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.
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. Since investors seek to optimise productivity of their investments, these are likely to introduce advanced equipment and systems in local business firms to boost performance. Third benefit of foreign direct investment is the enhancement of competition in the receiving economy. The increase in industry output relative to demand has a lowering impact on price, adding welfare to consumers. Fourth benefit is concurrent growth in domestic investment. Business growth influencing a cycle of growth encourages local investments. Fifth benefit is access to export markets via the investor when foreign investments pour into manufacturing operations targeting local consumption and exports. Sixth benefit is the alleviation of the foreign exchange gap, which occurs because of limited savings or limited foreign exchange. Foreign direct investment can influence both causes to stabilise foreign exchange. (Markusen & Venables, 1999)
However, there could also be adverse impacts of foreign direct investments. First is the capital flow into an industry where there is already a monopoly exported would increase output and reduce prices of exports resulting to negative welfare effects. Second, capital flows could affect weaker local business firms (Cooper, 2002).Third is the greater benefit to the source economy more than the host economy especially when foreign direct investment targets primary commodity exports leading to deterioration in the terms of trade of the host country. Fourth, foreign direct investments usually flow through developing countries abundant in resources but with weak infrastructures. Weak infrastructure makes the host economy susceptible to resource and market exploitation (French, 1998; Taylor, 2000).
Overall, the role of foreign direct investments on developing countries depends on the offsetting effect of benefits and adverse impacts. Benefits should outweigh the adverse effects but there would always be costs for the host economy. Even with positive effects on the economy, there would always be changes in the recipient economy.
Role and Impact of Foreign Direct Investments on Small Island States
Read (2004) explained that globalisation and regionalism are factors determining the growth of small island states. These factors determine growth in terms of the extent of foreign direct investment from other economies to support the development of industries, the existence of market for its industries, and support in the development of its economic and political infrastructures. Foreign direct investment plays a key role in the development of infrastructures through capital flows and indirectly, information and technology sharing as well as the growth of various industries revolving around the abundant resources in the economy.
However, Mellor (1997) also explained that globalisation create risks for small island states particularly the decline in exports because of competition from other economies able to trade the same products at lower costs. As such, the lowering of trade barriers would work to the disadvantage of small island states without sufficient economic infrastructures to support the competitiveness of exports and local industries.
Hampton and Christensen (2002) provided that one form of foreign direct investment that led to the growth of many small island economies came in the form of offshore finance. The entry of foreign direct investments through offshore finance highly depends on a sufficient and stable financial and banking infrastructure in small island states to attract this form of investment. The benefit for small island states is the existence of funds to support the growth of local industries in the form of loans as well as the creation of jobs especially in the banking sector. However, the downside is the concentration of economic activities in one industry creating risks.
Another form of foreign direct investment is through capital flows in the industries of small island states. Bräutigam and Woolcock (2001) propounded that not all small island states have strong financial infrastructures to attract offshore accounts. Baldacchino (2002) explained that some small island states primarily have cottage or small industries revolving around tourism services and small-scale manufacturing. As such, these small island economies cannot experience a similar benefit from foreign direct investment via offshore accounts. The benefit from capital flows is in the form of the acquisition of these small firms to comprise subsidiaries for foreign firms or via outsourcing of production to small island states. However, the downside is again the concentration of the development in industries conducive to the needs of foreign investors such as manufacturing and tourism. There would be an imbalance in the development of various industries.
Makola (2003) explained that in the case of African economies, the attraction of foreign direct investment is in the form of outsourcing of production by many global companies. One abundant resource in African countries is abundant labour resulting to the ability to offer labour at low prices. Even small island states forming part of the African region were able to draw significant foreign direct investment through low cost labour. In the short-term, the impact is the creation of employment opportunities in selected industries depending on the extent of skills development of the labour force. In the long-term, the positive impact is the provision of income for households and consumption and the adverse impact is again the limitation of growth in selected industries. If this happens, small island states need to enhance benefits from foreign direct investments to offset or even outweigh the adverse impacts.
Chapter 3 Methodology
Research Design
The methodological framework applicable to the investigation of the importance of foreign direct investment in small island states follows the research onion model (Saunders, Lewis & Thornhill, 2003) shown the in Appendix. This model considers various methodological concerns in the research process.
