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3. Investment Policies and Major Determinants of Capital Flows to Arab Countries

Editor(s):
Saíd El-Naggar
Published Date:
May 1993
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Objectives and the Global Framework

This paper examines the flow of foreign direct investment (FDI) into the Arab countries, its developments during 1970–90, differences among countries, and reasons explaining these trends. The paper’s main purpose is to assess how successful Arab countries have been in attracting FDI into sectors other than oil and gas as a means to expand and diversify their economic base and their exports, and to create high-quality employment. The growing preoccupation with FDI in developing countries in general and in Arab countries in particular reflects the fact that over the last decade FDI has changed from being a rather small and marginal source of foreign capital in the developing world to become a large and significant source; it is rapidly becoming a very important single source of long-term foreign capital available to developing countries, replacing the more traditional sources such as official grants and loans as well as commercial bank borrowing. According to the latest World Bank statistics, net long-term resource flows from industrial to developing countries increased only marginally over the last ten years, from an annual average of $68.6 billion during 1982–86 to $72.9 billion during 1987–91, or by less than inflation (Table 1). During the same periods, however, FDI to developing countries more than doubled, from under $10 billion to nearly $23 billion. As a result, the share of FDI in the total net resource flow increased from 14.3 percent to 31.5 percent.

Table 1.Long-Term Financial Flows to Developing Countries(Annual averages in billion U.S. dollars; current prices)
1982-861987-91
Official development finance
Grants12.121.4
Loans (net)22.722.1
Private loans124.06.5
Foreign direct investment9.822.9
Aggregate net resource flows68.672.9
Source: World Bank, Financial Flows to Developing Countries (September 1992).

Including commercial banks.

Source: World Bank, Financial Flows to Developing Countries (September 1992).

Including commercial banks.

With few exceptions, developing countries are in need of foreign resources to cover the gap in the current account of their balance of payments and to supplement domestic savings. During the 1960s and until the early 1980s, this search for funds steered them toward commodity cartels, commercial bank borrowing, and multilateral and bilateral aid. FDI remained small, as many developing countries shunned this source of financing for ideological reasons, and most of them did not really need it because considerable commercial bank credit was available (from recycled petrodollars), and their creditworthiness was largely intact. The debt crisis, however, dried up bank credit and compelled developing countries, Arab as well as others, to ease their restrictions on FDI and actively to encourage and promote FDI inflows. Hence, it is appropriate now to take stock of the present situation and recent developments and to analyze some of the reasons for recent trends.

In recent years, developing countries initiated considerable institutional and policy changes that have made their overall economic environment more attractive for foreign investors to the point where there is increasingly sharp competition among these countries for the limited amount of FDI available. In pursuing structural adjustment policies, sectors have been opened up to private investment (including FDI), ownership limitations relaxed, application processes streamlined, incentives made transparent, and regulations on the repatriation of profits relaxed. In sub-Saharan Africa alone more than 20 countries have revised their investment codes since 1982 or introduced new ones. Argentinean oil exploration has been opened up to foreign participation; the Republic of Korea opened up 80 percent of its industrial sector, compared with 50 percent ten years ago, and abolished restrictions on profit repatriation; automatic approval systems are in place in Korea and Venezuela; and licenses have been simplified for Mexico. In Malaysia if the enterprise exports 50 percent or more of its output and employs 350 full-time local staff, 100 percent foreign ownership in the enterprise is allowed; China allows 100 percent ownership in areas where the technology is desired; and so on.

Equally important has been the recognition by many developing countries that centrally planned economies have performed less well than market-driven economies. Hence, the structural adjustment programs supported by the World Bank and the IMF have promoted more private sector involvement, both domestic and foreign, opening the door to increased FDI. It is now generally accepted that market-based prices are critical indicators for entrepreneurs and other economic operators so that resources are directed to the most valuable uses and that it is the alertness of the entrepreneur that creates and introduces innovations in the marketplace. There has been a recognition that impeding or prohibiting the competitive process by central planning (or even excessive regulation) deprives the economy of its fundamental engine of growth.

However, attracting FDI has turned out to be more difficult and time consuming than expected. The expectation that once the macroeconomic issues have been tackled through a structural adjustment program FDI will start to flow in en masse has turned out to be over optimistic; this issue is one addressed in this paper.

Data Base

As is well known, both the data and the literature on foreign direct investment in developing countries are unfortunately not very reliable or comprehensive. This is particularly true for Arab countries, given the insignificance of the existing levels of FDI in the Arab world (other than oil) and the low importance that until recently Arab countries placed on promoting FDI. Most of these countries have started to promote themselves actively as FDI locations outside the oil sector only over the last decade or two, whereas in Latin America, for instance, FDI has a long history, often dating back to the last century.

There are fundamental differences in the data available from the data base sources.1 These differences are not only related to issues of differing reporting periods and variations in defining foreign direct investment and in recording worker’s remittances but also to variations in accounting procedures, such as ways of reporting financial transfers of oil companies between subsidiaries and parent companies. Other reasons for discrepancy are that some data are collected on a fiscal-year basis while others are on a calendar-year basis. Finally, FDI is defined differently in different countries: In theory, most definitions agree that FDI is an investment made to acquire a management interest and influence in a foreign enterprise; in reality, however, the thresholds used vary between 10 percent (OECD, United States, and Japan) and 25 percent (Germany) of ownership of the voting stock; they also vary over time (Japan reduced the threshold in 1980 from 20 percent to 10 percent). The key characteristic in determining FDI is having an “effective management voice,” and this depends on firm specific circumstances. In theory, two principal data series—the IMF balance of payments data and the OECD/DAC data are the same two streams of data examined from different ends. The IMF data look at the inflow of FDI into the host country and include reinvestments and disinvestments as positive or negative FDI. The data reflect the inflow of FDI irrespective of source, thus making it difficult to distinguish regional links or links between Arab and non-Arab FDI for the purpose of our analysis. The data are supplied by the host country and are subject to the institutional data collection limitations prevailing in the country. The OECD/DAC data look at investments from the other end of this flow, that is, from the point of view of the investing country (the home country). Furthermore, the data cover only OECD member countries and therefore exclude investments made by one Arab country in another, or, more generally, among any developing countries.

Owing to the limitations of reliable data, the literature on FDI in the Arab world is not empirical and relies on surveys and mission reports that focus primarily on other more comprehensive subjects. Under these circumstances, this form of analysis provides some perspective on the nature of FDI that cannot be gleaned from the raw data. As a result, it is difficult to determine empirically what is happening. Some of the reports appear to be recycled information that has appeared elsewhere, in others, conclusions are drawn from groups that are neither large nor representative. There is considerable analysis of stocks of FDI, and cross-country comparisons of FDI are made over time. This approach ignores the accounting limitation that most investment is valued at its historical book value and is not brought up to market prices at regular intervals. This approach usually results in older investments being undervalued in comparison to more current investments. The stock of investment dating from the 1940s cannot be compared with recent FDI to conclude that the percentage share of, say, Asian FDI has grown dramatically. No doubt the growth of Asian FDI is real but, by ignoring the book and market valuation, discrepancy is exaggerated. The problem is accentuated where inflation is high. This paper therefore focuses on annual flows over the last twenty years rather than on accumulated stocks.

For the purposes of this paper, seven Arab developing countries were analyzed—three Maghreb and four Mashreq countries (Morocco, Algeria, Tunisia, Egypt, Jordan, Saudi Arabia, and Oman). The selection took into account both the importance of the countries as hosts of FDI and the availability of consistent data on FDI flows. Excluded are countries considered high-income economies by the World Bank Group, such as the United Arab Emirates and Kuwait.

Overall Setting

Relative Position of Arab Countries in the World

In spite of major efforts to decontrol and liberalize their economies and to stimulate and encourage private investment—domestic and foreign—and notwithstanding the urgent need for such funds, the flow of FDI to developing countries has grown rather modestly over the last twenty years (less than 5.5 percent a year in real terms) and remains low today. During the same period, FDI flows among industrial countries expanded by over 8 percent a year starting from a much larger base. During the second half of the 1980s, FDI flows among industrialized countries averaged over $168 per capita in 1990 prices, while those to developing countries averaged barely $5.5 (Table 2).

