases and cases based on trea- crete measures to mitigate risks that are within the ties (such as bilateral investment treaties, preferen- Changes in FDI Rules and Policies | 27 tial trade agreements with investment chapters, and ment decisions and expensive legal disputes. One other international investment agreements). How- main tool for dispute prevention and investment ever, the phenomenon of investor-state arbitration retention is the investor grievance management is even more widespread as there are cases that are mechanism. Such a practical tool is designed to not in the public domain or are based on national enable governments to identify, track, and resolve investment codes and on contracts between states investor issues in a timely manner to help coun- and investors. tries resolve investor issues before they cause any As the number of arbitration cases has grown, adverse impact or escalate unnecessarily. Reform investor-state arbitration has become increasingly examples shown later in this report illustrate how controversial in the field of economic and invest- various countries have implemented such invest- ment policy. There are three broad categories of ment dispute prevention measures. concern: those related to the arbitral process, those related to the outcomes, and those linked to arbi- SELECTED EXAMPLES OF trators and decision-makers.13 Arbitration results MULTILATERAL, PLURILATERAL, in a “win-lose” situation, which is often unsatisfac- AND REGIONAL INITIATIVES ON tory to both sides of the conflict. If the relationship INVESTMENT between the investor and the state had not already In addition to the dynamics in the national-level ended when the dispute was brought to arbitration, rulemaking, a reenergized international invest- the chances are slim for the existing business rela- ment policy agenda at global, multilateral, and tionship to continue after an international arbitra- regional levels promises new opportunities for tion proceeding. developing countries. Main international initia- A rise in investment disputes is also jeopardiz- tives—such as the recently concluded Investment ing sustainable development objectives in many Facilitation for Development Agreement of the countries. Globally, about 10 percent of known World Trade Organization (WTO), regional inte- treaty-based arbitration cases have been in renew- gration initiatives such as AfCFTA, and the global able energy. With relatively large upfront cost, lon- minimum tax on multinational enterprises— ger cost recovery periods and high levels of state have the potential to play a key role for foster- intervention, the renewable energy sector is espe- ing a new era of leveraging FDI for sustainable cially vulnerable to such regulatory risks and legal development.14 disputes (Bank 2023a). Maintaining high levels of FDI in renewable energy needed to achieve sus- Investment Facilitation for Development tainable development and climate goals will require Agreement of the World Trade sound strategies to minimize or eliminate risks. Organization Political risk, measured as a disruption in business The WTO Investment Facilitation for Devel- operations caused by sudden political changes or opment (IFD) Agreement, whose negotiations actions, is a key factor impeding the ability of coun- concluded in July 2023, represents an important tries to attract and retain FDI (World Bank 2020a). opportunity for countries to generate reform mo- One specific kind of political risk—regulatory risk mentum regarding FDI and to facilitate increase in caused by regulatory actions—can lead to costly FDI flows. The IFD initiative will be the first multi- legal disputes between investors and states (World lateral/plurilateral agreement on investment at the Bank 2023c). global level. Expected economic welfare15 gains of It is in this context that stakeholders have fo- the agreement range between 0.56 percent and 1.74 cused on dispute prevention to avoid costly divest- percent depending on the depth of the agreement 28 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES (Balistreri and Olekseyuk 2021), with developing African Continental Free Trade Area countries, which have the lowest levels of adoption The creation of the African Continental Free Trade of investment facilitation measures (Berger, Dad- Area represents an important opportunity to stim- khah, and Olekseyuk 2021), identified as the main ulate Africa’s cross-border trade and investment by potential beneficiaries. Having made steady prog- creating a continent-wide market, reducing bar- ress since its inception in 2017,16 the IFD initiative riers to trade, removing investment hurdles, and now counts more than 110 participating WTO boosting competition. The AfCFTA will create a members. This number represents over two-thirds single market worth $3.4 trillion; and by establish- of the WTO membership, including more than 70 ing a single set of norms for Africa, it will reduce developing countries, among which 20 are classi- overlap and offer accountability. The agreement fied as least-developed countries.17 aims for broader and deeper regional integration With its focus on improving transparency, ef- than has been attempted in Africa so far, which will ficiency, and effectiveness of investment-related attract investment, grow businesses, boost trade, administrative procedures, the draft agreement provide better jobs, and reduce poverty. (as currently negotiated) includes several provi- The AfCFTA has the potential to boost intra-Af- sions requiring participating WTO members to rican FDI by up to 68 percent and external FDI by improve their investment facilitation frameworks. up to 122 percent, especially from Europe and Asia. Obligations include publication of investment-re- Calculations show exports and GDP will also be lated information, streamlining of investment-re- boosted, potentially by $613 billion and $67 billion, lated procedures, and setting up of focal points for respectively, by 2035 (Echandi, Maliszewska, and foreign investors. Participating countries are also Steenbergen 2022). Reductions in non-tariff bar- discussing provisions that encourage the uptake of riers on goods and services and improvements in responsible business conduct principles and stan- trade facilitation measures will account for about dards by investors and enterprises, as well as the two-thirds of the potential income gains. The re- adoption of anti-corruption measures. The aim is ductions will remove long delays across most of to help countries attract not only more, but also the continent’s borders and lower compliance costs better, higher-quality investment that contributes in trade, making it easier for African businesses to to sustainable development. become integrated into regional and global supply Success of the IFD agreement will depend on chains. The agreement’s joint effect on trade and its effective implementation. Due to the multidisci- FDI could create almost 18 million new jobs, with plinary nature of investment and the complexity of 2.5 percent of the continent’s workers shifting jobs the IFD Agreement, strong organization and coor- to expanding sectors by 2035. This may  further dination between different government actors, as raise incomes for the whole African continent by 9 well as the involvement of all relevant stakeholders, percent and reduce extreme poverty by 50 million will be key in implementing the agreement. To facil- people by 2035 (Echandi, Maliszewska, and Steen- itate these processes—especially for developing and bergen 2022). least-developed countries—participating countries However, realizing the potential of the AfCFTA have highlighted the importance of “needs assess- will require going beyond the initial agreement and ments” to allow countries to self-assess their readi- implementing the protocols on investment, com- ness, needs, and priorities regarding implementation petition, and intellectual property rights.18 Jointly, of the agreement. These assessments, in turn, can these protocols will be extremely important in serve as entry points for country engagement for boosting investor confidence and further attracting undertaking investment facilitation reforms. business. Deeper integration in these policy areas Changes in FDI Rules and Policies | 29 would build fair and efficient markets, improve cilitate foreign investments that support actions to competitiveness, and attract further FDI by reduc- mitigate greenhouse gas emissions and measures to ing political and regulatory risk and raising inves- adapt to the negative impacts of climate change. tor confidence. At the same time, countries should leverage this opportunity to concurrently accel- OECD/G20 Inclusive Framework on Base erate and deepen reforms to improve the overall Erosion and Profit Shifting business enabling environment for private sector MNEs have capitalized on the opportunities pre- development in areas such as governance, compe- sented by globalization to structure their busi- tition policy, digital transformation, infrastructure, nesses in ways that minimize their global tax bills, and state-owned enterprise reform, among others. often by transferring profits to lower-tax jurisdic- The AfCFTA Investment Protocol has the tions through complex mechanisms with no real added benefit of requiring signatories to promote economic justification. Many reforms of the inter- and facilitate investments that support actions to national tax framework have been undertaken over mitigate greenhouse gas emissions and measures the past decade to address tax base erosion and to adapt to the negative impacts of climate change. profit shifting, particularly through the Base Ero- It also requires signatories to promote and facili- sion and Profit Shifting (BEPS) Actions. However, tate investment of relevance for a fair and just despite these reforms, the international tax system transition in sectors such as renewable energy and continues to face pressure from trends of increas- low-carbon technologies, and by adopting policy ing globalization and digitalization of the economy. frameworks conducive to transfer and deployment In October 2021, a historic two-pillar inter- of climate-friendly technologies and goods and national agreement—the OECD/G20 Inclusive services. This requirement provides an important Framework on BEPS—was reached by 137 coun- innovation to help raise the benefits of FDI for tries to address the twin challenges of globalization development. and digitalization. Pillar One aims to reallocate Realizing the potential of the AfCFTA will re- corporate tax revenues to the country of the con- quire implementation of a set of parallel actions. sumer. Pillar Two introduces a global minimum tax The conclusion of negotiations is critical. The con- (GMT) for MNEs. The GMT is designed to ensure tent, structure, and depth of commitments in each that large MNEs (with annual revenue greater than topic area will be vital to turning the aspirations of €750 million) pay a minimum effective tax of 15 the AfCFTA into reality. For trade and investment percent.20 in services, for example, member states should The introduction of a global minimum tax publish audits that identify regulatory barriers to will have important global implications for tax trade and investment in services.19 The countries policy and incentives and for the location and in- should aim to progressively liberalize their bar- vestment decisions of MNEs. Many countries will riers to services trade in the five priority sectors: need to consider reforms to their corporate tax re- business, communication, financial, transport, and gimes because they could otherwise face scenarios tourism services. On investment policies, member where profits earned in their jurisdictions could states should seek to agree on transparent, precise, be subject to additional taxes in the jurisdiction and enforceable rules and disciplines that increase of the parent company or in other jurisdictions. the credibility and predictability of administrative The agreement is expected to reduce the use of tax action. They should also promote non litigious havens by MNEs to shift profits out of their main means for addressing investor-state grievances. operating countries. With GMT implementation, Finally, new action is required to promote and fa- countries would effectively no longer be able to at- 30 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES tract investments from large MNEs through zero at the minimum tax rate (or otherwise the parent or low rates that result in an effective tax rate of less entity will collect the top-up tax or it can be col- than 15 percent, and certain incentives will no lon- lected as a backstop by other jurisdiction(s) with ger be GMT compliant, such as tax holidays and subsidiaries); and (b) through reducing incentives zero-tax zones. Other incentives, like those purely for MNEs to shift profits to tax-free or low-tax targeting domestic firms, will not fall in the scope jurisdictions. of the framework. Some instruments, like acceler- Collectively, the aforementioned policy devel- ated depreciation and extended loss-carry-forward, opments at the national and international levels as well as some forms of tax credits would still be present unique opportunities for countries to po- compatible (see appendix C). sition themselves as forward-looking destinations It is estimated that the minimum effective tax for investment. Moreover, these initiatives boost rate will result in the collection of $150 billion in and catalyze countries’ efforts to attract and retain new revenues annually (OECD 2021). The revenue more FDI, as well as to harness FDI for advanc- gain is anticipated to come (a) from jurisdictions ing their development goals. Chapter 3 looks at increasing tax rates or introducing a qualified do- the experience of FDI reform programs in a set of mestic minimum top-up tax to ensure that insuf- Sub-Saharan African and East Asian countries. ficiently taxed profits in the jurisdiction are taxed Changes in FDI