The role of private investment in Iraq's economic development

Role of Private Investment on Economic Development in Iraq

Private investment in developing countries

An overview on early Empirical studies

In 1980s, the developing countries encountered some increment in their development behaviours with debt crisis, which affected the formation of capital. Concurrently, the affected countries were transforming from the post-era to a structural reform efforts. In mid 1980s, the developing countries adopted the reform programs within the new paradigms (Serven&Salimano, 1993) & (Jaspersen, Aylward&Sumlinski, 1970). Consequently, this led to the formation of environmental private sector that highly relied on the existing market. The formation and implementation of the new policies affected the availability of response to the private investments. The debt crisis lowered the private investments within the developing countries and this disheartened them. The recovery process was slow and this affected the efforts to stabilize and adjust the countries in the following years (Serven&Solimano, 1993b; (Cardoso, 1993). This enabled many researchers to draw their attention on the magnitude and communications among private investments and the ways in which they react to the new incentive structures. This enhanced focus on the factors that affect investments together with the ways in which macroeconomic policies influence developing countries as well as their private investment (Rama, 1993)Greene & Villanueva, 1991; Solimano 1993). The achievements of developing countries in irreversibility, uncertainty and credibilityhave had a positive impact on their investments. The paper highlights the following issues:

3.2. Finance and investment

The major characteristics of developing countries are their poor developments in financial market leading to short-term local currency financing. The market further has few players, which lowers competition, reducing the total received yields and increasing the transaction rates (Platz, 2009). Concurrently, the economic theory states that there is a high relationship between investment and the development in financial status. It commonly occurs when financing SMEs together with large-scale investment projects because they highly rely on developed financial. This implies that any form of increment within the financial intermediation, will lower the financial costs applied in investments and increases the investments and such incidence increases the financial needs. This enabled Huang (2006), to conduct a research on the causality that commonly occurs between the aggregate private investment and the financial development within the globalized world. The research used a panel data that 43 developing countries developed in 1970-1998, ensuring that the analysis occurred in two different stages. The initial stage used data collected in five years and the results showed a positive causal effect in both directions and high levels of persistence in the data between the developments in financial and the private investment. The second step used data collected in a year and it resulted into adaptation of interdependence and heterogeneity among the involved countries.

According to the analysis, there is the incorporation of the private investment and financial development, which leads to positive causal effects within the co-integrated system. Stiglitz & Weiss (1994), contends that during the micro level, many firms encounter financial problems making them to seek control on either their interest rates or credit rationing. The lenders within the financial markets encounter difficulties in differentiating between the good and bad borrowers due to varying factors. These factors entail the asymmetric information, adverse selection and incentive effects among others. Consequently, this makes the creditors to decide on rationing the credit volume during the allocation of credit in firms.

Despite the differences in the model, this literature focuses on the fact that investments might have greater impacts on the financial factors. Dissimilar studies conducted in the field are good evidence because some researchers tested the financial variables together with different roles that that they play in various models and they obtained positive results (Fazzarii, Hubbard & Patersen, 1988). According to the research, the effects of investment on financial factors differ depending on the policies that firms have regarding their retained profits. The recent review by Hassett & Hubbard (1999) indicated that there is enough evidence to support the claim on the roles that financial factors play in the decisions regarding investments. Concurrently, this is also evidence in the many economics and finance researches.

3.3. Private investment and macroeconomic policies applicable in developing countries

There have been different studies in developed countries regarding their investments, which contradict those in developing countries because such studies are limited. This is because developing countries have not shown much interest in conducting researches in the sector. The few existing studies on investment in developing countries are poor because they employ traditional models including the neoclassical and endogenous. The inconveniences are also common because some of the studies rely on equation with varying variables, which they think that are beneficial to the investment activities. Researchers should consider increasing the rate at which they conduct such researches in the developing countries.

3.3.1. Impacts of Monetary and Credit policies on private activities

There are different factors that affect private activities, with the major ones being stability in prices and inflation. To attain the aims, it is imperative to focus on monetarism even though inflation is a monetary phenomenon. With fixed exchange rates, much money supply leads to balance in payments because they lower the cost of imports while increasing those of exports. Capital flight can play a significant role in handling the issue of balance of payment. Different factors such as restrictive monetary policy and low supply of money are capable of lowering inflation, eliminating the balance of payment leading to stability required in the allocation of resources (Croce & Khan, 2000).

Monetary and credit policies have many impacts that affects the private investments together with their long and short-term performances. This makes the policies to be imperative element that determines the private investments. There have been different studies on the effect of those policies on private investments. According to De Melo&Tybout (1986), these studies show that restrictive monetary and credit policies have an impact on bank credit, which affects per capita user cost and these reduces the activities within the private investment. Concurrently, the same research revealed that increase in interest rates reduces private investments because it increases the opportunity cost involved in the internal funds. Furthermore, different researchers (Blejer & Khan, 1984; Lim, 1987; Dailami (Dailami & Walton, 1989)(1990) (Larrain & Vergara, 1993)Vergara (1993) insists that financial markets plays a significant role in understanding the ways in which monetary and credit policies affect the investment and the reasons to why the situation is common among the developing countries. The researchers claim that the effects of credit policy on investment are higher than interest rates. This is because the credit allocation mechanism has high level of access to borrowing at any given interest rates depending with the firms. It is further evident that credit has a positive impact on private investment

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(Atukeren, 2005; Bouton & Mariusz, 2000; Chee-Keong, Zulkornain & Siong-Hook, 2010)

Remarkably, there has been much research on decisions that lenders and banks make, which are important in determining the relationship between credit policies and the economy in the country. Consequently, the studies supported the joint effects of interest rates and credit channels. The results from the different studies have also indicated that increase in interest rates lowers the level of lending in banks, because the banks will have the major responsibility of adjusting their asset portfolio

Dailami&Giugale used the firm investment model to bring out the relationship between credit policy and private investment. The model connects the credit ceiling and the net in the firm together with the state of the credit market that the bank puts in consideration before deciding on their lending decisions. Some of the factors that banks consider include the sentiments, supervisory practices, credit policy and the levels if interest rates among others. This implies that during tight monetary policies companies interested in acquiring loans undergo strict evaluations. This might lead to the postponement or ignoring of the investment plans in a firm. Furthermore, the researchers apply the same model in creating an empirical equation, which draws attention on the real and aggregate credit and their results indicate that interest rates and volume of credit have a significant impact on the activities of private investments.