Furthermore, the limited amount of FDI flowing to the developing world was very unevenly distributed. It was concentrated heavily in a small number of countries, and the overwhelming majority of developing countries received virtually nothing. Thus, in 1990 nearly 70 percent of total FDI flowing to developing countries went to the 20 top performers, which accounted for only 15 percent of the total population, whereas the remaining 81 developing countries listed in the 1992 World Development Report (totaling about 85 percent of the population) received a little over 30 percent of all FDI (Appendix Table 7). As a result of their remarkable success in attracting FDI, the 20 top performers averaged a quite satisfactory $28 per capita, whereas the remaining 81 developing countries remained largely unsuccessful, receiving on average only a meager $2.3 per capita.

As a group, the seven Arab countries studied were not particularly successful in attracting FDI. Excluding investments by foreign oil companies, which follow very special rules, inflows of FDI averaged a low $4.7 per capita a year during 1986–90, measured in 1990 prices, or only 0.2 percent of GDP. This was substantially lower than the already low averages of the developing world as a whole ($5.5 and 0.3 percent, respectively). Among major regions, only Africa south of the Sahara had a lower FDI inflow during this period ($2.7), whereas in South America it was substantially higher ($18–19 per capita).

Table 2.Foreign Direct Investment Flows(Yearly averages; 1990 prices)
1970-741976-801981-851986-90
Total flows (billion U.S. dollars)
Into developing countries9.111.416.121.6
Into developed countries37.843.059.6131.9
Total46.954.475.7153.5
Per capita flows (U.S. dollars)
Into developing countries3.23.64.65.5
Into developed countries55.661.081.8168.3
Total13.314.117.932.5
Source: International Monetary Fund, Balance of Payments Statistics Yearbook.
Source: International Monetary Fund, Balance of Payments Statistics Yearbook.

However, the same phenomenon already observed for the developing world as a whole existed also within the group of Arab countries—performance among countries in attracting FDI was very uneven. In fact, the average annual FDI inflow among the seven Arab countries during 1986–90 ranged from only $0.30 in Algeria to nearly $14 in Saudi Arabia (Table 3). The two best performers among the seven countries (Saudi Arabia and Tunisia) were successful enough to join the group of 20 top performing developing countries worldwide, performing better than such important countries as the Philippines and Turkey (Appendix Table 6). The other five, however, all fall within the group of less successful developing countries.

Table 3.Inflows of FDI, 1986–90(Annual averages)
FDI per CapitaFDIFDI
(U.S. dollars)(Percent of GDP)(Percent of GDI)
Some Top Performing
Developing Countries
Portugal1092.38.6
Greece821.57.9
Malaysia803.412.5
Costa Rica372.08.4
Mexico341.57.8
Argentina341.211.2
Thailand231.76.1
Chile191.05.6
Arab Countries
Saudi Arabia140.21.1
Tunisia100.73.2
Jordan60.31.8
Oman60.10.5
Morocco40.41.6
Egypt30.31.3
Algeria0.3
Group Weighted Average4.70.21.0
Sources: Appendix Tables 36.
Sources: Appendix Tables 36.

Recent Trends Among Arab Countries

A more detailed analysis of FDI data for the seven Arab countries during 1970–90 period2 (Chart 1) reveals four interesting points: (1) the common trend among the seven countries is slight; (2) the size of the country is not an important factor in attracting FDI; (3) the level of economic development is an important factor in attracting FDI; and (4) favorable economic policies are of crucial importance in attracting FDI.

Chart 1.FDI Per Capita in 1990 U.S. Dollars

(Five-year averages)

These points are analyzed briefly below.

Common Trend. Even a cursory glance at Chart 1 is sufficient to realize that there is hardly any common trend among the seven countries concerning the inflow of FDI over the last twenty years. Except during the second half of the 1970s when six of the seven countries achieved an increase in the inflow of FDI at the same time—massive for four, rather modest for two—during no other period did more than four countries experience the same trend at the same time; while about half of them improved their performance, the other half deteriorated. Some of the countries, like Algeria, did well during the 1970s but badly during the 1980s; others, like Egypt, did much better during the 1980s; others, such as Jordan, did well during the late 1970s and early 1980s but badly thereafter. During the five-year period in the early 1980s when Jordan experienced its greatest success in attracting FDI, Oman and Algeria suffered their most severe declines, while five years later the situation had reversed. Furthermore, FDI flows into only one country—Saudi Arabia—showed a steady trend over the four periods; in the six other countries, these flows moved up and down in an apparently random fashion. In consequence, little generalization is possible except that for six of the seven countries FDI inflows during 1986–90 were substantially larger than twenty years earlier. These apparently quite haphazard trends reflect the combined impact of a number of natural, political, and economic factors that influence FDI flows in different ways and to a different extent. Since economic policies are among the most determinant of these factors, it is quite obvious that the seven countries pursued few common policies concerning FDI. Each followed its own policy, suffered its own setbacks, and enjoyed its own successes independently of what its neighbors did and/or experienced.

Country Size. Contrary to general belief, this study does not show that the size of a country has been important in attracting FDI. In fact, the three sample countries with the largest populations—Egypt, Morocco, and Algeria—are the ones with the lowest inflow of FDI per capita, an observation lasting for most of the four periods under consideration. On the other hand, Tunisia, which has the third-lowest population, had the second-largest inflow of FDI, while the two smallest countries (Jordan and Oman) occupied a good third place among the seven countries. The old theory (still often heard) that large countries have a built-in advantage in attracting FDI because they offer an attractive domestic market has not been confirmed by the findings of this study. With export-oriented FDI increasingly replacing both traditional import-substituting investments (automobiles in Mexico, Brazil, and Argentina) and resource-based investments (copper in Chile, oil in Saudi Arabia), the size of a country becomes less and less relevant as a factor in attracting foreign investment. As discussed below, other factors such as political stability and consistently attractive economic policies become increasingly decisive; in both respects Tunisia has been doing well. In fact, small countries with a light, approachable, and flexible administrative apparatus have some definite advantages over their larger competitors with heavy and rigid bureaucracies.

The findings related to the Arab world are corroborated by earlier analysis carried out by MIGA on Africa south of the Sahara.3 It found that not a single African country with a population of over 2 million was successful in attracting FDI in the last twenty years, excluding oil and gas. The few African success stories—and there are some—are limited to small countries such as Mauritius, Seychelles, and Swaziland, largely deprived of natural resources, but pursuing strongly market-based and export-oriented economic policies. FDI inflow into these three countries averaged close to $20 per capita during 1986–90.

Level of Economic Development. Although the size of a country might not be crucial in attracting FDI, a country’s level of development (as measured by the level of GDP per capita) is important. More developed countries tend to be more successful in attracting FDI. In this study’s sample, this correlation is particularly strong at the tail end of the line: The two sample countries with the lowest GDP per capita—Morocco and Egypt—experienced well below average inflows of FDI during 1986–90, occupying fifth and sixth positions respectively, among the seven countries (Table 4). On the other hand, Saudi Arabia attracted the highest inflow of FDI. To a large extent, this reflects the fact that good, reliable infrastructure—physical as well as human—is an important factor in attracting foreign investors. Hence the close correlation between FDI inflows and the literacy rate as discussed below. In countries where per capita GDP runs ahead of infrastructural development as a result of recent, large developments in hydrocarbon, the correlation between levels of per capita GDP and FDI inflow is much weaker. This is an important reason why Oman, with a per capita GDP close to that of Saudi Arabia, was much less successful in attracting FDI, reaching only fourth place among the seven countries.

Favorable Economic Policies. Whereas Oman did not deviate too substantially from the norm, two other countries—Tunisia and Algeria—deviate much more so, albeit in different directions and for different reasons. Tunisia is doing much better in attracting FDI than its per capita GDP suggests, while Algeria is not doing well. Whereas Tunisia ranks only fourth in the level of GDP per capita, it was a strong second in the level of FDI it managed to attract, consistently in all four periods. Algeria on the other hand, which has the third-highest per capita GDP of the group, saw its inflow of FDI decline to virtually zero during the 1980s, occupying last place during 1986–90. Both cases reflect the vital importance of appropriate macroeconomic policies in attracting FDI—that is, the existence of an attractive, stable, and predictable investment climate. In Tunisia, macroeconomic policies strongly supportive of FDI inflow (much of it from other Arab countries) showed positive results; in Algeria, the lack of such policies, and an ambivalent policy stance vis-à-vis FDI until very recently, contributed to the virtual collapse of FDI inflows in spite of the high level of GDP. These issues are assessed in some detail in the next two sections.

