Small Scale Enterprises are Sustainable Foreign Direct Investments

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In this article Mazdak outlines the aspects which characterize SMEs as sustainable FD Investors and the relevance of SMEs as sustainable FDIs.

There has always been a deep discrepancy in the economic science and literature on the evaluation of foreign direct investment (FDI) for the development of the host countries. Many case studies from the second part of 20th century point out the reckless behavior of foreign investors and the economical and ecological damages caused to the society of the host country. Despite these negative aspects, the majority of the latest economic literature is in favor of FDI and is convinced of its positive effects on overall economic development. Apart from financial resources, foreign investors also provide new technologies and know-how, new jobs and other positive impulses for the economic growth of the country they emigrate to. Constantly assessing every economy by criteria such as market size, efficiency level or the existing natural resources, foreign investors are hunting for new destinations for their commercial activities.

Thus, there is extreme competition to attract FDI among developing and developed countries. Investment Promotion Agencies (IPA) and trade organizations are created to communicate the advantages of the host countries to the international FDI community. Trade and investment policies are liberalized and incentives are put in place in the battle to attract foreign investors. Surveys and economical reports from internationally renowned organizations such as the competiveness reports and rankings of World Economic Forum and IMD Institute of Lausanne or the Doing Business Report of The World Bank keep monitoring the economic framework of each country and their optimization efforts.

SMEs in the FDI world

A closer examination of the FDI theory and practice shows that they mainly reflect the behavior patterns and decision-making processes of Multinational Corporations (MNCs). The reason for this fact lays in the history of FDI, which has always been directly linked to cross-boarder activities of MNCs. European companies such as Virginia Company owned by King James I and East India Company were among the oldest corporations with international trade structures set up by FDI in the beginning of 17th century. Seeking natural resources, better trade infrastructure, cheap labor and effective entry into new markets, the MNCs were involved in many regions and different economic sectors. MNC activities included projects in railways, mining, tramways, water, gas, electricity, banking, insurance, finance, land plantations and agriculture. Although very complex and cost intensive, most of the FDI projects (predominantly in mining and manufacture sector) were extremely profitable for the MNCs, not least because of their strong influence in the host country. For the same reasons FDI remained predominantly a playground for MNCs for more than 2 centuries.

The counterparts of the MNCs are the Small and Medium Sized Enterprises (SMEs). In most countries SMEs are the beating heart of the domestic economy. They have the biggest share of employment and fuel innovation through research and developments and practical experience. In many cases SMEs are called “the hidden champions” dominating their economic sector even beyond the borders of their home countries.

Historically SMEs focused their commercial activities on the domestic and regional markets. Traditionally their international business is based on two pillars: a) exporting goods (mainly regionally) and b) serving MNCs of their country as suppliers, trusted partners and subcontractors. However, continuing globalization of the last 3 decades changed the local, regional and international business framework for the SMEs, specifically in the developed countries. The increasing relocation of their MNC clients to regions with cheap labor put them under enormous pressure to internationalize. The liberalization of global markets led to lower prices which strengthened their foreign competitors. Weak domestic markets made it inevitable for SMEs to reach out directly for lucrative projects in emerging markets. Despite their limited experience and financial abilities it was inevitable for them to internationalize their business to a much higher level and also become members of the FDI community.

Sustainable development: MNCs versus SMEs

While the vast majority of FDI research concentrates on inflow and outflow, motivation, attraction and the impact of FDI, little has been said about the differences between MNCs and SMEs as foreign direct investors. The Brundtland Commission Report’s definition of sustainable development as “development which meets the needs of the present without compromising the ability of the future generations to meet their own needs” offers a suitable scale for assessment of both groups. Their behavior in the host country can be examined with respect to the three dimensions of sustainability: economical, ecological and social. Evidently, a thorough scientific research on this topic would go beyond the frame of this article. However, a few examples and experiences from the FDI daily business are enough to explain an existing difference in this field.

Having strong political influence, an active international network, vast financial and human resources, MNCs have the power to optimize their benefits in all three dimensions. Economically they secure their know-how, occupy key positions in their foreign ventures and partnerships with their own staff and optimize the financial outcome of their activities for their shareholders. Case studies from production facilities of the US automotive industry in South America from end of the last centuries are suitable examples for this aspect. Up to today the MNCs negotiate existing commercial laws and regulation to create the best tax environment, subsidies and any other possible support or advantage from the government of the host country before making any investment decisions abroad. Ecologically MNCs use the natural recourses of the host country without paying attention to the ecosystem or wellbeing of the local environment. Large oil and mining companies in African countries are still withstanding the international pressure to comply with global ecological standards. Numerous reports document the horrific damages of the local landscape, water supplies or forests in African, Asian or South American countries caused by reckless exploration of local resources. The daily activities of the MNC employees and their families are mostly kept separated from the society of the host country, which makes social exchange, interaction or integration almost impossible. In some countries personal safety or cultural differences makes this kind of separation necessary. However, in other cases the employer even imports their food from their home country and their staff remains in separate camps in their free time with all their needs taken cared of by their companies.