Additionally, Shrestha&Chowdhury (2005) supported the same views by claiming that credit constraints found in developing capital markets together with inadequate financial intermediation affects the decisions that firms make regarding their investments in a negative way. Inadequate long-term financing and future market makes the bank loans and other external borrowing to be the only borrowing sectors private sectors can use to invest their finances (Khan & Khan, 2007). On the contrary, Huang (2006) claimed that there is appositive relationship between financial development and private investments. This is because the researcher believed that financial development will increase the total opportunities and incentives to the investors while within developed financial sectors, the mobilization and distribution of the resources will be effective for investors.

3.3.2. The effects of fiscal policy on the private investment

The effects of fiscal policy on private investment act through three different channels, which entail the following.

The fiscal deficit affects the investment because it has an impact on private savings so that they can finance the deficits. This also implies inadequacies in fiscal sustainability, which influences investments in private sectors.

The second channel happens through the level, composition and quality involved within the public investment, which shows the level at which the public investment replaces the private investments (Schmidt- Hebbel, Serven, & Solimano, 1996).

The final channel regards the level of taxation on the corporate earnings and the rules applicable in depreciations.

There have been arguments that fiscal policy and public expenditure reduces the private investments in two different manners. These include increasing the interest rates or lowering the private funds involved in financing the investments.

According to the neoclassical theory, the interest rate is also an imperative variable in finding the level of investment. Consequently, it results into a negative effect because it upsurges the interest payable in investments. Concurrently, McKinnon and Shaw, contends that this is likely to cause a positive relationship between the investment and interest rate. This is possible because the interest rates have high chances of increasing the savings and this increases the volume of domestic credit, which forces the equilibrium investment to increase. This led to the formation of McKinnon-Shaw hypothesis, which believed that the quantity of fiscal resources has more impact on investment than the cost of fiscal resources (Khan & Khan, 2007;(Arvanitidis, Petrakos & Pavleas, 2007).

The public plays a significant role in the public investments among the developing countries. The public also have an impact on the private sectors by either causing a crowding in or crowding out. Keynesian approach believes that crowding out has a minor effect on both private and public sectors. For example, underemployment lowers the total demand in a state and this is likely to lower the level of production. During such circumstances, the government plays a significant role in ensuring that it increases the demand through lowering the rate of taxes while increasing the public expenditures. Consequently, this is likely to increase the demand as well as the private investments thus increasing the general investments. This is likely to increase the interest rate without any effect on the crowding out.

On the contrary, different research argue against the conclusion by claiming that availability of such policies in the state can enhance increment within the public infrastructure, which might be essential to private investments. This implies that improving the infrastructure is beneficial to the private sectors especially on their credit, which enhances their investments. On the contemporary, this implies that lack of good infrastructure in the developing countries affects the development within private sectors in a negative way. Consequently, this will affect the provision of goods and services such as social services, roads and power plants among others in such countries and these are essential services to the private sectors

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(Abdelhadi, Areiqat & Altrawenh, 2011; Khan M, 1997; Khan & Reinhart, 1990; Majeed & Khan, 2008)

. Remarkably, this means that countries with enough and good public infrastructure are likely to benefit the private sectors in the region. Therefore, it is imperative for the public sectors to consider improving the infrastructures so that they can benefit the private sectors ( Chibber, Dailami&Shafik 199; (Hulten, 1996). Importantly, it should come to notification that restrictive fiscal policy plays the role of lowering the high fiscal deficits, which crowd out private sectors through increasing interest rates of lowering the existence of credits. It is therefore imperative for the fiscal adjustment to give private sectors chance for expansion. According to Van Wijnbergen (1982), and Matin&Wasow (1992), it is true because there were some similar outcomes in Korea and Kenya respectively, since there is a high relationship between increase in tax and decrease in expenditure. Additionally, it is possible that the decrease in fiscal deficit is likely to lower the private investment. This is a common issue in the developing countries because lowering the public investment has a negative impact on the private investment (Blejer & Khan, 1984; Greene & Villanueva 1991).Developing countries should also put in consideration that fiscal policy decreases the aggregate demand together with the expected output, which might end up affecting the private investment using accelerator principle.

The empirical studies conducted in different developing countries have been able to confirm the results. This is because the studies indicated that the government is very imperative in the economic activities of any given country. The research indicated that it is possible because the private sectors do not perform large investment projects in developing countries. The capital within the public sectors affects the private investments in two different ways, which include the fact that they compete for resources with each other and can have goods that compete in the market. In the economic literature, they refer to such situation as the crowding out. On the contrary, it is possible for the capital in the public sector to have a positive impact on the productivity, thus causing a positive externality, which is common in the investment of infrastructures. According to the economic literature, they refer to such positive impact as the crowding in ADDIN EN.CITE

(AGARWAL, 2009; Atukeren, 2005; Bouton & Mariusz, 2000)

Different studies have also indicated that tax system has an impact on investment (Pinell-Siles, 1979). This is because the study found out that shortages within the tax system occurring from inflation and taxable income has a negative impact on the investment within the affected country. Furthermore, the research revealed that both private and public investments have an impact of the development process of the given country. Therefore, this enables Khan and Reinhrt (1990) to apply the growth model in determining the benefits of both private and public investments. During their research, their major aim was analyse the adjustment policies in the market that plays a significant role in the improvements of private economic activities in developing countries. The researchers use an example of twenty-four Latin American and Asian countries to show the relationship between private and public investment. The results indicate that the productivity of public and private sectors differ where the private one is positive while the public one is negative. In justifying this, the researchers gave an example of IMF and the bank. They also claim that many researchers have ignored to conduct many studies on the impact of public investment on economic growth. They claim that in most countries, public investment play the role of offering public services such as health facilities and schools, which are vital in the improvement of private investment, and this supports growth.