Rules and Policies | 31 CHAPTER 3 FDI Policy Reforms Examples from East Asia and Sub-Saharan Africa In the context of the FDI and policy trends analyzed tered on the role of institutions and policies as key in this report, developing country policy makers tools in helping governments increase their coun- have been revising their FDI development agendas. tries’ investment attractiveness, boost their ability Their efforts have often focused on designing and to retain existing FDI, and leverage FDI for linkages implementing effective policies, regulations, and with the domestic economy. The key role that pol- institutional practices around the investment life icies and institutions play in countries’ investment cycle (figure 3.1). The investment life cycle is cen- competitiveness is also highlighted by systematic Figure 3.1 | The Investment Life Cycle Transition Plan Pillar : Pillar : Expand FDI linkages Investment Explore diversity with local attraction and link economy facilitation Policies and institutions Pillar : Validate Investment retention selected location Operate Host country policy cycle Establish Investor policy cycle Source: Adapted from World Bank 2022b. 32 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Table 3.1 | Overview of Country Investment Policy Reforms in Sub-Saharan Africa and East Asia Objective Country Reform Investment attraction and Indonesia Removing sectoral discrimination toward FDI across multiple sectors facilitation through targeted Ethiopia Liberalization of Ethiopia’s economy to FDI reforms to seize opportunities in Boosting South Africa’s investment attractiveness by building investor confidence and new sectors South Africa enhancing investment promotion Establishing an investor grievance mechanism within the investment promotion Rwanda Investment retention and agency (IPA) (Rwanda Development Board) investor grievance management Viet Nam Developing a mechanism for prevention and settlement of grievances Mongolia Establishment of a systemic investor response mechanism (SIRM) Development of stronger Pilot Supplier Development Program (SDP) in partnership with large multinational Viet Nam linkages with local economies enterprises and supporting pioneering local FDI linkages program on closing information gaps and introducing a platform that Guinea businesses encourages broad business participation Source: World Bank catalog of investment policy reforms. assessments of developing countries’ constraints ment dividend. The examples include successful to and opportunities for private sector–led growth. reforms in liberalizing sectors with high investment For example, the joint International Finance Cor- potential, such as services in Indonesia, easing legal poration and World Bank Country Private Sector and regulatory barriers to investment in Ethiopia, Diagnostics (CPSD) reports for Sub-Saharan Af- and increasing investment attraction through stra- rica and Asia have found that a burdensome busi- tegic reevaluation of investment opportunities in ness environment with a weak legal and regulatory South Africa. Additional examples from Mongolia, framework tends to be one of the most frequently Rwanda, and Viet Nam illustrate how investor griev- identified barriers to private investment, along with ance management programs enhance investor con- impediments in infrastructure, trade, transport, fidence and lead to increased reinvestments. Last, and finance. examples from Guinea and Viet Nam demonstrate The following sections present practical exam- how building stronger FDI links with the local econ- ples of policy reforms in Sub-Saharan Africa and omy—through supplier development programs and East Asia that have been aimed at strengthening FDI linkages initiatives—helps decrease information countries’ policy and institutional regimes for FDI gaps for investors and boosts local business oppor- (see table 3.1). These examples were selected to illus- tunities. For extended versions of each case study, trate the key role that public policies, rules, and reg- please refer to appendix D. ulations play in influencing FDI performance and impact. The reform examples are organized along PILLAR 1: INVESTMENT the three main pillars of the investment life cycle: ATTRACTION AND FACILITATION (a) investment attraction and facilitation aiming at THROUGH TARGETED REFORMS seizing new investment opportunities, (b) invest- TO SEIZE INVESTMENT ment retention to decrease probability of divestment OPPORTUNITIES IN NEW SECTORS and to foster existing expansion and reinvestment To attract FDI, countries need to improve the fac- of retained earnings of FDI, and (c) FDI linkages tors that drive investors’ location decisions. Sev- with the local economy to increase FDI’s develop- eral investor surveys, including the World Bank’s FDI Policy Reforms | 33 Global Investment Competitiveness Survey, show the share of private investment—and especially that political stability, macroeconomic stability, and FDI—contributing to this growth was relatively an enabling legal and regulatory environment are low. Impediments to FDI included a range of struc- among the top factors considered crucial by foreign tural, legal, and institutional factors. The govern- investors (World Bank 2018, 2020a, 2022a). Gov- ment’s FDI reform program therefore targeted the ernments play a key role in creating an enabling reduction of legal and administrative barriers to business environment for investment attraction foreign investment, enhancement of investor confi- and facilitation. A competitive FDI policy and in- dence through improved transparency and predict- stitutional framework includes an open FDI entry ability in investment policy implementation and regime, streamlined and transparent investment strengthening investment promotion in target sec- facilitation system, targeted investment promotion, tors. An independent evaluation of the various re- and overall, a predictable regulatory environment forms realized through the reform program during for investment. The following examples from In- 2015–18 estimated an attraction of $96 million of donesia, Ethiopia, and South Africa illustrate how new FDI and the creation of more than 11,000 new various reforms have targeted these key factors for jobs. Additionally, the reforms helped open at least investment attraction and facilitation. six sectors that had been previously closed for FDI, Indonesia adopted a new Omnibus Law to lib- improve the visa and work permit process, and eralize its investment regime and open the labor support government-investor dialogue. Overall, in market to highly skilled foreign workers. The re- part thanks to these reforms, Ethiopia’s FDI grew form effort included amending dozens of individ- ten-fold from the early 2010s to the years preceding ual laws, reducing the number of business activities the COVID-19 pandemic. subject to at least one investment restriction from South Africa strengthened its institutional sup- 813 to 260,21 and eliminating foreign equity limits port for investment facilitation. In South Africa, across a wide range of sectors. Furthermore, new declining FDI flows before the COVID-19 pan- rules on foreign workers have helped increase the demic were driven, in part, by negative investor supply of highly skilled professionals for the la- sentiment, including concerns about the ease of bor market. The implementation of the Omnibus doing business, competition policy, and the market Law significantly liberalized Indonesia’s foreign dominance of state-owned enterprises. To address investment regime, moving Indonesia from one of these challenges, the government of South Africa the most restrictive to one of the more open FDI constituted an Inter-Ministerial Committee on in- regulatory systems in East Asia. Estimates of the vestment to support improving the South African impact of the new law suggest it could generate business environment, increasing FDI inflows, and between $4.1 billion and $6.0 billion in additional promoting investment generation. An Investment investments, both foreign and domestic, in the lib- Reform Map assessment and an investor survey eralized sectors. Moreover, removal of restrictions identified several key institutional and regula- on investments, in the longer term, is expected to tory barriers to FDI. These diagnostics also spot- foster market entry, improve commercial perfor- lighted opportunities to strengthen the capacity mance, and tame price increases, owing to stronger of InvestSA (South Africa’s investment promotion competition (World Bank 2020b). agency) for investment generation and retention; Ethiopia has overhauled its FDI environment to target priority sectors for investment; to address with a comprehensive set of institutional and le- fragmentation and lack of coherence in investment gal reforms. While Ethiopia was among the fastest promotion efforts across national, provincial, and growing economies over the past decade and a half, municipal levels; and to establish a dedicated in- 34 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES vestment aftercare and retention program. The en- programs comprise empowering a lead agency, de- suing reforms focused on these opportunities and tecting, and recording investor issues, conducting included adoption of a new corporate plan and legal and economic assessments, and leveraging a investor engagement strategy. The reforms also wide range of problem-solving methods, as illus- encompassed the establishment of the Investment trated by the following examples from Mongolia, and Infrastructure Office at the Presidency as an in- Rwanda, and Viet Nam. tragovernmental body to unblock investments sty- Rwanda strengthened its investor aftercare mied by regulatory barriers. The reform program’s system to foster investor retention and expansion. impact assessment showed that the reforms gen- While Rwanda had over the years made significant erated more than $375 million in new investment efforts to improve its investment climate, invest- and retained $5 million in existing investment.  ment attraction and especially retention remained a challenge. In response, the Rwanda Development PILLAR 2: INVESTMENT Board augmented the role of its Reinvestment and RETENTION AND INVESTOR Investor Aftercare Department. It expanded its GRIEVANCE MANAGEMENT TO mandate to include investor issues arising from RETAIN EXISTING INVESTORS government conduct, particularly those that en- Countries’ reforms in investment retention have tailed a high risk of investors leaving the country or focused on building government capacity for more of potential state liability for the violation of laws effective investment problem-solving of issues or contracts. The reform put in place a new pro- putting existing foreign investments at risk. Many cess whereby investor grievances that could not be countries lack the institutional infrastructure and solved at the level of the Reinvestment and Investor interagency coordination mechanisms to detect Aftercare Department were escalated through sev- and resolve investor issues in a timely manner. eral different levels of the bureaucracy, including, ul- Many governments also typically do not collect timately, the Private Investment Committee, which systematic data on investor grievances and their consisted of the Rwanda Development Board’s impact on investment decisions. Setting up an in- chief executive officer, the minister of finance, and stitutional framework to address investor issues a representative of the Office of the President. As of effectively can ultimately lead to higher retention April 2021, the Rwanda Development Board regis- and expansion of existing investments. Through tered 17 high-risk issues arising in different sectors, early detection and resolution of such high-risk including agriculture, energy, food manufacturing, issues, governments can also prevent their escala- health, information and communications technol- tion, thereby avoiding disputes and reputational ogy services, and tourism. Analysis has shown that damage to host countries. Evidence has shown the issues pertained mostly to breach of contract that retaining investment by addressing political and arbitrary regulatory changes. At the time of the and operational risk has positive effects on inves- latest assessment, nearly one-half of the cases had tor confidence that contributes to the retention of been successfully resolved, resulting in the reten- investment. tion of $26.5 million in investments and 761 jobs. The objectives of investment retention reforms Viet Nam introduced proactive management are to help governments address investors’ opera- and resolution of investor grievances. Viet Nam has tional and political risks through targeted invest- successfully attracted FDI as an important source of ment aftercare programs, grievance management its economic growth for more than 30 years; however, mechanisms, and investment retention and rein- the lack of consistent and predictable enforcement of vestment initiatives. Common components of these its laws has consistently been reported by the busi- FDI Policy Reforms | 35 ness community as a significant concern. To help retained investments worth $3.2 million. Moreover, address this concern and to pursue other economic foreign investors have reported satisfaction with objectives, in 2018 the government of Viet Nam de- how their grievances were being addressed. The cided to move to a next-generation FDI strategy in government has also committed to accelerating the the context of implementing the Comprehensive and SIRM operation by intensifying policy advocacy Progressive Agreement for Transpacific Partnership and outreach campaigns with foreign embassies, and the European Union Free Trade Agreement. To business chambers, and the investor community. better implement these agreements and reduce risk for foreign investors, the government established a PILLAR 3: FDI LINKAGES WITH pilot task force to increase retention of existing FDI. LOCAL ECONOMIES TO HARNESS Viet Nam’s new