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Chapter 2
Literature Review
The purpose of this chapter is to review theories and apply theories to
Cambodia’s determinant factors of FDI. This chapter is divided into 3 sections:
Section 1 : The theories and the determinants of foreign direct investment (FDI) activities.
Section 2 : Empirical evident on the determinant of foreign direct investment.
Section 3 : Overviews economic and foreign direct investment in Cambodia
a. The theories and the determinants of Foreign Direct Investment
activities
The theory of the determinants of MNE activity explains both the location of
value adding activities, and the ownership and organization of these activities. The
first is the theory of international resource allocation based upon the spatial
distribution of factor endowments and capabilities. This theory chiefly addresses itself
to the location of production. The second is the theory of economic organization,
which is essentially concern with the ownership of that production and the ways in
which the transactions relating to it (including those which may impinge on it
location) are managed and organized (Dunning 1993: p. 66).
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1. The Product Cycle Model
The earlier influential approach in explaining FDI was that of Vernon’s
product cycle hypothesis (1966). The product cycle hypothesis states that based on the
comparative advantage arising from the pattern of factor endowments; initially
a product was invented in the home country with comparative advantage in
technology and innovatory capabilities, and produced for the home market in the
home country near to both its innovatory activities and markets. At a latter stage of
the product cycle, because of a favorable combination of innovation and production
advantages offered by the home country, the product was exported to other countries
most similar to the home country in demand patterns and supply capabilities.
Gradually, as the product becomes standardized or mature and labor becomes a more
important ingredient of production costs, the attractions of sitting value-adding
activities in a foreign, rather than in a domestic, location increase. Eventually, if
conditions in the host country are right, the subsidiary could replace exports from the
parent company or even export back to the home country.
2. The Internalization Theory
In the mid 1970s some economists, for example Buckley and Casson
(1976), Lundgren (1977), and Swedenborg (1979), proposed the application of
internalization theory to explain why the cross-border transaction of intermediate
products are organized by hierarchies rather than determined by market forces. The
basis hypothesis of the internationalization theory is that multinational hierarchies
value-added activities across national boundaries to that of the market, and that firms
are likely to engage in FDI when ever they perceive that the net benefits of their joint
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ownership of domestic and foreign activities, and the transactions arising from them,
are likely to exceed those offered by external trading relationship. Internalization of
theory give a particular distribution of factor endowments, MNE activity will be
positively related to the costs of organizing cross-border markets in intermediate
products.
Internationalization theory is mainly concerned with identifying the
situations in which the markets for intermediate products are likely to be internalized,
and hence those in which firms own and control value-adding activities outside their
natural boundaries. Buckley and Casson’s (1976) assertion that MNEs are typically
both vertically and horizontally integrated led them to a model centered on the
relationship between knowledge, market imperfections and the internalization of
markets for intermediate goods. This comprehensive treatment of vertical and
horizontal FDI is possible in so much as “the vertically integrated firm internalizes a
market for an intermediate product, just as the horizontal MNE internalizes markets
for proprietary assets” (Caves, 1996: p.13).
Buckley, (1991) suggested that, it is better described as a paradigm than a
theory, in as much as the kinds of market failure that determine one form for foreign
added value activity may be quite different from that of another.
As Buckley and Casson observed, for multinational enterprises to serve
foreign markets through direct investment rather than alternative modes of doing
business, like exporting or licensing, there must exists some internalization
advantages for the firm to do so.
The internalization approach incorporates the idea of market imperfections
identified by Hymer and extends it to provide an explanation for the existence of
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multinational firms across national boundaries. In general, it argues that, faced with
imperfections in the markets for intangible assets and imperfect information, firms
tend to internalize operations to minimize costs of transactions and increase
productive efficiency. While this approach emphasizes the importance of transaction
costs resulting from market imperfections, both Buckley (1987) and Casson (1987)
have acknowledged the need to integrate location-specific variables with
internalization variables to explain the MNE activities.
Buckley and Casson (1976: pp.37-38) specified five types of market
imperfections that call for internalization:
When the co-ordination of resources over a long period is needed;
When the efficient exploitation of market power requires
discriminatory pricing;
When bilateral monopoly produces unstable bargaining situations;
When the buyer cannot price correctly the (usually intangible)
goods on sale, or when public goods are involved;
When government interventions in international markets create
incentives for transfer pricing.
3. The Eclectic Paradigm
One organizing framework was proposed by Dunning (1980, 1981a, 1981b,
1993), who synthesized the main elements of various explanations of FDI, and
suggested that three conditions all need to be present for a firm to have a strong
motive to undertake direct investment. This has become known as the “OLI”
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framework: ownership advantages, location advantages, and internalization
advantages.
a) Ownership specific advantage:
It is to what extent a company is able to, and interested in, engaging in
foreign direct investments in dependent mainly on the possession or the ability to
acquire ownership of specific advantages, patents, management knowledge, capital,
brand name and manpower allows the company to go abroad.
A firm’s ownership advantage could be a product or a production
process to which other firms do not have access, such as a patent or blueprint. It could
also be some specific intangible assets or capabilities such as technology and
information, managerial, marketing and entrepreneurial skills, organizational systems
and access to intermediate or final goods markets (Dunning 1993). Whatever its form,
the ownership advantage confers some valuable market power or cost advantage on
the firm sufficient to outweigh the disadvantages of doing business abroad. Although
ownership advantages are firm specific, they are closely related to the technological
and innovative capabilities and the economic development levels of source countries.
b) Location advantages:
It involves a number of factors that favor a location in comparison to an
alternative location to the extent that a company, which is to engage in a FDI, chose
the particular location a head of the competing location (Ekstrom, 1998). The factors
deciding the location of the foreign direct investment involve labor costs, marketing
factors, trade barrier and government policy (Hood & Young, 1982).
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It is included not only resource endowments, but also economic and
social factors, such as market size and structure, prospects for market growth and the
degree of development, the cultural, legal, political and institutional environment, and
government legislation and policies (Dunning, 1991 a) .
Labor costs are affected by imperfection in the international market for
labor. Since regulations for immigration exist worldwide, the mobility of labor is
reduced and differences in wage costs arise. This create different production cluster
area around the world, each specialized in different wage level. An example of this is
the low wage area in Southeast Asia producing toys and clothing, and on the other
hand Western Europe with it high tech production and high wage levels.
Marketing factors also affect the alternative location of FDI. Market
size, market growth, stage of development and the presence of local competition will
affect the decision of where to locate a FDI. In some market domestic brands are
preferred, and a presence in a specific market is needed for success. The location of a
FDI in that specific market is therefore essential to be able to label products “made
locally” (Daniels & Radebaugh, 2001).
