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1 Student First Name: Rima Student Second Name:Binsaeed Copyright subsists in all papers and content posted on this site. Further copying or distribution by any means without prior permission is prohibited, except for the purposes of non-commercial private study or research, as defined in the Copyright, Designs and Patents Act 1988, or as otherwise authorised by statute. To obtain permission, please contact the author of the relevant paper in the first instance or with details of your request. 1

2 The Effect of Government Policies on Foreign Direct Investment Inflows Abstract: Saudi Arabia considers attracting increased levels of foreign direct investment (FDI) one of its major economic goals for the near future. Acknowledging that, the competition for FDI is as intense as the country s need for it, Saudi Arabia has undertaken an ambitious reform program affecting all aspects of its investment environment policy, economic, and legal to enhanced FDI inflows to the country. Therefore, this research attempt to study and evaluate the new Saudi's government policies towards foreign direct investment and to what degree the new policies influenced the FDI inflows into Saudi Arabia in the recent years. These new policies including sectors privatization, law and regulations, trade agreements, tax invectives, removable of trade restrictions, easy of establishing a business, clustering (trade centers), and infrastructures level. Literature Review: With the growing integration of the world markets and increased competition amongst the host countries to attract FDI, the host country s economic fundamentals may not be sufficient for inward FDI. Therefore, it now becomes important to study afresh what determines inflow of FDI. In this regard, there is a need to focus on the role played by host government policies in attracting Inward FDI (Globerman and Shapiro 2001). Brewer (1993) discuses various types of government policies that can directly and indirectly affect FDI inflow through their effects on market imperfections. It is argued that same government policy can increase or decrease market imperfections and thereby increase or decrease FDI inflows. Moreover, Cohen (2007) urges that the action and non-action of host government are the most decisive factor with regard to 2

3 whether or not an investment environment in specific country attract or not attract FDI. Jones and Wrwn (2006) argue that host government policies toward foreign investment play critical role in the FDI inflow. However, Banga (2003) found that the empirical evidence on the affect of the government policies on FDI inflows is unclear. UNCTAD (1996) reports that incentives can have an effect on attracting FDI only at the margin, especially when one considers the type of incentive and the type of project. Nevertheless, some studies e.g., Contractor (1991) finds that policy changes have a weak influence on FDI inflows. Caves (1996) concludes that incentives are generally ineffective once the role of fundamental determinants of FDI is taken into account. This view is also supported by Hoekman and Saggi (2000) who believe that incentives offered by the host government may attract some types of FDI, but it will not be an important factor when generalized to other types of FDI. Furthermore, Blomstrom and Kokko (2002) have discussed whether FDI incentives are justified for the host economies given the fact that this entails a transfer of resources from host countries to foreign firms. Objectives: There has been a an increase in competition amongst the developing countries to attract FDI, resulting in higher investment incentives offered by the host governments and removal of trade restrictions on operations of foreign firms in their countries. The question addressed by this study is: How effective are these selective government policies on attracting FDI inflows to Saudi Arabia? To answer this, the study will examines the impact of fiscal, financial and other incentives offered by the Saudi government in the recent years including sector privatization, law and regulations, trade agreements, tax invectives, removable of trade restrictions, easy of establishing 3

4 a business, clustering (trade centers), and infrastructures level to induce FDI inflows to Saudi Arabia. There is a startling gap between current thinking on the important affect of the government policies on attracting FDI inflow and the lack of recent empirical evidence on shifts in more other government policies that affect FDI inflow in a specific country. The main objective of this research is to narrow this gap by making use of comprehensive survey data and textual research. Therefore, we seek in this paper to empirically examine the affect of government policies on attracting FDI inflows in Saudi Arabia after controlling for the effect of economic fundamentals of Saudi Arabia. Research Questions and Hypothesis: This research attempts to answer the following main question: Q: What are the affect of the government policies on FDI inflows in Saudi Arabia? The purpose of the research is to explore what are the affect of the Saudi government new investment policies on FDI inflow in Saudi Arabia. According to this, the following main hypothesis will be tested: Hypothesis 0: There is a positive relationship between the government policies for foreign direct investment and the FDI inflows in the Saudi Arabia. The main hypothesis divided to sup hypothesis as follow: Hypothesis 1: There is positive relationship between the privatization policy and FDI inflows in Saudi Arabia. Hypothesis 2: There is positive relationship between law and regulations and FDI inflows in Saudi Arabia. Hypothesis 3: There is positive relationship between trade agreements and FDI inflows in the Saudi Arabia. 4