Notably, different studies have indicated that fiscal policy has an ambiguous effect on investment in both the private and public sectors. The studies indicate that government spending that rely on any form of borrowing have high chances of replacing the private investment through increasing the interest rate or lowering the availability of credit in the private sectors. Additionally, the studies also indicate that the short-run effects of attractive fiscal environment on the private investment might be limited. The research also encouraged different countries to draw their attention on improving their infrastructures because lack adequate infrastructure in a country affects development within the private sectors thus affecting the economy of the involved countries. The government should also work hard towards reducing the tax rates while increasing the rate of public expenditures. This is imperative because it will increase the rate of productivity in private investment, which will increase the general investment in a country.

3.3.3 The role of exchange rate on private investment

Developing countries depend on capital product goods and imports to boost their economy and thus exchange rates are a crucial determinant in designing macroeconomic policies. Reducing expenditures and using domestic goods are part of adjustment programs that involve devaluing the currency to bring results for private investors. The effects of policies centered on exchange rates are difficult to determine because of the mechanisms that produce varied effects of private investment. These effects also change according to short and long run periods.

Currency devaluation affects investment in a summary of five channels defined by Chibber et al., 1992. The steps include; changing the supply price of capital goods, raising the price of imported goods, changing income distribution, changing actual income of consumers, and affecting the nominal and real interest rates. Changing income distribution involves increasing the product wages. Consumer's income affects demand for goods produced domestically. Nominal and interest rates also affect the capital supply price.

Devaluation affects the economy in a complex manner because the effects through various channels are in opposite directions. Devaluation has profound effect on aggregate demand, which greatly influences private investment. When devaluation through increased exportation, and economic growth, motivate final demand, the long run effect is likely to be positive. This also implies that the same effect is negative in the short run. Change in exchange rates affects the volume of exports and level of competition because it influences investment through the sectors that produce goods in the international trade market.

Faini & De Melo carried out empirical studies in 24 developing countries. They discovered that devaluation affects private investment negatively in the short run but gradually changes to positive impact in the end. This is because it affects the price of capital goods. Solimano, 1992 conducted a study that proved long run benefits outweigh short run expenses. Cardoso, 1993 also conducted a study but could not find any noticeable relationship between aggregate investment and exchange rates.

To understand devaluation, one must look at both the supply and demand concepts of the economy. The tendency to increase prices has a significant effect on demand. As prices increase while income remains constant, the average consumption rate reduces. This is because people can only afford to buy fewer products with their constant income. Serven explains that the increase in price reduces wealth and consequently domestic capacity (2002). Decrease in average demand reduces sales since people can only purchase products within their income. Reduced sales have a negative impact on economic activities and end up reducing investment from the private sector.

Looking at the supply side, devaluation affects private investment. This is because it affects the price of tradable investment and greatly determines the level of private investment in a country. Devaluation also affects price of intermediary goods, foreign debt and financial position. Devaluation may change the structure and composition of private investment in some ways. For example, devaluation increases private investment by increasing the price of tradable goods. This also leads to decrease in private investment in the non-tradable sector of the economy. Solimano still holds that the net effect of exchange rates on private investment is uncertain as proved by econometric studies (1989).

Devaluation has contradicting effects on private investment especially when it comes to the sectors of tradable and non-tradable sectors. This means that countries with a huge export segment are likely to benefit from devaluation. If the economy of a country depends on imports and intermediate goods, private investment is likely to decline. This is to say that whether national or internationally based, private investors are driven by the export and import trade. The factors that influence this trade, for example exchange rates, also influence investment. Firms that run and operate through loans and debts are likely to experience negative effects because of the fact that devaluation is constantly fluctuating.

Irreversibility, Uncertainty and private investment in developing countries

When making decisions concerning private investment it is important to consider the irreversible nature of capital goods. For a seller to make profit, he must sell goods at a higher price than the purchase price. This means that the selling of products has a cost that is not recoverable. This makes the sale of goods have some level of uncertainty that may influence private investment and the decisions that accompany the practice. This is important especially for investors in developing countries (Mellati, 2008). When the risk to investment depends on the uncertainties of sales, investors prefer to put their money in short run investments that are likely to bring benefits to the economy than long run investments. This is because every investor wants to put his financial resources in an enterprise that will start bringing in returns as soon as possible (Ay San et al., 2005). Private investors are reluctant to invest in a country whose future exchange rates are uncertain because all investors calculate the risk they are likely to take and the expected consequences. Uncertain future rates are likely to bring down a seemingly profit- making investment. They are, therefore, unprepared to take such risks, regardless of the current stability of the rates (Mellati, 2008).

Another uncertain factor that influences private investment is the volatile nature of the economy. This looks at issues like consumer pricing, terms and conditions of trade, interest rates and GDP growth rate. Investors consider these factors and their influence on investment. This also makes investors opt for short-term businesses (Pindiyck, 1991). For example, the interest rates determine the percentage of profit that an investment is likely to bring in. This means that if a country has fluctuating rates, the possibility of incurring losses in long run investments is quite high. Investors choose to have short run investments that will incur profits for the period they are in operation and by the time the rates fluctuate, investors have their profits.