The existence of trade barriers is a factor that influences the choice of
location for FDI. Trade barriers encourage companies to make FDI in markets that
would be too expensive to export to, due to tariffs and quotas (Hood et all., 1982).
Apart from labor costs, marketing factors and trade barriers, government
policy also affects the decision of where to locate FDI. Companies evaluate the
investment climate in the home country; meaning the political, social and economic
environment. This climate affects the perceived risk of locating operations in the
specific location.
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The reason why the location advantage is of such importance is the
relationship between the expected profitability of exporting versus the expected
profitability of locating operation a broad. The location advantages can then either
favor the decision to stay in the home country, or to locate operations abroad
examples of reasons for internalizing operations to specific location are; market size
and growth, source of supply, transportation costs, trade barriers and physical
distances (Ekstrom, 1998).
c) Internalization:
The multinational enterprise must have an internalization advantage. If a
company has a proprietary product or production process and if it is advantageous to
produce the product abroad rather than export it, it is still not obvious that the
company should set up a foreign subsidiary. One of other alternatives is to license a
foreign firm to produce the product or use the production process. However, because
of market failures in the transaction of such intangible assets, the product or process is
exploited internally within the firm rather than at arm’s length through markets. This
is referred to as an internalization advantage.
4. Factors influencing choice of location
In an attempt to explain the underlying factors that are influencing the
choice of host market, Gilomre, O’s Donnell, Carson and Cummins (2003) presented
ten factors. These factors are explained below.
a) Knowledge and experience of foreign market:
The more information and experience a company has about a certain
location, the more likely it is that this company invests there. Increased knowledge
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about a foreign country reduces both the costs and uncertainty of operating in that
foreign market place (Gilmore et al 2003).
b) Size and growth of the foreign market:
Factors like proximity and access to a free trade area, the size of the
foreign market and its growth potential are regarded as key factors according to
Gilmore et al. (2003). Regarding the free trade area one should keep in mind that the
size and growth of that particular free trade area may be more important that the size
and growth of the particular country in which the company is about to invest.
c) Government emphasis on FDI and financial incentives:
If the government of the host country actively works to attract FDI, then
that country will be more attractive compared to a system with government bodies forcing
the foreign investors to undertake lengthy, bureaucratic processes before the investments
are approved. Examples of incentives are; generous tax incentives, worker-training
support packages, good transport facilities and well developed telecommunications.
However, Gilmore et al. (2003) argue that, based on earlier research studies, financial
incentives have relatively little impact on the choice of location.
d) Economic policy:
Inflation, tax rates and the tax structure of the host country are examples
of economical policy factors and these examples are also key investment
considerations. Several studies have shown that the rate of corporate taxation has a
negative effect on investment decisions, meaning that the higher corporate taxes the
fever investments are conducted.
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e) Cultural closeness:
The cost for entering a market, which is similar in culture to the home
market, is smaller compared to entering a market with few cultural similarities.
However, there is a disagreement among researchers about the extent to which
companies prefer to invest in markets exhibiting near and similar cultures.
Nevertheless, most companies tend to successively enter markets at an increasingly
cultural distance from the home country.
f) Cost of transport, material and labor:
Transport and raw materials are key cost factors that companies take
into consideration when conducting an FDI. However, the cost of labor has been more
extensively explored in the FDI literature and the research has produced mixed
feelings. Dunning (1980), for example, has conducted research showing that higher
wages reflect a more productive workforce and associated with increased foreign
investments. At the same time, other researchers have come to the conclusion
showing the reverse effect, meaning that high salaries have a negative impact on the
flow of FDI (Gilmore et al., 2003).
g) Availability of resources:
Companies conducting FDI are influenced by the availability of
resources, in particular labor and raw materials. Population density and
unemployment rates are two examples of labor related factors, while the standard and
amount of local suppliers are raw material related factors, while the standard and
amount of local suppliers are raw material related factors. However, the importance of
availability of raw materials has recently showed to have less impact since raw
materials are already often sourced on a global basis. Concerning the human resources
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the single most important factor is to what the education of the workforce are
comparable to the needs of the specific company.
h) Technology:
Access to technology is considered to be one of the most important
factors concerning investment location, and especially the ownership level of the
investing company in today’s globalize markets. It is important to note that high
levels of research and development expenditures are not necessarily connected to a
high level of technological advancement.
i) Political stability:
A great concern for companies conducting FDI is that host government
will “change the rules of the game” within the industry where the company is active.
Therefore, a climate with political stability is very attractive for companies active on
the global market.
5. OLI versus internalization
The generalized predictions of the “OLI” framework are straightforward. At
any given moment of time, the more a country’s enterprises, relative to those of others
possess ownership advantages, the greater the incentive they have to internalize rather
than externalize their use, the more they find it in their interest to exploit them from a
foreign location, then the more they are likely to engage in foreign production. The
framework also can be expressed in a dynamic form. Changes in the outward or
inward direct investment position of a particular country can be explained in terms of
changes in the ownership advantages of it enterprises relative to those of other
nations, changes in its location advantages relative to those of other countries, and
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changes in the extent to which firms perceive that these assets are best organized
internally rather than by the market (Dunning, 1993).
Dunning (1993a: p.85) argues that “the eclectic paradigm is less an
alternative theory of international production than one which pinpoints the essential
and common characteristics of each of the mainstream explanations”. That is the
reason why he renamed it ‘paradigm’ instead of the original ‘theory’. However, the
claim that the eclectic paradigm has uniquely the global explanation of international
production is not universally accepted. Rugman (1980), in particular, claims that
internalization is in itself a general theory of foreign direct investment. He extensively
analyzed previous contributions to the theory of FDI to demonstrate that
internalization is the key element in all existing explanations. Buckley (1983a) saw it as
the consequence of applying static concepts to a dynamic issue - the growth of the firm.
Dunning’s distinction between asset and transaction ownership advantages may be
seen as a concession to this criticism (Corley, 1992: p.11). But Casson (1987)
admitted that the empirical work recognizes the importance of ownership advantages.
Ownership advantages may be dynamic and volatile, but they are the factors
that, by being internalized, allow firms to cross borders and become MNEs. Dunning
(1991) accepts that the internalization theory has the leading explanation of why a
firm should choose to engage in foreign investment. But he dismisses its capacity to
explain the level, structure and location of all international production. Dunning sees
the internalization theory not as an alternative but as a very important contribution to
his approach. One, he admits, that considerably influenced the evolution of his view
of foreign direct investment (1991: pp.122-123). Since the very beginning, and
despite the many subsequent developments, the internalization approach is a theory of
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the firm that chose to cross national borders - a theory of the MNE. By contrast, the
eclectic paradigm is a theory of FDI. It wraps the theory of the firm with the
macroeconomic and socio-political environment in which the decisions are made:
“The main difference between the determinants of intra-national and international
production lies in the unique economic, political and cultural characteristics of
separate sovereign states” (Dunning, 1993a: p.86).
