Importance of Foreign Direct Investment to Small Island States: The Case of Seychelles

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Importance of Foreign Direct Investment to Small Island States: The Case of Seychelles

Chapter 1 Introduction

Background of the Research

Small island states generally refer to the states with a geographic area of less than 1,000 square kilometres and a total population of less than one million people. These have common characteristics with implications on the role of foreign direct investment. First, small island states have narrow economic base because of the limited range of resources. As such, it is common for small island states to develop abundant resources making the economy revolve around only a limited number of economic sectors such as tourism or financial services. Second, these also develop strong economic dependence on larger economic to gain markets as well as obtain investments. Third, the production systems of small island states experience strong vulnerabilities to internal and external economic issues because there is a limit to their ability to take advantage of economies of scale and the strong dependence on other economies. Fourth, there are strong connections between the economic, socio-cultural, and politico-legal systems of small island states leading to a ripple effect of issues arising in one system. (Ghina, 2003) Due to these characteristics, small island states greatly depend on foreign direct investment to keep the economy afloat. However, there are also differences in the situations of small island states, with some states in a better position more than other states. Developing small island states experience greater problems in managing limited resources, in depending on other states, in managing vulnerabilities of economic sectors, and in developing effective economic and socio-political infrastructures. This means that the relative importance of foreign direct investment to small island states also depends on their particular contexts such as regional location, extent of resources, effectiveness and stability of economic structures, strength and reach of trade linkages, stability of the political system, and role of culture. As such, the study considers the importance of foreign direct investment in the context of Seychelles, a developing small island state near mainland Africa, to explore the role and impact of foreign direct investment on developing small island states.

Problem Statement

There is general recognition of the importance of foreign direct investments to small island states but small island states are differently endowed and with different historical developments and systems so that to understand the relationship fully, there is need to consider the significance of foreign direct investments based on the specific context of particular small island states.

Research Questions

To focus of the investigation is to address the following questions:

1. What are the strengths and vulnerabilities of small island states that determine the need for foreign direct investments?

2. How do small island states obtain foreign direct investments?

3. How does foreign direct investment affect small island states?

4. How important is foreign direct investment to small island states

Research Objectives

The following research objectives guide the research process:

1. To discuss the operation of foreign direct investment on economies

2. To determine the specific role of foreign direct investment on small island states

3. To explore the role of foreign direct investment on Seychelles

4. To draw conclusions and implications on the importance of foreign direct investment on small island states

Significance of the Study

The study intends to contribute in filling information gap on the importance of foreign direct investments to developing small island states by using the case study method to draw in-depth information on Seychelles. Although many studies confirm the important role of foreign direct investment to small island states, there are limited studies considering the nature, extent and dynamics of the role of foreign direct investments given the specific contexts of particular developing small island states. Of the studies considering one or more small island states, the focus is on small island states specializing in offshore financial services. The study seeks to focus on developing small island states not providing offshore financial services.

Organisation of Research

The study has five chapters reflecting the stages of the research process and supporting the readability of results. Chapter 1 introduces the study by providing the background or context of the study, research problem, research question, significance of the study, and organisation of the research. Chapter 2 contains the framework for the study by reviewing existing information on foreign direct investment, particularly the definition, dynamics of foreign direct investments in economies, role and impact of foreign direct investment in developing economies, and the role and impact of foreign direct investment on small island states. Chapter 3 discusses the approaches and methods is collecting and analysing data to address the research questions and achieve the objectives. Chapter 4 discusses the case of Seychelles, particularly its situation as a small island state contiguous to Africa, its engagement in foreign direct investment, and the importance of foreign direct investment to the economy. Chapter 5 provides a summary of the results, conclusions relative to the research questions and objectives, and recommendations for future research.

Chapter 2 Literature Review

Definition of Foreign Direct Investment

Foreign direct investment has a general and specific conceptualisation. Brooks, Fan & Sumulong, 2003) defined foreign direct investment as the flow of capital from one firm in one economy to another firm in another economy. This constitutes the general concept of foreign direct investment. OECD (2008) defined foreign direct investment as a form of investment made with the objective of creating a long-term interest by a direct investor or direct enterprise based in one economy to a direct investment enterprise based in another economy. Long-term interest implies significant control, but not necessarily controlling interest, gained by direct investors or direct enterprises. This constitutes the specific conceptualisation of foreign direct investment.

Dynamics of Foreign Direct Investments in the Global Economy

The enhanced role of foreign direct investment was because of the globalisation and regionalisation trends. Globalisation meant lowering of trade barriers of different economies making it easier for investments to flow across markets. With various ways of benefiting from involvement in other economies, the flow of capital from one economy to another intensified. Access to raw materials and resources, cost savings from lower labour and operating cost, and expansion to other markets are benefits for investors to engage in foreign investments. (Dunning, 1993) Regionalisation expressed through membership in trade organisations resulting to market integration also made foreign direct investment appealing as a means of involvement in other economies by establishing long-term interests with expectation of high returns on investment. (Brewer & Young, 1997) In addition, national governments lost control of the traditional means of promoting local competitiveness because of the lowering of trade barriers. Exchange rate policies used to influence competitiveness diminished in importance. Governments turned to foreign direct investment as means of improving economies. (Barros & Cabral, 2000; Blomstrom, Kokko & Zejan, 2000) Foreign direct investment reflects the perspective of investors as well as the perspective of recipient firms and economies.

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Role and Impact of Foreign Direct Investments on Developing Economies

Foreign direct investment could improve welfare in developing economies. First benefit of foreign direct investment is the increase in output and income of the host economy. The investment of capital to different economic sectors increases the levels of production resulting to growth and expansion of business. This creates employment opportunities that in turn translate into income for households. With household incomes, spending increases that supports revenue generation for businesses. This goes on in a growing cycle of growth. Second benefit of foreign direct investment on developing economies is technological transfer. ...

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