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Foreign Direct Investment: What Sort of Trade off?

Post-war history shows no poor country moving to the development "take-off"

stage on aid alone. This, together with the trend line that shows there will not

be much official development aid money around in the next decade puts a premium on

attracting capital. As prospects for public sector borrowing overseas are equally

dim-due to doubts about debt servicing capabilities-private foreign direct investment

(FDI) has become not only a sine qua non for all of the least developed countries

but its continuance has come to be taken as barometer of any government's track record.

As expected, competition for a slice of the world's stock of FDI has intensified.

Capital scarcity is driving more and more countries to draw up policies conducive

to winning the approval of the international investing community. While no one questions

the benefits, both direct and indirect of FDI, there is often too little thought

as to the implicit trade-off between the interests of government and FDI requirements.

At the moment Cambodia has an interim coalition government charged with defending

the interests of the state, pending the passage of a new constitution and the formation

of a government. As an aid to policy formation, this article will consider the key

questions of the implicit trade-off between the interests of government and the FDI

community. Where the country's long term good can be said to lie. It will also consider

Cambodia's investment sex appeal.

One assumption will underlie these observations. That the essential precondition

for attracting FDI-economic stability-will be realized. In other words, that appropriate

policy measures will be enacted through the IMF/World Bank Stabilization Program,

that appropriate policy measures will be enacted to correct Cambodia's severe macro-economic

imbalance. An imbalance made visible like the tip of an iceberg by three-digit inflation

and its source, the wide unfounded budget deficit.

Here, one obvious comment-the twin prongs, monetary and fiscal policy-of which the

latter is by far the key-cannot be expected to deliver the goods if external assistance

is just confined to urgent infrastructure rehabilitation. Quick-flowing budgetary

and balance of payments lifelines is the support most needed if unfavorable foreign

investor perceptions regarding the country's "terminal ward" category are

to be removed.

One last proviso-none of the major parties in the election formulated a clear economic

program-except for paying lip service to the continuance of a liberal market economy

and the need to improve public revenue. This calls for some crystal ball gazing.

Three things make this difficult. There has been practically no long-term FDI in

the country since pre-1970, nor attempts to find out and match what neighboring countries

similarly placed are doing. Finally, with Cambodia still in a statistical Stone Age,

much essential data is simply unavailable.

Nevertheless, enough is known to sketch the shape of the environment the two sides-Government

and FDI-will have to cohabit and the trouble spots to be avoided.

To be realistic, such a sketch must start by enumerating hard truths that determine

the Cambodian situation and investment climate irrespective of the achievement of

fiscal balance, or government in power. The logic of these parameters will then be

explored to see where they lead in terms of policy issues. This analysis should hopefully

shed light on policy objectives that will receive a "thumbs up" and those

a "thumbs down" from foreign direct investors.

To move to substance, there are three predominant hard facts determine any future


  1. First, the population constraint: any government wishing to retain power and

    avoid social unrest must ensure the economy grows at least as fast as population

    (on present trends, this means the economy must double in size within just 22 to

    25 years);

  2. Next, the size constraint: due to its small market size, low effective demand,

    poor natural resource-based potential (with the exception of natural gas), and limited

    surplus capital, Cambodia does not have the option of going it alone;

  3. Finally, its absorptive capacity constraint, an unavoidable factor for a decade

    at least: this catch-all phrase includes a series of critical features stemming from

    history-like a potentially explosive huge rural/urban imbalance, a near defunct infrastructure,

    chronic human skill-capital shortage, cultural preference (like the Greeks) for trading

    activities rather than building and working in factories, an understandable predilection

    for the immediate over the long term, and a dependency syndrome broken only once

    since colonial times.

Cumulatively, these features suggest vulnerability to exploitation, quick-fix

policies, plus a related need to hold outside world interests that will no longer

be guilt-driven by their neglect of the Pol Pot era.

Let me insert a sketch of the two main role players: government and foreign investors.

The difference in optic between government and FDI, though obvious, bears repeating.

The economic rationale for governance, both in terms of political and technical management,

stops at the macro-level. In Cambodia's case this means managing the successful completion

of the transition to a market economy with its essential back-stops: physical infrastructure

plus the stability that underpins a healthy private sector.

Regulatory aspects concern control of the money supply, a manipulative fiscal policy,

overseeing a supportive legal framework that business can rely on and, genuine protection

of the environment.

The micro-level, unless there is a clear case for official intervention to redress

failure or inefficiency, should be left to the markets' players. The great development

policy lesson of the 1970s and 1980s, that competitive markets determine production

and allocation of goods and services, not governments, is a lesson that Cambodia

can ill-afford to ignore.

The foreign direct investor (FDI), on the other hand, is in the business of "risk-based

capital management." Three types of risk can be distinguished: the choice of

market to be invested in (potential selling range, communications possibilities and

product quality); the ambient business environment (government stability, "red

tape", corruption and danger of nationalization); and financial risks (exposure

to interest rate changes, currency exchange prices and ease of profit/capital remittances).

