Description
There has been and still is controversy about the social impact of multinationals in the extractive industries, particularly when operating in developing countries. Whilst developing countries are increasingly seeing Foreign Direct Investment (FDI) as a means for development, serious questions are being raised regarding the social outcomes. Much attention in this respect has focused on the extractive industries.
1
Summary of emerging lessons
• Existing empirical evidence suggests that Foreign Direct Investment (FDI) brings both costs and benefits for a country.
The balance of costs and benefits can differ according to the geographical level of analysis. In some cases the costs are
so unacceptable that a cost-benefit analysis seems inappropriate.
• The interaction between FDI and development is a process associated with market failures, which call for intervention to
set a framework in which to manage the process of FDI and development.
• FDI in the extractive industries is characterised by the long-term and sunk nature of investments, the importance in total
FDI for some countries and the risks it can place on health and safety and the environment.
• In theory, a tri-sector partnership model of social management can improve the developmental impact of FDI and help
maintain certain social standards.
• However, there are challenges ahead. In particular, more empirical evidence is needed to assess whether partnerships
make a real difference for social and economic development in practice.
Dirk Willem te Velde
Overseas Development Institute
Tri- Sector Partnerships to Manage Social Issues in
the Extractive Industries: Application of Theories of
Foreign Direct Investment and Development
May 2001
This paper aims to provide some theoretical foundation to the emerging concept of tri-
sector partnerships for social management in the extractive industries. It considers the
partnership model in the context of the costs and benefits of Foreign Direct Investment. It
discusses whether a partnership can address market failures related to information needs
in the market for skills and technology, and whether it can safeguard acceptable social
outcomes.
Why is the Developmental Impact of Multinationals in the
Extractive Industries an Issue?
There has been and still is controversy about the social impact of multinationals in the
extractive industries, particularly when operating in developing countries. Whilst
developing countries are increasingly seeing Foreign Direct Investment (FDI) as a means
for development, serious questions are being raised regarding the social outcomes. Much
attention in this respect has focused on the extractive industries. Concerns range from
violations of pollution, health and safety regulations, to minimum wage requirements and
rising community tensions caused by inequalities in the distribution of local benefits.
2
In order to benefit from FDI, governments have increasingly liberalised their FDI regime
over the past decades. It has become clear that the benefits from FDI to the country are not
automatic and that desirable social outcomes for local communities need to be
safeguarded. At the same time, multinationals increasingly appear to have an operational
(i.e. compliance and risk management) as well as reputational interest in improving social
outcomes and developing local capabilities. The question is whether and how the different
parties – company, government and civil society – can manage FDI in order that the social
benefit of multinationals can be realised for local communities and the host country as a
whole.
Foreign Direct Investment and its Impact on Development
There is reasonable agreement that affiliates of foreign multinationals are different from
domestic firms. Countries strive to attract foreign multinationals believing that these
corporations possess desirable assets that can help to achieve certain developmental
objectives. However, multinationals may also have negative effects. Table 1 provides an
overview of some of the positive and negative effects of FDI on the development of host
countries.
The impact of FDI on development is not static, it is a dynamic process with an important
role for host country policies to provide an enabling environment. For instance, there are
market failures related to poor information in the market for skills and technologies, and
problems caused by the absence of complete markets for the environment. The
(development of) demand and supply of skills and technology may not always match, and
the absence of markets for pollution leads to a failure to internalise costs related to
pollution. Such market failures call for policy interventions to set a framework in which to
manage the process of FDI and its effects on the development of the host country.
There are two further aspects frequently overlooked in the process of assessing the impact
of FDI on development – both relating to the cost-benefit analysis that assesses the impact
of FDI (see box 1). First, a cost-benefit analysis of an FDI project is likely to lead to
different assessments depending on the target group, e.g. national economies versus local
communities. What may be efficient and effective at the national level may not be so at the
community level. For instance, at the macro level, if tax revenues are not channelled
directly or indirectly to communities in the regions where the investment takes place, a
cost-benefit analysis undertaken at the national level is unlikely to show up such
inequalities at the local community level. Similarly, at the micro level, a local ‘social
investment’ programme undertaken by a particular business operation can be ‘selective’
and may benefit certain local communities only, despite negative effects of the operations
being visible in neighbouring communities.
The compensation of the losers by winners associated with an FDI project is therefore an
important consideration. Different FDI projects may or may not be approved, and with
different conditions, depending on whose interests drive cost-benefit analysis.
Another case where a cost-benefit analysis of FDI may be problematic is where an
investment imposes unacceptable consequences for health, safety or environmental
outcomes. Such outcomes cannot be expressed in monetary terms or be used in a cost-
benefit analysis at either community or national level. Although modern valuation
techniques exist, there is a case to impose certain minimum safety or health standards.