Various authors and researchers have studied the effect volatility has on private investment. These authors have found proof that volatility of the economy has negative effects on private investment (Aizenman & Marion, 2003). Bleaney & Greenaway also discovered that terms of trade and their fluctuations influence the decision-making process by private investors. The fact that once one begins an investment it is impossible to reverse it makes private investors uncertain of the decisions to make.

Changes in significant factors like oil prices, variations in agriculture and tourism have contributed to the volatile nature of the economy in developing countries. Fr example, the unpredictable weather and climatic changes cause unpredictable crop growth while the politics of these countries influences tourism activity. This means that the economy continually fluctuates and is unpredictable since the factors that influence these changes are also unpredictable. This definitely influences private investment since despite willingness to invest, the uncertainty of the economy cannot guarantee investors they will make any profits. The stability of a country's economy determines the adjustment cost that private investors are willing to incur. If a country has a stable, economy, private investors are likely to invest in adjustment costs during unstable economic times. If the economy is unstable, investors prefer to have short-term projects.

A macroeconomic institution whose policies include stimulating private investment focuses more on stability of the economy than tax rates. This is because investors look at the probability of an investment repaying all the costs and expenses incurred while also bringing in profits. This framework involves an outlook of the future and the chances of a stable economy that will ensure meeting the goals of the investment. This means that an investor will incur whatever tax rate as long as the business will bring in more than the cost incurred. This also means that economic instability greatly discourages private investment.

Unstable exchange and interest rates also have detrimental effect on private investment. This is because they determine the price for importing and exporting products. When such rates are unstable, it is highly possible to incur a loss within seconds. This is because the exchange rates are determined by factors that rarely consider the private investor.

Larrain & Vergara conducted a research on East Africa that showed the success of private investment (1993). They showed that during this period the countries had high stability levels both economically and political. They also had credible policies and policy implementers. They focused on the effect of exchange rates on private investment and discovered that low variability encouraged expansion of private investment in East Africa.

Faini & De Melo looked at the experiences countries have when it comes to adjusting structures to create stability. They realized that despite going through positive changes and reforms, countries are still prone to external shocks. This is driven by the pressing need to offset debts and ensure stability in implementing the new policies and reforms (1992). Such matters make investors avoid long-term investments because of the uncertainty of whether the policies and reforms will be sustained. Investors work on the assumption that varying exchange rates in a country represent economic instability. This is in the case where such rates fluctuate constantly. They also discovered that the policy environment has everything to do with the different investment activities in different regions. This means that countries with sustained policies enjoy more private investment than the countries, which are still trying to implement these policies. The evidence of this fact is the kind of projects that private investors put up in different countries. The likelihood of reversing policies on trade is a factor to consider. It is important to give it consideration despite the fact that it is an old tradition. Kamim & Rogers carried out a research in which they discovered that policy reform in matters of trade reduced capital accumulation in Mexico. This happened during the first years of reform (2000).

The issue of private investment is a great source of revenue for any country. Iraq needs it most to be able to boost its economic status and register economic development. To achieve this goal, this section looks at the role of exchange rate in private investment. This section points out that investment relates to exchange rates directly. This means that friendly exchange rates and policies are very likely to attract long-term private investors. Iraq should therefore work on building friendly exchange rates and policies that attract investors. The section also looks at the uncertainties, irreversibility and private investment in developing countries. Iraq faces an unstable economy because of the political circumstances that have seen the country endure a number of attacks. The fact that once investors start a long-term enterprise they cannot pack and leave means that the country must assure investors that their money is n the right place. This means that the county has to ensure it has reforms and policies that favour private investment. These policies must be sustainable as discussed in this section.

3.3.7. Non-Economic Factors effect on the private investment

To add to my list of the factors economic in nature provided, there are other aspects to be considered which have an influence on the upsurge in the growth of investment in the private sector. Just to mention, sound and proper governance where appropriate systems are put in place to ensure proper resource utilization. In addition, the quality of the institutions and entrepreneurial skills for the private sector to make optimum and viable big investment decisions based on a reasonable assessment of risks and potential pay-offs.

Various research studies have recently shifted their interest to the non-economic factors. These are mainly first-rate governs and eminence of institutions, these factors play harmonizing function with the traditional economic factors. It has been recommended that the types of entrepreneurship that can be recognized and the enterprise strategies put in play be heavily predisposed by the peripheral environment on a broad-spectrum and the institutional context specifically.

Government-sourced factors become efficient on private investments generally

In terms of political risk and upheaval. Political risk can be broken down into three components majorly political stability, from of command change and aptitude of performing the policies (Le,

2004). Again, a developed physical infrastructure provided by the state also has the budding of affecting the viability of private investments.

It is acknowledged that some non-economic factors and political risk facts may have unconstructive blow on private investment, and there is satisfactory pragmatic evidence at this direction. Aysan et al. (2005) examined the determinants of unsatisfying private investment growth in the Middle East and North Africa (MENA) throughout the 1980s and 1990. Their paper shows empirically for a panel of 40 developing economies, that other than the traditional determinants of investment, government policies explain MENA's low investment rate.

Additionally, inadequate structural reforms represented as poor financial development and deficient trade openness has been a crucial factor for the discrepancy in private capital formation. Economic uncertainties mostly brought about due to huge and heavy external debt burden of the region and economic volatility have constituted major restraints for firms to invest. (Le, 2004) as distinct from other studies, compares the private investment to rate of return differential, risk aversion, and several types of political risk.