Table 4.FDI and Level of Development, 1986–90
Ranking According to
FDI per capitaGDP per capita
Saudi Arabia11
Tunisia24
Jordan35
Oman42
Morocco56
Egypt67
Algeria73
Sources: Appendix Table 5; World Bank, World Development Report.
Sources: Appendix Table 5; World Bank, World Development Report.

In addition to the above four points, political stability is an important factor influencing the flow of FDI. Political turmoil in Algeria during the late 1980s as well as political uncertainties around Jordan during the same period explain much of the sudden decline in FDI inflows into these countries after extended periods of quite satisfactory performance.

Source Countries

Data limitations make it difficult to assess flows of FDI among Arab countries. In fact, the following analysis is limited to flows from OECD countries. As a caveat, it is important to know that during 1981–90 OECD/DAC figures totaled about half the IMF figures, and in some individual countries the differences were even larger.

Among the 12 OECD member countries that report regularly to the DAC, 6 accounted for over 99 percent of total net FDI flows to the 7 sample countries during 1981–90. They were (in declining order of importance) the United States, France, Germany, Italy, Japan, and the Netherlands (Table 5). The small FDI flows of the other 6 source countries canceled each other out almost completely, with a sizable return flowback into the United Kingdom nearly canceling out the flows of FDI from the other 5 countries. Among those 12 source countries, the United States was by far the most important, accounting by itself for nearly 55 percent of total net FDI flows into the 7 host countries. Investments by U.S. private corporations were concentrated exclusively on 2 host countries—Egypt and Saudi Arabia—while no U.S. investments were reported to have taken place in any of the other 5 countries. France and Germany, the two next largest source countries, had a share of approximately 12 percent each. France’s net share, however, was depressed by some large disinvestments in Algeria during the first half of the 1980s. Excluding Algeria, France’s share exceeded 18 percent, making it clearly the second most important provider of FDI to the region. As could be expected, French private companies focus particularly on Tunisia and Morocco, where they were by far the most important source of FDI; they were also quite active in Egypt. German investments were spread widely throughout the region; the zero net flow to Saudi Arabia was the result of a substantial inflow during the first half of the 1980s, nearly offset by an equally large outflow recorded during the second half of the decade. Investments by Italian, Japanese, and Dutch companies (between 8 percent and 5 percent of the total) were spread quite widely among the seven host countries, except that they have all kept out of Egypt. U.S., French, and German investors together accounted for nearly 85 percent of total FDI inflows from DAC countries into Egypt. British companies were the only net disinvestors repatriating investment capital from Egypt, Jordan, Morocco, and Saudi Arabia.

Table 5.FDI Inflows by Country of Origin and Country of Destination (DAC Countries Only)(Percentage average, 1981–90)
Origin/

Destination
AlgeriaEgyptJordan1MoroccoOman1Saudi

Arabia
TunisiaTotal

(net)
France-112.225.0-25.361.3-1,440.05.242.312.5
Germany28.020.338.010.2-16.00.111.511.8
Italy18.92.513.924.6-8.04.425.48.1
Japan-0.23.712.7-0.1708.09.70.77.1
Netherlands-0.64.06.31.3828.03.39.84.9
United Kingdom-3.4-227.8-0.2-1.31.5-2.6
United States38.977.554.8
Others2-33.99.082.22.928.01.18.83.4
Total100100100100100100100100
Source: Organization for Economic Cooperation and Development, Development Assistance Committee (DAC).

Net flows to Jordan and Oman were very small ($7.9 million and $2.5 million;, respectively). This explains the extreme results shown for these countries.

Austria, Belgium, Finland, Norway, and Sweden.

Note: In absolute amounts (current U.S. dollars), the DAC ligures total only about half of the IMF figures for the entire ten-year period. In individual countries, discrepancies are even larger.
Source: Organization for Economic Cooperation and Development, Development Assistance Committee (DAC).

Net flows to Jordan and Oman were very small ($7.9 million and $2.5 million;, respectively). This explains the extreme results shown for these countries.

Austria, Belgium, Finland, Norway, and Sweden.

Note: In absolute amounts (current U.S. dollars), the DAC ligures total only about half of the IMF figures for the entire ten-year period. In individual countries, discrepancies are even larger.

Case Studies

Algeria

In spite of its exceptionally advantageous geographical location, its historically close links with Europe, its fairly well-developed physical and human infrastructure, and its relatively high level of private fixed investments, Algeria has been successful in attracting FDI over the last ten years. It was quite successful during the 1970s, attracting substantial FDI inflows particularly from France and less from Arab countries. Starting in 1981, these flows almost ceased; in fact, in the early 1980s there were two large disinvestments by French companies, and for the rest of the decade FDI inflows stagnated at insignificantly low levels. During the later years, IMF and DAC figures are close and uniformly low, suggesting that there were no inflows of FDI from either the industrial countries or the Arab countries.

This lack of success by one of the more developed Arab countries is largely due to three factors, which are major determinants of FDI in all developing countries: (1) the macroeconomic situation, including growth of GDP and of private domestic investment; (2) economic policies pursued by the Government; and (3) overall political situation and political stability.

In the case of Algeria, factors one and three were quite positive during the 1970s but worsened markedly during the 1980s; factor two improved gradually during the 1980s, but too late in the decade to have a major impact and too little to overcome the two other negative elements. The overall economic situation in Algeria was very satisfactory during the 1970s, with total GDP expanding at an average annual rate of 7.3 percent in real terms between 1971 and 1980 as a result of high hydrocarbon prices and the rapid pace of industrialization. These boom years created attractive prospects for foreign investors even though the economy remained heavily regulated and suffered from serious distortions and inefficiencies. During the 1980s, the situation deteriorated dramatically: First, overall economic growth slowed to only 2.6 percent a year, particularly after the 1986 oil price collapse; the balance of payments became a major bottleneck, with the current account balance moving from a surplus of 0.6 percent of GDP in 1980 to a deficit of 4.3 percent in 1989; and foreign debt accumulated rapidly with foreign debt-service charges increasing from less than 27 percent of exports in 1980 to nearly 64 percent in 1991.4 Second, and as important, the overall political situation became increasingly volatile, unstable, and unpredictable starting in late 1989. Together, this created a most unattractive climate for foreign investors.

In this situation of economic slowdown and political uncertainty, the increasing, courageous attempts to liberalize and decontrol the economy, initiated in 1987 and pursued since, had no chance to exercise the expected stimulating impact on FDI and cannot be expected to do so as long as the other two handicaps remain. Even the fact that the Algerian private sector continued to invest heavily during the 1980s (on average a high 18.6 percent of GDP a year)5—usually an attractive sign to foreign investors—did not stimulate any interest by foreign investors.

Egypt6

After a long hiatus during the fifties and sixties, Egypt very slowly and gradually managed to attract some FDI starting in 1975, the beginning of the open door policy. In absolute amounts, FDI has increased considerably since then, from virtually zero up to 1975 to $200 million a year (in 1990 prices) during the first half of the 1980s before declining slightly, to $173 million a year during the late 1980s (Appendix Table 2). These were among the highest absolute figures achieved by an Arab country over these twenty years, excluding oil investment. Considering Egypt’s size, however, on a per capita basis, FDI inflows remained rather low, averaging only $4.5 during the 1981–85 peak years, and declining to an even lower $3.5 during 1986ȓ90 (Appendix Table 5).

Given the relatively large Egyptian market, its considerable export potential, attractive geographical location, and fairly well-developed physical and human infrastructure, this performance was not very strong. Even more so, as private sector investment in general (domestic and foreign) was fairly high, at 16.4 percent of GDP during the 1980s, and overall economic growth was quite high during the 1970s (at 10.4 percent a year during 1973–80) and still a respectable 4.7 percent a year during 1980–91.7 Hence, from an overall economic point of view, conditions appeared quite favorable to attract foreign investors.