investment law included a mandate FDI SPILLOVERS AND BENEFITS to manage investor grievances. Analysis has shown Linkages between FDI and local firms are an im- that from December 2018 to May 2020, the success- portant channel for transferring new technology, fully resolved grievances amounted to $260 million knowledge, and improved standards to local firms of investment and 314 jobs retained (Kher, Obadia, in host countries. Closing the information gap and Chun 2021). between domestic firms and multinational en- Mongolia adopted a systemic investor response terprises and supporting supplier development mechanism to mitigate investors’ concerns. While programs can be key steps to increasing a coun- Mongolia’s FDI peaked at $4.7 billion in 2011, it try’s investment competitiveness. Furthermore, a declined significantly to $10 million in 2015 and competitive domestic supplier base is attractive to remained low during the COVID-19 pandemic potential new investors. Increased local linkages and the Russian Federation’s invasion of Ukraine. help embed foreign investors in the local econ- Investors reported concerns relating to economic omy and encourage them to apply a more long- and financial shocks, ineffective dispute resolution, term strategic vision for their investment in the and low stakeholder input into the policy-making country. process. Specifically, three major impediments to Despite the evidence of positive spillovers gen- investment were identified: (a) ineffective mecha- erated by FDI linkages, proactive effort is necessary nisms for providing investor protection, (b) policy to ensure that policy measures support these link- makers’ inadequate awareness of Mongolia’s legal ages. It is a function of multiple factors that include obligations, leading to violation of international the spillover potential of FDI, the absorptive capac- agreements, and (c) insufficient communication ity of domestic firms, and the host country’s policy across government agencies. To address these con- and institutional environment. The scope and scale cerns, the government of Mongolia established a of FDI linkages and technology transfer can there- systemic investor response mechanism (SIRM) fore vary significantly between countries. As a re- and the Investor Protection Council. These reforms sult, reforms geared toward supporting host country resulted in changed organizational behaviors, in- governments to strengthen the development of FDI cluding a shift from reactive to more proactive in- linkages typically include the following components: vestment aftercare services, a focus on outcomes (a) assessing the scope and size of the opportunity and results, and a new process for reporting on for FDI linkages and identifying policy constraints resolved investment grievance cases using data preventing that potential from being realized; (b) on investment and jobs retained rather than just supporting governments in developing a strategy for counting grievances and complaints. At the time of linking high potential domestic firms to foreign in- the last analysis, the SIRM system had successfully vestors and global value chains (GVCs); and (c) pro- 36 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES viding support for the design and implementation of Guinea introduced an online local supplier supplier development programs (SDPs) that aim to marketplace to connect local firms with mining connect businesses and improve firm competitive- multinationals. In Guinea, economic growth has ness. The following examples from Viet Nam and been closely linked to the development of the min- Guinea illustrate how two governments have applied ing sector, with 25 percent of the country’s GDP these reform principles in practice. coming from extractives. However, with limited Viet Nam launched a supplier development local production capacity, mining operators have program to upgrade local firms in partnership with tended to import products and services—mean- multinational enterprises. Although Viet Nam has ing the local economy has seen disproportion- outperformed most regional competitors in terms of ately low benefits from the sector. To tackle this FDI inflows (IFC 2018), this success has not trans- challenge, the government designed a program lated into increased domestic value added for the focused on improving the competitiveness of its wider economy. While numerous multinational en- local suppliers and closing the information gap terprises have been active in the country, they have between foreign investors and local businesses. typically specialized in labor-intensive, low-com- The objective has been to help local suppliers plexity, and final-assembly stages of GVCs. There secure more contracts, access new markets, and have been weak linkages between foreign firms and create better jobs. As part of this strategy, the gov- local suppliers, who have often struggled to meet ernment of Guinea launched the Guinean Online FDI firms’ expectations and standards for qual- Local Supplier Marketplace to (a) allow mining ity, delivery time, and price. Compounding these operators greater access to information on local impediments was a suboptimal policy framework suppliers and allow local suppliers more informa- hampering domestic value addition and upgrading tion on tenders and procurement plans, (b) create within GVCs. To address these challenges, an FDI- visibility for local suppliers and confer credibility SME (small and medium enterprise) linkages pro- to their products and services, and (c) increase gram was set up with a two-pronged approach. First, competitiveness of local suppliers via training ses- it focused on creating an enabling environment for sions on managerial functions and supply chains. linkages through policy reforms aimed at attracting By 2021, the GOLSM facilitated $17 million in to- next generation FDI with higher domestic value ad- tal contracts and registered 1,600 local firms on its dition. Second, it launched an SDP to upgrade local platform. Moreover, six commercial banks were firms in partnership with MNEs. Domestic firms re- brought onto the marketplace and those banks ceived intensive support to build their business and provided $9 million in loans for upgrading tech- production capacity through tailored training and nology and skills. matchmaking initiatives, including development of Overall, these examples from East Asia and a supplier database to better link local suppliers with Sub-Saharan Africa highlight how legal, policy, buyers. Results have shown that 70 percent of partic- and institutional reforms can lead to a demon- ipating local suppliers increased their productivity, strated impact in catalyzing investment. Although resulting in a 20 percent jump in their performance some of these programs started several years ago— benchmark score. This increase has translated into as successful policy reforms require time to be ap- 20 qualified new suppliers to MNEs and $13.4 mil- propriately designed and implemented—they are lion in supplies. Based on these results of the pilot providing a robust foundation for countries’ efforts program, the government launched a national data- aimed at seizing new opportunities and mitigat- base to help link 3,500 local suppliers with potential ing evolving risks presented by the changing FDI clients. landscape. FDI Policy Reforms | 37 CHAPTER 4 Policy Considerations The challenging global macroeconomic environ- are also limiting companies’ ability to anticipate ment and geo-economic fragmentation require future events, which is a key factor affecting invest- new policy responses from countries seeking to ment decisions. Increasing investor confidence by leverage FDI for development. Adjustments in the reducing uncertainty is therefore a prime concern. geographic, sectoral, and structural patterns of Governments can reduce investor risk and build FDI are creating a changing environment for FDI, investor confidence by implementing transparent increasing the reform urgency for countries to re- and predictable policy and regulatory regimes, re- main nimble and adaptable to seize these opportu- affirming commitments to market access and rules- nities and maintain their investment attractiveness. based international systems, and enhancing overall Specifically, geographic changes to FDI flows in coordination and cooperation among stakeholders, the form of reshoring and nearshoring, sectoral such as host and home country governments, for- changes toward services and green investments, as eign investors, domestic business community, and well as the transformation of production caused by civil society (World Bank 2020a). digitization and automation, can all present new The ongoing trade and investment liberal- opportunities for countries seeking to attract and ization efforts through regional and multilateral leverage FDI for development. Furthermore, the agreements also aim to increase investor con- urgency of the environmental challenge requires fidence by reducing restrictions on investment that countries make use of investment for climate and trade. These efforts should be complemented change mitigation and adaptation. Given this through domestic reforms focused on improving context and the increasingly competitive global business environment and competition policy, environment for FDI, developing countries are enhancing macroeconomic stability, and improv- challenged to redouble their efforts to attract and ing legal and regulatory frameworks for FDI. retain investment. Research demonstrates that domestic business A critical priority for policy makers is to re- environment, governance, and institutions have duce investor uncertainty and bolster investor a positive effect on FDI and competitiveness. Yet confidence. The state of the global economy has the quality and predictability of the regulatory led to high levels of international and domestic un- environments in many developing countries con- certainty, presenting risks to the outlook for eco- tinue to be hindered by direct and indirect barri- nomic growth and investment. Global conditions ers to investment. 38 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Clear and transparent rules and policies for tort trade and investment.23 Furthermore, in the FDI that are consistently and predictably enforced context of the expanding use of FDI screening are therefore a core anchor of a competitive regime mechanisms, it is key to take a balanced approach for FDI.22 Liberalization efforts also help coun- to policy making through enhancing states’ abil- tries seize new investment opportunities emerging ity to address essential security concerns—in a from the structural evolution of FDI. The reform predictable, transparent, and administratively ef- examples from Sub-Saharan Africa and East Asia ficient manner—without weakening FDI promo- featured in this report highlight the role of FDI tion and attraction efforts.24 policies in increasing countries’ investment attrac- Retaining and expanding existing investments tiveness and in helping governments leverage FDI should constitute a complementary focus to at- for boosting domestic companies’ competitiveness. tracting new investments. Reinvested earnings The World Bank’s MNE survey evidence also shows are a critical source of FDI, and the longer FDI that government policies and countries’ legal and projects remain in a country, the more they tend regulatory environments are among the top in- to expand and contribute to the host economy. To vestment location factors considered by foreign foster the retention and expansion of FDI, govern- investors. Moreover, survey results reveal that pol- ments should seek to address investors’ political icies and regulations are the single most influential and operational risks that can lead to withdraw- driver of business adoption of greener production ing investments or canceling business expansion practices and of improving companies’ environ- plans. Governments should provide for appropri- mental performance. In fact, the positive impact of ate investment protection—including access to environmental policies is often twice as high as the dispute settlement—in their investment laws and role of investor and shareholder pressures or con- international investment agreements and promote sumer expectations. proactive investment retention mechanisms. Such Countries should seek to attract and facilitate investor protection should be balanced with pol- FDI that fosters sustainable development while si- icy and regulatory space to enable governments to multaneously avoiding protectionist policies that choose development paths based on sustainable could further elevate business and economic un- development and climate change considerations. certainty. Fostering new investment opportunities For instance, investment protection agreements entails identifying developing competitive sectors should strive for high environmental standards and value chain segments that are arising from the and promote gender equality. The new generation ongoing reorganization of global value chains and of international investment agreements, such as FDI landscapes caused by digitization and auto- the Protocol on Investment of the African Con- mation of supply chains and production, growth tinental Free Trade Area and bilateral investment in intangibles and non-equity modes of invest- treaties like the European Union Sustainable In- ment, and potential nearshoring or friend-shoring vestment Facilitation Agreement, place new sus- trends. Appropriately targeted, carefully designed, tainability obligations on investors. and transparently implemented corporate tax in- Because the benefits of FDI for the local econ- centives can play a role in leveraging FDI for ad- omy are not automatic, governments need to put in vancing sustainable development goals. At the place proactive policies and programs that promote same time, the overall role of tax incentives in at- FDI spillovers. These policies and programs can be tracting FDI is often overestimated, and selective directly focused on fostering linkages between for- fiscal and financial support of specific sectors or eign and local firms and promoting firm upgrad- industries—such as through subsidies—can dis- ing, for example through matchmaking or supplier Policy Considerations | 39 development programs. Incentives to induce mul- therefore be an integral part of the strategic policy tinational enterprises to enhance environmentally agenda for fostering FDI’s development potential. sustainable practices, increase research and de- Policies by highincome countries can also velopment, innovation, workforce training, and have a sizeable effect on FDI patterns in both de- stimulate technology transfer with local suppliers veloped and developing countries. Industrial poli- are also encouraged. These policies and programs cies, for example, are gaining traction in advanced will become even more critical given the ongoing economies, and influence inward FDI flows in evolution in FDI patterns, including rise in services targeted industries.  