Box 1: Assessing the impact
of FDI
Because FDI is associated with
direct and indirect costs and
benefits, a simple quantitative
measure (FDI flows, direct
employment, etc.) is not
sufficient as a means of
assessing the impact of FDI on
development. Three
alternatives exist. First, there
are detailed econometric
studies assessing one aspect of
the investment, e.g.
productivity spillover effects.
Second, there are cost-benefit
analyses, valuing the costs and
benefits of all aspects. Finally,
there are qualitative accounts
comparing outcomes in similar
situations but with alternative
policies in place. While the
first two approaches are
criticised for not being able to
construct a ‘strategic
counterfactual’, the qualitative
approach cannot address cause
and effect satisfactorily.
Outcomes of all approaches
further depend on the time
framework of analysis.
3
Table 1. Foreign Di rect Investment and host-country development
Effects on Development
Possible role of a tri-sector
partnership model of social
management in the
extractive industries
Positive effects Negative effects
1. Employment and
Income
Provides employment and
incomes directly.
May indirectly crowd-out other
employment by replacing
existing employment or
pushing up factor prices.
Limited direct role, but
indirectly to raise employment
through improved local
linkages (see point 4).
2. Capital Stable source of external
finance, improving the balance
of payments, and potentially
raising fixed capital formation.
May pre-empt investment and
opportunities of domestic
firms.
Successful partnerships may
facilitate further FDI inflows
through better image amongst
investors, potentially resulting
in lower risk mark-ups.
3. Market access Firms can gain access to export
markets by using global
networks of multinationals.
Multinationals can maintain
tight controls of export
channels.
Limited direct role.
4. Structure of
factor and product
markets
Entry by foreign firm may lead to
more competition.
The entry of foreign firms can
lead to further concentration
and market power.
Limited direct role.
5. Technology, skills and
management
techniques
Provides up to date techniques,
skilled personnel and advanced
management techniques
Positive spillover effects on
domestic firms through backward
and forward linkages,
demonstration effects and
human resource development.
Spillovers are not automatic or
free. Reliance on foreign
technology and skills may
inhibit development of local
capabilities. Increased
linkages raise dependency of
domestic firms on
multinationals.
Improves capacity to absorb
positive spillovers and enhance
linkages with multinationals,
indirectly creating employment
and productivity.
6. Fiscal revenues Multinationals can raise fiscal
revenues for the domestic
government through the
payment of taxes in case of new
economic activities with more
value added.
If multinationals crowd-out
domestic firms, fiscal revenues
may actually be lower through
the use of special tax
concessions, eventually
leading to an erosion of the tax
base. Special tax concessions
are an implicit subsidy and in
case of lack of transparency
can lead to rent-seeking
behaviour.
In the medium to long term,
may improve the transparency
and distribution of fiscal
revenues and spending.
7. Political, social and
cultural issues
Foreign firms can expose host
country to other norms and
values, e.g. environmental
management, ethics.
Foreign firms may lead to
political, social and cultural
problems, by imposing
unacceptable values (labour
and environmental standards)
interfering with political regime,
and are said to exacerbate
existing problems of
corruption.
Improves the local relevance
and acceptability of
environmental and social
standards and ethics.
Foreign Direct Investment and in the Extractive Industries
There are several reasons why FDI projects in the extractive industries play a different
role in the development of developing countries than FDI in other industries.
First, while the stock of FDI (the outward investment stock of major developed countries
in 1997) in the mining, quarrying and petroleum industries amounted to only 8.7 per cent
of total FDI, this percentage is entirely different taken from the perspective of many
developing countries. For instance, nearly 83 per cent of the stock of U.S. FDI in Nigeria
was located in the petroleum industry in 1999, 70 per cent in Indonesia, 32 per cent in
India, 30 per cent in Venezuela and 24 per cent in Colombia.
Second, rates of return on FDI appear highest in the primary industries. The rate of return
on U.S. FDI abroad in 1996 was 37 per cent in the primary sector in Africa (excluding
South Africa), which is double the rate of return on U.S. FDI in other industries in Africa.
In addition, home countries of FDI repatriate a substantial part of such profits on FDI in
Africa. For instance, 75 cents for every dollar invested in Africa was repatriated
compared to 37 cents on average for all countries.
4
Third, projects in the extractive industries often require large lump-sum investments,
which are sunk for a long period and hence such investments are relatively more
vulnerable to political and social risks. The increased risk requires high rates of returns
and implies the use of a high risk-premium.
Fourth, the negative social and environmental effects of extractive industries tend to
emerge first at the site of investment. Projects tend to be pollution intensive, take place in
the context of complex social issues (such as land ownership and a dependency by local
communities on the natural environment) and often in regions where local government is
weak.
Finally, tax revenues are usually collected by national, rather than local, governments,
with local authorities dependent on transfers from the national treasury. Hence, the
problems of the winners of FDI (in this case the national level) compensating the losers
(the local level) are often accentuated in the extractive industries.