A number of factors, however, discouraged a more rapid growth in FDI. First, the difficult balance of payments and foreign debt situation raised the danger of developing foreign exchange shortages, which to a great extent hampered the importation of spare parts and raw materials as well as the transfer of dividends and capital. This perceived danger was highlighted by the widely shared perception that public enterprises received preferential treatment in the allocation of scarce foreign exchange, which was tightly controlled by the Central Bank and could pay their imports at a more advantageous exchange rate than private enterprises.

Egypt was running a substantial current account deficit already in the 1970s, averaging 5–6 percent of GDP; it increased to an average of 7.5 percent during the 1980s.8 This deficit created increasingly severe foreign debt problems with the debt-service ratio exceeding 20 percent of exports in the 1970s;9 in spite of several debt reschedulings, this ratio did not improve throughout the 1980s,10 resulting in serious debt arrears and severely limiting the country’s capacity to import and to transfer dividends abroad. In fact, over the last twenty years, tight import restrictions had to be imposed frequently, and financial transfers were limited and/or often delayed.

Second, the frequent balance of payments difficulties experienced in Egypt during the last twenty years were largely the result of the strongly inward-looking, import-substituting development strategies introduced in the fifties and sixties and changed only gradually since. The exchange rate was consistently overvalued, discouraging all non-oil exports, which in fact declined substantially. The economic climate therefore discouraged foreign investors from setting up export-oriented industries, while the domestic market remained dominated by public enterprises little disposed to accept private competitors, foreign as well as domestic, except in a few joint ventures. The limited amount of FDI coming into the country focused largely therefore on nonmanufacturing sectors such as tourism and some other services such as real estate and banking.

Third, while macroeconomic policies have improved substantially since the mid-1980s when the first reforms—-supported by the IMF and the World Bank—were initiated, the attitude of the public authorities vis-à-vis private investment in general and foreign private investment in particular has largely remained ambivalent, often with a significant difference between policy formulation at the policymaking level and policy implementation at the working level. Much has in fact improved in the way of liberalizing foreign trade, making the Egyptian exchange rate competitive, decontrolling investments, and freeing prices; as a result, the investment climate has improved considerably. Unfortunately, the changes that took place in the mid- to late 1980s are too recent to have yet produced tangible results, considering that the normal period is five to six years for foreign investors to wait before they come back on any significant scale into a country undergoing a fundamental structural adjustment of its economy. This situation, however, can be expected to improve within the next years.

Finally, political stability has been a positive factor in Egypt. Administrations have survived political setbacks and proved their ability to adapt in a flexible and orderly manner to changing circumstances.

Jordan

Between the early 1970s and the mid-1980s Jordan was increasingly successful in stimulating the inflow of FDI, with the average annual inflow increasing from slightly over $3 per capita (in 1990 prices) to a very high $30 per capita (Appendix Table 5). The level of $30 reached during 1981–85 was the best result achieved by any of the seven sample countries during any of the four periods analyzed in this paper. If it had continued, it would have brought Jordan into the group of 20 top performing developing countries. During the second half of the 1980s, however, FDI inflows declined sharply, to a little over $6 per capita. This fall paralleled a general decline in Jordan’s economic activities during 1986–90, triggered by the regional crisis in the aftermath of the 1982 oil price decline, and worsened by the 1990 crisis in the region.

Given its small domestic market, Jordan is a classical case of a developing country that can attract significant amounts of FDI only for export-oriented projects, and in fact has done so successfully for a time. Although this has rewards, it also has risks. Taking advantage of its proximity to and familiarity with the neighboring oil-rich region, Jordan’s economy had grown rapidly during the 1970s and early 1980s. During these years, the Government pursued a strongly export-oriented growth strategy based on free and unimpeded private economic initiative. Foreign trade and foreign financial transactions were largely free, and the exchange rate remained competitive in spite of large workers’ remittances and substantial inflows of aid from some Arab countries. As a result, exports of goods and services to neighboring countries increased rapidly; at the same time the number of Jordanians working in these countries, most of whom were well trained, expanded markedly. Rapid export growth together with an expanding domestic demand, fueled by large workers’ remittances, led to a GDP growth of over 8 percent a year in real terms during the 1970s11 and about 6 percent during 1980–87. Private investment grew rapidly, from under 16 percent of GDP during the mid-1970s to a high 24 percent during 1980–82.

The combination of political stability, highly favorable economic policies pursued consistently by the Government, good export prospects, a booming domestic market, and a well-trained labor force created ideal conditions for attracting foreign direct investment, and foreign investors responded strongly and positively. During the peak years 1980–82, 9–10 percent of private investment (5 percent of total investment) was undertaken and financed by FDI originating largely in other Arab countries (Appendix Table 4). This share is very high even in a worldwide comparison.

The situation deteriorated dramatically during the course of the 1980s as Jordan was hit by the rapid fall in the price of oil in 1982 and the subsequent slowdown in regional economies. Exports, workers’ remittances, and Arab aid all declined considerably. The most immediate and dramatic impact was on investments: fixed, private investments started to decline in 1983 and continued to do so throughout the rest of the decade to a level of little more than 10 percent of the 1982 peak; GDP continued to grow slightly for a little longer, reaching a peak in 1987, but it declined during the following four years.12 Finally, with the government budget and the balance of payments running large deficits and the foreign debt becoming increasingly burdensome (total foreign debt outstanding and disbursed tripled as a share of GDP from 60 to 180 percent during the 1980s),13 the risk of foreign exchange shortages became more and more real. In spite of significant and successful adjustments in government policies since 1988–89, supported by IBRD and IMF assistance, a major decline in FDI inflows could not be avoided, with foreign investors largely waiting on the sidelines until the situation has clarified sufficiently.

Different from many developing countries, the sharp setback during the late 1980s was caused largely by exogenous factors outside the Government’s control. Once the political and economic situation in the region has stabilized, a renewed growth in FDI inflows can be expected, focusing increasingly on export-oriented manufacturing industries.

Morocco

Over the 1970–90 period, Morocco experienced a relatively steady, but rather mediocre inflow of FDI, fluctuating between a low of a little over $2 per capita a year (in 1990 prices) during the early 1970s and a high of nearly $5 during the late 1970s (Appendix Table 5). Results in the 1980s were between these two extremes. This lack of success in attracting FDI is somewhat surprising, as the country profits from an attractive geographic location for European investors and other investors interested in the European market; it enjoyed long years of political stability; it has achieved satisfactory economic growth over the past twenty years; and it is successful in implementing an economic stabilization and structural adjustment program started during the first half of the 1980s that made Morocco one of the best performing developing countries during the second half of the decade.

The single most important factor explaining the low level of FDI inflows during the 1980s was the short time since the economic reforms really started to bite, given the rather long phase-in period. Experience in many other developing countries indicates that a delay of six to eight years is not unusual between actual implementation of far-reaching economic policy changes and a real change in attitude by private foreign investors. Morocco’s economic reform program was indeed far reaching. To reduce an unsustainable current deficit of the balance of payments of 13 percent of GDP14 in 1980 and 1981 to manageable levels, painful stabilization measures had to be maintained for years, including a sharp reduction in public investment outlays. Among others, these measures resulted in a slowdown of overall economic growth, from about 6.5 percent a year during the late 1970s to 3.3 percent a year during the early 1980s. This environment is not an attractive one for foreign investors. Furthermore, while the reform program succeeded in opening up the trade regime and improving Morocco’s competitiveness in the world market, actual export performance, although much improved during the late 1980s, still remains relatively low. On a per capita basis, Moroccan exports of manufactures were only half those of Jordan during 1986–90, and little more than one-fourth those of Tunisia (Appendix Table 8). The effects of the largely inward-looking economic policies Morocco pursued up to the early 1980s cannot disappear overnight. These policies shaped the nature of the old, established foreign companies, largely French, that were accustomed to an unchallenged and highly profitable existence well protected from any disturbing import competition; the few foreign direct investments of recent years were mostly small expansions made by such companies in line with the slowly expanding domestic demand. This situation is changing only slowly. In spite of the major opening of the economy since 1985, an increasing liberalization and reform of foreign trade, and a substantial real devaluation of the dirham, the nature of foreign investment is changing only very gradually from import substitution to exports.