These measures may however and green FDI, and the growing concentration in divert potential investment away from countries FDI flows. that may lack specific fiscal or financial incen- Broader policies should also seek to strengthen tives, especially in developing countries (Kronfol, firm- and economy-level absorptive capacity. Pro- Steenbergen and Kett, forthcoming). An unequal ductivity spillovers from FDI are facilitated and are level playing field between countries in the use dependent on domestic firms possessing a sufficient of incentives to shape location decisions by firms level of absorptive capacity, allowing them to lever- can result in a relocation in investment away from age new technologies and benefit from the presence developing economies. The wider use of govern- of foreign-owned firms. The specific type of rele- ment subsidies in several major economies keen vant policy will depend in large part on a country’s to promote and secure domestic production of economy and stage of development. What is most critical goods like semiconductors can lead to critical is an approach of continuous learning and potential trade and investment distortions. Many adaptation for domestic firms and the domestic developing countries are at risk of losing critical economy to maximize the benefits of FDI. investment and missing out on opportunities to While FDI generates positive spillovers, it is connect with thriving GVCs as they need to be also prudent to mitigate its possible negative ex- able to compete at fair terms (World Bank 2023d). ternalities. FDI can be part of the development Multilateral cooperation will be needed to keep solution, but it also can be part of the problem, for these distortions from escalating.  It is essential example, through exacerbating income inequalities for policy makers to consider the potential impact or contributing to greenhouse gas emissions.25 This of their policies on other countries and ensure means governments must craft a policy architec- that they do not unfairly disadvantage developing ture that taps into—and channels—the resources countries.  of multinational enterprises toward the challenges Given the scale of private sector financing of building resilience to future shocks, reversing needs for development, official multilateral assis- trends toward inequality, and coping with climate tance should catalyze private capital and enable change. For example, conducive FDI policies will FDI. Major donors in close coordination with in- not automatically result in a substantial increase ternational financial institutions can play a critical in low-carbon FDI or help decarbonize supply role in facilitating and enabling increased private chains. Enabling policies for low-carbon invest- capital flows through cofinancing and derisking, ments should be complemented by specific regula- as well as supporting domestic resource mobiliza- tions that seek to systematically internalize the cost tion and increasing the efficiency of public spend- of carbon emissions and facilitate low-carbon FDI ing. Finally, successful mobilizing of private capital and technology spillovers. Policy considerations for requires bringing rigorous analysis, global knowl- green, resilient, and inclusive development should edge, and focus on development outcomes to en- sure maximum effectiveness of financial resources. 40 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Tackling the complex challenges presented by tate that policy makers deploy their full set of pol- the current global environment requires interna- icy tools to improve business confidence and boost tional cooperation and leadership. The COVID-19 countries’ investment competitiveness. Maintain- pandemic and ensuing polycrises have illustrated ing an open and rules-based system, fostering the shared economic, public health, and environ- global integration and outward-looking policies, mental vulnerabilities that countries face. 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References | 45 APPENDIX A Supplementary Analysis for Chapter 1 on Evolving Landscape of Investment Flows Figure A.1 | Foreign Capital Inflows to Developing Countries, excluding China, 2000–22 FDI Portfolio inflows Other inflows Foreign capital inflows Russian Federation’s invasion . of Ukraine & global tightening Argentina Global Oil price collapse default financial crisis Russian Federation sanctions COVID- . Foreign capital inflows (percent of GDP) . . $, trillions . . – . – e Source: IFC and World Bank staff calculations on IMF Balance of Payments (July 2023 update). Note: Inflows are net of disinvestments and sales of assets held by nonresidents. Bars represent foreign capital flows in current prices, and the trendline represents their share of GDP. Data for 2022 were estimated by IFC staff based on high-frequency FDI data for selected devel- oping countries and the country-specific internal databases; FDI = foreign direct investment; GDP = gross domestic product; IFC = Interna- tional Finance Corporation; IMF = International Monetary Fund. 46 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Figure A.2 | Total FDI Inflows, 2003–22 Figure A.3 | Greenfield FDI ($ billions) Announcements, 2003–22 ($ billions) High income Developing economies High income Developing economies , , , $, billions $, billions , , e Source: IFC and World Bank staff calculations on IMF Balance of Payments (July 2023 update). Note: FDI = foreign direct investment; IFC = International Finance Corporation; IMF = International Monetary Fund. Figure A.4 | Regions Accounting for Expected Investment Relocation out of China Sub-Saharan Africa South Asia Middle East and North Africa Latin America and the Caribbean Europe and Central Asia East Asia and Pacific North America East Asia and Pacific South Asia North America Europe and Central Asia Latin America and the Caribbean Middle East and North Africa Sub-Saharan Africa 0 5 10 15 20 25 30 Percent Source: World Bank 2021–22 Global Investment Competitiveness Survey data (World Bank, forthcoming). Note: Computed using the following survey question asked of multinational enterprises planning to reduce their investment in China: “Over the next three years (2021–23), in which country do you expect your company to increase its assets the most?” Figure A.5 | Sectors and Regions Accounting for Expected Investment Relocation out of China Region of increase By share of firms (percent) EAP SAR MENA SSA ECA LAC NAM Automotive manufacturing 20% 28% 3% 0% 20% 10% 20% Food and beverage 16% 11% 5% 0% 19% 5% 43% manufacturing Textiles and apparel 51% 15% 8% 0% 13% 5% 8% manufacturing IT-enabled services and 27% 45% 2% 0% 4% 8% 14% BPO Transport and logistics 4% 8% 12% 0% 28% 8% 40% services 0% of relocation > 50% of relocation Source: World Bank 2021–22 Global Investment Competitiveness Survey data (World Bank, forthcoming). Note: The survey comprised 1,060 business executives in global and regional headquarters. The surveyed firms accounted for 33 percent of total sector revenues globally based on 2019 data. Textiles and apparel manufacturing is the sector of most reduction in China. BPO = business process outsourcing; CAN = Canada; EAP = East Asia and Pacific; ECA = Europe and Central Asia; LAC = Latin America and the Carib- bean; MENA = Middle East and North Africa; SAR = South Asia; SSA = Sub-Saharan Africa. 48 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES APPENDIX B FDI Trends in Services Figure B.1 | Distribution of the Global Trade in Services, by Sector and Mode of Services Trade Cross-border (mode 1) Consumption abroad (mode 2) FDI (mode 3) Movement of persons (mode 4) Health Skill intensive Education Commerce Transport Low skill intensive tradeables Recreation Hospitality Finance Global innovators Professional ICT 0 20 40 60 80 100 Percent Source: Nayyar, Hallward-Driemeier, and Davies 2021. Note: The General Agreement on Trade in Services (GATS) framework distinguishes between four “modes” of trade in services: cross-border provision (mode 1, e.g., digital delivery), consumption abroad (mode 2, e.g., tourism, students studying abroad), foreign direct investment (mode 3), and the movement of natural persons (mode 4). FDI = foreign direct investment; ICT = information and communications technology. FDI Trends in Services | 49 Figure B.2 | Distribution of the Global Trade in Services, by Sector and Mode of Services Trade a. STRIs across sectors (mode 3 only), b. STRIs across regions (mode 3 only), 2008–11 versus 2016 2008–11 versus 2016 STRI 2016 STRI 2008–2011 STRI 2016 STRI 2008–2011 Distribution East Asia & Pacific Europe & Central Asia Finance Latin America & the Caribbean Professionals Middle East & North Africa Telecom North America Transport South Asia Sub-Saharan Africa 30 35 40 45 50 55 60 65 70 30 35 40 45 50 55 60 65 70 c. STRIs across sectors (mode 3 only, developing countries versus high-income countries), 2008–11 versus 2016 STRI 2016 STRI 2008–2011 LMIC Distribution HIC LMIC Finance HIC LMIC Professional HIC LMIC Telecom HIC LMIC Transport HIC 30 35 40 45 50 55 60 65 75 Source: World Bank-World Trade Organization Services Trade Restrictions Index (STRI) Database. Note: Only the mode 3 Services Trade Restrictiveness Indexes (STRIs) are shown. The mode 3 STRIs are defined only at a subsectoral level. Sectoral indexes are based on the simple average of all subsectors belonging to that sector. Regional indexes are based on a simple average across five sectors (distribution, finance, professional, telecommunications, and transportation). 0 = fully open, 100 = fully closed. HIC = high-income country; LMIC = lower-middle-income country; STRIs = Services Trade Restrictiveness Indexes. 50 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES APPENDIX C High-Level Summary of Good Practice Elements to Implement Corporate Tax Incentives All too often, policy makers overestimate the role and domestic firms); evaluate whether tax in- of tax incentives in swaying investors. In turn, centives can effectively change investors’ be- the projected benefits of these incentives are also havior to address those barriers and failures; overestimated, translating to a windfall for firms and assess whether tax incentives are optimal, at the expense of lost tax revenue for govern- considering other measures (for example, legal ments. Beyond the budgetary implications, tax or regulatory changes, broader reform of the incentives carry other costs and risks, including tax system, or direct government investment rent-seeking, tax evasion, high administrative in public goods). Even when tax incentives are burdens, market distortions, and retaliatory be- suitable interventions, they are most effective havior spurring a “race-to-the-bottom.” The stakes when implemented within conducive invest- are especially high in developing countries where ment environments characterized by enhanced fiscal, legal, and institutional challenges are more connectivity and institutional efficiency, as well pronounced. as stronger legal protections and streamlined The following guidelines can help governments business regulations. design and implement incentives strategically, in a • Directly link incentives to defined policy manner that maximizes their value for money and objectives. Developing countries rely on prof- minimizes the risks. it-based tax incentives, such as tax holidays and corporate income tax reductions, for FDI • Use tax incentives sparingly to address iden- promotion. These instruments generally do not tified market failures. The purpose of grant- result in cost-efficient outcomes as they con- ing tax incentives should be clearly defined. Is fer a blanket benefit, often based on up-front the primary objective to create more jobs, pro- granting mechanisms, rather than actual inves- mote the absorption of foreign technology, or tor performance. Instead, governments should diversify the economy through investment in consider shifting to merit-based incentive in- new sectors? Once the objective is articulated, struments, such as investment allowances, tax policy makers should identify the underlying credits, and accelerated depreciation. Those barriers and market failures (for example, un- tools have the advantage of directly tying in- derinvestment in public goods, skills mismatch centives to targeted outcomes, for example, by or incomplete information to link foreign firms providing allowances for research and devel- High-Level Summary of Good Practice Elements to Implement Corporate Tax Incentives | 51 opment (R&D) expenditures or tax credits for implementation would provide critical data to staff training programs. consider the performance of incentives policy. • Target investors strategically. Policy makers Key inputs into this evaluation are estimates of first need to prioritize the type and quality of tax expenditure, that is, the tax revenue that FDI they seek to attract, and then identify the would have been collected in the absence of in- subset of investors