Preferential agreements to lift tariff barriers for the world’s 50 least developed countries (LDCs) have been widely praised. But these and other market access opportunities have failed to produce the desired results. By themselves they are not enough if countries lack the capacity to produce goods and services as well as the infrastructure and technical know-how for exporting them. In addition, the "rules of origin" that oblige beneficiary countries to import the raw materials for their export products from the very countries offering them market access have further limited their ability to benefit. As one example, in 2001 only 42% of LDC imports by the "Quad countries" - Canada, Japan, the European Union and the United States — benefited from privileged market access.

Developing supply-side capacity

Creating or expanding productive capacity depends on investment and a business climate that will encourage more investment. National governments can make powerful contributions by investing in physical infrastructure - roads, ports, railways and transportation logistics - and in human capital - supporting basic education, specialized training and nutrition and health care services that develop a productive workforce. However, many developing countries, and especially the LDCs, lack the resources needed to invest in creating the human and physical resources that will make them into attractive platforms for production.

This is where foreign direct investment (FDI) has a role to play. It offers the potential to transfer knowledge, technology and management know-how, improve skills, boost entrepreneurship and stimulate learning by domestic enterprises through linkages with foreign firms. It can also help expand local production capacity and improve local competitiveness.

For a country to benefit from FDI in a meaningful fashion, however, a local business culture is needed that can absorb what it has to offer and put it to work for the host economy. This is precisely what happened in such East Asian "tigers" as Singapore, Malaysia, Taiwan and Thailand. They had the right national development strategies on board to create the conditions that attract external investment and boost the development of the private sector. Peace and political stability are also essential: transnational corporations (TNCs) increasingly demand a friendly business environment that includes protection of intellectual property rights and real property, transparent tax laws, a functioning judicial system, generous financial incentives and sound regulatory frameworks. Labour costs (wages plus benefit packages) must be competitive. A large domestic market (such as Brazil, China or India) or a regional trading group that creates a large local market is of interest to TNCs that sell to developing markets. Most of the LDCs, however, are small countries with even smaller markets. As a group, in 2002 they accounted for a paltry 0.8% of all FDI inflows.

But FDI is not a magic wand. Nor should it be seen as a substitute for domestic investment, which is the leading source of investment in developing nations: in recent years it amounted to more than triple the FDI total and double the amount of public investment, according to the World Bank. Furthermore, in the absence of appropriate policies, the negatives of FDI may outweigh the positives.

Among the possible negative effects: privatized state companies acquired by foreign firms can become de facto monopolies, squeezing local competition and charging exorbitant rates for such vital services as telecommunications. Secondly, local firms can be "crowded out" by more powerful foreign affiliates. Thirdly, overly attractive investment incentives have sometimes drained local resources so much that there is no net gain.

Countries that benefit the most from FDI are those where local enterprises learn from foreign affiliates and become competitive in the process. When TNCs use local small and medium-sized enterprises (SMEs) to provide intermediate goods to final manufacturers, this helps them improve standards and management processes. Over time, the build-up of expertise in dealing with TNCs enables these SMEs to export directly to the developed world, command better prices and become internationally successful in their own right.

New routes to competitiveness

New opportunities for expanding employment and increased efficiency and economic growth are spreading quickly to developing countries, information and communication technologies (ICT) being the most visible example. ICT improves competitiveness by reducing transaction costs, opening up broader markets and streamlining management. It does, of course, require a basic telecommunications infrastructure - power supply, phone lines, hardware and skilled personnel.

Another opportunity lies in outsourcing or offshoring, in which foreign firms create jobs in developing countries because they offer highly competitive labour -- wages can be at least eight times lower than in rich countries. Outsourcing generates jobs not only in relatively unskilled manufacturing jobs, but also now in the better-paid service jobs in the financial and information technology sectors. The value of jobs created in the developing world through offshore outsourcing was estimated to be worth $320 billion last year, and spending is expected to rise to $585 billion by next year, according to Goldman Sachs. The income this produces for developing countries stimulates local economies, and the transfer of technology upgrades professional skills and productivity. But only a limited number of developing countries have taken advantage of outsourcing, again because of inadequate infrastructure.

Outsourcing is slated for explosive growth: the volume of offshoring is expected to increase by 30-to-40% a year for the next five years, which could prove a windfall for developing countries, among others. And some 3.3 million white-collar jobs will move overseas from the United States by 2015, according to the May-June 2004 issue of Foreign Affairs, citing a variety of sources. By 2005, the journal says, one of every 10 information technology jobs will be outsourced overseas, and by 2009, 2 million financial-sector jobs will be offshored. For traditional IT-related services, according to an UNCTAD study prepared for UNCTAD XI, a projected 25% will be outsourced to developing countries by 2010.

But some believe the perceived threat posed by outsourcing to jobs in developed countries is exaggerated. The United States has outsourced perhaps as many as 200,000 jobs a year to India since 1994, but the US economy has posted net gains of 2 million jobs annually in the same period.