A Tri-Sector Partnership Model of Social Management
In general, partnerships are characterised by the co-ordination and co-operation between
parties in order to deliver certain objectives with each other’s consent. Parties involved in
tri-sector partnership arrangements to manage social issues in the extractive industries
include the government (local authorities, central government departments and/or the
industry regulators), civil society organisations (NGOs, community groups and SMEs)
and the corporate business. Depending on the way in which the partnership is structured,
each partner will have both formal and informal roles to play, and carry different
expectations and obligations, see e.g. Business Partners for Development (BPD) Working
Paper 5 and box 2.
Company managers opting to negotiate a tri-sector partnership arrange to manage the
complex social issues relating to FDI in the extractive industries appears to be a relatively
innovative management technique. The use of the partnership model is, in part, a
response to the need of companies to operationalise their corporate social responsibilities
at reasonable and sustainable cost.
There are several reasons why a company might prefer a partnership model, rather than
deliver local social investment programmes on its own. First, the existence of high
transaction costs associated with investments could favour a partnership. Such
transaction costs may relate to the need to obtain construction and other permits and
finding workers with suitable skills and local knowledge to implement the investment.
Second, a business is usually not specialised in making social investments (constructing
roads, health centres, etc.) and hence building on each other’s specialisation can lead to
more efficient use of resources. Third, long-term co-ordination of supply and demand for
social investment programmes at the local level between government and business and
civil society can ensure a more effective use of resources to bring social development.
Finally, the partnership model – particularly a ‘tri-sector’ model - can also reduce
volatility in the relations between parties, leading to improved risk management.
In practice, there may also be additional costs. The costs include the additional resources
needed to engage in a partnership as such. Further, a business may not want to loose full
control over the investment. Empirical evidence comparing direct and indirect costs and
benefits of implementation of investments through partnerships is scarce, and is very
difficult to obtain. The problem is that unless there is a natural experiment, there is often
no detailed information on the counterfactual: what would have happened in the absence
of a partnership. Some encouraging evidence on specific projects is beginning to emerge,
see BPD working paper 10.
Box 2: Partnerships
There has been an increasing
interest in partnerships over
the past decade, and the
experience gained also has
certain implications in several
areas for tri-sector
partnerships. In particular,
there are various forms of
partnerships that can be
‘chosen’ varying from
interactive participation,
participation for material
incentives or by consultation
to passive and manipulative
participation. Secondly,
mutual accountability is
important, but is not always
easy for all parties. Finally, the
development of a partnership
grows as trust between parties
evolves. Repeatedly successful
partnerships can formthe basis
of practical steps towards an
ideal situation of complete
‘trust’ and full information on
all sides.
5
Using Tri-Sector Partnerships to Enhance the Developmental
Impact of Foreign Direct Investment in the Extractive
Industries
Table 1 outlines ways in which the tri-sector partnership model of social management
might overcome some of the market failures associated with the interaction between FDI
and development as well as some of the negative social and environmental consequences.
With the retreat of an effective voice of local communities to shape FDI through
democratic government, a tri-sector partnership model may offer a way to fill this gap
and safeguard acceptable social outcomes. Examples are given below.
Employment and income. Foreign investors may create employment by extracting
previously unexploited natural resources or may take over existing domestic firms and
not create employment directly. Partnerships are not expected to play a direct role in this.
However, indirectly they may raise local employment by familiarising (foreign) firms
with the presence and quality of local skills and suppliers. For instance, in the Sarshatali
Coal Mining Project in West Bengal, a BPD project in India, local procurement through a
partnership reduced the costs of livelihood assessments and avoided the need for external
consultants. Sometimes linkage programmes deal with such information related market
failures (see box 3).
Capital. Successful partnerships at local level may help to improve further FDI inflows
or domestic investment into previously unexploited natural resources or into other
industries by improving the image of the region or country. The resulting decrease in the
risk mark-up is expected to play a minor role amongst other determinants of investment,
e.g. the presence of mineral resources in the extractive industries.
Market access and market structure. Partnerships are not expected to play a major role in
facilitating market access and structure. However, partnerships that include industry
regulators could be used to minimise restrictive business practices and anti-competitive
behaviour more effectively.
Technology, skills and management techniques. Social investments in local health (e.g.
the local health centre in Las Cristinas gold mine, a BPD project in Venezuela), skills and
infrastructure improve the capacity to absorb positive spillovers from and enhance
linkages with businesses. The concept of absorptive capacity plays an important and
positive role in the theory of FDI and development (see box 4).
At the same time, businesses also have an incentive to make social investments through
partnerships over and above the developmental needs of the local people. Such
investments will improve local skills, motivation and health of the local workforce, and
thus create more efficient labour inputs and higher quality local suppliers on which
businesses become increasingly dependent. Efficient labour inputs and the availability of
quality local suppliers improve business efficiency, while the consent of the local
communities provides a ‘social license to operate’.