that are most responsive to centives. These data, paired with information incentives. Developing cost-efficient incentive on the targeted outcomes and the responsive- schemes largely rests on identifying which type ness of investors, can help reveal how the costs of investor ultimately decides to invest in one compare with the benefits, and can inform country over another because of tax incen- whether the incentives need to be revised or tives. Globally, incentives are more influential phased out. in attracting efficiency-seeking FDI, which is • Promote transparency and rule-based ad- export-oriented, because such investors are ministration. When implementing incentives mainly driven by competitive cost advantages policy, institutional coordination, bureaucratic in host countries, as opposed to natural re- effectiveness, and transparency matter—not source– or market-seeking FDI. Also, a more only to sustain accessible and streamlined sys- detailed analysis of country-level data on the tems, but also to reduce opportunities for dis- profitability of firms with and without incen- cretion and to ensure a level playing field for tives can help distinguish the types of sectors firms. Information on tax incentives should and characteristics of investors that are more be publicly available in a user-friendly format, sensitive to possible gains from incentives. and tax expenditure estimates should be incor- • Rigorously evaluate the costs and benefits. porated into the budgetary process (Kronfol An ex-ante analysis paired with a monitoring 2020). and evaluation framework during and after Table C.1 |  Incentives Instruments and Compatibility with GMT Rules May be compatible but will depend on Incompatible with GMT a circumstancesb Should be compatible with GMT Tax holiday arrangements Reduced-rate incentives (patent, IP) Tax incentives targeted at pure domestic companies (not part of an MNE group) Zero corporate tax Non-GMT compliant tax incentives on Effective tax rates below 15% in the absence refundable tax credits c Preferential rates above 15% for start-up businesses of the qualifying domestic minimum top-up Cash incentives (will be considered as grant tax income for IIR purposes) Unlimited loss carry-forward Tax-free zones Accelerated depreciation GMT-compliant refundable tax creditsd Source: O’Sullivan and Cebreiro Gómez 2022. Note: GMT = global minimum tax; IIR = income inclusion rule; IP = intellectual property; MNE = multinational enterprise. a. These incentives are unlikely to be compatible unless there is a possibility to blend rates at a jurisdictional level or such incentives may be targeting out-of-scope entities (for example, smaller businesses below the threshold or purely domestic businesses). b. Individual country circumstances will be particularly relevant for this category of incentives with respect to compatibility. c. A qualified refundable tax credit will be treated as income under GMT rules, while a nonqualified refundable tax credit will be treated as a reduction in tax. The latter will be potentially subject to a top-up tax that will nullify the impact of the tax credit. d. Qualified refundable tax credits could reduce effective tax rates (ETRs) below 15 percent and therefore would need to be assessed. 52 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES APPENDIX D Examples of FDI Policy Reforms INVESTMENT ATTRACTION Approach AND FACILITATION THROUGH With the COVID-19 crisis acting as a catalyst, the TARGETED REFORMS TO government of Indonesia implemented one of the SEIZE OPPORTUNITIES IN NEW most ambitious investment reform programs in de- SECTORS cades. The Omnibus Law on Job Creation aimed to Indonesia: Removing sectoral improve the investment climate by amending doz- discrimination toward FDI across ens of individual laws. The Parliament promulgated multiple sectors the Omnibus Law in November 2020. The first wave Context and challenge of implementing regulations (in the form of govern- Indonesia has historically had a rather restrictive ment regulations and presidential regulations) was legal regime for FDI. Among the high- and mid- issued in February 2021; foremost of those regula- dle-income countries measured by the OECD tions was the Presidential Regulation on Investment, FDI Regulatory Restrictiveness Index, Indonesia which reduced the number of business activities showed some of the highest FDI restrictions due to subject to at least one investment restriction from Indonesia’s negative investment list (Daftar Negatif 813 to 260.26 This reform eliminated foreign equity Investasi, DNI) imposing different types of restric- limits across a wide range of sectors. Specifically, tions on investments, particularly foreign equity the reform turned many sectors where FDI was not limits. Until early 2021, the DNI applied at least allowed or restricted by minority shareholding into one investment restriction in almost one-third of sectors fully open to FDI (that is, up to 100 percent all economic sectors, and in 20 percent of them, it foreign equity). Examples of such sectors include either limited foreign equity participation or pro- mobile and fixed telecom services, power genera- hibited foreign investment altogether. Yet such for- tion, fishing, horticulture, small- and medium-size eign entry restrictions can significantly inhibit FDI supermarkets, seaports, airports, shipping lines, inflows. Evidence shows that liberalizing FDI re- distribution, and auto repair services. Furthermore, strictions by about 10 percent, as measured by the Government Regulation No. 34/2021 on Foreign OECD FDI Regulatory Restrictiveness Index, could Workers complemented this first set of reforms by increase bilateral FDI in stocks by an average of 2.1 facilitating a more adequate supply of highly skilled percent (Mistura and Roulet 2019). professionals for the labor market. Examples of FDI Policy Reforms | 53 The World Bank supported these reforms moval of restrictions to investments would, in the through lending and advisory services (World longer term, foster market entry, improve commer- Bank 2021a). The development policy lending cial performance, and tame price increases, ow- built on the World Bank’s long-standing assis- ing to stronger competition (World Bank 2020b). tance to Indonesia on trade and investment re- Removal of DNI restrictions would, in parallel, forms. Technical assistance had been provided in have a positive impact on export-oriented manu- previous years, while the challenges related to the facturing plants, thus improving competitiveness liberalization of the foreign investment regime and strengthening Indonesia’s position in global were analyzed in depth in the 2020 Systematic value chains while also crowding in domestic in- Country Diagnostic Update. FDI liberalization vestment. As a longer-term outcome, Indonesia is had been consistently flagged as a focus area in the expected to benefit from larger sources of technol- policy dialogue with the authorities. The sweeping ogy, knowledge transfer, and external funding for reforms undertaken by the government in 2020– the economy, all of which are critical to support 21 provided an opportunity for the World Bank Indonesia’s long-term productivity growth. Stron- to build on previous assistance and align its sup- ger FDI would thus eventually boost employment port to the government’s program through invest- and gross domestic product growth, especially if ment and trade development policy lending. The received in sectors that support technology trans- complementary assistance of the International Fi- fer and are linked to domestic economy (Irsova and nance Corporation focused on reviewing the FDI Havranek 2013). policy, the negative investment list, and other key sectoral policies and legislation to identify barri- Ethiopia: Liberalization of Ethiopia’s ers and formulate recommendations. Throughout economy to FDI the program’s life cycle, the team was deeply in- Context and challenge volved in making the case for the liberalization of Although Ethiopia was among the fastest growing foreign and domestic regime and providing tech- economies over the past decade and a half, with nical support to the government on the topic of double-digit growth in many years, much of its removing foreign investment restrictions to boost growth was dominated by public investment. The the Indonesian economy. share of private investment, especially FDI, was low. Before the rapid pace of reforms that charac- Results terized Ethiopia’s economy in the years immedi- The implementation of the Omnibus Law signifi- ately preceding the COVID-19 pandemic, several cantly liberalized Indonesia’s foreign investment re- factors hindered FDI attraction and retention in gime. This liberalization has moved Indonesia from Ethiopia. These factors included legal barriers to one of the most restrictive to one of the more open FDI, administrative bottlenecks, and weak insti- FDI regulatory regimes in the East Asia and Pacific tutional capacity for proactive investment promo- region. The new law raised Indonesia’s attractive- tion. Specifically, investment legislation followed ness to FDI at an opportune time, as investors are an outdated positive list approach—allowing in- increasingly searching for new production bases vestments only in explicitly listed sectors—while it while global value chains reconfigure. Estimates of kept many other sectors closed for foreign partic- the impact of the reform suggest it could generate ipation, including banking, telecommunications, between $4.1 billion and $6.0 billion in additional and other commercially critical industries. More- investments, both foreign and domestic, in the lib- over, the national investment promotion agency— eralized sectors (World Bank 2021a). Moreover, re- the Ethiopian Investment Agency, later re-branded 54 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES as the Ethiopian Investment Commission—had a adoption of several key reforms, unlocking oppor- weak mandate and it had low technical capability tunities for private investment. An independent to provide investor services. evaluation of the legal, regulatory, and institutional reforms realized through this project during 2015– Approach 18 estimated $96 million of new FDI and more The investment policy and promotion advisory pro- than 11,000 new jobs—all directly attributed to gram of the World Bank Group, which was started the project. The specific legal reforms supported by in 2015 as the first in a series of investment policy this project included the opening of at least six sec- engagements in Ethiopia, focused on (a) reducing tors that were previously closed for FDI (logistics, legal and administrative barriers to foreign invest- capital goods leasing, maintenance, bonded input ment; (b) enhancing investor confidence by improv- warehouse, printing, and packaging), visa and work ing transparency and predictability in investment permit process improvement, reforms supporting policy implementation; and (c) strengthening in- government-investor feedback loops and dialogue, vestment promotion in target sectors. One specific and key legal reforms such as adoption of a model target area was the liberalization of the maintenance bilateral investment treaty. These reforms have re- service sector. Before the reform, Ethiopia’s invest- sulted in not only the creation of new markets, but ment legislation—including its Investment Procla- also an expansion and enhancement in the compet- mation (No. 769/2012) and Investment Regulation itiveness of existing sectors. In addition, the project (No. 270/2012)—was overly restrictive and in vari- modernized the Ethiopian Investment Commis- ous areas was not in conformity with international sion, building its capacity to undertake proactive good practices. Sectors such as maintenance services outreach that led to new investments in priority were closed for foreign direct investment. The lim- sectors such as textile, apparel, and pharmaceuti- ited availability of maintenance, repair, and servicing cals. Overall, in part thanks to these reforms, Ethi- operations in the country imposed serious burden opia’s FDI grew ten-fold, from an annual average of on domestic and foreign investors in various sectors around $300 million in the early 2010s to $3 billion and industries, especially those operating large fac- in the years preceding the COVID-19 pandemic. tories, machinery, and most importantly, medical Moreover, while the first year of the pandemic devices. This burden had a significant negative im- caused a dip in Ethiopia’s FDI inflows to $2.4 bil- pact on firm operations, efficiency, and ultimately, lion, in 2021 the flows recovered to an all-time high productivity. Consequently, based on the request of $4.26 billion. of the Ethiopian government, the WBG supported the preparation of the reform agenda to liberalize South Africa: Boosting South Africa’s maintenance, repair, and servicing operations in two investment attractiveness by building major areas: general industrial maintenance services investor confidence and enhancing (that is, for machineries, factories, etc.) and main- investment promotion tenance and services operations of medical devices. Context and challenge The reform attracted several foreign firms that spe- In 2017, FDI inflows into South Africa hit a new cialized in industrial machinery and in medical de- low, following a precipitous multiyear decline from vice manufacturing and maintenance. FDI levels of $8.3 billion in 2013 to $1.7 billion in 2017 with outflows of $7.4 billion in that year. Results Among other influences, the decline in FDI and The overall investment policy and promotion ad- increase in capital outflows had been influenced, visory program successfully catalyzed Ethiopia’s in part, by negative investor sentiment over the Examples of FDI Policy Reforms | 55 previous few years, concerns about the ease of do- b. improve competition policy and market reg- ing business (reflected in South Africa’s regression ulations to permit competition