Investment decisions are mainly driven by profitability motive (Jorgenson, 1963). The forward-looking nature of investment dictates the significance of a stable and secure environment -- in particular the security of property rights. At the same time, "good" governance institutions are perceived as lowering uncertainty and promoting efficiency North (1981). In this sense and as portrayed by the World Bank (2004), better governance improves the investment climate by improving bureaucratic performances and predictability. This in turn reduces uncertainty, as well as the cost of doing business. Sound governance enhances better service delivery. Cross-country correlations using broad proxies for investment climate quality suggest a strong positive link between the investment climate and private investment decisions

Low private investment, an emerging issue of the MENA region is addressed, with keen interest to the government's role. In fact, the MENA countries have on average been characterized by a pronounced deficit in "good" governance institutions. This shortfall is particularly related to democratic institutions such as political rights, civil liberties, or freedom of the press. Similarly, the quality of administration has also been of some concern. These deficiencies have been reported as being at the root of the slow economic activity in MENA (see El Badawi, 2002; and the World Bank, 2004).

Where governance and its impact on private investment are concerned, the study by (Aysan, Nabli & Veganzones-Varoudakis, 2006) In MENA, governance inadequacies greatly contribute to the low private investment performances of the region during the 1980s. This is the case for the "Quality of Administration" and "Political Instability," which insufficiencies compared to East Asia, has cost on average per year 1.4 point of private investment to GDP. On the side of "Political Stability," the main undoing of the region during the 1980s resulted from the presence of internal and external strife. In the 1990s, the gap with East Asia has noticeably gone down and enhancement in the quality of administration and in the political stability of the region has notably helped investment's decisions. "Public Accountability," however, went down in the same period with a yearly cost of 0.7 point of GDP. This result shows that improvement in democratic institutions is still a key issue in the region.

Other than inadequacies in governance, low private investment in MENA results from deficit in structural reforms. Trade policy deficiencies (compared to Eat Asia) have reduced private investment decisions by 1 and 1.9 per cent of GDP on average per year respectively during the 2 sub-periods. Identically, a superior financial system (such as in the East Asian economies) would have stirred firms' decisions to invest by 1.9 points of GDP during the 1990s. This makes of structural reforms an important question that MENA governments have also to address if the region wants to catch up with more successful developing economies.

The penalty, which a developing country faces due to political stability, cannot be measured due to their intensity because they affect the entire development process. In an unstable nation there will be copious difficulties experienced in the saving sector within the country. If the public tolerates challenges in the saving schemes present in the country then security for their money happens to be at limited levels thus discouraging the public from taking part in the investment process. This is a problem that a developing country can handle and ensure that the political stability does not influence the economic growth negatively. However, there are consequences in dealing with matters that link political stability and economic growth of a country.

Consumers most likely end up increasing their expenditure at the expense of saving due to lack of a serene saving environment. The explanation to this point is simple. Individuals opt to spend the little they have rather than wait and stare at it as it goes to waste due to unstable political environment. Political instability is prone to bring about dislocation of individuals in the public in that they are in areas that they cannot access reliable sources for their livelihood. It is obvious that the moment investors invest; they are in a position to favour the industry or business venture that they have made investments (Felipe, 2012). Corruption in the public takes many forms such as acceptance and giving of bribes for better service and favour, or to be given monopoly power or to secure government procurement and contracts. Tanzi (1998) provides the apt meaning of corruption: the abuse of public power for private benefit (Everhart & Sumlinski, 2001).

One motive why corruption seems to depress investment is that it acts as a tax on private investment. A "corruption tax" is particularly burdensome for deeds such as investment projects that by nature involve a long time horizon and a multiplicity of logistic, administrative and legal steps. The result is an increase in the cost of capital, hence a reduction in anticipated profitability, as well as a relative incentive toward investments involving fewer administrative steps: that is, the tax is distorting, too.

One insinuation and obvious fact is that without corruption more resources will be available for private investment. To add on this there would be an increase in public revenue because of less "leakage" due to corruption could translate into more public services and/or reduced taxes. Most important might be the impact on incentives: with high corruption, investment simply might not occur (Everhart & Sumlinski, 2001).

Tanzi and Davoodi (1997) investigate the impact of corruption on public investment, using infrastructure investment as their proxy for public investment and the Political Risk Service's International Country Risk Guide index as their measure of corruption. They find that corruption tends to increase the number of projects undertaken and to expand their size. Corruption increases the share of public investment to GDP, and lowers the quality of public investment put in place.

The explanation behind this observation tends to be straightforward. Infrastructure projects can be great and the execution often carried out by private firms. The enticement for the private enterprise to pay a "charge" to secure the contract is strong, especially when dealing with a large contract. If unscrupulous officials in the public sector motivate the endorsement of an investment project, rates of return and cost-benefit analyses become mere exercises. The firm paying the "charge" is unlikely to stomach the cost of the bribe. This hidden cost will be compensated in some dubious means for instance use of poor and low quality materials to develop projects and unqualified personnel come into play. Perhaps an "understanding" will be reached with the bribed official that the Initial low estimate will be revised upward as the project progresses. Alternatively, the bid may be padded initially. In other scenarios, the particular organization that offered the bribe might compensate the cost of the bribe through overcharging its services. All these aspects end up making investment in the public to be very costly and more often never meet the required standards.

Good Governance

Most developing nations boast or attains the required rates at which the public decides to venture into private investing process through the help of good governance. Good governance being processes possess several roles that positively influences motivation of more private investments within any established nation. It is for the better side of the country at large where the government allows investments by the public in a more protected manner. By applying good governance, it appears as the only secured manner in which finance owned by the public can be secured through strategies and programs developed by the state.

Furthermore, a well-secured governance system ensures first considerations of public interests through means of providing loans to enable the public to engage in private ventures through long-term investments (Boyes & Merlyin, 2009). With this roles and strategies in hand, good governance as a policy effectively contributes to the stimulation process of the public to engage in private investments in any developing nation.