Research Philosophy
The research adheres to the objective approach described as the perception of reality of social entities outside of social actions (Saunders, Lewis & Thornhill, 2003). This means that reality exists even without action from a social entity, which in the investigation is the researcher. The objective approach supports the research because the focus is on the structures, systems, processes and relationships revolving around the role and impact of foreign direct investment on Seychelles, a developing small island state. These are realities existing without the significant influence of the researcher. Objectivity also refers fact-based research process (Gill & Johnson 1997), which comprises the perspective of the researcher in the collection and analysis of data.
Research Approach
The study aligns with the inductive approach, which is the drawing of generalisations from a wide range of specific data, which in the research comprise of information on the overall situation of Seychelles, its economic infrastructures, and nature and extent of foreign direct investments. These would support interpretations on the role and impact of foreign direct investment in Seychelles and conclusions on the importance of foreign direct investments to developing island states.
Research Strategy
The research utilises case study as investigative strategy. Robson (2002) described the case study strategy as the empirical method of inquiry or “strategy for doing research which involves an empirical investigation of a particular contemporary phenomenon within its real life context using multiple sources of evidence” (p. 178). Yin (1984) also explained case study as the method of deriving evidence from a wide range of sources in support of a comprehensive understanding of situations. This applies to the study for two reasons. One, the focus of the study is the phenomenon of foreign direct investment in small island states. The other is the derivation of a wide range of information on the phenomenon in the specific context of Seychelles.
Methodological Choice
The choice of investigative methodology is mono method, particularly the qualitative method. Rubin and Rubin (2006) described the qualitative method as involving the process of coming up with detailed or in-depth descriptions or information on the phenomenon subject of the investigation. The use of a single method supports the study since the purpose is to derive thorough information to support conclusions on the importance of foreign direct investment to small island states.
Time Horizon
Cross-sectional is the study’s time perspective. Saunders, Lewis and Thornhill (2003) explained cross-sectional studies as the investigation at a certain point in time. This aligns with the study since the focus is to determine the importance of foreign direct investment to Seychelles at present or as of the time when data collection commences and concludes. Historical information on Seychelles comprises the context of the investigation. Data collection comprises a two-month period, which is short enough for the phenomenon not to change radically but long enough to allow comprehensive collection of data.
Techniques and Procedures
Data Requirements
The data requirement for the research comprises secondary data, which are information drawn for its intended purpose different from the current study. The reporting of secondary data could be as raw data such as statistics or as interpretations, conclusions and generalisations. Sources of secondary data are books, journals, papers and reports, and relevant online sources.
Data Collection Method
The method of collecting data is desk or secondary research. This pertains to the concurrent processes of collecting, integrating, classifying, interpreting and analysing data from secondary sources. This is the opposite of primary data collection, which derives data from key respondents. This is the appropriate strategy because the requirements and scope of the investigation encompasses the entire economy of Seychelles and the operation of foreign direct investment in Seychelles. The type of data required includes articles and books discussing the pertinent concepts, the results of previous studies, and official reports and statistics.
Data Analysis Method
The manner of analysing the data involves the identification of themes that would also comprise the sub-sections of the research report, drawing of implications on the phenomenon studies, and making of conclusion on the data found relative to the research questions and objectives. Deriving generalisations on the importance of foreign direct investments on developing small island states and small island states in general also comprise an analytical tool.
Validity and Reliability Issues
Research issues emerge relative to the choice of methodological framework. One issue is reliability explained by Easterby-Smith, Thorpe and Lowe (2002) as the degree that the selected approaches, strategies and methods lead to consistent results. The reliability issue in the study is researcher bias or degree of impartiality of the researcher during the research process. Since desk research is the method of data collection, the extent or range of information derived and interpretations greatly depend on the researcher. The resolution of the issue is by using a wide range of secondary sources to represent various perspectives. In this way, the perspective of the researcher finds balance with divergent perspectives resulting in less biased outcomes. Another issue is validity or the extent that findings reflect the phenomenon studied (Easterby-Smith, Thorpe & Lowe, 2002). Achieving valid data in the study is through the derivation of comprehensive data guided by the research questions and objectives. This ensures that derivation of an accurate understanding of the research phenomenon.
Timeline
The research process involves a six-month period as shown the table below. The collection of secondary data through desk or library research takes the longest time because this is critical aspect of the research.
