Differentiating Extractive, Manufacturing and Service Investments in LDCs.

The problems facing foreign investors in LDCs depend on the type of investment, whether in an extractive industry, manufacturing for the host market or for export, or a service industry. Differences arise from the objectives of MNCs, capital investment, timeframe, balance-of-payments, currency stability and operating controls in the host country. An awareness of these differences is important/or the multinational investor's pre-in vestment planning and negotiating with a host government.

Extractive, manufacturing and service investments create different types of problems for companies planning foreign direct investments (FDIs), especially in less developed countries (LDCs). For manufacturing, there are differences between plants producing primarily for the host market and those seeking low-cost labor to produce exports. The problems affecting EDI have not previously been presented systematically, and there is a need for a comprehensive scheme that multinational executives can use to analyze different types of investments.

Exhibit 1 highlights the different characteristics under four categories of investments. The exhibit illustrates how issues that are highly controversial for one kind of investment are less controversial for others.

MNC Objectives

Extractive. A foreign investor's primary concern when setting up an extractive facility is a reliable source of raw materials to feed downstream operations. The majority of mining and petroleum companies are highly integrated, and the extractive operations are the first in a long series of processing facilities. Hence, the concern is to control costs, not necessarily show a profit.

Manufacturing for host market. An import-substituting investment is motivated by a desire to make a profit or preserve and gain market share. Multinational corporations (MNCs) try to head off competition by negotiating subsidies or tariff protection from a host government, and they may have the bargaining power to gain more protection than is possible in industrialized countries. However, this type of investment is particularly sensitive to economic conditions and political pressures in LDCs, which makes the objectives more problematic.

Manufacturing for export. In export operations, MNCs seek low cost operating locations. They want cheap labor for labor-intensive operations, primarily assembly of components into standardized products. The products tend to be mature and price-competitive, so cost control is an important objective. Foreign companies typically are concerned about quality assurance and reliability of supply. They are also concerned that their investments be free of administrative costs and hassles when setting up and operating plants.

Services. The most common types of FDI are hotels and financial services, mostly banks. Both types of foreign operations frequently focus on serving the needs of the international community, i.e, foreign travelers in the case of hotels and local affiliates in the case of banks. When foreign hotels service locals, they are usually the wealthiest and most internationalized citizens. The services rendered by foreign banks relate to foreign borrowings and transfers of funds.

Host Country Objectives

Extractive. The most important benefits that host LDCs hope to obtain from extractive industries are foreign-exchange earnings, government royalties, tax revenues and jobs for host citizens. Technology transfer and downstream marketing may be significant, although these supporting services are increasingly available in "unbundled" form on the open market.

Manufacturing for host market. The benefits host countries seek from foreign import-substituting plants are varied and diffuse. MNCs are likely to bring in a "package" of goods and services, including technology transfers, employment opportunities, capital inflows, training of host citizens as managers, technicians and laborers, and opportunities for local producers to supply raw materials and services to the foreign plant. There can be a demonstration effect whereby local companies learn manufacturing and management skills from the foreign plant and eventually compete with it.

The host government hopes that foreign plants will become cost efficient and develop sufficient quality to export products. However, unskilled workers, inadequate transportation and communications facilities, small-scale and inefficient production facilities, and costly government rules and red tape often hamper a plant's operation. Consequently, many are unable to export significant amounts at competitive, unsubsidized prices. Host governments may also try to persuade foreign investors to place plants in remote or politically sensitive regions to further regional development or gain political support.

Manufacturing for export. Benefits from export-oriented assembly plants include primarily jobs and foreign exchange earnings. There may be some technology transfer, but it is relatively slight because most plants are labor-intensive, low technology operations. Host LDCs may want the plants to purchase inputs from local suppliers, but foreign companies often do not get the necessary quality and reliability from local producers. Governments may also hope for tax revenues, although they tend to bargain them away in the competition to attract desirable plants.

Services. Hotels are desirable investments for host LDCs because they bring in foreign exchange. Hotels increase the inflow of foreign tourists and business people if there are sufficient attractions and opportunities in the host country. Hotels are labor-intensive and create employment opportunities for low-skilled, entry-level workers. Benefits do not depend on who owns the hotels, but foreign participation helps significantly in marketing, management and technical support. Hotels bring in some new technology, but it is usually not highly proprietary in nature. They also create some managerial positions, but most jobs are menial.

Foreign banks can have a substantial demonstration effect on domestic competitors and thereby increase capital resources and efficiency of the host's financial markets. Benefits depends on how freely the host government allows foreign banks to compete with local banks, because LDCs often protect domestic banks against such competition. Foreign banks are likely to have strong links to international financial networks and capital sources that enhance the host's international financial flows. They create a few jobs and bring in a little new technology. In general, the benefits to host LDCs are less obvious and more dependent on government policies than other types of FDI.

Capital Investment

Extractive. Extractive installations usually require more capital and take longer to establish than other investments. They require high initial expenditures for locating new deposits, setting up processing facilities, building infrastructure, and establishing downstream processing plants and marketing networks. They have to go where mineral deposits are or where soil and climatic conditions are suitable for plantations, making them location dependent and vulnerable to political and economic risks.

Manufacturing for host market. The cost of establishing manufacturing plants depends on the capital intensity and the availability of suitable sites. Manufacturing investments are usually smaller in scale than extractive ones and, depending on the industry, may he located in less specialized buildings or even rented space. The set-up costs are generally less than for a mine or an oil field, and the timeframe is much shorter.

Manufacturing for export. The costs of setting up export assembly facilities are significantly lower and the timeframe shorter than for import-substituting plants, because they are less capital intensive, more likely to be in low-cost facilities or receive government support. It is easy to move machinery and equipment into or out of a host country, making plants "footloose." A major cost and time factor is the training of workers who have low industrial skills, are often illiterate and are accustomed to the rhythms of agricultural jobs.

Services. Local partners or lenders in many LDCs increasingly supply the capital required to establish hotels and banks, so foreign capital commitments are relatively modest. The costs and time required to set up service industries depend on the construction needed. Once a facility is built or remodeled, the biggest remaining expense is training employees. While not negligible, it is not as demanding as training engineers or technicians for jobs in extractive or manufacturing plants.

Balance-of-Payments

Extractive. Foreign extractive companies are not concerned about weaknesses in a host's currency or balance-of-payments position because their returns are raw or semi- processed materials. They almost always produce a net foreign-exchange inflow for the host country, which helps reduce any balance-of payments deficit and strengthen the currency.

Manufacturing for host market. The demands of import-substituting plants on a host's currency reserves include financing machinery and equipment, importing raw materials and components, expatriate salaries, licensing technology and administrative fees plus dividend payments and capital repatriations. The majority of plants do not export enough to cover their foreign-exchange costs; hence, they are likely to aggravate a host's balance-of-payment deficit.