6. Motives for foreign production
The motives for firms to engage in foreign production can be classified in
four groups: natural resources seeking, market seeking, efficiency seeking and
strategic asset seeking.
Natural resources seeking FDI is justified by the fact that these resources,
e.g. minerals, raw materials and agricultural products - tend to be location specific.
The need to guarantee a cheap and safe supply of natural resources justified much of
the FDI flows in the 1800s and early 1900s, largely from the most industrialized
nations (i.e. Europe, USA and Japan) to the less developed areas of the globe
(Dunning, 1993a: pp.110,124).
Market seeking corresponds to FDI that aims at supplying the local market
or markets in adjacent territories. It may represent a deeper involvement of the firm,
following the success of exports, or the expansion of the firm to a wholly new market.
Transportation costs and government regulations are the main reasons behind market
seeking FDI. However, Dunning (1993a: pp.58-59) suggested that strategic reasons
may also be associated with this type of FDI. Some examples are to follow the firm’s
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clients in their foreign expansion, the need to adapt products to local conditions and
tastes, or the reduction of transaction costs.
Efficiency seeking FDI has three main forms:
First, and probably the most frequent type, firms often seek to increase their
cost efficiency by transferring production, totally or in part, to low labor costs
locations. This is especially likely to happen in industries where unskilled or semi-
skilled labor represents an important part of the production costs.
The second type of efficiency seeking FDI corresponds to investment
aimed at rationalizing the operations of existing MNEs. The target may be the
exploitation of comparative advantages in adjacent territories (e.g. following a process
of economic integration, such as the creation of the single European market, in 1992),
or to exploit economies of scale and scope across borders. However, prior market
seeking FDI or costs reducing FDI is a pre-condition for this variation of efficiency
seeking foreign investment.
Finally, strategic asset seeking FDI is probably the fastest growing of the
four motives for overseas investment (Dunning, 1994).
In contrast to the other motives for FDI, strategic assets seeking investment
does not imply the exploitation of an existing ownership advantage of the firm.
Instead, FDI may be a vehicle for the firm to build the ownership advantages that will
support its long-term expansion at home and abroad, as argued, for example, in the
network literature. Alternatively, strategic asset seeking investment may not involve
strengthening the firm’s position, but rather to weaken the competitive position of its
competitors (Dunning, 1993a: p.60).
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7. Czinkota and Rokainen’s major determinants of Foreign
Direct Investment.
According to Czinkota and Ronkainen (2001) there are a variety of reasons
for companies to expand internationally. In the table below, we have listed the reasons
of companies conducting FDI according to these authors.
a) Marketing factors:
• Size of market
• Market growth
• Desire to maintain share of market
• Desire to advance exports of parent company
• Need to maintain close customer contact
• Dissatisfaction with existing market arrangements
• Export base
Marketing objectives, the shareholders pressure for increased profits,
and corporate desire for increased growth are major reasons for companies conducting
FDI. In today’s competitive global environment companies are forced to seek wider
market access in order to maintain and increase their sales. The quickest way to
extend the company’s activities internationally is to acquire a foreign firm.
Conducting a FDI as a way of entering a new market provides the company with
better intelligence about the political climate and easier access to opinion makers, as
well as other decision makers.
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b) Trade restriction
• Barriers to trade
• Preference of local customers for local products
Another group of incentives for conducting FDI is to avoid current
barriers to trade like duties, tariffs, import quotas, preferences of local customers for
local products and other trade restrictions. In addition to these trade restrictions and
cultural barriers, companies sometimes are forced to establish a plant or facility in a
foreign country due to the country-of-origin-effect. The country-of-origin-effect
means that a country has a built-in positive stereotype for production location and
product quality.
c) Cost factors
• Desire to be near source of supply
• Availability of labor
• Availability of raw materials
• Availability of capital/technology
• Lower labor costs
• Lower production costs other than labor
• Lower transport costs
• Financial (and other) inducements by government
• More favorable cost levels
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For a firm to stay competitive is has to aware of the cost structure. It is
difficult for a company to compete on market if its costs are substantially higher than
those of the competitors. Therefore, many companies conduct FDI to increase the
availability of labor, raw materials or capital and technology. Another way of cutting
costs is to enter a foreign market that presents the company to lower labor, transport,
and other production cost. Except from these factors, companies also conduct FDIs
due to more favorable cost levels in as specific country, or because a certain
government in a country can offer them financial or other inducements.
d) Investment climate
• General attitude toward foreign investment
• Political stability
• Limitation on ownership
• Currency exchange regulations
• Stability of foreign exchange
• Tax structure
• Familiarity with country
Once a company has made the decision to expand internationally, the
investment climate plays a major role. A company will be reluctant to invest in a
country with low economic growth, political instability and major limitations in
ownership. On the other hand, a company will be positive towards investing in a
country with a positive general attitude toward foreign investments, a stable exchange
rate and where the culture is similar with the culture in the home country.
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8. Rugman and Hodgett’s reasons for foreign direct investment.
Czinkota and Ronkainen (2001) argue that there are five major areas of
reasons for conducting FDI. However, Rugman and Hodgetts (2003) believe that
there are seven major reasons, namely; increase sales and profits, enter rapidly
growing markets, reduce costs, gain a foothold in economic blocs, protect domestic
markets, protect foreign markets and acquire technological and managerial-know-
how. These reasons will now be discussed more thoroughly.
a) Increase sale and profits
When looking at the large and best known MNCs, one can see that they
earn extremely large amounts of money through overseas sales. At the same time,
smaller companies being active in smaller economies need to look outside their home
boarders. Sometimes large MNCs write contracts with local companies and if these
small companies are performing what they are expected too, and then the MNC might
want to extend the contract and allow the small local firm to supply other worldwide
locations. In addition, the global markets often are considered to be much more
lucrative than the domestic market.
b) Enter rapidly growing markets
When new market is emerging they present great opportunities for many
companies. In order to utilize on these benefits the companies have to enter the new
market as quick as possible. One way of increasing the speed of entry is to conduct a
FDI. China, which has been considered as a closed market throughout the history, has
during the past two decades started to move towards a more market-driven economy
and is therefore experiencing and annual growth rate of seven to eight percent. This
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has also lead to more and more MNCs trying to enter the Chinese market and it is
today one of the worlds most attractive markets to enter.
c) Reduce costs
High labor expense or high transportation cost together with a shortage
of supply of materials is two reasons for companies choosing to conduct FDI. A third
reason is the cost of energy. In energy, intensive industries companies might be forced
to move their operations overseas in order to cut costs. A fourth cost is high
transportation costs. If the production facility is located to far away from the suppliers
or the customers, then the transportation costs will disable the company from being
competitive. An example of reducing costs due to production location is the US
companies that have set up operations closely connected, but on each side of the US-
Mexican border, for the purpose of shipping goods between the two countries. US
components are shipped into Mexico duty free, allowing the company to benefit from
the low wages in the country, and after being assembled by Mexican workers the
products are re-export to the US.
d) Gain a foothold in economic blocs
For quite sometime, the EU and NAFTTA (North America Free Trade
Area) have been the two dominant economic blocs. For many international companies
it is crucial to access these blocs from inside, since once a company has established
itself within a free trade area it can export goods to other member nations without
having to pay for customs and taxes. However, a third strong economic bloc is
developing which is called the ASEAN bloc. A common believe is that these
economic blocs will grow stronger over time and finally it will be a must for MNCs to
be presented in all three blocs to stay competitive on the international market.