To some extent, the slow growth of FDI reflects the same ambivalence in the attitude of the public authorities vis-à-vis FDI as was observed in Egypt. Although high-level officials are generally open-minded and committed to pursuing the path of economic decontrol, modernization, and export orientation, the lower level of the government bureaucracy, with whom foreign companies have most of their day-to-day contacts, often unfortunately do not share the same goodwill but continue to exhibit a strong preference for command and control, reflecting the old attitude of mistrust vis-à-vis the private sector in general and FDI in particular.

The still relatively high production costs in Morocco, in particular labor and transport costs, are a further negative factor (even after the devaluations). This is a major handicap for any export-oriented FDI activity. While the minimum wage is not high, lack of well-trained workers, including foremen and mid-level technicians, force foreign employers to pay salaries substantially above the minimum, or even to bring in expensive expatriates. This situation reflects Morocco’s large illiteracy rate (51 percent), which is the highest in North Africa and one of the highest in the Arab world (Appendix Table 9). Substantial improvements and expansion in education and training infrastructure are needed to overcome this bottleneck. Transport costs are high, because the port of Casablanca is not performing to expectations and road transport, although mostly private, is badly overregulated and controlled. Shortcomings in infrastructure—physical as well as human—are in part the result of the sharp cuts in public investment over the last few years, in the context of the economic adjustment effort. Over the coming years substantial increases in outlays on infrastructure will be required to allow Morocco full use of its economic potential.

Oman

According to the limited information available, the inflow of FDI into Oman (other than oil related) has remained very small. Only two investments of any substantive size are recorded, one Dutch in 1986 and one Japanese in 1987, both about $15 million each. On the other hand, there seems to have been substantial disinvestment, particularly by French companies, during several years between 1974 and 1988. The lack of any significant FDI until the late 1980s is certainly not a reflection of lack of political stability or fundamentally misguided macroeconomic policies. To the contrary, after the political changes in 1970, Oman enjoyed a very stable political regime. Similarly, macroeconomic policies were largely private-sector-oriented and largely supportive of exports. Finally, per capita GDP was fairly high—nearly $1,300 in 1975 and over $3,600 by 1980.15 These positive factors, however, were more than offset by a number of negative ones, in particular lack of easily developable economic potential, lack of physical infrastructure, and lack of a large and well-trained labor force. These limiting factors were particularly strong during the 1970s and early 1980s.

Oman is one of the most typical examples of a country where, as a result of sudden, large oil discoveries, economic wealth ran way ahead of economic and social development for a number of years. As was to be expected in this kind of situation, the country was not in a position to turn its newly found oil wealth immediately into broad-based economic development. This task was particularly complicated in Oman by the country’s limited natural resource base and the low level of development prevailing when oil production began. Judged by its per capita GDP of about $150 in the late 1960s,16 Oman was then one of the least developed countries in the world. An even more serious impediment to rapid economic growth was the exceptionally low educational level of its population as a result of the low school attendance rate, estimated at a little over 4 percent of total school-age population,17 including pupils attending Koranic schools. In spite of enormous efforts undertaken since 1970, this educational handicap could not possibly be fully overcome within two decades. Oman is therefore still suffering from a severe shortage of well-trained personnel at all levels. Lack of human resources is particularly damaging in a country with a very small domestic market and a very limited amount of natural resources, where the only chance to attract foreign investment is for fairly sophisticated, export-oriented projects. A country with hardly any domestic market or domestic raw materials to exploit and process and only a small and inadequately trained labor force has little to offer a foreign private investor. The limited capacity of the Oman economy to generate and directly absorb productive investments during the 1970s was recognized even by the Government, which for many years invested substantial parts of its oil revenues abroad rather than waste them in an economy not yet able to use them effectively and efficiently.

The situation, however, is clearly improving: Primary school attendance is now virtually universal and half the school-age population attends secondary schools. Infrastructure for transport and power has been expanded considerably and is now quite satisfactory. With these bottlenecks largely overcome, the inflow of FDI is expected to grow, and in fact it has grown during the second half of the 1980s.

Saudi Arabia

Saudi Arabia has done well in attracting non-oil FDI. Together with Tunisia, it is one of only two Arab countries that are part of the group of 20 top-performing developing countries worldwide. With inflows of FDI per capita (in 1990 prices) increasing regularly, from an average of $10 in 1976–80 to nearly $14 in 1986–90 (Appendix Table 5), Saudi Arabia ranged thirteenth and fourteenth among that group (Appendix Table 6). It was first among Arab countries during the second half of the 1980s. This successful performance resulted from the combined effect of a number of existing factors together with attractive economic policies as well as political stability and predictability. Saudi Arabia was the preferred host country for U.S. and Japanese investors in the Arab world. During the 1980s, over 70 percent of all U.S. and 68 percent of all Japanese direct private investment in Arab countries was made in Saudi Arabia, and close to 90 percent of all foreign investment in Saudi Arabia was made by U.S. and Japanese companies.

With a total GDP of about $100 billion, Saudi Arabia is the largest economy in the Arab world, about the same size as Norway, or two and one-half times the size of the next largest Arab country, Algeria. Although the economy has grown little since the oil price collapse of 1982, it still represents a substantial domestic market, widened by export possibilities in the Middle Eastern markets, including the countries of the Gulf Cooperation Council (GCC). In addition, Saudi Arabia has an abundance of cheap energy; a strong industrial base in petrochemicals built up over the last decade; excellent and inexpensive infrastructure, including a well-educated labor force; and an ample supply of capital to cofinance foreign investments.

These “physical” advantages are reinforced by very attractive economic policies. Except for oil extraction, Saudi Arabia has always been a largely free-enterprise-oriented economy, with little government interference and control. Foreign trade is mostly free, and the foreign exchange regime is free and stable, including capital transfers. Non-oil exports are encouraged and have in fact increased from almost zero in 1970 to a respectable 4 percent of GDP by 1990,18 most of it manufactured products, including petrochemicals. The virtual absence of inflation during the 1980s together with the lack of further growth put considerable pressure on wages and salaries, which in a way led to marked improvements in the country’s competitiveness. Thus, FDI continued to grow during the last decade in spite of a stagnating domestic market. Saudi Arabia and Oman were the only two of the seven sample countries that did not need to go through an economic stabilization and adjustment program during the 1980s.

In addition to this attractive and stable macroeconomic environment, the Government further stimulated FDI by introducing a number of tax incentives. Saudi Arabia, however, has not made many promotional efforts to attract FDI. In fact, investment promotion remains low, and as a result, smaller and medium-sized foreign investments have not been common in Saudi Arabia.

Finally, Saudi Arabia’s well-known political stability is an important consideration for foreign investors, particularly for highly capital-intensive investments, with a lengthy payback period.

Tunisia

Tunisia has been quite successful in attracting FDI, particularly up to the mid-1980s, and somewhat less during 1986–90. In FDI per capita, it has ranked consistently in either first or second position among the seven sample countries during the four time periods under review; the same is true for FDI as a share of domestic investments (Appendix Table 4). Even in a worldwide comparison, Tunisia did well; it has been one of the 20 top-performing developing countries with regard to FDI since the mid-1970s. From 1975 to 1985 Tunisia was ranked tenth or eleventh among the 20 countries, with an FDI-per-capita inflow of over $17 a year in 1990 prices (Appendix Table 6). During the second half of the 1980s it slipped to sixteenth position, as per capita FDI fell to a little over $10. What explains this very good performance as well as the sizable worsening during the last five years?

First, Tunisia has a number of natural advantages; second, it has made good use of these advantages—better than other countries in a similar situation. Tunisia has a very advantageous geographical location; strong historical links with Western Europe reinforced by an unusually smooth transition to independence; remarkable political stability with a demonstrated ability to master peacefully even difficult political problems; well-developed physical and human infrastructure (with the lowest adult illiteracy rate in North Africa and the third lowest in the Arab world). More important, however, Tunisia’s economic policies have consistently been moderate and reasonable; extreme swings were largely avoided, and damages created by such swings remained limited. As much less was broken than in other countries, less had to be fixed, and the adjustment process was less disruptive and painful. Hence, even when the rapid increase in the balance of payments current account deficit reached 8.6 percent of GDP in 1982–84 and the budget deficit exceeded 6.3 percent, which made implementation of a stabilization program unavoidable in the late 1980s, the difficulties were more limited than in many other developing countries and did not have the same devastating effect on FDI.