Social investments that improve local skills and infrastructure play a dual role. They act
as ‘determinants’ of FDI by improving business efficiency, and also affect the effects of
FDI on development by influencing the quantity and quality of linkages and spillovers
between local and foreign firms.
Fiscal revenues
A tri-sector partnership may lead to enhanced transparency in the distribution of tax
revenues in the medium to long-run. This ensures that local communities, neighbouring
and other communities benefit to the same degree thereby taking into account pre-
investment conditions of communities.
Political, social and cultural issues. Through tri-sector partnership arrangements, civil
society is empowered to deal more directly with local concerns on social outcomes of
(foreign) investment. The partnership opens new avenues of communication with
government, enabling the representatives of communities to press for a regulatory
Box 3: Linkage programmes
In some countries investment
promotion agencies set-up by
the government intervene in
the market by enhancing
linkages between local firms
and foreign firms. Such
linkage programmes
(sometimes sponsored by
foreign investors) involve
training schemes to enhance
the quality of local suppliers as
well as ‘awareness’
programmes making foreign
firms aware of the potential of
local firms in procurement.
Linkage programmes aimto
reduce the so-called ‘import-
bias’ that foreign firms procure
goods and services abroad
because of information gaps,
even though local supplies
with the same quality and
lower costs may be available.
Box 4: Absorptive capacity
FDI does not automatically
lead to country or community
development. What has
become clear is that a certain
minimumlevel of absorptive
capacity is needed to capture
spillover effects (e.g. new
technology or new
management techniques) from
FDI. The absorptive capacity
can be shaped by different
actors and depends on the
presence of a skilled local
workforce, technological
competencies of local firms
and physical and
telecommunications
infrastructure. For instance,
local training programmes
enhance the quality of the
local labour force, benefitting
the foreign investor as well as
improving the capacity of local
firms to absorb positive
spillovers.
6
framework to be set by government to ensure that social benefits are realised in the
region of operations and/or that the social provisions provided by the company for its
staff are also channelled to the local population e.g. provision of education, health care,
infrastructure. The partnership approach in the Sarshatali Coal Mining Project appears to
have increased the relevance of social investment to the needs of local communities.
The above virtuous circle of FDI and development (enhanced development, improved
business performance, and further FDI inflows) is brought about by co-operation of all
sides, not by confrontation. Confrontation leads to social and political unrest, which may
damage the reputation and hence the value of a company’s intangible assets, reduce the
development of local capabilities and indirectly hamper any attempt by government to
attract further FDI inflows. Partnerships in various forms can facilitate the co-operation
and development of trust between the different parties. Perhaps there are lessons to be
learned from the many experiences of improved labour relations through social partners
representing employees, employers and government. Such evidence is usually not
quantitative, but anecdotal and qualitative.
Concluding, tri-sector partnerships can play a role in managing the developmental impact
of FDI by addressing certain market failures that characterise the interaction between FDI
and economic and social developments of host-countries and safeguarding acceptable
social outcomes. In particular, tri-sector partnerships appear to raise employment
indirectly, improve the capacity to absorb technological or other spillovers, enhance the
transparency of fiscal revenues, and deal more directly with local concerns on social
outcomes (see table 1). While initial evidence is beginning to emerge, we need further
evidence to determine the importance of the role of partnerships in enhancing the
developmental impact of FDI.
Future challenges
• Tri-sector partnerships can improve the social and economic effects of FDI.
However, not much work has been done to incorporate tri-sector partnerships into
the theory of FDI and development. We also need more empirical evidence to assess
whether partnerships make a real difference for social and economic development in
practice. Encouraging evidence is beginning to emerge from BPD (see the Working
Papers series).
• This paper generalised on the roles and drivers of partnerships. However, it is
possible that roles and drivers of partnerships differ by partner, by FDI project and
over time, and in the future it may necessary to account for this heterogeneity.
References
Business Partners for Development, various publications including working papers and
accounts of their projects, seehttp://www.bpd-naturalresources.org/
Lall, S. (2000), “FDI and development: research issues in the emerging context”, Policy
Discussion Paper, 20, Centre for International Economic Studies, University of Adelaide.
Maxwell, S. and T. Conway (2000), “Perspectives on Partnership”, OED Working Paper
Series, No. 6, World Bank.
Moran, T.H. (1998), Foreign Direct Investment and Development, Institute for
International Economics, Washington, DC.
UNCTAD (1999), World Investment Report. Foreign Direct Investment and the
Challenge of Development, UNCTAD, Geneva.
Author: The author is a Research Fellow at the International Economic Development Group at the Overseas Development Institute
Acknowledgements: I am grateful to Simon Maxwell (ODI) and Sheila Page (ODI) for helpful comments. This paper was written for
BPD/Care and Michael Warner (BPD) provided helpful comments and suggestions.