In the recent studies, information collected shows that most successful economies extensively rely on good governed institutions, which in turn possess a link to the economical expansion of a developing nation. Special considerations have been placed due to the existence of a strong relationship between motivation of private investments and the act of good governance in developing nations. An aspect of good governance contributes to the ability of determining the efficiency level of the public in taking part in the private investments process.

In return, the public becomes beneficial because of the many advantages related to good governance specifically in a developing country. This is observed through availability of products achieved through investment to the private investment, which increases the total availability of consumer goods within a given nation or country. In recent times, most developing countries require good governance because it happens to be good determinant of the investment environment (Boyes & Merlyin, 2009).

Transparency

This process involves the initial engagement of possessing visible investments to every investor thus allowing everyone to take part in the process of policy implementation through private ventures suitable for money investments. This achieved by engaging the public to actively participate in private investments in the decision making process to be clear on the possible dealings within the private investment. The major role of transparency is to ensure that most private investment in any developing nation rated at its best.

Furthermore, the process through serving major criteria ensures that investors are accessed to sufficient information on the progress of the private investments thus encouraging the public participation (Pinstrup-Andersen & Watson, 2011). The public requires transparency in order to affirm the safety of their capital on the private investment through a guaranteed flow of cash within a given investment.

On the other hand, additional investors need derivation in the private investment thus ensuring a most efficient position according to the economic state of a developing country. Most developing nations require efficient transparency in almost all private investments by the public in order to increase the chances of engaging the public to take part in the investment program. The above mentioned strategies ensures the accountability of the roles of transparency on private investments thus maintaining levels that contributes to the countries total economic growth (Pinstrup-Andersen & Watson, 2011).

While practicing the process of transparency, several challenges emanates on the private investments.

The state needs to step in because it is its responsibility in establishing well-demonstrated strategies applicable to the public thus ensuring the public does not get discouraged in the investments levels (Pinstrup-Andersen & Watson, 2011). The details provided at the investment levels needs the public scrutiny thus ensuring a reasonable or significant yield in terms of profits and in case of losses, the process becomes traceable where the problem emerged.

Good governance and a secured economic environment are important factors that help in enhancing private growth and investment in developing nations or countries (Dhonte & Kapur, 2006. Governance is the total capacity of governments to plausibly guarantee a secure economic environment through providing significant benchmark against which governance can be evaluated.

A well-secured economic environment results from a well-emphasized revisit on investment and venture will amass to the investor and the entrepreneur, which becomes a significant requirement for a well-sustained growth. Provision of a better environment for investment is significant for the growth of private initiatives in a given market economy. The government further becomes less relend based on certainty of the total expected returns due to its influence to the outcome position.

Lack of economic security leads to emergence of factual uncertainty that reduces the horizon business planning capacity, which in turn affects the capital accumulation level of a given country. It is observed that, by trying to reduce the uncertainty, the economic security eventually lowers the threshold and further increases the investment rates (Serven, 1996).

By trying to ensure a good environment that is essential for sustained growth in a given market economy, certain rules observed based on the outlines system. The rules ensure deserved freedom of entry into the market, purity of available contracts, and access to information. Creating a secured economic environment has been a lengthy and complex process in most societies because of the prevailing far-reaching social change and profound historically related factors. This solved through policy prescriptions that helps to avoid any possible conflicts that emanates between different moral and social values.

Several dimensions of a well secured environment include competent law and order that involves protection from external threats such as economical, social and from house racketeering. At this stage, the possible risk to investors is related to a business environment as shaped and molded by government policies and behaviour that become adversely affected by government shifts in policy, which in turn results to harm to the business conduct, lower rates of returns, and finally assets stipulation.

In the recent study of empirical work carried out by Poirson, (1998), which tried to find the possible role or significance of economic security on private growth and investment in almost 53 developing nations during the year 1984-1995. Since then, most private investors mostly affected by expropriation risk, the civil liberty degree and the risk of independence bureaucracy. While dealing with investments, political terrorism and risk expropriation influences the economic growth in the short run while contract rejection and corruption influenced the economic growth in the end.

Basing on the facts stated, many public and private institutions reforms have been done for many developing nations in order to improve the economic security. This has led to increment in private investment, and the total economic growth, which in turn could raise private investment by 0.50 to 1 percentage point of the total Growth Domestic Product in the short to medium run. In the event of time, emanating uncertainty certainly reduces the horizon planning business affecting the total capital accumulation.

Coordination Failures and Self-fulfilling Expectations

Investment behaviour in developing countries is quite uncertain due to various issues surrounding the micro and macro environment. Further, the investment trend in developing countries has credibility issues surrounding it and is irreversible. This means that once one has decided to pursue a certain investment channel, and actually put in money in the investment opportunity, it is not easy to recover the original amount when market trends seem not to favour that investment. One may decide to pull out an investment before the required time has lapsed and recover a certain fraction of the original investment made but not the whole.

Conformist investment theories have not been able to explain investment trends in developing countries. Countries subject to these theories focus on creating political stability and endearing investment policies in order to attract foreign direct investment in their country. However, the model of coordination failure and self-fulfilling expectations provides an explanation of the failures if the macroeconomic investment theories. Moreover, investment decisions by firms are interdependent thus giving rise to imperfect competition in the market. This creates a situation whereby the profitability of a firm's investment depends on the profitability of that of others. Hence, a country manages to encourage a fraction of firms in an industry to make a certain investment, then all the country will follow suit and thus increasing the economic activity of the state leading to profits. Further, if single firms do not invest owing to the knowledge of minimum profits or losses, then other firms will follow (Dornbusch, 1990; Cooper & John; 1988).