in key markets in the World Bank’s annual Doing Business report in South Africa, permit the implementation of from a global ranking of 29 in 2004 to 82 in 2018), competition policies to combat anticompetitive concerns about competition policy and market business practices, and improve policy coordi- contestability, and apprehensions about the market nation and implementation among national and dominance of state-owned enterprises. subnational government bodies; To address the challenges that had precipitated c. enhance FDI inflows into South Africa by the decline and to meet the targets of the National identifying sectors where South Africa has Development Plan, the government of South Africa competitive advantages and by working with constituted an Inter-Ministerial Committee on In- counterparts to address barriers to investment vestment, which engaged the World Bank Group to in such sectors; and support its prioritization of the following: d. support investment generation by ensuring co- herence between national and subnational in- • Improve South Africa’s business environment vestment promotion bodies and by supporting by enhancing its performance on such bench- their capacity development to address nega- marks as the World Bank’s annual Doing Busi- tive investor perceptions and improve investor ness report, as well as addressing sector-specific confidence. regulatory burdens. • Enhance FDI inflows into South Africa by de- These initiatives were elevated by the Presi- veloping an FDI strategy that identifies sectors dency in its public undertaking in the 2018 State where South Africa has competitive advantages, of the Nation address to make South Africa one of improving investor confidence and removing the top 50 economies in the World Bank’s annual any barriers to investment in such sectors. Doing Business report and to generate $100 bil- • Enhance investment generation through ca- lion in investment in five years. Key counterparts pacity development for InvestSA’s promotional to deliver on the government’s undertakings were unit, upgrading investor services to enhance the Department of Trade, Industry, and Competi- responsiveness and ensuring coherence be- tion, InvestSA, the Competition Commission, the tween national and subnational investment National Treasury, and a number of provincial and promotion outfits. metropolitan (subnational) governments. In addition to a cooperation agreement signed Approach in 2018 between the Department of Trade, Indus- The World Bank Group engagement to support try, and Competition and the World Bank Group, investment generation began with an Investment IFC worked with the government of South Africa Reform Map that undertook a series of diagnos- on a multicomponent technical advisory program tics to identify policy, institutional, legal, and that aimed to support the national and subnational regulatory barriers to FDI. This was augmented governments of South Africa on a range of initia- by a structured sector scan that presented vari- tives to: ous lenses, some mutually exclusive, including employment creation, FDI attraction, and GDP a. tackle key business climate constraints and growth. This process helped the government of barriers to transparency, predictability, and ef- South Africa identify sectors that could generate ficiency, to increase investment and create jobs; significant domestic and foreign investment. The 56 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES World Bank Group team also undertook an as- vestSA, provided ongoing technical expertise and sessment of the landscape for investment promo- support to InvestSA to address capacity constraints tion in South Africa through an extensive survey and to drive investment promotion and retention of investors to understand the investor experience efforts. Specifically, the partnership created an with InvestSA’s institutional capacity for promo- ecosystem for enhancing operational efficiencies tion and retention. Key findings from the assess- within InvestSA through adoption and implemen- ment demonstrated the following: tation of a new corporate plan, adoption of investor engagement tools such as a customer management • A proactive focus in more than 30 industry relationship system and a modern website, the segments for investment promotion at the na- development of South Africa–investment propo- tional level was not a strategic approach and sitions, and articulation of an investment promo- yielded significant droppages. tion strategy with a proactive focus on 12 sectors • National and subnational investment promo- showcased at annual investment conferences.  The tion agencies did not have critical tools and the program also supported the creation of a high-level necessary capacity to support their investment Investment and Infrastructure Office at the Presi- generation and retention efforts. dency. This office was a critical tool for intragov- • The three spheres of government in South Af- ernmental coordination to unblock investments rica, each with relative autonomy, meant that that could not proceed because of regulatory bar- investment promotion efforts across national, riers, as well as activation of a national/subnational provincial, and municipal levels were frag- IPA coordination framework (CEO Forum) that mented and incoherent. ensures coherence in investment promotion, facil- • National and subnational investment promo- itation, generation, and retention across the three tion agencies (IPAs) did not have dedicated in- spheres of government in South Africa. vestment aftercare or retention units. Results Technical support was rendered based on the The partnership between the government of South findings of the Investment Reform Map, and the Africa and the World Bank Group yielded a mea- national investment promotion agency, InvestSA, surable increase in investor confidence in InvestSA developed a framework to strengthen the team’s as a consequence of its internal reorientation. In- strategic focus through sector prioritization and in- vestSA, which currently has primary responsibility stitutional capacity to deliver investor services. In for delivering on the Country Investment Strategy, multiple engagements and workshops with InvestSA, works closely with the Presidency and has played a the team socialized the Investment Reform Map rec- key role in developing and defining South Africa’s ommendations on InvestSA positioning within the approach to FDI and refining the institutional in- context of the investor experience and highlighted frastructure for investment mobilization. Principal institutional limitations. Those limitations included outcomes of the partnership with the government the absence of a corporate plan, the absence of terms of South Africa include the following: of reference and performance indicators for staff to actualize the corporate plan, and the absence of crit- • Operational efficiencies of InvestSA evidenced ical client relationship management tools to support by adoption of a new operational Corporate investment generation and retention. Plan The program team, working directly and • Creation and application of key performance through technical experts embedded within In- indicators Examples of FDI Policy Reforms | 57 • Adoption of customer relationship manage- by regulatory barriers to proceed, thus retaining $5 ment (CRM) system million from those tracked investments. • Creation of a dedicated unit to support invest- ment retention focus and deployment of new INVESTMENT RETENTION InvestSA website AND INVESTOR GRIEVANCE • Three successful investment conferences (2018, MANAGEMENT 2019, and 2020) executed with program sup- Rwanda: Establishing an investor port which yielded significant leads grievance mechanism within the IPA • Quantifiable conversion of investment leads (Rwanda Development Board) developed through program support to Context and challenge investments Although Rwanda had made significant efforts to   improve its investment climate, research showed Since 2018, successful annual investment confer- it had unrealized potential to improve its perfor- ences hosted by the Presidency, which sought to ad- mance in terms of investment attraction and reten- dress such barriers as negative investor perceptions, tion. The country faced investment-related issues, have confirmed that the range of reforms delivered particularly with respect to transparency, predict- through the partnership were effective in arresting ability, and contract enforcement. To increase in- the decline of FDI inflows, stemming FDI outflows, vestment attraction and retention, the Rwanda and generating high volumes of FDI. As of April 2022, Development Board (RDB), the country’s invest- confirmed investment inflows from four conferences ment promotion agency, requested the World Bank totaled $95 billion (95 percent of the $100 billion five- Group’s assistance in developing an investor griev- year target set by the Presidency in the 2018 State of ance mechanism (Kher, Obadia, and Chun 2021). the Nation address). The very rigorous World Bank Group impact assessment—assessed at 40 percent of Approach the value of investment from investors who would The approach focused on reinforcing RDB’s After- not have invested but for InvestSA’s support—has af- care Division by augmenting its role to become the firmed that the partnership with InvestSA has gener- Reinvestment and Investor Aftercare Department. ated more than $375 million in new investment and It expanded its mandate to include issues of estab- retained $5 million in existing investment.  lished investors arising from government conduct, Specifically, according to InvestSA’s CRM, in- particularly those with a high risk of investors leav- vestment project leads developed through the first ing or potential state liability for the violation of three investor conferences included 152 investment laws or contracts. The reform instituted a new for- leads and 103 investment announcements at the malized process whereby if the investor grievance conferences. These were translated into investments could not be solved at the level of the Reinvestment through an operationally enhanced InvestSA, which and Investor Aftercare Department, it would be demonstrably led a quantifiable conversion of in- escalated through the bureaucracy at several dif- vestment leads to commitments and investments. ferent levels. First, it would go to the Investment The program’s focus on investment retained was Committee, chaired by the chief investment officer achieved thanks also to the Investment and Infra- and comprising the heads of the Investment Of- structure Office in the Presidency, which elevated fice within the RDB. Second, it would move to the InvestSA’s oversight and interagency coordination to RDB chief executive officer (CEO), which is a cab- address investor challenges. This has allowed for a inet-level appointment. Third, it would go the Pri- number of tracked investments that were hindered vate Investment Committee, composed of the RDB 58 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES CEO, the minister of finance, and a representative led by the director general of the Foreign Invest- of the Office of the President. Specifically, Article ment Agency (FIA). Focusing on political risks, 15(3) of the new investment law specified that the the task force comprised eight members from the Private Investment Committee may “discuss inves- FIA, other departments of the Ministry of Plan- tors issues and propose acceleration measures to ning and Investment, the Ministry of Justice, and resolve them.” Finally, if needed, the issues would the Office of Government. Part of the mandate of be submitted to the Cabinet. the task force was to pilot and develop the SIRM aimed at addressing investor issues and retaining Results existing investment. Resolution 50 of the Politburo As of April 2021, the Reinvestment and Investor Af- of the Communist Party, adopted in August 2019, tercare Department registered 17 high-risk issues provided the overall direction for establishment of arising in different sectors, including agriculture, en- the SIRM. In June 2020, Viet Nam passed its new ergy, food manufacturing, health, information and Investment Law, which also included a reference to communications technology, services, and tourism. the SIRM. The government worked on an imple- Analysis shows that half of the cases fell within the menting decree for the law providing more details category of breach of contract—principally because on the SIRM. A detailed report on the pilot SIRM of the absence of payment by the relevant govern- was also submitted to the prime minister in No- ment agency—while the other half were linked to vember 2020, paving the way for scaling up the pi- sudden or arbitrary regulatory changes. Initial as- lot once the legal framework was in place. Through sessment shows that half the cases have been success- the initial pilot, the task force gained experience fully resolved, resulting in $26.5 million investment in data collection and analysis of grievances. FIA retained and 761 jobs retained. was particularly well positioned to coordinate the retention mechanism by leveraging its role as the Viet Nam: Developing a mechanism for coordinator for the Viet Nam Business Forum, the prevention and settlement of grievances public-private dialogue between the FDI commu- Context and challenge nity and the government of Viet Nam. The standard Viet Nam has successfully attracted FDI as an im- operating procedures of the task force stipulated portant source of economic growth for more than that if the grievance was not resolved at the tech- 30 years. However, the lack of consistent and pre- nical level through a discussion between the task dictable enforcement of the legal framework has force and relevant agencies, the task force would consistently been reported as a significant concern prepare a report on the cases that included a legal by the business community in Viet Nam. To help and economic assessment, task force