7
doc_202513445.pdf
There has been and still is controversy about the social impact of multinationals in the extractive industries, particularly when operating in developing countries. Whilst developing countries are increasingly seeing Foreign Direct Investment (FDI) as a means for development, serious questions are being raised regarding the social outcomes. Much attention in this respect has focused on the extractive industries.
1
Summary of emerging lessons
• Existing empirical evidence suggests that Foreign Direct Investment (FDI) brings both costs and benefits for a country.
The balance of costs and benefits can differ according to the geographical level of analysis. In some cases the costs are
so unacceptable that a cost-benefit analysis seems inappropriate.
• The interaction between FDI and development is a process associated with market failures, which call for intervention to
set a framework in which to manage the process of FDI and development.
• FDI in the extractive industries is characterised by the long-term and sunk nature of investments, the importance in total
FDI for some countries and the risks it can place on health and safety and the environment.
• In theory, a tri-sector partnership model of social management can improve the developmental impact of FDI and help
maintain certain social standards.
• However, there are challenges ahead. In particular, more empirical evidence is needed to assess whether partnerships
make a real difference for social and economic development in practice.
Dirk Willem te Velde
Overseas Development Institute
Tri- Sector Partnerships to Manage Social Issues in
the Extractive Industries: Application of Theories of
Foreign Direct Investment and Development
May 2001
This paper aims to provide some theoretical foundation to the emerging concept of tri-
sector partnerships for social management in the extractive industries. It considers the
partnership model in the context of the costs and benefits of Foreign Direct Investment. It
discusses whether a partnership can address market failures related to information needs
in the market for skills and technology, and whether it can safeguard acceptable social
outcomes.
Why is the Developmental Impact of Multinationals in the
Extractive Industries an Issue?
There has been and still is controversy about the social impact of multinationals in the
extractive industries, particularly when operating in developing countries. Whilst
developing countries are increasingly seeing Foreign Direct Investment (FDI) as a means
for development, serious questions are being raised regarding the social outcomes. Much
attention in this respect has focused on the extractive industries. Concerns range from
violations of pollution, health and safety regulations, to minimum wage requirements and
rising community tensions caused by inequalities in the distribution of local benefits.
2
In order to benefit from FDI, governments have increasingly liberalised their FDI regime
over the past decades. It has become clear that the benefits from FDI to the country are not
automatic and that desirable social outcomes for local communities need to be
safeguarded. At the same time, multinationals increasingly appear to have an operational
(i.e. compliance and risk management) as well as reputational interest in improving social
outcomes and developing local capabilities. The question is whether and how the different
parties – company, government and civil society – can manage FDI in order that the social
benefit of multinationals can be realised for local communities and the host country as a
whole.
Foreign Direct Investment and its Impact on Development
There is reasonable agreement that affiliates of foreign multinationals are different from
domestic firms. Countries strive to attract foreign multinationals believing that these
corporations possess desirable assets that can help to achieve certain developmental
objectives. However, multinationals may also have negative effects. Table 1 provides an
overview of some of the positive and negative effects of FDI on the development of host
countries.
The impact of FDI on development is not static, it is a dynamic process with an important
role for host country policies to provide an enabling environment. For instance, there are
market failures related to poor information in the market for skills and technologies, and
problems caused by the absence of complete markets for the environment. The
(development of) demand and supply of skills and technology may not always match, and
the absence of markets for pollution leads to a failure to internalise costs related to
pollution. Such market failures call for policy interventions to set a framework in which to
manage the process of FDI and its effects on the development of the host country.
There are two further aspects frequently overlooked in the process of assessing the impact
of FDI on development – both relating to the cost-benefit analysis that assesses the impact
of FDI (see box 1). First, a cost-benefit analysis of an FDI project is likely to lead to
different assessments depending on the target group, e.g. national economies versus local
communities. What may be efficient and effective at the national level may not be so at the
community level. For instance, at the macro level, if tax revenues are not channelled
directly or indirectly to communities in the regions where the investment takes place, a
cost-benefit analysis undertaken at the national level is unlikely to show up such
inequalities at the local community level. Similarly, at the micro level, a local ‘social
investment’ programme undertaken by a particular business operation can be ‘selective’
and may benefit certain local communities only, despite negative effects of the operations
being visible in neighbouring communities.
The compensation of the losers by winners associated with an FDI project is therefore an
important consideration. Different FDI projects may or may not be approved, and with
different conditions, depending on whose interests drive cost-benefit analysis.
Another case where a cost-benefit analysis of FDI may be problematic is where an
investment imposes unacceptable consequences for health, safety or environmental
outcomes. Such outcomes cannot be expressed in monetary terms or be used in a cost-
benefit analysis at either community or national level. Although modern valuation
techniques exist, there is a case to impose certain minimum safety or health standards.