In view of the above, this logic suggests that there might be two types of balances: the good position and the bad position. Prosperity in economic activities including investments characterises the good position while a low investment activity characterises the bad position. Keynesian sums up the expectations of private investors by providing the action with an analogy of animal spirits, which determine which of the above two, prevails in the economy. This is to mean that one of the balance prevail out of the market players collective instinct so to speak as opposed to planning or adherence to a model. Therefore, the wait-and-see approach of private creates the coordination failures through the self-fulfilling expectations paradigm

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(Cooper et al., 1994; Rodrik, 1998; Serven & Solimano, 1993)

. An economic recession, for example, and a stabilisation package provided as a stimulant to economic activity, will result to investors to delaying investment until the recovery of the economy. The measure of economic recovery is through the behaviour of other key investors in the economic. This will result to delay recovery of the economy thus leading into low investment equilibrium because of self-fulfilling pessimistic expectations.

In addition to the above, an analysis of investment determinants seem to indicate that private investment seems to respond more positively to structural reforms in some countries as compared to other. This is a clear indication that the uncertainty and irreversibility hypothesis provide a better explanation to the problem. However, Ozler & Rodrik (1992) state the differences arise out of the degree of political stability in a certain country. (Ozler & Rodrik, 1992) outlines the consequence of external reaction on the domestic private investment and the relationship between the two. This was relationship is called "political transmission mechanism." The negative effect of an external reaction identified in light of increasing world interest rates, or a reduction in capital inflows to the public sector, was analysed in relation to private investment as it can either reduced or magnified by the political transmission mechanism.

During the experimental part of their investigations into the influences of investments, they selected a number of developing countries; and they improved traditional investment models by including intelligent substitutes for political variables. This experiment brought to light the fact that external reactions have an effect on private investment behaviour. Generally, the experiment elucidates on the fact that private investment are in larger volumes in economies that uphold political rights.

Distribution of income is yet another significant determinant of private investment as suggested by (Alesina & Perotti, 1996; De Dominicis, Florax & De Groot, 2008) . This is because, when there is high unequal income distribution in a population then the result is division in both socially and politically thus undermining efforts for economic progression.

Over the last decade, focus has been on the effects of the macroeconomic trends on investments. It is clear that positive policy change, democracy and political stability largely encourage foreign direct investment in Iraq. Foreign Direct Investment in Iraq focus is on the availability of energy in the country. Foreign investors and the government sign a form of Production Sharing Contract (PSC), which means that government will get a fraction of the revenue generated by the company based on energy, or mining related activities in Iraq. The availability of mineral resources in developing countries encourages FDI overriding negative factors that may deter the same such as political instability, as in the case of Iraq.

In conclusion, therefore, investments have three characteristics; irreversible, uncertain and issues of credibility. These characteristics are what inform investors who are considering making investments in developing countries as they determine the volume and type of investment made. The uncertain nature of investments makes firm take their time to analyse the markets as well as the behaviour of other firms in the industry. Irreversibility ensures that firms are take precaution before making an investment since a wrong decision could translate into a major setback for a firm. Further, the macroeconomic state of a country determines the volume of FDI the country may receive, but there are situations where the resources available override the macroeconomic atmosphere of the country.

Chapter Three

3. Foreign Direct Investment and Economic Development

3.1. Introduction

Third world countries and developing countries all have one major goal that they share in common. This goal is economic development. This has been their interest since the end of the Second World War. This goal requires sufficient economic resources. These resources stimulate economic growth and control the level of population growth. Various theories have explained how economic growth can be realised but two ways explain this in detail. We have the ways- increase for factors of production; and increase in the efficiency with which those factors are used. Through this, growth brings about increases in investment (i.e. capital accumulation) and the efficiency of investments

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(Anthony & Mba, 2011; Borensztein, De Gregorio & Lee, 1998b)

The need for economic development by these countries requires sufficient capital accumulation to fund development projects. The source of capital becomes a major challenge. This is because the only logical source of the funds, which is external borrowing, tends to be quite costly due to the high interest rates. The alternative means appears to be allowing foreign investment into the local industry to boost the growth. This has promoted globalisation and opened up avenues for job opportunities. Recently, foreign capital globalisation, particularly FDI inflow has amplified notably in developing countries, due to the fact that FDI is the most stable and prevalent component of foreign capital inflows (Adams 2009). The importance of FDI has emerged from the role played by MNCs in creating positive benefits in economic growth through easy access to funds, employment creation and also transfer of technical acquaintance and labor to the people, and enhancing competitiveness (Kobrin 2005; Adams 2009).

In this particular context we focus on the link between economic growth and development and FDI, the first section is concerned with the concept of FDI, while section two tackles The brunt of FDI on economic growth how and to what degree FDI affects domestic investment (DI) and economic growth in the host countries . Thirdly the effects of FDI on economic growth are measured. Section five discusses the most important determinants of FDI, while section six focuses on polices that can improve the investment climate.

The concept of the foreign direct investment (FDI)

According to the United Nations Conference on Trade and Development (UNCTAD,

2008) foreign direct investment can be defined a long-term relationship between companies in the source country (the investor) and another company in the host country (country of investment). Basing on this definition the donor country that is (the foreign investor) is the owner of the particular asset with which it intends to invest in the other country or the company that owns assets in another company or production unit that belongs to a country other than its native country. To add on this, the particular investing company has to hold not less than 10% of the normal shares or the voting power on the board of the registered companies or their equivalent of other companies. The local companies are called as subsidiary units or affiliates.