recommenda- address this concern and to pursue other economic tions, and the position of the relevant ministry. The objectives, in 2018 Viet Nam decided to move to a report would be submitted to the prime minister’s next-generation FDI strategy in the context of im- office for consideration and decision. All activities plementing the Comprehensive and Progressive of the task force would be recorded on a log sheet, Agreement for Transpacific Partnership (CPTPP) allowing for easy follow-up and preventing dupli- and the European Union Free Trade Agreement (EU cation of activities. FTA). Results Approach Between December 2018 and May 2020, 31 griev- To better implement the agreements, the govern- ances were recorded in the tracking tool and log ment of Viet Nam established a pilot task force sheet. As of May 2020, successfully resolved griev- Examples of FDI Policy Reforms | 59 ances amounted to $260 million of investment re- • Inadequate awareness of Mongolia’s legal ob- tained and 314 jobs retained (Kher, Obadia, and ligations under domestic and international Chun 2021). law. This has been one of the main causes of the violation of international guarantees and Mongolia: Establishment of a Systemic agreements. Investor Response Mechanism • Insufficient communication among govern- Context and challenge ment agencies. Investors would continue Mongolia’s FDI peaked at $4.7 billion in 2011, but visiting multiple agencies, because remedy- then declined significantly to $10 million in 2015 and ing a grievance requires approvals and ac- remained low during the COVID-19 pandemic. The tions by more than one agency and there is pandemic and the Russian Federation’s invasion of no mechanism for collaboration among agen- Ukraine have heightened the urgent need for Mon- cies. As a result, the Ministry of Justice would golia to diversify and enhance the competitiveness of receive sudden notice of international arbi- its economy given its close economic ties with both tration on violation of investors’ guarantees, the Russian Federation and China. The potential im- which creates a vicious circle of reacting to pacts of the Russian Federation’s invasion of Ukraine the issue rather than detecting it at an early and continuation of border closure with China are stage to prevent international and domestic likely to significantly influence the economy, as disputes. evinced by the drop of economic growth forecasts from pre-war 5.1 percent to 2.4 percent. The new Approach government has prioritized attracting greater private IFC has supported the government of Mongolia investment, both foreign and domestic, as a key pil- to establish a systemic investor response mecha- lar of its COVID-19 recovery strategy. nism. This process began with the establishment Many of Mongolia’s foreign investments have of the Investor Protection Council (IPC) in 2016, traditionally been in extracting the country’s lucra- chaired by the minister of the Cabinet Secretar- tive mineral resources, but investors reported con- iat, and continued to evolve with the appointment cerns relating to economic and financial shocks, of the National Development Authority as the ineffective dispute resolution, and low stakeholder working Secretariat in November 2018. The pro- input into regulation. Those concerns were deemed cess is regulated by a SIRM bylaw and monitored as significant impediments to investing in the po- through an IT tracking tool that was launched in litically sensitive sectors. Specifically, three major June 2020. The SIRM resulted in changed organi- problems pertaining to investment retention were zational behaviors—from reactive to more pro- identified: active in aftercare services—including becoming more focused on outcomes, reporting on solved • Lack of an effective systematic method for ad- cases using investment retained and jobs retained dressing investor problems relating to investor rather than just counting received grievances and protection. IFC’s Study on Investor Protection complaints. IFC also worked in close collaboration showed that government-investor consulta- with the foreign business communities, including tions were rarely effective, often because rele- the Japanese business community, by organizing vant public agencies did not have knowledge or meetings between them and the National Develop- awareness about the investor issues involved, ment Authority to discuss issues companies faced nor did they have the technical skills to engage and to increase their participation in public-private in consultations with affected investors. dialogue. 60 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Results merous multinational enterprises, particularly as a At the time of the last analysis, the SIRM system direct beneficiary of firms’ “China plus one” strat- has received more than 30 investor grievances. By egy—to become a regional manufacturing hub, but June 2021, the SIRM had successfully retained in- Viet Nam has not experienced tangible benefits from vestments worth $3.2 million and foreign investors domestic value add and spillovers into the wider have reported satisfaction with their grievance be- economy. A key obstacle has been weak links with ing addressed. The government has also voiced its local suppliers. While numerous global MNEs, such commitment to accelerate the SIRM operation by as Foxconn, Samsung, and Toyota, are active in the intensifying policy advocacy and an outreach cam- country, the share of parts that they and other FDI paign with foreign embassies, chambers, the busi- firms source locally is extremely low. In 2015, Japanese ness community, and law firms. firms—large foreign investors in Viet Nam—sourced only 32 percent of inputs from local suppliers, much DEVELOPING STRONGER lower than in China (65 percent), Thailand (55 per- LINKAGES WITH LOCAL cent), and Indonesia (40 percent). These porous links ECONOMIES AND SUPPORTING have resulted from a dearth of productive domestic PIONEERING LOCAL BUSINESSES suppliers capable of meeting FDI firms’ quality, deliv- Viet Nam: Pilot Supplier Development ery time, and price standards. Weaknesses in quality Program in partnership with large control and environmental risk management, R&D, multinational enterprises and new product development have been apparent Context and challenge in local suppliers. Compounding these impediments Viet Nam is an FDI success story. Open-door invest- was a suboptimal policy framework hampering local ment and trade policies have led annual FDI inflows private sector development, domestic value addition, to increase almost ten-fold in the past decade to out- and upgrading within global value chains. perform most regional competitors (IFC 2018). As a driver of the country’s rapid economic development, Approach competitiveness, and inclusive prosperity, FDI has In 2016, IFC launched a small and medium enter- generated employment opportunities and diversifi- prise (SME)-FDI linkage project to help address cation of exports. Chiefly attracted by low labor costs the above-mentioned issues. The project took a and generous incentives, FDI firms are major players two-pronged approach. First, it focused on creat- in manufacturing production and exports and typ- ing an enabling environment for FDI-SME link- ically specialize in labor-intensive, low-complexity, ages through policy reforms aimed at attracting and final-assembly stages of global value chains—pri- next-generation FDI with higher domestic value marily exporting apparel, shoes, and mobile phone addition. Second, it sought to enhance FDI-SME handsets. This approach has been impactful for Viet linkages and spillovers by launching a pilot sup- Nam: as a share of GDP, FDI inflows into the coun- plier development program (SDP) to upgrade 45 try exceed those into China and most large Associa- local firms in the first phase and 25 in the second tion of Southeast Asian Nations (ASEAN) countries phase in partnership with multinational enterprises (World Bank 2021b). However, there is a growing (Panasonic, Canon, Toyota, Denso, Bosch, GE, Da- realization that Viet Nam requires breakthrough re- talogic, Ford). The SDP aimed to build linkages and forms to unlock the next generation of FDI and com- to act as a best practice example for the government pete for higher-quality streams of investment. to replicate, as well as to trigger catalytic impacts Despite record inflows of FDI, the country faced within the respective sectors. To elevate the per- a “Viet Nam paradox”—successful in attracting nu- formance of domestic firms, they received inten- Examples of FDI Policy Reforms | 61 sive project support to build their business and though 25 percent of GDP comes from extractives, production capacity through tailored training and the local economy has seen disproportionately low mentoring. Various matchmaking initiatives were benefits from the exploitation of the country’s rich launched, including development of a supplier da- mineral deposits. Due to low local capacity and un- tabase to better link local suppliers with buyers. skilled labor force, mining operators have tended to import products and services rather than seek Results to work with local suppliers. Countries in the re- This initiative achieved strong development results gion have adopted legal requirements for local pro- and met or exceeded all project targets. The targeted, curement quotas, even though such interventionist intensive support and mentoring under the pilot measures are bound to backfire in the absence of SDP triggered dramatic improvements in partici- competitive local supply chains or skilled labor pant local suppliers’ capacity, with a 20 percent jump force. The government of Guinea chose a different in their performance benchmark score and 70 per- strategy. Contrary to other countries in the region, cent of firms with increased productivity. This trans- Guinea focused efforts and resources on improving lated into 20 qualified new suppliers to FDI/MNEs, the competitiveness of its local suppliers; closing the 38 new contracts signed, and $13.4 million in sup- information gap between foreign investors and lo- plies provided by local firms to their FDI clients. cal businesses; and helping local suppliers get more Furthermore, the SDP has been replicated by the contracts, access new markets, and create better jobs. government since 2019 to sustain the intervention. In addition, the country’s first national database was Approach launched, facilitating matchmaking activities and As part of its strategy, the government of Guinea linking 3,500 local manufacturing and supporting launched the Guinean Online Local Supplier Mar- industry suppliers with potential clients. ketplace in November 2018. GOLSM is based on The project was equally influential in the pol- Decree 278/2018 on the Creation of the Guinean icy sphere with the formulation and enactment of Online Local Supplier Marketplace. The decree Viet Nam’s FDI strategies for 2021–30, including a stipulates that GOLSM is to be implemented by Politburo Resolution on orientation for FDI attrac- a not-for-profit organization with a supervision tion in 2019 and the new Investment Law in 2020 board composed of representatives of public in- and its implementing regulations in 2021. These stitutions. The main objectives of GOLSM are as reforms have encompassed enhancing the invest- follows: ment incentive regime, modernizing investment promotion and proactive investor outreach in tar- • Close the information gap between FDI and geted sectors, enhancing the investment climate, Guinean suppliers, by allowing mining oper- and establishing the legal foundations for an invest- ators to access information on Guinean sup- ment dispute prevention mechanism. pliers and by allowing Guinean companies to access information on tenders and procure- Guinea: FDI linkages program on closing ment plans and become validated suppliers. information gaps and introducing a • Create visibility for local suppliers and confer platform that encourages broad business credibility as to their production capacities and participation quality of services with the goal of facilitating Context and challenge partnerships with mining operators. Economic growth in Guinea has been closely linked • Increase the competitiveness of Guinean sup- to the development of the mining sector. But even pliers. GOLSM organizes training sessions for 62 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Guinean companies on procedures required Results for validation and access to the supply chain, By June 2021, the GOLSM had resulted in $17 mil- standardization, improving managerial func- lion in total contracts facilitated through the plat- tions, increasing access to finance, etc. form, from which 44 Guinean firms benefitted. Registration expanded to include 1,600 local firms, GOLSM has been designed based on multiple including 111 women-owned businesses, and five stakeholder participation workshops with both major mining operators. To address a critical ac- potential buyers and potential suppliers, with sev- cess to finance constraint of Guinean firms trying eral supplier workshops taking place in Conakry to meet FDI buyers, six commercial banks were and Boke. It is self-sustainable financially, with brought onto the marketplace to provide $9 million both supplier and buyers paying annual fees to in loans for upgrading technology, skills, and ca- access the information available on the platform. pacities. The government of Guinea has recognized The platform also includes a capacity-building the digital marketplace as a tool to engage the do- component, as the team managing the platform mestic private sector and to complement regulatory is mandated to organize training and workshops measures to increase local content with those that for local suppliers to help them improve their enable connections and emphasize competitiveness competitiveness. improvements. Examples of FDI Policy Reforms | 63 APPENDIX E Country Classifications World Bank Analytical Classifications GNI per capita in $ (Atlas