How to boost foreign direct investment

As the world's finance ministers and bankers gathered in Dubai for the annual IMF/World Bank meeting in 2003, discussion inevitably turned to the economic failures of the Arab world.

Numerous remedies to the economic malaise were offered, ranging from banking reform to the usual prescriptives of economic liberalization. But the one issue most agreed upon was this: the Arab world must dramatically restructure its foreign direct investment (FDI) climate to attract more global funds.

As it stands now, the Arab world nets less than one percent of global foreign direct investment, and only about four percent of FDI flowing to the developing world.

What's more, most of that investment goes to the oil and gas industry, which is not a large job creator. If the Arab world intends to achieve growth rates to match the employment demands of their youthful populations, larger - and more efficient - FDI flows are essential.

It's no secret that foreign investment can do wonders for an economy: from creating jobs to transferring technology to raising labor and product standards. The job part will be critical for the Arab world. According to the World Bank, the Middle East/North Africa region will be faced with a serious employment crunch by 2010.

All told, the region will require some 100 million new jobs, the vast majority of which will need to come from the private sector.

The traditional regional workplace - in the public sector - is today bloated, inefficient and a serious drag on growth. Indeed, the public sector produces the bewildering bureaucratic rules and red tape that are the bane of the foreign investor's existence.

Rather than creating an enabling investment environment, most Arab governments burden foreign investors - and their own private sector - with cumbersome regulations.

The Arab world could certainly use the boost that FDI brings. The 260 million people of the 22 Arab countries combined have a GDP less than that of Spain or Mexico. Some 25 percent of Arabs live below the poverty line.

Some 20 million Arabs are out of work. Over the past decade, the average annual growth rate has been less than one percent, while the region-wide unemployment rate has been higher than any region except sub-Saharan Africa.

In the last 25 years, per capita income has grown at an annual rate of 0.5 percent, and the Arab world has seen its average standard of living decline relative to the rest of the world.

On just about every major economic health indicator, the Arab world lags behind the rest of the world, barring sub-Saharan Africa.
Lessons can be learned from Latin America and Southeast Asia. Clearly, much of the growth in the 1990s in those regions was fueled by FDI.

Even amid a FDI-related crisis in the late 1990s, most Southeast Asian economies looked more promising than those of the Arab world. The Arab world can also, in hindsight, look at what those regions did wrong, and try to avoid those same mistakes.

A comparative look at South Korea and Egypt is telling. In 1950, South Korea and Egypt looked very similar in terms of per capita income and GDP. Today, South Korea is the 11th largest economy in the world, churning out hi-tech goods and creating a prosperous society.

Egypt, for its part, seems mired in a never-ending cycle of economic stagnation. What's the difference between the two countries? One key ingredient of South Korea's rise was its ability to attract foreign direct investment.

Sometimes the mere act of opening the door to foreign investment enriches the economic infrastructure of a country. The influx of foreign capital tends to force the maturation of financial and capital markets - either by precipitating a crisis that leads to restructuring, as in Southeast Asia, or, preferably, by the simple fact of necessity: capital needs a reliable home.

Veteran economic observers of the Arab world regularly lament the region's illiquid and immature capital markets.

Despite these problems, the Arab world is not without success stories. Dubai, and the UAE in general, lead the charge in attracting FDI. Tunisia, Morocco, Jordan and Oman have also seen their FDI rates rise in the past few years. The big picture, however, remains gloomy.

So what's holding back FDI? Sami Haddad, the International Finance Corporation's director for Middle East and North Africa, identifies six key impediments to FDI growth in the Arab world: conflict and regional instability; unpredictable macroeconomic conditions and public policy choices; weak institutions and high administrative barriers; inadequate infrastructure; underdeveloped financial sectors; inadequate availability of a skilled and flexible workforce.

"All of these, in varying degrees, contribute to a poor foreign investment environment," says Haddad.

Ziad Abdelnour, a New York-based investment banker, notes that even when non-oil FDI makes it way to the Arab world, returns are low by global standards, causing large capital flows to go elsewhere. The World Bank concurs, noting that the Middle East/North Africa region had the lowest rate of return on investments in the world last year.

In fact, Arabs aren't even investing at home. Some 85 percent of the investments of wealthy individuals from Gulf countries are located abroad, a figure approaching $1 trillion.

As one Gulf investor told Arabies Trends, "We might invest in a hotel here or there, but the real money is going abroad, into Western capital markets. Until the environment for investment changes, I just don't see that money returning to the Arab world."