1st month
2nd month
3rd month
4th month
5th month
6th month
Draft of the Research Proposal
Approved Research Proposal
Desk/Library Research
Data Analysis
First Draft of the Research Report
Second Draft of the Research Report
Final Research Report
Chapter 4 Case Study
Historical Development of Seychelles
The written history of Seychelles first emerged in 1502 through the accounts of Vasco da Gama, a Portuguese explorer. In 1742, a French expedition went to explore the island followed by another expedition in 1756. It was during this time that Seychelles received its name in honour of the then finance minister Moreau of Seychelles. The French first colonised the island. French immigrants brought their slaves and established agricultural production establishing the plantation industry with the intention of competing with the Dutch in the spice trade. To provide labour to the plantations, Seychelles was a destination of the African slave trade. Then in 1794, the rulership changes as Seychelles came under British control but with the government run in Mauritius. During the succeeding thirteen years, the rulership changed between the British and French through sea battles affecting economic development in the island. IN 1811, the series of wars ended with Seychelles falling under British occupation as a dependency of Mauritius. The Treaty of Paris in 1814 officially made Seychelles part of the British territory. In 1835, two significant events occurred, which are the abolition of slavery and the establishment of the Roman Catholic religion. In 1888, Seychelles ceased to be a dependency of Mauritius with the establishment of executive and administrative councils for the island. In 1897, the councils received power to govern Seychelles then n 1903 Seychelles became an autonomous British colony. (“Seychelles—History”, 2007)
The 1940s brought important political changes to Seychelles with the first election of the legislative council in 1948. In 1964, socialist and democratic parties emerged. By 1970, the elected leaders of Seychelles negotiated with Britain over the independence of the island together with the creation of its constitution. Finally, in 1976, Seychelles became an independent republic ruled through the parliamentary system and regained territorial control over the three smaller islands of Aldabra, Des Roches and Farquhar. Seychelles has a short history as an independent country by achieving independences a little more than thirty years. (“First Republic”, 2008)
During its initial years of independence, Seychelles experienced political and economic instability, a situation it shared with other newly independent African states. IN 1977, the Prime Minister France Rene deposed President James Mancham and made himself the new president. His programs aimed to redistribute wealth from the limited number of wealthy families to the greater population but this revolutionary stance led to the displacement of 10,000 people. In 1978, President Rene changed the constitution to establish a one-party system. In the next decade, many coup attempts with the help of mercenaries from South Africa sought to restore the deposed Mancham into office but these failed since President Rene found help from Tanzania. (“Second Republic”, 2008)
In 1991, pressures from the international community established the multi-party system expressed in the constitution of 1993. He successively ran for office and won for four consecutive terms. His presidency was responsible for the adoption of the free-market economy in the late 1990s. President Rene stepped down in 2004 and replaced by Vice President James Michel who remains as president at present. (“Third Republic”, 2008)
Situational Analysis (PESTLE)
Political Situation
Seychelles has achieved a stable political situation. Although there are criticisms over the state of democracy at Seychelles, its restoration of the multi-party systems and the cease of coups support a peaceful political system, albeit there is room for improvements. The ruling Constitution of Seychelles established in 1993 provides for democratic governance with the President and Vice President as the executive leaders, a 34-member legislature comprising a unicameral law making body, and a judiciary appointed by the executive. The president plays the role of head of the state and head of the government. The president’s term is for five years for a maximum of three terms. Twenty-five members of the legislature serve through popular mandate and the selection of the remaining nine members depend on the political parties winning a minimum of ten percent of popular votes depending on the proportion of votes obtained. The unicameral legislature consists of the 34-seat National Assembly. The members of the legislature also serve five years as representatives of Seychelles twenty- three districts. (“Seychelles—Government”, 2007)
Economic Situation
Seychelles has a developing and changing economy. Consistent with its economic history, the economy of Seychelles revolves around agricultural production. Seychelles grows various agricultural products including bananas, cassava, cinnamon coconuts, sweet potatoes, and vanilla. Fishing and boat building are also important economic industries in Seychelles. The tourism sector is a recently emerging industry since the post independence of Seychelles. Another developing sector is offshore finance as Seychelles starts to build its banking and finance infrastructures. These four industries comprise the economic backbone of Seychelles. Major exports of Seychelles include canned tuna, cinnamon bark, copra, frozen fish, and vanilla. All other food and non-food products and equipment needed by Seychelles comes from importation from Great Britain, France, South African, Saudi Arabia and Spain. (“Seychelles—Economy”, 2007)
Socio-Cultural Situation
Seychelles has a population of more than 80,000 people. The population is of mixed or multicultural descent with the people having African, French, Arab, South Asian, and Chinese ethnic backgrounds. More than eighty percent of the population of Seychelles adhere to the Roman Catholic religion with minority groups adhering to Christianity, Hinduism, and Islam. English is the official language but majority of the population speak Creole. (“Seychelles—Land and People”, 2007) Seychelles also has a relatively high literacy rate when compared to other African states and there is concurrently low level of unemployment (UNDP, 2008).