Box 1: Assessing the impact
of FDI
Because FDI is associated with
direct and indirect costs and
benefits, a simple quantitative
measure (FDI flows, direct
employment, etc.) is not
sufficient as a means of
assessing the impact of FDI on
development. Three
alternatives exist. First, there
are detailed econometric
studies assessing one aspect of
the investment, e.g.
productivity spillover effects.
Second, there are cost-benefit
analyses, valuing the costs and
benefits of all aspects. Finally,
there are qualitative accounts
comparing outcomes in similar
situations but with alternative
policies in place. While the
first two approaches are
criticised for not being able to
construct a ‘strategic
counterfactual’, the qualitative
approach cannot address cause
and effect satisfactorily.
Outcomes of all approaches
further depend on the time
framework of analysis.
3
Table 1. Foreign Di rect Investment and host-country development
Effects on Development
Possible role of a tri-sector
partnership model of social
management in the
extractive industries
Positive effects Negative effects
1. Employment and
Income
Provides employment and
incomes directly.
May indirectly crowd-out other
employment by replacing
existing employment or
pushing up factor prices.
Limited direct role, but
indirectly to raise employment
through improved local
linkages (see point 4).
2. Capital Stable source of external
finance, improving the balance
of payments, and potentially
raising fixed capital formation.
May pre-empt investment and
opportunities of domestic
firms.
Successful partnerships may
facilitate further FDI inflows
through better image amongst
investors, potentially resulting
in lower risk mark-ups.
3. Market access Firms can gain access to export
markets by using global
networks of multinationals.
Multinationals can maintain
tight controls of export
channels.
Limited direct role.
4. Structure of
factor and product
markets
Entry by foreign firm may lead to
more competition.
The entry of foreign firms can
lead to further concentration
and market power.
Limited direct role.
5. Technology, skills and
management
techniques
Provides up to date techniques,
skilled personnel and advanced
management techniques
Positive spillover effects on
domestic firms through backward
and forward linkages,
demonstration effects and
human resource development.
Spillovers are not automatic or
free. Reliance on foreign
technology and skills may
inhibit development of local
capabilities. Increased
linkages raise dependency of
domestic firms on
multinationals.
Improves capacity to absorb
positive spillovers and enhance
linkages with multinationals,
indirectly creating employment
and productivity.
6. Fiscal revenues Multinationals can raise fiscal
revenues for the domestic
government through the
payment of taxes in case of new
economic activities with more
value added.
If multinationals crowd-out
domestic firms, fiscal revenues
may actually be lower through
the use of special tax
concessions, eventually
leading to an erosion of the tax
base. Special tax concessions
are an implicit subsidy and in
case of lack of transparency
can lead to rent-seeking
behaviour.
In the medium to long term,
may improve the transparency
and distribution of fiscal
revenues and spending.
7. Political, social and
cultural issues
Foreign firms can expose host
country to other norms and
values, e.g. environmental
management, ethics.
Foreign firms may lead to
political, social and cultural
problems, by imposing
unacceptable values (labour
and environmental standards)
interfering with political regime,
and are said to exacerbate
existing problems of
corruption.
Improves the local relevance
and acceptability of
environmental and social
standards and ethics.
Foreign Direct Investment and in the Extractive Industries
There are several reasons why FDI projects in the extractive industries play a different
role in the development of developing countries than FDI in other industries.
First, while the stock of FDI (the outward investment stock of major developed countries
in 1997) in the mining, quarrying and petroleum industries amounted to only 8.7 per cent
of total FDI, this percentage is entirely different taken from the perspective of many
developing countries. For instance, nearly 83 per cent of the stock of U.S. FDI in Nigeria
was located in the petroleum industry in 1999, 70 per cent in Indonesia, 32 per cent in
India, 30 per cent in Venezuela and 24 per cent in Colombia.
Second, rates of return on FDI appear highest in the primary industries. The rate of return
on U.S. FDI abroad in 1996 was 37 per cent in the primary sector in Africa (excluding
South Africa), which is double the rate of return on U.S. FDI in other industries in Africa.
In addition, home countries of FDI repatriate a substantial part of such profits on FDI in
Africa. For instance, 75 cents for every dollar invested in Africa was repatriated
compared to 37 cents on average for all countries.
4
Third, projects in the extractive industries often require large lump-sum investments,
which are sunk for a long period and hence such investments are relatively more
vulnerable to political and social risks. The increased risk requires high rates of returns
and implies the use of a high risk-premium.
Fourth, the negative social and environmental effects of extractive industries tend to
emerge first at the site of investment. Projects tend to be pollution intensive, take place in
the context of complex social issues (such as land ownership and a dependency by local
communities on the natural environment) and often in regions where local government is
weak.
Finally, tax revenues are usually collected by national, rather than local, governments,
with local authorities dependent on transfers from the national treasury. Hence, the
problems of the winners of FDI (in this case the national level) compensating the losers
(the local level) are often accentuated in the extractive industries.
