The Growth Spiral

by Richard Eliot

Prospects for Investment

The decision to expand into overseas markets is often determined by the financial stability of a territory under consideration. A market in the course of development offers significant advantages to investors who view development prospects as an opportunity to ensure long term growth. Financial stability of these markets depends to a great extent upon the availability of investment capital and upon the commitment by investors to the success of their ventures.

Higher Returns

Investment projects in developing markets yield significantly higher returns than similar projects in developed economies. This is exemplified in newly industrialized markets where the benefits derived from investment in human and productive resources have yielded extraordinary economic growth.

There are two primary reasons for the high rate of return on investment in developing markets:

The latter phenomenon can be illustrated by an investment in a railway. A railway may have little incremental impact in a region with a well developed infrastructure, while the equivalent railway in a developing region generates a significantly greater increase in economic activity. Similar results are experienced in other industries. Projects with the highest likelihood of success are those which are compatible with the stage of economic development for the region under consideration.

An investment in a growth region should not be viewed in isolation. Many interrelated factors affect the successful introduction of products and services in these developing regions, Many of which are within the control of the investor. A physical infrastructure, including transportation and communication, can be created when value is added to the goods being produced.

Other factors, however, are beyond the control of the investor. These exogenous factors often relate to the economy at large, and those sectors which are dependent on external resources.

Exogenous Risks

External borrowing obligations of a developing market is one exogenous factor which affects the long term prospects of direct investment projects. The debt service on these obligations has wide ranging implications for all sectors of the developing economy.

Resources required to service the external liabilities of a developing market reduce the availability of local sources of investment capital. This leads to uncertainty towards the long term growth prospects for the market under consideration, and to an increased risk premium relating to a capital investment project.

Management of this risk is the key to success for a direct investment project. With financing for these programs originating from external sources, the developing economy must maintain an outward oriented export policy to meet its external obligations. A review of development projects conducted by the World Bank has shown that programs with the highest likelihood of success are those which improve infrastructure, invest in human resources and expand productive bases.

One measure of the ability of a developing market to meet its external borrowing obligations is the degree of participation and integration into the world economy. In order to maintain these sources of financing and to achieve terms sufficient for sustained growth, the growth in export earnings must exceed the growth in external borrowing obligations.

Export incentives are often implemented at the expense of local consumption and development, in order to meet external obligations. Yet the balance between local development and outward-oriented market policies must be sufficient to meet the present needs of the population, while preparing the market for continued expansion of production. This cycle of financing debt obligations with increases in export earnings is detrimental to long term domestic development, when current consumption continues to be met through the importation of goods and services.

Absorption Capacity

The ability of a local market to absorb investment in development programs remains a significant influence for direct investment decisions. A local market's absorption capacity for external investment is an indication of its ability to implement a long term growth pattern.

Investment absorption relates to the propensity of a local market to transform the introduction of new resources into measurable increases in economic activity. The effectiveness of each incremental increase in direct investment depends upon a myriad of interrelated economic, political, and social customs specific to the local market and its relationship to the world economy. While the fundamental approach to evaluating local markets is essentially consistent between markets, experience in one market is not always readily transferable to the next.

The interdependence of external financing and market development is evident through the interaction of all sectors of developing economies. Multilateral sources establish an effective means to control priorities, communicate information, and to coordinate development programs. Bilateral agreements are useful in establishing long-term trading patterns by emphasizing programs in the mutual interests of both participants. Commercial lenders provide the major source of funds for expanding productive bases, while private aid programs are generally dedicated to the development of human resources.

The continued participation of developing markets in the world economy is in the interests of all sources of development finance. To ensure expanded participation by these markets, all trading partners must facilitate their involvement. Facilitation of expanded involvement serves the interests of the world economy as a whole by increasing the economic activity of all participants. The scope of this expanded participation largely depends on the strengthening and expansion of established trading relationships.

Trading Partnership

One source of development finance which is receiving greater attention is the revenue generated by existing suppliers to developing markets. As established creditors of these markets, suppliers of raw material and manufactured products have a vested interest in the level of economic activity of their customers. They are familiar with the operating parameters of the given market and are in a good position to make informed investment decisions.

Imports for most developing markets often require a greater proportion of foreign exchange than the maintenance of their external liabilities. Additional borrowing to meet the demand for imported goods and services diminishes the ability of a developing market to strengthen and expand its productive base.

A supplier which reinvests the proceeds generated by its trade with developing markets contributes to their expanded involvement in international trade by reducing their external liabilities and contributing to sustainable economic growth.

A fundamental shift in commercial relations is necessary in order for a supplier to accept payment for goods sold to developing markets in the respective local currency, and then to reinvest these earnings the local economy.

Reinvestment of earnings in the purchasing market:

A coordinated effort among suppliers to a developing market to commit resources for the financial stability of their customer ensures these suppliers of continued access to their markets. A long term commitment through direct investment in permanent facilities also leads to greater attention to local market demands.

There are identifiable advantages to supporting the ability of a developing market to expand its participation in international trade. By increasing the availability of financial resources and by reversing the cycle of dependence on external support, the developing market achieves greater stability and independence.

All objectives of economic development are supported by this avenue of investment. It expands the productive base of the economy and leads to diversification within the commercial and industrial sectors. Diversification of production reduces the vulnerability of developing markets to adverse global trends. Direct investment in local production facilities also leads to the introduction of new processes and products which can then be exported to other markets. It enhances local expertise by involving the population in achieving their development objectives.

Effective Governance

Direct investment is by nature a long term commitment with responsibility for the success of the project resting with the investor. The perspective of evaluating performance relative to the economy in which an enterprise is doing business may not always comply with established norms of operations. Evaluating the performance of direct investment projects depends largely on the priorities of the individual investor.

By evaluating this performance relative to the incremental impact on the developing market, the success of a given project becomes readily apparent. Yet to compare an operation in a developing environment to one in another market may yield results not entirely favorable to the development effort.

The basis for effective management practices in developing markets is the ability to function in an environment where more attention is directed to fundamental issues. The transition from dependence on external resources to independence in the global marketplace is an enormous process involving every participant. A road map to economic development requires that there first be roads to travel. Where these roads lead ultimately depends on the direction provided through a commitment to global economic development.

Armed with the ability to understand an operating environment perceived to be both challenging and indispensable for continued growth, the decision maker can readily adapt to unfamiliar surroundings and achieve remarkable progress in attaining development objectives. The rewards for supporting a productive course in international trade and development are available to every leader who accepts the challenge.

Bibliography

World Development Report 1990
The International Bank for Reconstruction and Development
Oxford University Press
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