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e) Protect domestic markets
There are numerous examples of when MNCs have entered a new
market only with the aim to defend their home market. If, for example, a Danish
company enters Sweden, then Swedish companies might react to this by establishing
themselves on the Danish market. This is done to bring pressure on the Danish
company that entered the Swedish market. Furthermore, some companies go
international because their customers on the home market are demanding it, resulting
in a situation where the company either can not meet customer demand or has to
follow their customers out on the international marketplace.
f) Protect foreign market
As well as companies have to defend their home market; they have to
defend all those foreign markets they have invested in. One example of this is to extend
the product line by acquiring a company on a foreign market and merge it with another
company on the same market. However, in to days globalize marketplace it is
sometimes hard to tell the difference between home market and host market for MNCs.
g) Acquire technological and managerial-know-how
A final major group of reasons behind why companies conduct FDI is to
acquire technological and managerial expertise. One way of doing this is to establish
themselves close to leading competitors, or close to universities and other research
centers.
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9. Performance of Foreign Direct Investment
a) Financial capital factor
When business firms invest in foreign countries, capital financing
activities affect their entering mode, and further more, their investment performance.
There is a strong relationship between size of parent companies, dept ratio, size of
investment, parent company’s product growth rate, profit making capability and
capital obtaining capability, source of capital, and capital application. These related
factors can be summed up as the financial capital factor.
Company size is to be measured relative to the capital obtaining
capability. For long-term capital, subsidiary firms largely depend on the parent
company. For many other purposes they may consider the local bank. At any time,
size reflects the business firm’s competitive capability in both output market and in
terms of obtaining finance.
Clearly, bit business firms have better capital obtaining capability, and
more opportunities to enlarge their competitive capability, and capture a bigger
market share; they can better channel their resources than those of small business
firms. So, the performance of big business firms may be better than that of small
business firms. Gomes-Cassers, (1990) Cavusgil & Nevin (1981) measure the parent
company size as the employee number. Their research result verifies that the business
firm size is the predictable index for profitability.
As mentioned before, another factor, investment size, also affects
business firm’s performance. When investing in the foreign countries, business firms
can be assumed to hold the optimistic attitude and a direct result may be, other things
being equal, a high investment size that may lead to a better profit performance.
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Danials (1970), Vernon (1983), and Shama (2000) verify that business firm’s perform
well when parent companies provide abundant capital for investment. Growth rate and
profit capability of parent companies reflect the conditions in the product market as
well as business competition. Business firm which make a profit can supply at least
part of the capital themselves and also can get help to obtain capital from outside in
order to replace the out-of-date plants and facilities and absorb the market risk when
pursuing a rapid growth strategy.
b) Business performance
The measurement of the effectiveness of global operation can be
determined in terms of various aspects with multiple criteria. Chen (2001)
summarized all kinds of criteria in two main categories: objective criteria and
subjective criteria. The objective criteria are based on financial indicators such as
profitability, return on investment, and return on assets. Kan (1997,1998) emphasizes
the relation between location, infrastructure, domestic resource exploitation and
profitability of FDI. Some non financial indicators such as the level of business
survival (Killing, 1983), duration of survival (Harrigan, 1988), and stability of
shareholding (Gomes-Casseres,1987) are also used in the literature Khan and Aghro
(1992) found exchange rates to be a major determinant of FDI in South Africa. The
objective criteria have been used widely in measuring the effectiveness of foreign
direct investment in a firm. But they also have practical constraints. Anderson (1997)
pointed out that the objective indicators, of effectiveness could be only used as part of
measurement dimensions. A firm needs to make use of some relevant qualitative
dimensions to measure its overseas market because it usually takes several years to
show positive financial performance.
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b. Empirical Evident on the Determinant of Foreign Direct
Investment.
1. Domestic market
Empirical evidence of the relevance of the host country’s market as a
determinant of FDI was recurrently found in survey studies and in the investigation of
US FDI in the EEC. Naturally, all the subsequent econometric tests of the location
determinants of FDI included the domestic market as an independent variable. Most
found it to be significant.
The market size hypothesis also derives from neoclassical theory. It was
introduced in the studies of the determinants of FDI as a location variable associated with
economies of scale (Scaperlanda and Mauer, 1969: p.560) and, thus, market
imperfections. It assumes two levels: the absolute size of the market, and its growth rate.
Despite the strong theoretical sense of the claim, the empirical support is
apparently inconclusive. Studies that used data prior to the first enlargement of the
EEC, when new investment was dominant, found market size significant, but not
market growth (Bandera and White, 1968; Scaperlanda and Mauer, 1969). The
opposite was found by Culem (1988) with more recent data. Nevertheless, the results
of Schmitz and Bieri (1972), Lunn (1980) support both hypotheses.
Clegg (1998) tested both variables with data for a 40 years period (1951-
1990). The aggregate data produced very poor results. However, after dividing the
period of analysis there was strong support for the market size hypothesis in the
period 1951-72, and for the market growth hypothesis in the period 1973-90. In other
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words, new investment seems to be associated with market size, while expansionary
investment is responsive to market growth.
2. Export market ]
There is abundant empirical support for the claim that export orientation
attracts FDI (Riedel, 1975; Kravis and Lipsey, 1982; Hein, 1992; Dollar 1992; Lucas,
1993; Jun and Singh, 1996) cited by Dunning (1993).
Most of the empirical evidence of the attractiveness of export markets to
FDI is indirect. The importance of export markets is implicit in the observation that
FDI grew steadily in Europe after the announcement of the creation of the EEC, in the
1950s, and that of the 1992 internal market. The same can be concluded from the
findings of Root and Ahmed (1978) that economic integration is a significant variable
among developing countries.