A Tri-Sector Partnership Model of Social Management
In general, partnerships are characterised by the co-ordination and co-operation between
parties in order to deliver certain objectives with each other’s consent. Parties involved in
tri-sector partnership arrangements to manage social issues in the extractive industries
include the government (local authorities, central government departments and/or the
industry regulators), civil society organisations (NGOs, community groups and SMEs)
and the corporate business. Depending on the way in which the partnership is structured,
each partner will have both formal and informal roles to play, and carry different
expectations and obligations, see e.g. Business Partners for Development (BPD) Working
Paper 5 and box 2.
Company managers opting to negotiate a tri-sector partnership arrange to manage the
complex social issues relating to FDI in the extractive industries appears to be a relatively
innovative management technique. The use of the partnership model is, in part, a
response to the need of companies to operationalise their corporate social responsibilities
at reasonable and sustainable cost.
There are several reasons why a company might prefer a partnership model, rather than
deliver local social investment programmes on its own. First, the existence of high
transaction costs associated with investments could favour a partnership. Such
transaction costs may relate to the need to obtain construction and other permits and
finding workers with suitable skills and local knowledge to implement the investment.
Second, a business is usually not specialised in making social investments (constructing
roads, health centres, etc.) and hence building on each other’s specialisation can lead to
more efficient use of resources. Third, long-term co-ordination of supply and demand for
social investment programmes at the local level between government and business and
civil society can ensure a more effective use of resources to bring social development.
Finally, the partnership model – particularly a ‘tri-sector’ model - can also reduce
volatility in the relations between parties, leading to improved risk management.
In practice, there may also be additional costs. The costs include the additional resources
needed to engage in a partnership as such. Further, a business may not want to loose full
control over the investment. Empirical evidence comparing direct and indirect costs and
benefits of implementation of investments through partnerships is scarce, and is very
difficult to obtain. The problem is that unless there is a natural experiment, there is often
no detailed information on the counterfactual: what would have happened in the absence
of a partnership. Some encouraging evidence on specific projects is beginning to emerge,
see BPD working paper 10.
Box 2: Partnerships
There has been an increasing
interest in partnerships over
the past decade, and the
experience gained also has
certain implications in several
areas for tri-sector
partnerships. In particular,
there are various forms of
partnerships that can be
‘chosen’ varying from
interactive participation,
participation for material
incentives or by consultation
to passive and manipulative
participation. Secondly,
mutual accountability is
important, but is not always
easy for all parties. Finally, the
development of a partnership
grows as trust between parties
evolves. Repeatedly successful
partnerships can formthe basis
of practical steps towards an
ideal situation of complete
‘trust’ and full information on
all sides.
5
Using Tri-Sector Partnerships to Enhance the Developmental
Impact of Foreign Direct Investment in the Extractive
Industries
Table 1 outlines ways in which the tri-sector partnership model of social management
might overcome some of the market failures associated with the interaction between FDI
and development as well as some of the negative social and environmental consequences.
With the retreat of an effective voice of local communities to shape FDI through
democratic government, a tri-sector partnership model may offer a way to fill this gap
and safeguard acceptable social outcomes. Examples are given below.
Employment and income. Foreign investors may create employment by extracting
previously unexploited natural resources or may take over existing domestic firms and
not create employment directly. Partnerships are not expected to play a direct role in this.
However, indirectly they may raise local employment by familiarising (foreign) firms
with the presence and quality of local skills and suppliers. For instance, in the Sarshatali
Coal Mining Project in West Bengal, a BPD project in India, local procurement through a
partnership reduced the costs of livelihood assessments and avoided the need for external
consultants. Sometimes linkage programmes deal with such information related market
failures (see box 3).
Capital. Successful partnerships at local level may help to improve further FDI inflows
or domestic investment into previously unexploited natural resources or into other
industries by improving the image of the region or country. The resulting decrease in the
risk mark-up is expected to play a minor role amongst other determinants of investment,
e.g. the presence of mineral resources in the extractive industries.
Market access and market structure. Partnerships are not expected to play a major role in
facilitating market access and structure. However, partnerships that include industry
regulators could be used to minimise restrictive business practices and anti-competitive
behaviour more effectively.
Technology, skills and management techniques. Social investments in local health (e.g.
the local health centre in Las Cristinas gold mine, a BPD project in Venezuela), skills and
infrastructure improve the capacity to absorb positive spillovers from and enhance
linkages with businesses. The concept of absorptive capacity plays an important and
positive role in the theory of FDI and development (see box 4).
At the same time, businesses also have an incentive to make social investments through
partnerships over and above the developmental needs of the local people. Such
investments will improve local skills, motivation and health of the local workforce, and
thus create more efficient labour inputs and higher quality local suppliers on which
businesses become increasingly dependent. Efficient labour inputs and the availability of
quality local suppliers improve business efficiency, while the consent of the local
communities provides a ‘social license to operate’.