5 Hypothesis 4: There is positive relationship between tax incentives and FDI inflows in Saudi Arabia. Hypothesis 5: There is positive relationship between removable of trade restrictions and FDI inflows in the Saudi Arabia. Hypothesis 6: There is positive relationship between easy of establishing a business and FDI inflows in Saudi Arabia. Hypothesis 7: There is positive relationship between clustering (trade centers) and FDI inflows in the Saudi Arabia. Hypothesis 8: There is positive relationship between infrastructures level and FDI inflows in the Saudi Arabia. Research Methodology: Following Banga, R. (2003), we adopt Dunning s eclectic paradigm as framework that emphasises the location advantages in terms of economic conditions or fundamentals of the host countries relative to other countries as determinants of crosscountry pattern of FDI. We will use a compensation of a survey to test the hypotheses. Surveys present advantages when collecting data that were suitable for this study. It allows a high level of standardisation that simplifies the data analysis and the comparison. Structured interviewed helps avoiding different interpretations and misunderstandings of the questions, which is of great importance since surveys offer no possibilities to explain the questions further to the respondent (Bryman and Bell, 2007). However, to avoid missing information that is not cover by the survey but still might be relevant to the study, a primary data such as a national statistic and economic indicators will be used and gathered from Saudi General Investment Authority (SAGIA) and other official sources to compare the survey result with data provided. 5

6 The data for this research will be gathering using a questionnaire, from companies operating in Saudi Arabia with a foreign equity. The purpose of the study was as mentioned, to identify the affect of government policies on FDI inflow in Saudi Arabia. The data for the foreign firms will be gathering through SAGIA. According to SAGIA, there are 1389 FDI licenses approved for foreign firms by The 1389 FDI licenses identified as the population for this research. We will choose 300 foreign investors who could potentially participate in the survey. We are targeting senior managers including presidents, CEOs, and vice president who engaged on the process of choosing Saudi Arabia as the market for their operations. We anticipate around 70% will be responded and participated in the survey. To analysis the data, Statistic Package for Social Science (SPSS) will be used. References: Banga, R. (2003). Impact of Government Policies and Investment Agreements on FDI Inflows. New Delhi: Indian Council for Research on International Economic Relations Working Paper No. 116, November Blomström, M. and A. Kokko (2002). The Economics of Foreign Direct Investment Incentives, Working Paper 9489, NBER Working Paper Series. Brewer, T. (1993). Government Policies, Market Imperfections and Foreign Direct investment, Journal of International Business Studies, 24,1 First Quarter, Bryman, A., and Bell, E. (2007). Business research methods. Second edition, Oxford University Press, New York. Caves, R. E. (1996). Multinational Enterprise and Economic Analysis, Second Edition, Cambridge: Cambridge University Press. Cohen, S. (2007). Multinational corporations and foreign direct investment: avoiding 6

7 simplicity, embracing complexity. New York: Oxford University Press. Contractor, F. (1991) Government policies toward foreign investment: an empirical investigation of the link between national policies and FDI flows, Paper presented at Annual Meeting of the Academy of International Business, Miami, FL. Hoekman, B., and Saggi, K. (2000) Assessing the Case for Extending WTO Disciplines on Investment Related Policies, World Bank Working Paper, Washington, D.C. Jones, J. and Wren, C. (2006). Foreign Direct Investment and the Regional Economy, Aldershot: Ashgate. Shapiro, D. and S. Globerman (2001). National Infrastructure and Foreign Direct Investment, Mimeo, Simon Fraser University. 7