More direct approaches were used by O’Sullivan (1993). O’Sullivan (1993:
p.141) based his model on the fact that in the period studied (1960-80) foreign
investors in Ireland exported over 80 percent of their non-food output. Since the
United Kingdom was the destiny of a big percentage of these exports, export markets
were proxy by the UK’s real GDP. It was found strongly significant. Lucas (1993)
used an index of foreign GDP to assess the importance of export markets in attracting
FDI to the export oriented countries in East and Southeast Asia. He concluded that
FDI was more responsive to foreign markets than to the home market despite being
both significant.
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3. Government policies and protectionism
There is, however, a clear contradiction between these results and the tariff
discrimination hypothesis discussed above for the studies of US investment in the
EEC. The suggestion was that FDI can be encouraged by barriers to trade
(Schmitz and Bieri, 1972; Lunn, 1980; Scaperlanda and Balough, 1983.
A number of factors help to explain the contradicting results associated with
protectionism. Market imperfections and ‘relative discrimination’ (Clegg, 1996)
between foreign and domestic firms vary widely across industries and countries,
making the results particularly sensitive to sample and methodology. Furthermore,
protectionism often coexists with export orientation. Protected economies can attract
export-oriented FDI by opening selected industries to FDI or by creating export
processing zones.
In any case, barriers to trade tend to be significant only when market
seeking is the main motivation of FDI. When that is not the case, protectionism
becomes less important. Moore (1993) did not find evidence that German FDI was
induced by tariffs in the host countries. Similarly, Kumar (1990) concluded that
protection was not a determinant of investment in India. Dunning (1993a: p.165)
mentions that Agodo (1978) obtained the same result for US investment in Africa.
4. Government incentive
The incentives are a determinant of FDI frequently cited in surveys
(Robinson, 1961; Forsyth, 1972; Andrews, 1971; all cited in Dunning, 1993a).
However, it was the opinion of UNCTAD (1998: p.104) that incentives are not a
relevant determinant of inward FDI. They are much more likely to influence the
36
precise choice of location within a country or region once the investment decision has
actually been made.
Government incentives are difficult to quantify. Kumar (1994) found
incentives less successful than export processing zones. Lim (1983) and Wheeler and
Mody (1992) concluded that they were no substitute for good infrastructure, natural
resources, or an expanding domestic market. Tsai (1991) and O’Sullivan (1993)
claimed that government support was not a significant determinant of FDI in Taiwan
and Ireland, respectively, inspire of massive programs to attract FDI.
5. Natural resource
Owen (1982) found a dummy variable representing natural resources
intensity a significant determinant of FDI in Canada. This is consistent with the
results of Buckley and Dunning (1976), who found a similar variable not significant
for the UK. Taveira (1984) studied the determinants of US investment in two sets of
developed and developing countries and found the percentage of primary commodity
exports in total incentives less successful than export processing zones. Lim (1983)
and Wheeler and Mody (1992) concluded that they were no substitute for good
infrastructure, natural resources, or an expanding domestic market. Tsai (1991) and
O’Sullivan (1993) claimed that government support was not a significant determinant
of FDI in Taiwan and Ireland, respectively, in spite of massive programs to attract FDI.
6. Labor cost
In the case of investment among developed countries labor costs were
normally found to be irrelevant. Some examples are Buckley and Dunning (1976),
Owen (1982), Gupta (1983), Dunning (1980), Taveira (1984), or Culem (1988).
A different conclusion was, nevertheless, reached by Caves et al (1980) and by
37
Saunders (1982). Both studies found wages a significant determinant of US
investment in Canada.
When developing countries were included in the sample, the relevance of
labor costs tended to increase. This was the case with Schneider and Frey (1985),
despite wages being less important than the level of development or the balance of
payments, Lucas (1993), and Kumar (1994). Jeon (1992) found that increasing
domestic wages at home were associated with Korean FDI in developing countries.
Riedel (1975) and O’Sullivan (1993) suggested that relative wages were among the
most important determinants of FDI in Taiwan and Ireland, respectively. Finally,
Flamm (1984) concluded that offshore investments were sensitive to labor costs,
despite a moderate response to wage changes.
Two exceptions to this were Kravis and Lipsey (1982) and Wheeler and
Mody (1992). Neither of the studies found labor costs to have a significant impact on
the location of US subsidiaries in samples that included both developed and
developing countries. Kravis and Lipsey (1982) suggested that labor skills, which
were not accounted for in the model, could be the reason for the unexpected result.
Wheeler and Mody (1992) provided a different interpretation. Their results suggested
that, as the national income increases, market size offsets the importance of labor
costs as a location factor - the loss of one location advantage is compensated by
improvements in the other, which invalidates the regression analysis.
7. Labor skill
Taveira (1984) and Schneider and Frey (1985) used the percentage of
population in secondary education, but found no evidence of its significance. This
38
variable is, however, too aggregated and is probably no more than an indicator of the
level of development.
In fact, school attendance is unlikely to be the relevant element. March
(1988) extracted a sample of 200 British men from the General Household Survey of
which 41 per cent had no qualifications and a further 10 per cent had only an
apprenticeship. However, only 3.5 per cent were classified as unskilled manual
workers. This suggests that even in the presence of low levels of formal education, the
existence of an industrial tradition, for example, may lead to reasonable productivity
levels with low training costs.
Most support for the relevance of labor skills is, in fact, indirect.
Swedenborg (1979) was surprised by a positive relationship between the wages of
foreign Swedish subsidiaries and FDI. Her suggestion was that high wages simply
reflected the skills of foreign workers (Dunning, 1993a: p.164). Lall (1980) and
Kravis and Lipsey (1982) made a very similar interpretation of their results regarding
labor costs, while Lansbury et al (1996) concluded that MNEs were attracted to
Central and Eastern Europe by labor skills as much as by labor costs.
At the firm or industry level, the investigation of the role of labor skills is
much simpler. Lall and Siddarthan (1982) tested both total remuneration and the
proportion of non-production workers in the labor force as determinants of inward
FDI in the US. Neither was significant, which is consistent with the fact that foreign
investment in the US is likely to be predominantly market or strategic asset seeking.
8. Physical and cultural proximity
The development of the internationalization theory (Johanson and
Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977; Johanson and Mattsson, 1988;
39
Vahlne and Nordstrom, 1988) was essentially inductive. Its development was based
on evidence from small samples of Scandinavian firms. But the same conclusions
were reached by Davidson (1980), for example, with a much wider sample. Moreover,
Taveira (1984) found US investment in both developed and developing countries to
be negatively affected by physical distance. Grosse and Trevino (1996) identified an
association between physical and cultural distance and investment in the US.
Veugelers (1991) concluded that a shared language and neighborhood increase FDI.
The latter was equally supported by Moore (1993). Papanastassiou and Pearce (1990)
found dummy variables for EC and Commonwealth countries positively related to UK
investment but a negative association with physical distance. Previous levels of bilateral
trade were identified by Lansbury et al (1996) to be a determinant of FDI in the US.