In spite of some nationalizations and “Tunisification” and considerable government intervention and control, Tunisia’s economic policies never veered as far to the left as in some other Arab countries. Furthermore, being a small country helped to avoid the worse excesses of import-substituting policies and to provoke a reversal in overall policy direction sooner than in many larger countries. In fact, as early as 1970 when countries like Egypt and Algeria still followed economic policies that were strongly public sector controlled and inward looking, the overall policy stance in Tunisia started to change gradually but persistently in favor of stronger private sector development, relaxed administrative controls, and the stimulation and diversification of exports other than fuel. These policies were pursued, with some ups and downs, during most of the following two decades. As a result, already during the early 1980s, when Tunisia’s fuel exports hit their peak, exports of manufactures exceeded 10 percent of GDP, a remarkable achievement for any developing country and the best proof of a successful export-driven growth strategy; during the second half of the 1980s such exports averaged over 16 percent of GDP (Appendix Table 8) and reached a peak of close to 22 percent in 1990, or nearly the same level as Germany.19

In addition to slowly but steadily decontrolling and liberalizing the economy, the Tunisian Government also began actively to attract more FDI by providing special incentives to export-oriented offshore companies in 1972 and on a more general level in 1974. These policies led to a substantial increase of foreign manufacturing investments during the second half of the 1970s, producing much of the increase in manufactured exports mentioned above (Table 6). The increasing overvaluation of the dinar during the early 1980s at a time of high oil prices and large Tunisian oil exports discouraged the further establishment of export industries. The marked decline in FDI in this sector was more than compensated, however, by large foreign investments in hotels and banks, often by Arab investors, and was strongly encouraged by the Government. A growing saturation in the banking sector and a certain dissatisfaction with the low level of profitability of these semipublic banks—together with Tunisia’s growing balance of payments difficulties and the strong decline in oil earnings in the Middle East—led to a sharp decline in Arab investments in the banking sector during 1986–90, the main factor for the overall decline in FDI inflows during this period. But FDI in tourism continued to grow, while FDI in export industries started to recover toward the end of the period, when the reform measures of the mid-1980s began to show the first results, in particular the substantial devaluation of the dinar, which declined by nearly half vis-à-vis the U.S. dollar between 1981 and 1989.

Table 6.Tunisia: FDI Inflows by Major Sectors(Annual averages in million U.S. dollars; 1990 prices)
1976-801981-851986-90
Manufacturing64.030.838.7
Tourism8.215.423.4
Banking
30.262.013.4
Others10.53.6
Total102.4118.779.1
Source: Government of Tunisia, Budgets Economiques.
Source: Government of Tunisia, Budgets Economiques.

Conclusions

The general analysis provided in the section on overall setting, but even more so in the brief country analyses in the previous section, brought out a number of factors that determined the level of FDI inflows into the seven Arab countries assessed in this paper. As mentioned before, each of these factors influences FDI in different ways and to a different degree, depending on the individual setting in each country. Hence, the present situation and recent trends, as observed ex post for each country, reflect the impact of different factors often pulling in different directions: while economic policies might be attractive for FDI, the political situation might not, and even if both are positive, lack of economic resources might discourage large inflows of FDI. These factors can be grouped under three headings: (1) natural factors; (2) political factors; and (3) economic factors. Our analysis will concentrate on the last group—economic factors—not only because these are the most important but also because they are the most amenable for economic policymakers. But first, the other two groups of factors will be assessed briefly.

Natural Factors

Location is possibly the most important natural factor. It provides a clear advantage to the Maghreb countries with their closeness to Europe and well-established transport links. Location was also a factor in explaining Jordan’s strong success up to the mid-1980s. It is important to realize, however, that good location alone is no guarantee for success in attracting FDI. Algeria is a vivid reminder in this respect.

As mentioned above, the size of the population is of little consequence. Although a large and expanding domestic market might provide some attraction, other factors, such as appropriate economic policies, have become much more important.

The same is true for the availability of natural resources. Of course, an almost complete absence of such resources (other than oil), as in Oman, is a handicap. On the other hand, an easily exploitable potential for tourism (as in Tunisia and Egypt) or for the cultivation of high-quality agricultural crops (as in Morocco or the Jordan Valley) helps to some extent as does the availability of large amounts of cheap energy. But again, these factors are not crucial. While Morocco and Tunisia are similarly endowed with natural resources, their success in attracting FDI has been quite different. Among the seven sample countries, Oman is the only one where lack of natural resources can be considered to have slowed down the inflow of FDI in any significant amount.

Political Stability

Political stability and predictability are of vital importance for attracting FDI. Political turmoil and instability are among the key factors explaining Algeria’s sudden lack of success in attracting FDI during the 1980s after a quite successful decade in the 1970s. Political instability and uncertainty—not so much in the country itself, but all around it—added to the sharp decline in FDI flows into Jordan during the second half of the 1980s after a decade of increasingly successful performance. In actual or expected political uncertainty, even the most attractive economic policies can do little to attract FDI.

Economic and Social Factors

The single most important factor determining FDI flows into these seven countries was the economic policies pursued by their governments. Except in the few instances mentioned above, the FDI flows into these countries observed over the last twenty years were largely determined by economic factors. They explain most of the differences in FDI inflows between the seven countries as well as changes over time. As discussed below, among economic factors, the macroeconomic policies pursued by the host governments are the most crucial. In addition, provision of an adequate infrastructure—physical as well as human—is also an important element for attracting more FDI. Finally, targeting investment promotion can play an important role in this respect.

Macroeconomic Policies. For a country to attract meaningful amounts of FDI, two sets of economic conditions have to be fulfilled: the investment climate has to be attractive; and the investment climate has to be stable and predictable. The second of these factors is often ignored by developing countries, which, after years of economic policies that are inward looking and public sector oriented, embark on courageous and far-reaching structural reforms and as a result expect a rapid resumption of FDI inflows. Expertences over the last decade in many developing countries, including Arab countries, indicate quite clearly that FDI is not like a water tap that a government can turn on and off at its convenience; it is more like a fruit tree that needs to be tended and watered carefully for years before it will bear fruit. If in the meantime the owner loses interest, the young tree will die and the process will have to be started all over again. This is the main reason for the five to six years’ delay observed in most developing countries between the time a structural adjustment program is implemented in earnest and the time foreign investors start to regain confidence.

This phenomenon of delayed reaction plays a crucial role in recent trends in FDI inflows into the seven sample countries. As mentioned above, except for Oman and Saudi Arabia, all sample countries had to implement stabilization with structural adjustment programs at some point during the 1980s. While the depth and timing of the crisis triggering that implementation varied, and the overall economic context within which it occurred differed from country to country, there were some remarkable similarities in the five countries: after years of worsening budget and balance of payment deficits during the late 1970s and early 1980s, the foreign debt situation became so tight and fragile that even a minor exogenous shock was sufficient to trigger a serious economic crisis. Such shocks were numerous during the 1980s, when prices of oil and fertilizer declined and the whole region suffered from serious economic malaise. To deal with the crisis, a reform program was initiated, almost invariably painful and resulting in a major slowdown of economic growth for several years.

Inflows of FDI were doubly affected by these developments. First, during the years leading up to the crisis when the economic imbalances were rapidly becoming unmanageable and tight foreign exchange restrictions had to be introduced, the investment climate obviously deteriorated and foreign investors moved to the sidelines waiting for improvement. Second, once the reforms were being implemented, a delayed reaction syndrome set in, with foreign investors taking their time to ensure that the governments were indeed serious about their programs, had the stamina and political clout to carry them through, and were successful in doing so. Much of the decline in FDI inflows observed at some time or another during the 1980s in Algeria, Egypt, Jordan, Morocco, and Tunisia were the result of this double impact. Although macroeconomic stabilization in most of these countries has been achieved by now and structural reform is well advanced, the five to six years’ “waiting period” for FDI to resume has only just come to an end.20 It is not by accident that Saudi Arabia, the only one of the seven sample countries that has shown a consistent upward trend in FDI inflow and by the late 1980s had emerged as the most successful of the group, did not experience an economic crisis and did not have to go through a reform program.