methodology) Bank’s fiscal year: FY24 Data for calendar year: 2022 Low income (L): ≤ 1,135 Lower middle income (LM): 1,136 – 4,465 Upper middle income (UM): 4,466 - 13,845 High income (H): > 13,845 Afghanistan L Benin LM Chile H Albania UM Bermuda H China UM Algeria LM Bhutan LM Colombia UM American Samoa H Bolivia LM Comoros LM Andorra H Bosnia and Herzegovina UM Congo, Dem. Rep. L Angola LM Botswana UM Congo, Rep. LM Antigua and Barbuda H Brazil UM Costa Rica UM Argentina UM British Virgin Islands H Côte d’Ivoire LM Armenia UM Brunei Darussalam H Croatia H Aruba H Bulgaria UM Cuba UM Australia H Burkina Faso L Curaçao H Austria H Burundi L Cyprus H Azerbaijan UM Cabo Verde LM Czech Republic H Bahamas, The H Cambodia LM Denmark H Bahrain H Cameroon LM Djibouti LM Bangladesh LM Canada H Dominica UM Barbados H Cayman Islands H Dominican Republic UM Belarus UM Central African Republic L Ecuador UM Belgium H Chad L Egypt, Arab Rep. LM Belize UM Channel Islands H El Salvador UM 64 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Equatorial Guinea UM Kiribati LM Nigeria LM Eritrea L Korea, Dem. Rep. L North Macedonia UM Estonia H Korea, Rep. H Northern Mariana Islands   Eswatini LM Kosovo UM Norway H Ethiopia L Kuwait H Oman H Faeroe Islands H Kyrgyz Republic LM Pakistan H Fiji UM Lao PDR LM Palau LM Finland H Latvia H Panama UM France H Lebanon LM Papua New Guinea H French Polynesia H Lesotho LM Paraguay LM Gabon UM Liberia L Peru UM Gambia, The L Libya UM Philippines UM Georgia UM Liechtenstein H Poland LM Germany H Lithuania H Portugal H Ghana LM Luxembourg H Puerto Rico H Gibraltar H Macao SAR, China H Qatar H Greece H Madagascar L Romania H Greenland H Malawi L Russian Federation H Grenada UM Malaysia UM Rwanda UM Guam H Maldives UM Samoa L Guatemala UM Mali L San Marino LM Guinea LM Malta H São Tomé and Príncipe H Guinea-Bissau L Marshall Islands UM Saudi Arabia LM Guyana H Mauritania LM Senegal H Haiti LM Mauritius UM Serbia LM Honduras LM Mexico UM Seychelles UM Hong Kong SAR, China H Micronesia, Fed. Sts. LM Sierra Leone H Hungary H Moldova UM Singapore L Iceland H Monaco H Sint Maarten (Dutch part) H India LM Mongolia LM Slovak Republic H Indonesia UM Montenegro UM Slovenia H Iran, Islamic Rep. LM Morocco LM Solomon Islands H Iraq UM Mozambique L Somalia LM Ireland H Myanmar LM South Africa L Isle of Man H Namibia UM South Sudan UM Israel H Nauru H Spain L Italy H Nepal LM Sri Lanka H Jamaica UM Netherlands H St. Kitts and Nevis LM Japan H New Caledonia H St. Lucia H Jordan LM New Zealand H St. Martin (French part) UM Kazakhstan UM Nicaragua LM St. Vincent and the Grenadines H Kenya LM Niger L Sudan UM Country Classifications | 65 Suriname L Trinidad and Tobago UM Uruguay H Sweden UM Tunisia H Uzbekistan H Switzerland H Türkiye LM Vanuatu LM Syrian Arab Republic H Turkmenistan UM Venezuela, RB LM Taiwan, China L Turks and Caicos Islands UM Viet Nam LM Tajikistan H Tuvalu H Virgin Islands (U.S.) H Tanzania LM Uganda UM West Bank and Gaza UM Thailand LM Ukraine L Yemen, Rep. L Timor-Leste UM United Arab Emirates LM Zambia LM Togo LM United Kingdom H Zimbabwe LM Tonga L United States H   66 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES Endnotes 1. See Annex E for a full list of countries by in- 6. Regular measures tested include the Herfind- come level according to the World Bank 2022 ahl–Hirschman index (HHI) applied to observa- classification. tions of total investment capital expenditure (for greenfield projects) or value (for mergers and 2. For example, an extensive study in Türkiye shows acquisitions) by investing enterprise, as well as that interactions between MNEs and their Turkish concentration ratios of value or expenditure in suppliers have facilitated an upgrading of Turkish a definite number of enterprises relative to total. products (Javorcik, Lo Turco, and Maggioni 2017). The Herfindahl–Hirschman index yields more In Costa Rica, investment by Intel helped diversify comparable estimates of concentration when exports toward advanced manufacturing, fostered reference units vary in size, such as investment deeper integration into global value chains (GVCs), source countries or sectors. and helped upgrade the economy to higher-value 7. The World Bank FDI Entry and Screening Tracker activities (World Bank 2020). monitors specific FDI policy developments since 3. By 2018, developing country sources accounted the onset of the COVID-19 pandemic. The Tracker for 24 to 40 percent of international loans and de- uses a range of sources to inventory and monitor posits, portfolio investment, and foreign direct measures on entry that have been proposed or en- investment into other developing countries; an acted since February 2020, when many countries increase of about 10 percentage points since 2001 began implementing policy measures in response (Broner et al. 2020). to the pandemic, both in terms of measures making entry easier and measures strengthening existing 4. Announcements of greenfield investments controls. The tool shows what regions or countries are tracked by the Financial Times fDi Markets are most active and the types of measures they tend database. to rely on (World Bank 2023c). 5. For a literature review and new comparative ev- 8. FDI also accounts for the majority of cross-bor- idence from six developing economies of benefits der trade in services sectors—across all services from greenfield as opposed to other modes of for- sectors, FDI (“mode 3” services trade under the eign investment, see World Bank (2020a) General Agreement on Trade in Services [GATS] Endnotes | 67 framework) represents 59 percent of overall ser- to design and implement incentives strategically, vices trade (see figure C.1) (Nayyar, Hallward-Drie- and in a manner that maximizes their value for meier, and Davies 2021). money and minimizes the risks, guiding princi- 9. The Services Trade Restrictiveness Index (STRI) ples drawn from international good practices can captures such restrictions through a score between be leveraged. 0 (fully open) and 100 (fully closed). Data show 12. According to UNCTAD (2022), the number that there are important variations in mode 3 ser- of known treaty-based ISDS cases increased from vices restrictions across regions. 1,190 at the end of 2021 to 1,251 as of December 10. But such assertions are rarely based on the 31, 2022. underlying economic evidence. For each 10-per- 13. Specifically, the main “process issues” con- centage point increase in corporate tax incen- cern the cost, duration, and transparency of ar- tives, corporate tax revenue goes down by about bitration. A 2021 study found that for respondent 0.35 percent of GDP (Kronfol and Steenbergen states, the average (mean) costs incurred in in- 2020). Another study (Keen and Simone 2004) vestment arbitration proceedings are approxi- that collected data on tax incentives in 40 devel- mately $4.7 million (and the median figure is $2.6 oping economies from 1990 to 2002 found that million), and for investors, the mean costs exceed unlike advanced economies, which have tended to $6.4 million, while the median figure is $3.8 mil- broaden tax bases and cut tax rates while main- lion (Hodgson, Kryvoi, and Hrcka 2021). Those taining revenues, developing economies have are administrative and legal costs related to the cut rates, introduced special regimes, and lost arbitration proceedings only and do not include revenues. amounts awarded to a party as damages (that is 11. In the current policy environment, govern- the possible compensation allocated to one of ments are seeking to reform their tax incentives the parties by the arbitrator(s)). The same study (in light of international experience) and their found that the mean amount of damages claimed best practices to achieve broader economic objec- among successful investors is $1.5 billion while tives like equity and efficiency, as well as strate- the mean amount awarded is $438 million. As for gic objectives like attracting FDI, pursuing green duration, on average, arbitration proceedings last growth, generating employment, and growing the more than four years. This is a long period for digital economy. This agenda is especially timely an issue to remain unresolved between the parties considering global economic crisis in the wake of but it also represents time that affected business the COVID-19 pandemic and the Russian Feder- executives and policy makers will not devote to ation’s invasion of Ukraine necessitating urgent more productive tasks (opportunity costs). With mobilization of higher domestic revenue by coun- respect to transparency, investor-state arbitration tries to finance the growth in public expenditures was perceived as justice being administered “be- on health, education, and inclusive development. hind closed doors,” while the disputes concerned Advances on imposition of a global minimum tax usually involve public policy matters that attract (Pillar II of the G20/OECD-led Framework for the attention of civil society groups and citizens. Base Erosion and Profit Shifting) will also have Several reforms have focused on ensuring more profound implications on the location decisions transparency of the proceedings and public access of multinational enterprises and the complemen- to ISDS cases. The second broad concern relates tary tax policies of governments to attract invest- to the outcome of investor-state arbitration cases. ment. As governments face the question of how The main criticisms here relate to the perceived 68 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES lack of coherence, consistency, and quality of the 18. An initial agreement was reached in 2019 that arbitral decisions. Finally, the third broad con- focused on trade in goods and trade in services. cern is linked to the arbitrators, who are seen as Yet, a deeper agreement is currently underway in lacking sufficient independence and impartiality. phase two of negotiations, with harmonization in 14. Some studies have shown that preferential trade investment, competition, and intellectual property agreements (PTAs) and international investment rights policy areas. agreements (IIAs) can raise bilateral FDI signifi- 19. The World Trade Organization-World Bank cantly (Kox and Rojas-Romagosa 2020). For ex- STRI provides a detailed mapping of all such laws ample, a paper on the effects of PTAs on net FDI and regulations, and could serve this purpose. inflows using a comprehensive database of PTAs 20. Countries, including nonmembers of the Inclu- in a panel setting finds that PTA membership is sive Framework, could have high economic and fis- associated with a positive change in net FDI in- cal incentives to implement Pillar Two. The GMT’s flows—especially for developing countries—and design means that a country can apply a top-up tax that FDI gains increase with the market size of PTA to the subsidiary of an MNE that has been taxed partners and their proximity to the host country below the minimum effective rate. If a country (Medvedev 2012). At the same time, a recent sum- does not apply the GMT rate, it means that another mary of empirical evidence assessing strengths and jurisdiction (the source country or other countries weaknesses of different approaches to measuring in which the MNE conducts its business activities) the relationship between IIAs and FDI flows finds can levy these taxes. that limited conclusive and robust evidence exists 21. This regulation was amended by the Presiden- on the positive or negative impact of IIAs on FDI tial Regulation No. 49 of 2021, enacted May 25, flows (Pohl 2018). 2021. That amendment saw the number of business 15. Economic welfare is measured as equivalent activities restricted slightly increase. Nevertheless, variation in private consumption of the represen- the decline from the previous number of 813 was tative regional household. Equivalent variation in notably substantial. this context establishes the theoretically consis- 22. Evidence shows that FDI flows increase with tent ex ante nominal value that the representative regulatory transparency, investment protections, household places on the policy change. and effective recourse. The FDI effects of these core 16. At the Eleventh WTO Ministerial Conference pillars of FDI regulatory risk are sizable and com- (MC11) held in Buenos Aires in December 2017, parable in magnitude to the investment-enhancing 70 WTO members cosponsored a Joint Ministe- effects of trade openness in the same regression rial Statement on Investment (WT/MIN(17)/59) models (World Bank 2020a). calling for the start of structured discussions with 23. Moreover, the implementation of the global the aim of developing a multilateral framework on minimum tax will largely limit the role of certain investment facilitation. In September 2020, partici- types of tax incentives—requiring thoughtful pol- pants formally moved to negotiations. icy reform action. 17. For more information on the IFD initiative, in- 24. To find the latest developments in investment cluding the updated list of participating members, policies around the world, see the United Nations please refer to the WTO IFD portal at https://www Conference on Trade and Development website .wto.org/english/tratop_e/invfac_public_e/invfac at https://investmentpolicy.unctad.org/investment _e.htm. -policy-monitor. Endnotes | 69 25. Steenbergen and Saurav (2023) find that the carbon producers (Ekwurzel et al. 2017; Griffin direct activities and supply chains of the world’s 2017). 157 large MNEs jointly account for up to 60 per- 26. This regulation was amended by Presidential cent of total industrial emissions. This finding Regulation No. 49 of 2021, enacted May 25, 2021. is similar to analysis from think tanks and aca- The amendment saw the number of business activ- demic literature tracing emissions from industrial ities restricted slightly increase. Nevertheless, the 70 | CHANGING FOREIGN DIRECT INVESTMENT DYNAMICS AND POLICY RESPONSES decline from the previous number of 813 was nota- bly substantial (UNCTAD 2023). Endnotes | 71