The Missing Link
Between FDI and Development in the Middle East
The Missing Link
The relationship between Foreign Direct Investment and economic development has long been thoroughly discussed by leading economists. The assumption that FDI endorses development has not received unanimous support, although in theory FDI does in fact boost growth and development in host countries.
FDI directly promotes economic growth and development by contributing to the gross capital formation of the recipient country. However, it is through indirect channels that FDI makes a significant difference in economies. FDI leads to the introduction of new goods in the economy which in turn leads to the insertion of local and intermediate goods, as a result of rising demand and market competition. Furthermore, FDI creates employment opportunities in the host country, taking advantage of unused skilled labor. This leads to the enhancement of labor skills in addition to the transfer of expertise to the local work force. As a result, a well established FDI system can break vicious cycles of underdevelopment.
However, FDI is not without its adverse effects on host economies. Without an absorptive capacity, the positive spillover effects and the development of human capital will not take hold. There are numerous infrastructural criteria that are imperative to support FDI, such as technological preparedness, an educated work force and institutional and financial development.
Interestingly, the Middle East suffers from the aforementioned paradox. Countries of the Middle East have been able to overcome many difficulties in paving the road to a successful FDI framework, yet they still remain incapable of reaping the fruits of their labor.
Middle Eastern countries generally, and Arab countries in particular, have attracted a considerable portion of global FDI inflows during the period between the 60s and the late 90s. In Egypt, for example, FDI inflows increased substantially rising from $1,214 million in 1992 to $2,330 million in 1994 reaching $2,643 million in 1998. At the same time, in the region as a whole, the FDI/GDP ratio increased to 1.27%. Unfortunately however, this momentum was lost. FDI inflows dropped sharply and by 2002 FDI performance in the Arab world lagged behind most other developing regions.
The disappointing FDI outcome could be traced back to several reasons. First of all, at the time, a preponderance of FDI in the region was directed to petroleum-related industries, while non-petroleum FDI in countries such as Egypt and Bahrain went mainly to tourism, banking, telecommunications, manufacturing, and construction. The lack of FDI recipient fields, in addition to scarcity of diversified economies in the region significantly reduced the inflow. Secondly, the region’s inward oriented trade policies and relative lack of economic liberalization coupled by strict investment regulations, have acted as a barrier against investment initiatives. Accordingly, the overall attractiveness of FDI opportunities in the region diminished considerably, due to a fear of a low rate of return by investors.
As a result, the second half of the past decade has witnessed revolutionary initiatives by many countries in the region to reform investment-support infrastructure. Countries like Saudi Arabia, Egypt and UAE have exerted impressive efforts in creating a favorable business climate, new investment opportunities and improving FDI frameworks. For example, the once unexploited Saudi Arabian mining sector, transportation, satellite transmission services, wholesale/distribution, as well as retail trade and commercial agencies have all been exposed to external involvement. The Kingdom also provided improved conditions for visas for foreign business travelers. In UAE, a new federal company law was issued allowing a 100% foreign ownership in some sectors, while on the other hand, mass privatization in many sectors of the economy has been taking place in Egypt. As a result the rankings of many Arab countries on the World Banks’ “Doing Business” list have significantly improved:
The economic liberalization of the region has allowed for a large inflow of FDI. According to the United Nations Conference on Trade and Development, FDI to the region has risen by a record of 10% in 2007 with Saudi Arabia and UAE on top of the chart of recipients. Along with Turkey, Saudi Arabia and UAE have received ground breaking $56.9 billion aggregate inflows, accounting for two thirds of the inflows to the whole region. FDI inflows to GCC countries have surged by one fifth in the same year reaching $43 billion, while Egypt has also received considerable inflows of $11,578 billion.
This surge has resulted in both a vertical and a horizontal inflow of FDI, in other words, not only was the region a large recipient of foreign funds, but intra-investment activities were also underway. Egypt and the Maghreb countries have become a major source of attraction for Gulf investors. Thus it is noteworthy that the share of GCC capital in Egypt’s total FDI has ascended from 4.5% in 2005 to 25.2% in 2007. The rise in FDI inflows continued throughout 2008 reaching $93.7 billion with Saudi Arabia still in the lead with a commanding $38 billion. While on the other hand Egypt experienced a decline to $9 billion, although it remained one of the largest recipients in the region due to sustained policy reforms.
Although these are impressive initiatives, FDI does not compose a major percent of the countries’ GDPs. These reform programs have been initiated recently, and it would be too soon to measure economic development based on FDI performance. Nevertheless, there are several short-term and long-term challenges that the region has to overcome before harnessing the power of FDI.
First and foremost, is the global crunch that has resulted in many impediments to FDI progress in the region. The financial crisis started to take effect in the region by the end of 2008 and spread throughout 2009. Consequently, a large part of the foreign funds were withdrawn and there was a massive drop in asset prices putting a severe strain on domestic balance sheets, which required rapid credit adaptations from banks. Furthermore the sharp decline in oil prices severely affected oil-dependant nations, which used oil revenues to initiate large investment projects; hence the GCC countries were the most affected by credit deficits and the plummeting of oil prices.
On the other hand, non-petroleum countries were also affected by the decline in tourism remittances, real estate, and the halting of many projects. As a result, FDI is estimated to have dropped by 32% in the region. What makes the issue worse is the fact that FDI inflows to the region largely surpass its outflows. This, in turn, severely curbs the region’s ability to use FDI as a means to mitigate the effects of the recession.
The region is also plagued with long-term obstacles that block the bridge between FDI and development. For example, unemployment has been considered a chronic illness in the Middle East. A problem that worsened during the financial crisis. Additionally, in terms of technological progress, the region lags behind global levels of progress, which in turn deprives the region’s human capital of a very important tool.
These obstacles significantly decreased the region’s absorptive capacity, creating a crowding phenomenon. In other words, at many times, FDI has resulted in the increase of unemployment due to the scarcity of skilled labor. It has drawn the local work force to multinational corporations instead of optimizing the skills of the unemployed. This in turn has eliminated local competition instead of endorsing it, thus halting the process of technology and expertise sharing and limiting local and intermediate products.
In order for FDI to have its intended effects, and promote development, numerous regulatory and institutional problems of the Middle East must be addressed. These reforms should not be limited to the financial sector, but should also address the educational and institutional sectors, to make use of the massive human capital that would be able to exploit the benefits of FDI. FDI will not lead to development by solely depending on abundant resources, and regulatory facilitations, it must go hand in hand with local infrastructural reform. Otherwise, the positive spillover cycle will be reversed.
Wessam Sherif
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