Social investments that improve local skills and infrastructure play a dual role. They act
as ‘determinants’ of FDI by improving business efficiency, and also affect the effects of
FDI on development by influencing the quantity and quality of linkages and spillovers
between local and foreign firms.
Fiscal revenues
A tri-sector partnership may lead to enhanced transparency in the distribution of tax
revenues in the medium to long-run. This ensures that local communities, neighbouring
and other communities benefit to the same degree thereby taking into account pre-
investment conditions of communities.
Political, social and cultural issues. Through tri-sector partnership arrangements, civil
society is empowered to deal more directly with local concerns on social outcomes of
(foreign) investment. The partnership opens new avenues of communication with
government, enabling the representatives of communities to press for a regulatory
Box 3: Linkage programmes
In some countries investment
promotion agencies set-up by
the government intervene in
the market by enhancing
linkages between local firms
and foreign firms. Such
linkage programmes
(sometimes sponsored by
foreign investors) involve
training schemes to enhance
the quality of local suppliers as
well as ‘awareness’
programmes making foreign
firms aware of the potential of
local firms in procurement.
Linkage programmes aimto
reduce the so-called ‘import-
bias’ that foreign firms procure
goods and services abroad
because of information gaps,
even though local supplies
with the same quality and
lower costs may be available.
Box 4: Absorptive capacity
FDI does not automatically
lead to country or community
development. What has
become clear is that a certain
minimumlevel of absorptive
capacity is needed to capture
spillover effects (e.g. new
technology or new
management techniques) from
FDI. The absorptive capacity
can be shaped by different
actors and depends on the
presence of a skilled local
workforce, technological
competencies of local firms
and physical and
telecommunications
infrastructure. For instance,
local training programmes
enhance the quality of the
local labour force, benefitting
the foreign investor as well as
improving the capacity of local
firms to absorb positive
spillovers.
6
framework to be set by government to ensure that social benefits are realised in the
region of operations and/or that the social provisions provided by the company for its
staff are also channelled to the local population e.g. provision of education, health care,
infrastructure. The partnership approach in the Sarshatali Coal Mining Project appears to
have increased the relevance of social investment to the needs of local communities.
The above virtuous circle of FDI and development (enhanced development, improved
business performance, and further FDI inflows) is brought about by co-operation of all
sides, not by confrontation. Confrontation leads to social and political unrest, which may
damage the reputation and hence the value of a company’s intangible assets, reduce the
development of local capabilities and indirectly hamper any attempt by government to
attract further FDI inflows. Partnerships in various forms can facilitate the co-operation
and development of trust between the different parties. Perhaps there are lessons to be
learned from the many experiences of improved labour relations through social partners
representing employees, employers and government. Such evidence is usually not
quantitative, but anecdotal and qualitative.
Concluding, tri-sector partnerships can play a role in managing the developmental impact
of FDI by addressing certain market failures that characterise the interaction between FDI
and economic and social developments of host-countries and safeguarding acceptable
social outcomes. In particular, tri-sector partnerships appear to raise employment
indirectly, improve the capacity to absorb technological or other spillovers, enhance the
transparency of fiscal revenues, and deal more directly with local concerns on social
outcomes (see table 1). While initial evidence is beginning to emerge, we need further
evidence to determine the importance of the role of partnerships in enhancing the
developmental impact of FDI.
Future challenges
• Tri-sector partnerships can improve the social and economic effects of FDI.
However, not much work has been done to incorporate tri-sector partnerships into
the theory of FDI and development. We also need more empirical evidence to assess
whether partnerships make a real difference for social and economic development in
practice. Encouraging evidence is beginning to emerge from BPD (see the Working
Papers series).
• This paper generalised on the roles and drivers of partnerships. However, it is
possible that roles and drivers of partnerships differ by partner, by FDI project and
over time, and in the future it may necessary to account for this heterogeneity.
References
Business Partners for Development, various publications including working papers and
accounts of their projects, seehttp://www.bpd-naturalresources.org/
Lall, S. (2000), “FDI and development: research issues in the emerging context”, Policy
Discussion Paper, 20, Centre for International Economic Studies, University of Adelaide.
Maxwell, S. and T. Conway (2000), “Perspectives on Partnership”, OED Working Paper
Series, No. 6, World Bank.
Moran, T.H. (1998), Foreign Direct Investment and Development, Institute for
International Economics, Washington, DC.
UNCTAD (1999), World Investment Report. Foreign Direct Investment and the
Challenge of Development, UNCTAD, Geneva.
Author: The author is a Research Fellow at the International Economic Development Group at the Overseas Development Institute
Acknowledgements: I am grateful to Simon Maxwell (ODI) and Sheila Page (ODI) for helpful comments. This paper was written for
BPD/Care and Michael Warner (BPD) provided helpful comments and suggestions.
7
doc_202513445.pdf