9. Political risk
Some econometric studies frequently fail to establish a relationship between
political risk and FDI flows (e.g. Chase et al, 1988; Flamm, 1984). Tu and Schive
(1995) combined survey analysis with econometric testing to conclude that political
stability and social order are, in general, preconditions for FDI, but have little
influence on the amounts invested.
This is consistent with Lucas’ (1993) suggestion that events which generate
political instability (e.g. Marcos’ martial law in the Philippines, Park’s assassination
in South Korea) do reduce FDI, but have a short run impact.
Schneider and Frey (1985) found political aid received from Western
countries and the World Bank to have a strong positive effect on FDI in developing
countries, while aid received form the Communist block had a negative impact.
Political instability had, nevertheless, a significant negative impact.
40
c. Overviews Economic and Foreign Direct Investment of Cambodia
1. Current situation of foreign direct investment in Cambodia
Since Cambodia began implementing its new investment law in September
1994 up to the end of 2003, the Council for the Development of Cambodia (CDC) has
approved 957 projects, worth a total of more USD 6,469,622,017 which employed
Cambodian’s labor more than 508, 801 people (See table 2.1).
Table 2.1: Investment project data
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Total
Number of project 26 124 186 205 144 91 61 39 34 47 957 Capital Investment USD
505,698,494
2,242,890,373
763,062,160
744,551,560
853,924,698
447,921,269
218,037,881
204,683,613
237,659,232
251,233,736
6,469,623,016
Labor (person) 13261 36392 70265 128,457 116,235 77,171 33,112 16,408 17,500 N/A 508801
Source: Cambodia Investment Board
All of 957 projects which had been approved, only 477 projects had been
operated (1994 to 2002) with the worth of capital investment in the amount of 2,386.3
million USD (See table 2.2).
Table 2.2 : Investment projects in operation Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 Total
Number of project 10 51 70 84 89 59 46 39 29 477 Capital
Investment($) 219.1 546.1 257 168.7 387.9 307.0 154.1 197.7 148.4 2,386.3Source: Hing Thoraxy, 2003
41
The flow of capitalization from ASEAN countries between first of January,
1995 to the end of 2003 were 2,320,883,663 USD, constituted by the capital investment
from Thailand 199,937,098 USD ranking number 2 among ASEAN countries (see table
2.3). Malaysia is an investment leader in Cambodia because of the huge amount of
capitalization investment in 1995, which the amount of capital up to 1,411,121,067
USD in many projects. But actually, most of projects has not implemented until now.
Table 2.3: ASEAN’s capital investment in Cambodia (USD) Country 1995 1996 1997 1998 1999 2000 2001 2002 2003 Total
Malaysia 1,411, 121,067
193,612,422
65,778,925
124,611,979
13,866,720
2,223,800
50,600,141
1,006,660
5,132,485
1,867,974,198
Thailand 18,554,817
52,366, 919
27,297,898
33,412,267
20,684,928
26,042,055
14,709,701 0 6,868,
512 199,937
,098 Singapore 104,465
,381 32,805,
146 15,120,
278 20,901,
340 1,021,185
8,058,816 1,000,
000 3,705,050
187,077,196
Indonesia 656,000 13,496,318
1,264,583.8
7,935, 637
783, 894
15,137,000 39,273,
432 Vietnam 173,
499.2 431, 030
512, 540
315, 000 24,165
,095 25,597,165
Philippines 1,024,575 1,024,
575
Total 1,534,970,764
292,280,804
109,461,684
187,292,253
36,869,267
51,776,671
66,334,417
26,171,755
15,706,047
2,320,883,663
Source: Cambodia Investment Board
More than 50 % of the FDI in the last few years had flown from ASEAN
countries, followed by those of the Asian-Pacific region, America and Europe. Before
1996, more FDI went to the tourism and hotel sector, particularly in 1995. However,
the textile, garment and agro-industrial sectors have attracted considerable investment
over the last few years.
According to the official figures supplied by the CDC, Malaysia was the largest
investment in Cambodia during 1995–2003, which accounted for 31.32% of total
investments and 70% of investment from ASEAN countries. Malaysia was the first
country to sign a bilateral visa exemption agreement with Cambodia in 1992 and
42
Malaysian investors were the first to come, and thus received a great many investment
concessions, including concessions in mining and forestry. Other important sources of
FDI were Taiwan (8.41%), China (5.36%), Korea (4.86%), the United States (4.12%),
Hong Kong (4.01%), Thailand (3.35%) accounted for 8.6% of ASEAN investment,
Singapore (3.14%), France (3.31%) and UK (1.53%) (See Appendix E).
Foreign investment in Cambodia grew in 1998, but has been constantly
declining in the last 3 years. In 1998, the Council for the Development of Cambodia
approved 144 projects with the capitalization in fixed assets worth of $ 853,924,698
and with the potential to provide 59,279 jobs. CDC also approved 91 projects worth
of $ 447,921,269 in 1999. The amount of investment capital was decreased 47.5% in
1999 comparing to 1998. It was also decreased about 51.3% in 2000 comparing to
1990 and 6.1% decrease in 2001 comparing to 2000. Comparing 2002 with 2001, the
capital investment has been increased 16% and also further increase 6% in 2003
comparing to 2002 (See Appendix E).
According to data from investment project monitoring, most of the present
investment activities try to take advantage of the special trade rights under the Most
Favored Nation (MFN) and General System of Preferences (GSP) that the United States,
European Community and other developed countries have awarded to Cambodia. All of
957 project, which had been approved from 1994 to 2003, the investment in industry
fields are accounted for 37% with 704 projects, the investment in tourism fields are
accounted for 35% with 76 projects, the investment in service fields are accounted for
22% with 89 projects, and the investment in the agriculture fields are accounted for 6%
with 88 project (See table 2.4, figure 2.1).