Only when the "guesstimates" seem reasonable, profit-wise, will the FDI

bandwagon start to roll towards a particular location.

Although the difference between government and FDI is essentially between a "pro-active"

and a "re-active" agent, meeting the exigencies of the latter cannot be


The essential point, though, is how far should this go? Having broadly demarcated

the roles of the main protagonists, one can now extend the implications for policy

of the three afore-mentioned inescapable parameters.

1) Population growth was the first. Its iron logic for government policy

is contained in a simple equation: HW = R (r1 + r2) / p where HW = Human welfare,

however defined; R = resources of which r1 = domestic and r2 = foreign; while P =

In Cambodia, the only element in the equation we are relatively sure of is that population

growth is between 2.8 and 3.2 percent per anum. Hence the inescapable doubling time

of 22 to 25 years. If "R", in whatever combination of "r1" and

"r2", does not increase at least twice as fast, then social welfare (HW)-the

raison d'etre for development-will have to be revised downward for up to 18 million


Doing so will inevitably widen existing inequality because, whenever the majority

derive their livelihood from land, high population growth is more deleterious in

its effects than when land use has declined as a major factor of production.

Three principal policy conclusions emerge. The need for nation-wide family planning

with the main emphasis-despite a cultural prejudice-in raising the average age that

Khmer females give birth one of the quickest ways of beginning the vital slowdown

process. Secondly, as human capital is the only asset of the poor, raising its productivity

must have top priority. This is not a soft humanitarian option. All recent studies

on the lessons of the last two decades show that improving education and health is

the key to economic performance.

2) Economic size, the second major policy constraint, is equally compelling.

Although geographically located in the fastest growing area of the world, Cambodia

is a featherweight in economic terms. This suggests not only a real risk of unequal

trade relationships with little in the way of credible defense but an equally low

profile in the cut throat race to attract FDI.

Again, a policy solution suggests itself. The only way for Cambodia to enhance

its investment-location attractiveness is by becoming part of a regional free trade

area. Given its weaknesses and inability reap the benefits of economies of scale,

its ability to survive as a small viable country will be dependent on being part

of a larger economic hub, albeit with appropriate safeguards.

As previously argued (Phnom Penh Post, After the Polls, Quo Vadis Cambodia",

April 23-May 6), Cambodia, through a unique set of circumstances, can easily join

the GATT. The one and only international trade organization whose contractual basis

provides built-in devices for safeguarding the interests of the weak against the

strong. That apart, there are two other important considerations:

For a country with Cambodia's background, GATT membership, together with the surveillance

functions of its Secretariat, is like receiving a seal of approval. A type of guarantee

that there will be no backsliding with respect to market-oriented policies. In investment

terms it is akin to being given a recognized credit rating. Joining GATT can also

be seen as a soft, safe, start-off for Cambodia's re-integration in the world economy.

Also important, if Cambodia's need to become part of a larger economic grouping is

accepted, are GATT provisions relating to free trade areas and custom unions. Given

that all the principal countries of the region are parties to GATT, Cambodia would

not only enjoy a degree of "protection" but have access to multilateral

dispute settlement procedures when its national trade interest was in jeopardy; something

it would not have were it to stand alone.

Membership of ASEAN is a related issue. Currently, a study is underway to examine

the procedures for the formal entry into ASEAN of Cambodia, Laos and Vietnam, the

latter having already been granted "Observer"status. With ASEAN finally

deciding to move, within 15 years from 1993, to a full free trade area including

harmonized FDI incentives, Cambodia cannot afford to remain outside. As a principal

entry criteria is manifest commitment to market values, Cambodia's negotiating position

for acceptance would be more credible if it also had the force of GATT membership

behind it.

3/ Absorptive capacity was the final constraint mentioned. Here, only three items

will be touched on-rural/urban imbalance; infrastructures; and human skill shortage.

The other points flagged were cultural, more susceptible-if at all-to the "invisible"

rather than the "helping hand."

The rural/urban imbalance cannot be ignored. Urban riches and foreign domination

therein have long been a source of political tension is Cambodia's history. A feature

successfully exploited but with disastrous results by the Khmer Rouge.

Here, the central objective must be two-fold: first, cushion the poor (mainly women)

from the hardships that go with the initial adjustment; second, ensure that the predominantly

rural population share, as much as possible, in the fruits of growth.

Infrastructure, currently the major headache, needs to proceed on the basis of a

mix of FDI priorities which generate maximum social spin-off. Targets which will

provide high returns are thus power supply, road networks and irrigation (including

the outlet of the Tonle Sap lake), together with urban utilities and communications.

At the same time, to avoid worsening the imbalance, simple investments in drinking

water, feeder-roads and electricity are proven ways of improving the productively

of the rural poor. A forceful credit policy, both to farmers and to women capable

of creating cottage industries, would probably create an income generating dynamic

far outweighing the initial capital outlay.

