Aug 05 2007

Foreign Direct Investment and GCC Countries

Foreign Direct Investment and GCC Countries
Recently, there has been a lot of research interest in foreign direct investment (FDI) in the Gulf Co-operation Council (GCC) member countries. Unfortunately, the scarcity of the data on FDI in GCC has hampered any in-depth research in this area of knowledge in the region. This article discusses the relationship between FDI and economic growth and the determinants of FDI from the viewpoint of the economic theory. In addition, it compares and contrasts the FDI flows and stocks in four, out of six, GCC countries . The other two countries are not included because there is no data available for them.

Although there is no complete agreement among economists on the relationship between FDI and economic growth, but there is a growing consensus in the literature that FDI is positively correlated with growth. From economic growth theory view point, this positive correlation between FDI and growth is based on the assumption that FDI brings about improvements in technology, efficiency, and productivity and these in turn stimulate economic growth. In this view, the contribution of FDI to economic growth comes through the transfer of technology and management practices from the developed to the developing economies. It has been argued that there is knowledge diffusion from FDI firms to local firms. In FDI literature, this is known as contagion, externalities or efficiency spillovers. This efficiency spillovers lead to improvements in the productivity and efficiency of the local firms. This transfer of knowledge happens when local firms enhance their productivity by simply copying the technologies of the FDI firms operating with them in the local market. Also, these spillovers happen when the local firms are impelled by the tough competition in the local market from the FDI firms to be more efficient in the use of their resources, otherwise they have to exit the market. Moreover, this contagion happens when well trained local employees of FDI firms move to work for the local firms or establish their own firms.

FDI literature points to a number of factors that determine FDI. These are namely market size, infrastructure and industrialization, labour cost, laws and regulations, free trade zones, business and investment climate, economic and political stability, open trade regime, fiscal incentives, transport cost, and regional economic integration.

Figure 1 shows the net inward flows of FDI as a percentage of gross fixed capital formation (GFCF) during the period 1997-2006. During this period, the average net inward FDI flows as percentage of GFCF is 31 per cent for Bahrain, 26 per cent for Qatar, 17 per cent for UAE, and less than 1 per cent for Kuwait. The figure shows that Bahrain and Qatar were outperforming UAE during the period 1997-2003, but UAE has been outperforming both Bahrain and Qatar since 2004. FDI flows to UAE have been picking up since 2003, refer to figure 1.

Figure 2 shows the stock of inward FDI as a ratio of the stock of outward FDI during the period 2003-2006. During this period, this ratio is 5 for Qatar, 4 for UAE, 2 for Bahrain, and 0.20 for Kuwait. These ratios show that Qatar, UAE and Bahrain have more inward FDI stock by foreigners than their nationals' outward FDI stock in foreign countries. For Kuwait, the Kuwaitis have more FDI stock outside Kuwait than foreigners have FDI stock in Kuwait. According to the United Nations Conference on Trade and Development (UNCTAD) classification of countries according to their actual and potential FDI performance, Bahrain, Qatar, UAE are classified as front runners, that is, countries with both high FDI potential and high actual performance. Kuwait, Oman and Saudi Arabia are classified as below potential, that is, countries with high FDI potential but low actual FDI performance.

Since financial capital is abundant in GCC countries , thanks to rising oil prices, the GCC are not so reliant on FDI for its financial contribution. Much more, the GCC require FDI to act as a conduit for technology, management, distribution services, and information about foreign markets. Should GCC countries like to attract more FDI then, the empirical evidence both econometric and investors' surveys, suggests that they need to improve infrastructures; streamline and simplify laws and regulations; bolster business and investment climate; strengthen macroeconomic stability; establish liberalized and business friendly industrial free zones to generate clusters effects; and engage in wider regional economic integration.

The FDI data used in this article is from the Economist Intelligence Unit (EIU) based on IMF and UNCTAD data. GCC national sources do not officially record or publish data on FDI inflows and outflows. FDI by definition refers to investments made abroad where the investor gains an effective voice in the management of the enterprise; this is often proxied using a threshold of 10% of equity ownership. Using this proxy means that all FDI data has its inherent limitations. High liquidity in GCC countries would imply that the GCC is a net exporter of foreign investment. However, whether this investment is indeed FDI, or not, is indistinguishable and, to a certain extent, a grey area for GCC countries . The IMF and UNCTAD data reports that GCC countries , with the exception of Kuwait, are net importers of FDI. Whilst the IMF and UNCTAD definition and the measurement methodology for FDI are clear, it is unclear whether it is being applied effectively to GCC countries .

The regulatory business environment in the GCC, where business is heavily dominated by family businesses, means financial dealings are not always transparent and are, therefore, less likely to be officially recorded as FDI outflows when appropriate. This, combined with the poor FDI national databases, means that the IMF and UNCTAD may actually be underestimating FDI outflows from the GCC. If FDI data in the GCC is to improve, governments are advised to set specialized databases that meticulously record all the FDI flows in and out of the GCC countries and not leave that task for the guesstimate of the IMF and UNCTAD.


© Press Release 2007

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