43
Table 2.4: Analysis of capital and project by sector Approved from 1994-2003
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Agriculture
N/P 2 6 26 24 4 12 5 1 6 2 I/C 559,815 6,041,768 118,495,570 65,577,452 51,609,320 63,884,623 9,758,836 400,000 40,345,020 3,711,375 L/C 100% 61.83% 46.81% 23.42% 24% 63.50% 63% 34.17% 50% F/S 38.17% 53.19% 22.42% 76% 36.50% 37% 65.83% 50%
IndustryN/P 20 82 127 168 125 66 40 28 19 29 I/C 84,475,679 299,484,392 413,007,633 512,464,298 647,582,145 161,474,723 59,402,781 85,926,761 52,049,332 86,628,379 L/C 32.25% 24.72% 28,85% 16.61% 22.36% 21.33% 16.95% 26.39% 23.05% 21.31% F/S 67.75% 75.28% 71.15% 83.39% 77.64% 78.67% 83.05% 73.61% 76.95% 78.69%
ServiceN/P 3 22 17 6 7 10 8 4 6 6 I/C 396,973,000 424,754,912 112,491,804 124,939,800 42,782,350 50,763,791 69,059,034 44,601,030 98,164,880 46,429,828 L/C 17% 23.39% 30.71% 38.50% 38.14% 45.20% 53.13% 77.50% 61% 66.67% F/S 83% 76.61% 69.29% 61.50% 61.86% 54.80% 46.88% 22.50% 39% 33.33%
TourismN/P 1 14 16 7 8 3 8 6 3 10 I/C 23,690,000 1,512,609,301 119,067,153 41,529,010 111,950,883 171,798,132 79,817,230 73,755,822 47,100,000 114,464,155
L/C 27.75% 24.19% 29.29% 58.88% 75% 28.25% 57.50% 66.67% 66% F/S 100% 72.25% 75.81% 70.71% 41.13% 25% 71.75% 42.50% 33.33% 34% Total 505,698,494 2,242,890,373 763,062,160 744,510,560 853,924,698 447,921,269 218,037,881 204,683,613 237,659,232 251,233,737 Total 26 124 186 205 144 91 61 39 34 47 Total I/C 6469622017 Total N/P 957 Source: Cambodian Investment Board Note: N/P= Number of Projects; I/C= Investment Capital; L/C= Local Share; F/S=Foreign Share
2.3.2. Overview of potential factors and the government policy
Figure 2.1: Percentage of capital by sector
6%
37%35%
Agriculture
22%
Industry
Service
Tourism
44
2. Overview of potential factors and the government policy toward
FDI in Cambodia.
Based on the theories above, the potential factors and government policy
toward FDI in Cambodia has been grouped to market factor, cost factor and
investment climate of Cambodia which will be more explained in the following
paragraph.
a) Market factors
1) Market size and growth
Cambodia has population of 13 million with GDP per capita is $ 297
in 2000 and purchasing power was about five times as great ($1,446) (See appendix C).
The real GDP grew well in 1995 (7.6%) and 1996 (7%) but declined sharply in 1997
(1%) and 1998 (2%). It has pick up again to grow strongly. GDP increased by 5 % in
1999 and 2000 and 5.5% in 2002 and 6% in 2003. The average annual GDP is 4.6%.
Cambodia’s upper and middle class, with a purchasing power
sufficient to buy sophisticated consumer goods, is to be found mainly in Phnom Penh
and other urban areas. However, the market of most interest to potential investors is
less the domestic than the regional one.
Indeed Cambodia are accessed by the investors as platforms from
which to enter the larger of ASEAN+4 market and gain benefit from Generalize
System of Preferences (GSP) and Most Favored Nation (MFN) and membership of
WTO. As a member of ASEAN+4, Cambodia has joined a market of more than 2
billion people from ASEAN 10 plus China, Korea, Japan and India. Within the
framework of the Common Effective Preferential Tariff (CEPT) of the ASEAN Free
Trade Area (AFTA), tariffs on most Cambodian exports to ASEAN will be reduced to
45
0–5% for most products by year 2010 and abolished entirely by year 2018.
(The CEPT scheme works on the principle of reciprocity and Cambodia has until year
2010 to reduce most tariffs on its imports to 0–5 %.)
As for international market access, Cambodia, a least developed
country (LDC), offers the prospective investor preferential access to the European
Union, Canada and the United States for a number of products, including garments.
2) Export oriented market
Through the Most Favored Nation (MFN) and the General System of
Preferences (GSP) status which were obtained in 1996 and 1997, Cambodia has
preferential access to such international markets as those of the United State,
European Community, with exemption tax and recently Cambodia obtained more
MFN and GSP from Canada, Japan, and China.
Cambodia was admitted to ASEAN in 1999. One of the advantages to
begin a member of ASEAN is that the investors in Cambodia can access to the
markets of ASEAN countries in the framework of AFTA. With Cambodia acceded to
the WTO in 2004, the forthcoming end of the Multifibre Arrangement (MFA) at the
end of 2004 will not necessarily hurt the industry, as its long experience and low
wages can keep it competitive.
According to the report from the Ministry of Commerce
(see Appendix D1-D7), the total amount of exports from Cambodia to foreign market
from January-October 2001 is USD 965,495,840.61, in year 2000 is
USD 1,025,382,809.94, in year 1999 is USD 673,214,770.92, in year 1998 is
USD 673,214,770.92, in year 1997 is USD 281,375,975, in year 1996 is
USD 101,756,627 and year 1995 is USD 27,407,723.
46
The single most important exporting industry has been ready-made
garments. Cambodian textile products have been exported to 27 countries, including
Japan, the United States and the countries of the European Union. In 1997, the
industry earned $ 222,324,545 in exports and has been increase dramatically to
USD 938,627,460.21 in October 2001.
b) Cost factors
1) Work force and labor cost
Cambodia has a population of 13 million people, of whom 51% are in
the “working age” group and over 60% of the workers are women. Cambodia’s low
labor costs are very attractive to investors. Labor costs are low compared with those
in other Asian countries with the average out to only US$ 75 per month. The
minimum wage in the garment industry is only $45 per month. Foreign companies are
currently paying approximately US$100 to US$150 per month for non qualified
workers with minimal English skills; US$200 to US$350 per month for workers with
good English language skills and perhaps a higher education, and up to US$700 per
month for bilingual and well educated employees.
Although Cambodians have low levels of education, the labor force is
traditionally a hardworking and strongly motivated one. (The Angkor complex in
Siem Reap offers historical evidence of the skills and patience of the Khmer people).
Investors generally found the Cambodian workforces trainable and
motivated. Shortage of skilled employees was seen as a problem, although some
investors acknowledged a modest positive trend in skill levels.
Expatriates are allowed to work in Cambodia provided that they
obtain a work permit. Such permits are usually granted to employees of foreign
47
enterprises authorized to operate in Cambodia so long as the applicants are key
personnel. Expatriates may be recruited for non-key positions when Cambodian labor
is not available.
2) Natural resource
Cambodia can build on its comparative advantage by developing
natural-resource-based industries of many kinds, including those based on non-
metallic mineral resources.
Oil and gas exploration recommenced in Cambodia in 1991,
following earlier efforts of the late 1960s and early 1970s, and has already produced
promising results. Altogether, 16,000 line kilometers of high-quality seismic data
have been obtained, indicating a potential for substantial oil and gas generation.