Technological Situation
Seychelles technological capability is still developing since it was only in September 2007 that the government approved the ICT policy for the country. Before the ICT policy, the technological capabilities of Seychelles revolved around marine research technologies funded by different private institutions and foreign aid. Foreign aid also funds its ICT policy. (“Seychelles launches ICT policy”, 2007) In addition, catering to tourists also led to the establishment of telephone lines. This means that Seychelles industries could benefit from technological transfers brought about by foreign direct investment.
Legal Situation
The regulatory environment for business in Seychelles has strong and weak points. The World Bank (2008) explained that existing laws and regulations in Seychelles provide incentives for investments in the areas of taxation, investment protection, property registration, business permits, and contract enforcement but create disincentives in the areas of closing a business, obtaining credit, employing workers, and overall ease of doing business. This means that similar to the regulatory framework in other African states, Seychelles needs to improve further its regulatory framework to support domestic business and draw foreign investments.
Environmental Situation
Seychelles has limited natural resources. The state is focusing on implementing marine biodiversity programs to ensure sustainability of its marine resources. Since one of the developing industries is tourism, Seychelles needs to focus on environmental conservation and sustainable development.
Nature of Foreign Direct Investment Needed
Based on the current situation and available resources of Seychelles, the foreign direct investment it needs to support the development of its tourism and offshore finance industries and other industries is in the form of transfer of physical, processes, skills and systems, and technologies through subsidiaries or joint ventures together with capital flows in terms of foreign exchange. Seychelles also have a food manufacturing industry so that the focus of foreign direct investments is likely to its tourism industry, offshore finance sector, and small food manufacturing industries.
Means of Obtaining Foreign Direct Investment
The process of obtaining foreign direct investments is through engagement in bilateral and unilateral trade agreements to promote the economy and its industries to other countries together, the development of the infrastructures needed to provide incentives for investors particularly improvements in its business regulatory regime, and building of the skills of its labour pool to support the labour resource needs of foreign investors. Focusing on incentives for investors would support the entry of foreign direct investment.
Impact of Foreign Direct Investment
The entry of foreign direct investment in the tourism, offshore finance, and food manufacturing sectors would provide benefits and drawbacks to the economy of Seychelles. Benefits include the creation of jobs, growth of industries, foreign exchange stability, and skills and technology transfer. Possible adverse effects include the decline in other sectors particularly agricultural sector resulting to unemployment. Limited or mismatch in skills of the labour pool from the agricultural sector with the demands of the growing industries would lead to the need for foreign labourers, which in effect would not address the unemployment and labour displacement problem. Nevertheless, since Seychelles has a high rate of literacy, it is easier for the state to retrain its workforce to address the skills level required by foreign investors. Nevertheless, having a skilled workforce could also become a problem for foreign investors relative to the cost of employment especially in the tourism sector and food manufacturing sectors. The relative consideration of the benefits and drawbacks would determine the extent of impact of foreign direct investment on Seychelles.
Importance of Foreign Direct Investment
Foreign direct investment is important to Seychelles in terms of providing capital directly to individual business firms or indirectly via loans through the banking and finance sector. The importance of foreign direct investment to Seychelles would be in terms of 1) its specific impact on growth in industries and 2) overall effect on the Seychelles economy. The importance would also consider the results of the weighing of the benefits and drawbacks.
Chapter 5 Conclusion
Summary of Results
This would contain a summary of all the important points by integrating the literature review and the results of the case study.
Conclusions
This would include implications of the results relative to the research questions and objectives. The research questions could comprise the sub-sections of this chapter. At the end, generalisations relative to Seychelles, developing small island states, and small island states in general.
Recommendations for Future Research
Recommendations for future research include the expansion of the study to include a comparison of two or more developing small island states or the comparison of the role of foreign direct investments on developing and developed small island states.
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Appendix
Research Onion Model
Source: (Saunders, Lewis & Thornhill, 2003, p. 102)
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