In addition to economic stability and predictability, a further factor explains foreign investors’ reluctance to resume investments rapidly after an adjustment program has been initiated. Foreign investors are sensitive not only to such macroeconomic factors as foreign exchange shortages, price controls, and investment conditions but they give equal importance to the government’s attitude to the private sector in general, and foreign private investment in particular, and not just in the form of policy declarations but in the form of actions and results. These actions include privatization, or at least a more efficient management of public enterprises along the lines of a private company. In this respect, changes have come slowly in most of the countries analyzed in this paper. It has proved much easier to devalue the exchange rate, liberalize imports, decontrol prices, and reduce budget deficits than to bring about a basic change in the attitude of public administration toward the private sector and to achieve meaningful reform of public enterprises. Hence, a major disincentive for stronger FDI inflows remains.

Besides the phenomenon of delayed reaction, an equally important macroeconomic factor in influencing FDI flows is the attractiveness of the investment climate. Among the different macroeconomic policies that make for an attractive investment climate, three are of particular importance:

  • Policies oriented to a free market with a minimum of government interference and control, where prices as well as the use and allocation of resources are determined by market forces, and where private enterprises are free to operate on their own initiative and in line with their own interests, without discrimination in favor of the public sector.
  • Outward-looking, export-oriented policies, rather than inward-looking import-substituting policies, where the exchange rate is competitive, foreign trade is largely free, and exports are encouraged by the government, rather than hampered by heavy administrative controls.
  • Foreign exchange policies that guarantee a sufficient availability of foreign exchange to allow for the necessary imports to run the foreign investment and for the transfer of dividends and capital.

Of the four top performers in attracting FDI, three had always pursued largely private sector oriented, outward-looking economic policies (Saudi Arabia, Jordan, and Oman); the fourth, Tunisia, went through a period of considerable state intervention and inward-looking policies but less than in other developing countries and for a much shorter time, and started to change course gradually more than twenty years ago. Furthermore, while some of these four countries have experienced periods of considerable foreign exchange shortages, none has ever experienced a fully blown foreign debt crisis requiring major debt rescheduling.

The three least successful countries have all gone through long periods of heavy state intervention and strongly inward-looking economic policies (particularly Algeria and Egypt, Morocco somewhat less). As a result, at the time they hit the economic crisis and had to adjust, their economies were much more distorted and investment misallocations and inefficiencies were much worse than in Tunisia and Jordan. As the need for adjustment was larger, more complicated, and more painful, the adjustment process necessarily took more time. This explains the relatively small increase in FDI inflows during the late 1980s.

Across the board, the structural adjustment policies have not yet borne much fruit. Contrary to expectations, most countries with adjustment programs have not so far succeeded in substantially increasing their exports of nontraditional goods, in particular manufactures. This is important because, whereas thirty to forty years ago foreign companies invested in developing countries mostly to exploit a natural resource (mining) or to penetrate the domestic market of the host country (automobiles), today FDI is undertaken increasingly as a means to produce goods cheaply for export. Therefore, countries that are successful exporters of manufactures tend to become attractive host countries for FDI. The close link between FDI inflows and exports of manufactures (implementation of export-oriented macroeconomic policies) is clearly apparent in the seven sample countries (Table 7): the three countries least successful in attracting FDI (Algeria, Egypt, and Morocco) were at the same time the three countries least successful in exporting manufactured products. On the other hand, Tunisia—the leading exporter of manufactures among the seven countries—has been the second most successful host country for FDI. During 1986–90 Tunisian exports of manufactures exceeded $216 per capita and per year, or 16 percent of GDP (Appendix Table 8), while Morocco’s exports of such goods averaged less than $65 per capita and per year, or 7 percent of GDP, in spite of its much broader resource base. In consequence, economic policies designed to stimulate nontraditional exports also make a country more attractive for foreign investors.

It is often argued that too much dependence on exports is too risky, and the example of Jordan during the late 1980s seems to strengthen that argument. But there is no a priori reason why exports should inherently be more volatile than domestic demand. Over the last years, experience in many countries, including the United States, has shown that during an economic downturn, export markets often hold up better than domestic demand.

Table 7.FDI, Exports of Manufactures, and Literacy, 1986–90
Ranking According to
FDI per

capita
Exports of manufactures

per capita
Literacy

rate
Saudi Arabia133
Tunisia212
Jordan3a41
Oman3b2(low)
Morocco555
Egypt666
Algeria774
Sources: Appendix Tables 5, 8, and 9.
Sources: Appendix Tables 5, 8, and 9.

Infrastructure. In addition to macroeconomic policies, the quality of human infrastructure has a major impact on FDI flows to developing countries. Among the seven sample countries there is a strong correlation between FDI flows and literacy rates; the three countries most successful in attracting FDI are also the three with the highest literacy rate (Table 7). Only for Algeria does this correlation not hold; as a result of the serious political and economic problems mentioned above, the inflow of FDI into Algeria during the 1980s was well below what its literacy rate would suggest; during the 1970s, however, this correlation was much stronger. This close relation between FDI and literacy reflects the importance of a foreign investor of finding sufficient and well-trained labor on the spot. This is particularly true for export industries that have to compete on the world market and for which the quality of labor and its cost are key factors in deciding on investment abroad. Hence, in any strategy aimed at increasing the inflow of FDI, much importance must be given to improving and expanding the schooling and training of the domestic labor force.

Inadequate and insufficient physical infrastructure, particularly in the fields of transport and energy, can be a major handicap for attracting FDI. However, with the possible exception of Oman until a few years ago, all seven countries have a fairly well-developed infrastructure, and the differences that do exist among them are not large enough to explain much of the differences in their respective FDI inflows.

Investment Promotion. While most of the seven countries have undertaken efforts over the last years to adjust their economic policies, and, in the process, to make their economies more attractive to foreign investors, their efforts at active investment promotion have remained limited. Even though it is not the purpose of this paper to assess in detail the institution-building and policy changes necessary to improve and streamline investment promotion, investment approval, and investment implementation, it is important to point out that in most of the seven countries analyzed in this paper there is substantial room for improvement in this respect. Given the toughening international competition for the limited amounts of FDI in the world, such improvements ought to be initiated without delay. They should be realized hand in hand with improvements in macroeconomic policies, including privatization, and in the provision of adequate human and physical infrastructure.

Recommendations

Based on the above analysis, two sets of recommendations emerge. As a means to stimulate and increase the inflow of FDI, governments ought to

  • pursue attractive macroeconomic policies, guaranteeing and encouraging the free play of market forces and private initiative;
  • maintain a level playing field between private and public enterprises;
  • encourage exports of nontraditional goods and services;
  • avoid foreign exchange crises requiring major stabilization efforts;
  • improve the training and efficiency of the domestic labor force;
  • provide adequate physical infrastructure; and
  • pursue all these policies in a steady, stable, and predictable manner, to regain and maintain the confidence of foreign private investors.

Of course, all these efforts will be in vain if a country finds itself in the midst of a political crisis that might well have little to do with the state of its economy, but this situation is out of the hands of economic policymakers.

APPENDIX
Appendix Table 1.FDI Inflow(Annual averages in million U.S. dollars; current prices)
1970-741976-801981-851986-90
Algeria165.16175.00-7.766.88
Egypt0.76224.282139.562,3155.803
Jordan11.9024.0767.5216.944
Morocco16.8954.1050.2495.37
Oman20.701.24-6.466.96
Saudi Arabia25.4448.9494.96184.48
Tunisia55.6643.6482.9072.26
Total86.51371.27420.96538.69

International Monetary Fund.

OECD/DAC, excluding petroleum.

World Bank.

Excluding 1990.

Government of Tunisia (Budget Economique), excluding petroleum.

International Monetary Fund.

OECD/DAC, excluding petroleum.

World Bank.

Excluding 1990.

Government of Tunisia (Budget Economique), excluding petroleum.

Appendix Table 2.FDI Inflow(Annual averages in million U.S. dollars; 1990 prices)
1970-741976-801981-851986-90
Algeria1144.55303.90-10.947.49
Egypt2.77240.702200.512,3173.203
Jordan18.4038.1095.7724.034
Morocco131.7392.2471.4799.61
Oman22.901.55-8.998.22
Saudi Arabia218.8585.07137.38195.76
Tunisia522.70102.39118.6679.07
Total231.90663.95603.86587.38

International Monetary Fund.