This definition is not limited only to the aspect and patterns of flow of foreign investment among the highly industrialised countries and where amalgamation between colossal companies and monopolies over company assets give them an advantage. It may also function where single foreign companies are concerned. This definition points out that foreign direct investment consists of taking possession of capital by buying of shares in the subsidiary company. It also entails the ploughing back of gains earned by the subsidiary company other than distributing it to share holders or short-term or long-term borrowing or credit between the mother company and its subsidiary companies, sub-contracts, management contracts, concessions, and licenses for producers and service providers.

The Arab Investment and Export Credit Guarantee Corporation provide a new light to the definition. It defines FDI as the stream of capital in the shape of production or financial assets, material or else coming from outside the host country, and which features in autonomous or joint investment projects for business purposes (The Arab Investment and Export Credit Guarantee Corporation, 1987).

FDI mainly concentrates on a lasting partnership between the parent and the subsidiary company along with some form of control in the subsidiary company's board. The direct investor can be an individual or legal entity from the public or private sector, a group of people, a company or group of companies, a government or a government organisation, or any other organisation such as an international financing organisation. The straight investor as a rule must be a firm which 10% or more of its ordinary shares or voting power in case of stock companies, or an equivalent in case of non-stock companies belongs to a foreign investor (Shernanna & El-Fergani, 2006)

FDI takes many forms that can be categorised as follows

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(Alfaro, 2003; Asiedu & Lien, 2011; Busse & Groizard, 2008)

El-Fergani, 2004):

1. Investment in the field of natural resources such as gas and oil, where FDI takes centre stage in extraction of these materials and fangs foreign market through exportation.

2. The FDI also targets local markets, which often at times face challenges and barriers to importation of some commodities. FDI invests in producing local goods to overcome this barrier. This mainly applied in manufacturing sector in 1960s and the 1970s as the policy of import substitution became popular among developing countries;

3. Investments probing of quality performance as the case with some companies in the industrialised countries, which relocate their investments elsewhere for cost-cutting purposes and to raise more profits. Developed countries are faced with the challenge of extremely high cost of labour, which increases the cost of production hence the need to seek cheaper labour from less developed countries. This theme constitutes the main aspect of Japanese investment in Asia, U.S. investment in Mexico and Central America, and European investment in Central and Eastern Europe;

4. FDI may also take the form of strategic investment. In this investment category, international organizations seek the sharpening of skills through investment in relevant countries. Examples of this form of investment include the numerous centres for R&D in Singapore, the computer programming development centres in India, and the airline booking centres in the Caribbean.

Developments and Trends in FDI globalisation

Lately there is a remarkable upsurge in the globalization of foreign capital and mainly FDI inflow has increased drastically in third world countries, as a result of stable and prevalent component of foreign capital inflows (Adams, 2009). FDI has played a major role by creating major returns and other economic benefits such as creation of employment economic growth and stability.

The yearly sum of FDI inflows was $13.346 billion in the year 1970, but 28 years down the line to 2008 it was increased to $1,697.353 billion. Back then the share of FDI inflows equalled only 0.50% of world gross domestic product (GDP), but currently this share has gone up to close to 2.78%. FDI inflows as a percentage of gross fixed capital formation equalled about 2.26% in 1970, while it augmented to around 16.15% in 2007 (UNCTAD 2009). The initial figure clearly depicts how developed nations account for majority share of FDI inflows even though there has been some significant growth in developing countries. The more the amount of capital invested in a given economy the better the future prospects of that economy hence FDI has greatly influenced the source of capital investment. This thereby also affects the level of growth that relates to a country's economy stability.

3.2. FDI effect on economic growth in the mother country

There is an explanation as regarding the aspects the FDI plays in hastening the level of economic growth in third world countries. Current theories of economic growth portray that FDI is a major force in changing the level of improving in technology by provision of more advanced ideas and innovation (Grossman & Helpman, 1994; Barro & Sala-I-Martin, 1995).

On paper we learn that FDI contribute to growth in the economy in various ways but majorly it can be analyzed from two broad categories (De Mello, 1999; Kim & Seo 2003). First, FDI can influence economic growth through capital accumulation by introducing new commodities and foreign technology. This perception is derived from exogenous growth theory view. On the other side, FDI can improve economic growth by enhancing a supply of knowledge in the parent country through knowledge transfer. This view comes from the viewpoint of endogenous growth theory. Summative conclusion from these theory is that FDI can promote economic growth by providing the required capital and required technological knowhow (Herzer, Klasen & Nowak-Lehmann D, 2008)).

Recently FDI has greatly contributed to the amount of capital raised in third world countries through various means such as facilitating of level of saving in the domestic economy, which raises the amount of capital required. Economic growth has a direct relation with FDI and this takes three forms:

A. FDI may influence economic growth directly through an investment channel.

B. FDI may also affect economic growth in an indirect manner by influencing the crowding effect.

C. Lastly FDI can also affect economic growth indirectly through promoting technological advancement in the parent country by creating positive externality (spill over effect) or by crowding-in DI through the linkage effect.

To add on this De Mello (1997) provides an argument that FDI promotes growth through capital accumulation by introducing new inputs and the importation of commodities with state of the art level of technology through the use of intermediate products. This concept similarly is shared by (Colen, 2008) who is of the opinion that economic growth is enhanced directly by FDI through expansion of the amount of capital available in the parent nation.

The level of economic growth that is affected from amount of capital accumulation is not only in the short run period but can also be seen from a long-term perspective. This is only attained through permanent raise in the level of technology, taken to be exogenous in this theory. From a different viewpoint, FDI may be regarded to be of more significance than domestic investment and other capital flows for growth. Basing on the definition of FDI as a whole package of resources including physical capital, state of the art technology and also production techniques, managerial and market knowledge. All these components have a left over effect to the domestic economy and therefore FDI directly has an impact and more strongly than domestic investment in speeding up the level of growth in the host economy. The reason behind this is that FDI Is more progressed technologically and with a more efficient level of management (Colen et al. 2008).