A monumental constraint if Cambodia is to manage its own destiny is the lack of human

skills. With today's small elite and training's built-in time lag, two expedients

need to be considered. Strongly encourage the most productive members of Cambodia's

large emigre population to return. Make it attractive to overseas Khmers to invest

back home; for example, expatriate Vietnamese investors have recently been allowed

to pay 20 percent less tax than other investors while retaining the same privileges

granted to FDI. Finally if a predominantly young population is to believe in the

sacrifices necessitated by the shift to a full market economy, then the government

must insist that promotion will be based on merit and honesty.

Potential FDI investment sectors are different. There are basically four. Agriculture

(essentially rubber, marine fisheries and, possibly, palm oil; Petroleum (most probably

natural gas); Manufacturing and Tourism.

Only three (fisheries, natural gas and tourism), have both long term foreign exchange

earning potential, and the possibility of showing cash returns in the short run.

Manufacturing, from the view point of FDI, even if rehabilitated, is limited.

Cambodia has never managed to build up much of an industry base. The existing sector

is small, lopsided, with a few large state-owned enterprises awaiting privatization

and multiple micro industries of the cottage type; it is also badly neglected. Development,

if it is to take place, would better concentrate on exploiting those areas where

Cambodians have both skills and access to materials viz handicrafts, food processing,

livestock, aqua culture and, of course, trading.

Again there is an FDI contrast. Today's Asian "tigers", the principal investors

in the region have become highly cost conscious. Labor shortages, exchange rate movements

making exports less competitive, and a reduction in trade preferences, are responsible.

Their choice is stark: move up market or shift to another low cost location. In the

case of Cambodia, FDI interests are likely to focus on the short-term exploitation

of natural resources and, should Cambodia become part of a regional trade zone, may

consider the country as a low cost assembly center.

The latter observation contains the nub of government's difference from FDI. The

government's optic is long term; unless persuaded to the contrary, FDI perspective

is invariably short term. Due largely to the fact that, to balance the downside they

faced in the past, investors in developing countries now look for a large potential

upside in their investments.

Unless Cambodia becomes part of a recognized trading association and FDI investors

view it as a jumping off point for further penetration of the regional market, it

would be unrealistic to see a change either in short term investment attitudes or

in the country's current lack of "attraction".

Apart from thinking through the implications of this challenge, there are two areas

for the government to establish in the interim. On the mundane level, government

must ensure that today's low wage advantage is not off-set by factors contributing

to low productivity.

This means paying attention to: ease of getting supplies through customs; cutting

bureaucratic "red tape" in acquiring business contracts; a legal system

that investors can rely on; copyright protection, land ownership and acquisition,

a speedy arbitration panel and adequate legal representation; provisions for export

processing; clear cut definitions of differences between joint ventures, 100 per

cent foreign owned businesses, contractual business operations; and Build-Operate-and-Transfer

infrastructure projects.

Such considerations are essential if investors are to be really persuaded that, in

the "Cambodia after UNTAC," their potential returns will exceed their cost-risk

relative to other potential locations.

But wooing investors also needs to be contained within a policy frame safeguarding

Cambodia's national interest. Basically, these can be boiled down to two yardsticks.

Sustained development and protection of the environment.

The former is short hand for saying social and economic change and must not take

place at the expense of future generations. To put this into practice, the national

government needs a simple rule of thumb: no economic activities-whether local or

foreign inspired-should be allowed that do not pass the criteria of sustainability.

The last parameter should be the environment. A buzzword the world over and of considerable

importance to Cambodia. It not only implies preserving the best physical attributes

that still make up the country today, but preserving the particular cultural identity

of the Khmers.

In practice, Cambodia's most viable options appear to embrace three possibilities:

  • Joining a regional trade association on the condition of vetting all activities

    from the view-point of sustainability. The latter is essential, ending up as the

    region's sweatshop is not in the country's interest;

  • Vigorously promoting "eco-tourism," the one and only activity with

    the triple advantage of enabling the country to earn immediate foreign exchange,

    place a "green" value to its environment and provide rural Khmers with

    the wherewithal to continue to preserve a way of life that they apparently wish to


  • Finally, place maximum emphasis on developing Sihanoukville as an entrepot port

    to serve the Vietnamese hinterland and Laos which, if current explorations (copper,

    gold, oil) bear fruit, may resemble another Brunei with the same import demands.

Of all the major policy issues drawn from this unromantic analysis, there is little

any hard nosed FDI would disagree with. The only lack of "complement-arity"

is likely to come from really requiring FDI to respect "sustainability"

and the "environment." In the business world it is easy to pay lip service

to these concepts, it is another matter when FDI finds it has to respect fish harvest

quotas, engage in reforestation, pay clean-up costs, or post "environment bonds"

to ensure good ecological behavior.

The coming period will prove a test of Khmer character and decisiveness, of what

they want their country to be and look like for their children's children.

It will also be a test of management: how to balance the population-propelled need

for growth with the preservation of a strong national identity and way of life relatively

resistant to change.

The need to stimulate a healthy investment climate for FDI is unquestionable. What

should be questioned is its form. Cambodia's development must be based on well-implemented

strategies not simply on the transfer of its resources abroad.



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