OECD/DAC, excluding petroleum.

World Bank.

Excluding 1990.

Government of Tunisia (Budget Economique).

International Monetary Fund.

OECD/DAC, excluding petroleum.

World Bank.

Excluding 1990.

Government of Tunisia (Budget Economique).

Appendix Table 3.FDI as Percent of GDP
1970-741976-801981-851986-90
Algeria10.380.69-0.020.01
Egypt20.010.140.400.28
Jordan10.360.471.490.343
Morocco10.210.400.350.36
Oman40.300.02-0.090.09
Saudi Arabia0.050.070.100.22
Tunisia50.350.721.010.71

International Monetary Fund.

OECD/DAC (1970–81); World Bank (1982–90).

Excluding 1990.

OECD/DAC, excluding petroleum.

Government of Tunisia (Budget Economique), excluding petroleum.

International Monetary Fund.

OECD/DAC (1970–81); World Bank (1982–90).

Excluding 1990.

OECD/DAC, excluding petroleum.

Government of Tunisia (Budget Economique), excluding petroleum.

Appendix Table 4.FDI as Percent of Domestic Investment (GDI)
1970-741976-801981-851986-90
Algeria1.01.5-0.10.0
Egypt0.10.51.41.3
Jordan1.81.25.01.8
Morocco1.21.61.41.6
Oman1.20.1-0.30.5
Saudi Arabia0.40.30.41.1
Tunisia1.62.43.33.2
Source; See Appendix Table 3.
Source; See Appendix Table 3.
Appendix Table 5.FDI Per Capita(Annual averages in 1990 U.S. dollars)
1970-741976-801981-851986-90
Algeria8.5916.95-0.540.31
Egypt0.101.014.503.48
Jordan3.2513.5530.146.36
Morocco2.114.873.424.08
Oman4.431.50-8.606.20
Saudi Arabia2.9210.0911.7213.77
Tunisia4.3917.1317.2610.16
Unweighted average3.689.308.276.34
Source: See Appendix Table 3.
Source: See Appendix Table 3.
Appendix Table 6.Twenty Developing Countries Most Successful in Attracting FDI1(Annual averages)
Million U.S. DollarsFDIFDI Per Capita
Current prices1990 pricesPercent of GDPPercent of GDIU.S dollars, 1990 prices
1976-801981-851986-901976-801981-851986-901976-801981-851986-901976-801981-851986-901976-801981-851986-90
Portugal84.43182.101,097.20141.30260.401,121.600.400.802.301.903.508.5514.8026.00109.00
Greece492.35466.10763.60811.40666.50819.401.651.301.506.105.807.9086.0067.7081.90
Malaysia558.901,082.921,286.88939.101,548.601,346.603.203.803.4012.9011.9012.4571.50104.0079.50
Papua New Guinea39.81102.00135.20265.00145.90148.2022.204.104.10211.0014.6017.60222.3043.8041.602
Costa Rica53.8457.0098.2097.3081.50105.801.601.602.006.706.708.4045.3033.0037.10
Mexico1,099.261,166.552,606.601,791.001,668.202,826.401.100.601.504.302.707.8027.3022.3034.10
Argentina255.27487.24953.37396.40696.801,064.400.400.801.201.704.9011.2014.5023.5033.80
Thailand96.60279.051,174.48166.40399.001,225.200.400.701.701.552.906.103.708.0022.50
Chile131.60212.20230.80204.00303.40241.200.700.901.005.407.805.6018.9025.9018.90
Guatemala93.0069.80142.00155.1099.80153.401.500.801.907.506.1014.7023.7013.3017.70
Korea, Rep. of61.44116.75676.00117.00167.00731.200.160.150.400.500.501.203.204.2017.40
Colombia96.20571.20454.60156.40816.90522.800.401.501.201.806.806.256.3029.8017.30
Dominican Republic61.0046.2498.58108.6066.10105.801.200.801.705.303.707.1020.0010.8015.40
Saudi Arabia48.9494.96184.4885.07137.38195.670.070.100.220.270.401.1010.0911.7213.77
Brazil1,944.801,978.201,424.203,379.802,841.701,516.801.000.800.404.304.301.9029.2021.9010.50
Tunisia43.6482.9072.26102.39118.6679.070.721.010.712.403.343.1517.1317.2610.16
Philippines68.4862.80492.60148.9089.80522.600.300.201.201.000.807.003.301.708.90
Honduras12.2615.8339.4020.6022.6042.400.700.501.002.802.706.806.005.508.80
Ecuador39.3252.4077.4060.6074.3084.400.500.400.701.901.903.207.908.508.30
Turkey32.8081.41390.9754.80116.40411.800.100.200.500.400.902.101.302.407.70
Sources: International Monetary Fund, Balance of Payment data base; OKD/DAC (Saudi Arabia); Government of Tunisia.

With popuiationi of over 2 million listed in order of FDI per capita during 1986-90.

1986-89 only.

Sources: International Monetary Fund, Balance of Payment data base; OKD/DAC (Saudi Arabia); Government of Tunisia.

With popuiationi of over 2 million listed in order of FDI per capita during 1986-90.

1986-89 only.

Appendix Table 7.Differing Performance Among Developing Countries in Attracting FDI, 1990
FDI
Population

(Millions)
FDI Inflow

(Billion

U.S. dollars)
FDI Per Capita

(U.S. dollars)
(Percent

of GDP)
(Percent

of GDI)
20 Most successful62917.828.21.23.2
developing countries1
81 Other developing
countries3,5177.92.30.41.4
Total average4,14625.76.20.82.2
Sources: World Bank, World Development Report, 1992; International Monetary Fund, Balance of Payments Statistics Yearbook, 1991.

Excluding Singapore.

Sources: World Bank, World Development Report, 1992; International Monetary Fund, Balance of Payments Statistics Yearbook, 1991.

Excluding Singapore.

Appendix Table 8.Exports of Manufactures(Annual averages, 1986-90)
In Million

U.S. Dollars
In Percent

of GDP
U.S. Dollars

Per Capita
Algeria316.20.5613.31
Egypt817.82.2516.39
Jordan399.17.53135.75
Morocco1,553.57.3664.84
Oman248.82.98175.18
Saudi Arabia2,150.22.65153.37
Tunisia1,672.816.30216.88
United States228,050.04.77927.00
Germany287,460.024.574,689.40
Source: World Bank, World Tables, 1992.
Source: World Bank, World Tables, 1992.
Appendix Table 9.Literacy Rates(Percent literate, aged 15 plus, 1990)
Algeria57
Egypt48
Jordan80
Morocco49
Omann.a.
Saudi Arabia62
Tunisia65
Turkey81
Malaysia78
Source: World Bank, Social Indicators of Development, 1991–92.
Source: World Bank, Social Indicators of Development, 1991–92.
1International Monetary Fund (IMF), World Bank Economic and Social Data Base (BESD). and other World Bank reports, the Organization for Economic Cooperation and Development (OECD) Development Assistance Committee (DAC), and the U.S. Commerce Department.
2Excluding oil and gas investments as much as possible.
3Roundtable on Foreign Direct Investment Policies in Africa, June 9–11. 1992, Opening Statement by Ghassan El-Rifai.
4World Bank data.
5World Bank, World Tables, 1992.
6The following analysis is based largely on OECD/DAC data for the 1970s and World Bank data for the 1980s. They exclude oil investment. The World Bank figures used from 1982 onward are substantially higher than the DAC data for the same years, as they also include Arab investment, but are lower than the IMF balance of payments figures, which include oil investments.
7World Bank, World Tables, 1992.
8Ibid.
9World Bank, World Debt Tables, 1981.
10World Bank. World Tables. 1992.
11World Bank Economic Reports.
12World Bank data.
13Ibid.
14World Bank, World Tables, 1992.
15Ibid.
16World Bank Atlas, September 1969.
17World Bank data.
18World Bank, World Tables, 1992.
19Ibid.
20Preliminary data for 1991 and 1992 seem to indicate that Morocco, which started its adjustment early, and Tunisia, which needed only a relatively mild adjustment, reached the end of the tunnel by 1990, and Jordan might not be far behind. Algeria and Egypt, however, still have some way to go, given the major adjustment efforts needed in these two countries and their rather late starting date.

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