The circumstances for SMEs as foreign direct investors are considerably different. Not being as influential and powerful as MNCs, economically SMEs have to comply with the local rules and regulations and face all existing challenges in the host country with their own limited abilities and recourses. Lack of financial resources makes SMEs much more careful with their activities and much more dependent on the market of the targeted country. The shortage of human resources forces them to hire and educate local staff. In many cases they even have to train the staff of their local suppliers, distributors or contracting partners to ensure the quality of their products and services for the end customers.

From the beginning SMEs have to learn the business and social framework of the host country. This also includes the environmental regulations. In fact, in many cases the SMEs implement the more advanced and environmental friendly behavior standards of their home country into their new venture. The use of water and energy and waste management rules are good examples in this context.

The entire process of internationalization of SMEs is based on close relationship and interaction with the local population, the companies and the authorities of the host country. This again leads to intensive personal connections and social and cultural understanding and a more sustainable development.

Attracting SMEs

As foreign direct investors, SMEs also benefit from the incentives offered by the authorities and marketing institutions of the host countries. However, most of the offered support programs concentrate on attracting MNCs rather than SMEs. These programs predominantly focus on company registration (one-stop-shop) and taxation. Although these aspects are also of importance for SMEs, it is more crucial for them to overcome other threads and obstacles in the process of internationalization.

These threads consist of lack of reliable and easily understandable information, cultural awareness, managerial know-how and the necessary network in the host country. Further, the most important question for SMEs in the new country is to understand how they can develop their business and remain successful over a long period of time? In other words, how to become economically sustainable in the new environment they operate in. Especially in the first two years SMEs need a lot of support when it comes to finding new projects and coping with the all the new social, cultural and business challenges. Often it is the sum of small issues that makes survival for SMEs very difficult in the new environment. Attracting SMEs as foreign direct investors means finding innovative and direct solutions for these issues, which usually occur after the establishment of the company in the host country.

IPAs and other FDI attracting organizations can use modern information and communication technologies, which offer diversified and effective options to supply transparent and updated information about the business framework and the economical potentials in their countries. Most of them have sophisticated websites and run expensive online and offline marketing campaigns. However, there is a huge discrepancy in the use and efficiency of new media between the developed and the developing world. In many cases the language barrier is not being considered. In other cases the information on the websites are not updated which leads to misunderstandings, delays and frustrations. Many questions are much easier answered through a phone call or easy accessible representative offices. Mostly family owned, SMEs have a traditional value structure which is based on personal relationships. Thus, they always prefer a direct and personal contact to clarify business related matters.
The role of the government in the host countries should not only be limited to definition and creation of a FDI friendly legal framework. Being de facto the largest participant in the local economy, governments can actively attract SMEs directly through economic promotion programs. A specific part of public projects can be assigned to SMEs. Some tenders for these projects can be pre-defined as joint venture projects between foreign and local SMEs, which will in turn promote international collaboration. Even projects for MNCs can be connected to participation of local or international SMEs as suppliers or subcontractors.
In many countries it is a matter of legal and even personal safety to comply with social rules and cultural habits of the host country. Many SMEs underestimate this aspect and often find themselves in a learn-by-doing process resulting in numerous issues in daily life. Therefore, generally any social program promoting cultural awareness is necessary and usually appreciated by the expatriate community. However, it is of great importance that these programs are communicated through effective channels so they can reach the different groups of expatriates in the host countries.

Conclusion

Multinational Corporations are still the most targeted foreign direct investors as their investments are large, they can raise the export activities of the host country, their names can be used to attract other investors and for many other reasons. Therefore, they should remain a crucial part of any FDI attraction strategy. However, they are no longer the only group active in the field of FDI. Driven by the forces of globalized economy Small and Medium-Sized Enterprises are increasingly participating in international transactions. They might not have the advantages of economy of scale but a sustainability assessment clearly proves their middle- und long-term benefits for the host countries. Hence, a holistic FDI strategy no longer can afford to avoid this group and their special needs in the process of internationalization. In order to attract SMEs as sustainable foreign direct investors, the host countries need also a sustainable incentive program with innovative measures and ideas matching with the special needs of SMEs. As in any other field, sustainability in FDI is also about giving and taking to achieve a win-win situation for all participants.

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