For the purpose of exploration, both land and sea areas of the
Cambodian territory have been divided into blocks, 32 altogether, of which the
offshore blocks I to IV have so far been explored. Three major oil companies:
Enterprise Oil Exploration Ltd, Premier Oil Petroleum Cambodia Ltd. and Campex;
have engaged in drilling with 30-year contracts. Positive results from drilling in Block
III in late 1993 were followed by the most successful test so far, carried out in Blocks
I and II in the first part of 1994, which produced a maximum flow rate of 4.7 m cubic
feet of gas and 180 barrels of condensate per day. Another company testing in Block
IV in the same year produced a maximum flow rate of 1.3 m cubic feet of gas and
1,180 barrels of oil per day.
Although Cambodia has good mineral resources, events of the last
two decades have prevented the development of the mineral sector. Potential exists in
respect of gold, gemstones (ruby, sapphire and zircon), phosphates (for fertilizer),
48
limestone (for cement and building stone), bauxite, clay, sand/gravel and granite, with
the first two commercially the most promising. Copper and zinc also exist but require
more exploration.
3) Infrastructure; utilities and transportation cost
Progress in certain infrastructure services and utilities was widely
acknowledged, while in some areas the private sector saw little change over the past
five years. Telecommunications were seen to have advanced most in recent years.
Although network disruptions had not been eradicated, the majority of private-sector
participants did not feel that this area constituted a problem for their business activities.
The improvement of the road transport network in the major cities and business centers
was mentioned as another area of significant improvement. On the other hand, road
transport in rural areas was still hampered by poor maintenance and with the higher cost.
One area identified as a particular problem for the private sector was power supply. The
problems was mainly cost, which was significantly higher than in neighboring countries.
In fact, the costs were so high that even the rather expensive operation of individual
power generators was cheaper than relying on supply from public operators.
4) Availability of capital and technology transfer
One issue affecting the development of industrial land is the inability
to secure loan capital using real estate as collateral. Financial institutions are reluctant
to finance property development using real property as collateral because the legal
and institutional framework governing land registration and the enforcement of
collateral is not satisfactory. A mortgage law has not been put in place and neither has
a law on bankruptcy. The recovery of defaulted loans is the main issue for investors.
49
Cambodia is country with low technology in the processing
manufacturing by using labor intensive in some industries. Meanwhile, the Cambodia
has offered incentive to investors who provide training and development of human
resources and the transfer of technology and expertise to local staff. There is no other
provision related to technology transfer.
c) Investment climate
1) Government incentive and protectionism
The government of Cambodia has established the Council for the
Development of Cambodia (CDC) in 1994 which responsible for attracting foreign
investment and approving the application for investment incentive pursuant to the
investment law promulgated in August 5, 1994 (see Appendix F). The Cambodian
Investment Board (CIB) is a department of CDC. Together the CDC/CIB is the
government agency responsible for granting investment incentive and approving
investment projects.
(a) Investment guarantees
The Investment Law and Sub-Decree contain a number of
important guarantees for the investors, as follows:
• Equal treatment of all investors.
• No nationalization adversely affecting the property of
investors.
• No price controls on products or services produced by
licensed investors.
• Remittance of foreign currencies a broad.
50
(b) Investment incentive
The following incentives are available to investment projects in
Cambodia:
• Nine percent corporate profit tax
• Up to eight year exemption from corporate profit tax,
beginning from the year of first profit.
• Five year loss carry-forward.
• Exemption from import duties for the period of construction
of the project and first year of business operation.
• Tax free distribution of dividends and profits.
• Employment of foreign expatriates where no qualified
Cambodians are available.
(c) Import duty exemption
Exemption from payment of import duties is available for most
investment project for the construction period and the first year of operation.
Investment projects exporting at least 80% of their production or located in Special
Promotion Zone may receive duty exemption for a longer period of time.
(d) Tax incentives
The Law on investment provides the following tax incentives to
eligible investors:
• A corporate tax exemption of up to six years, depending on
the characteristics of the project and the priority of the
government, as mentioned in a Sub-Decree. Corporate tax
51
exemption takes effect from the year the project derives its
first profit or after three years of operation, whichever occurs
first; or a special depreciation equal to 40% of the capital cost
of new and/or used tangible property used in manufacturing
and processing by the qualified investment project (QIP) if the
QIP elects not to use the corporate tax exemption above.
• 100% import-duty exemption on construction materials,
production equipment, intermediate goods, raw materials
and spare parts.
• Export-oriented QIPs; and
• Supporting-industry QIPs; and 100% exemption of export
tax, if any.
2) Political climate
In the transitional period between the signing of the Paris Peace
Agreements in October, 1991 and free national elections conducted by UNTAC in May
1993, Cambodia was governed by a Supreme National Council (SNC), regrouping all four
major political parties. Administration of the country was temporarily entrusted to UNTAC,
which successfully organized the elections with a large population turnout. Following the
installation of interim Provisional Government, the elected Constituent on September 24,
1993 the nation’s constitution which proclaimed King Norodom Sihanouk as a head of state
and established the Royal Government of Cambodia (RGC) within the framework of
parliamentary democracy. This same date marked the official end of UNTAC’s mandate.
The general election of July 1998 and 2003 considered as free and
fair by all national and international observers led to the formation of a new
52
parliament headed by Samdech Chea Sim at the upper house (Senate) and Prince
Norodom Ranariddh at the lower house (National Assembly) and the Royal
Government with Samdech Hun Sen as the Prime Minister (See Appendix G1).
After the resignation of King Norodom Sihanouk, King Norodom
Sihamoni was elected as a king of Cambodia which was celebrated on 29 October 2004.
Many foreign firms noted that Cambodia offered a stable political
environment. Firms stressed in particular the pro-business attitude of the Government.
This was reflected mainly at senior levels of the administration; cooperation at lower
levels was sometimes wanting. Despite claims that the government sometimes lacked
political will and would not act decisively enough, there was a consensus that it was
committed to helping investors, domestic as well as foreign, make their businesses work.
Table 2.5: History of political, legal & economic system
Era Legal system Political system Political power Economic system Pre-1975
French based Civil Code and Judiciary
Constitutional Monarchy
Held by Prince Norodom Sihanouk as Prime Minister until 1970; Lon Nol from 1970 to 1975
European socialist, centrally planned industrial development
1975-1979
Legal system destroyed
Monarch abolished, extreme Maoist agro communism
Khmer Rouge Agrarian, centrally planned
1979-1989
Vietnamese communist model
Communist Party, Central Committee and local committees
CPP (Vietnamese backed)
Soviet style central planning
1989-1993
Greater economic right
Communist Party, Central Committee and local committees
CPP (Cambodian controlled)
Liberalized central planning
1993-present
French based Civil Code combined with common law in certain sectors
Constitutional Monarchy
Shared between FUNCINPEC and CPP
Transition market economic
Source: DFDL, 2002
53
3) Economic environment
Cambodia is one of the most open economies in the developing
world. The Economic Freedom Index of the Heritage Foundation in the United States
ranks it at the top of the LDCs it covers. The economy is dominated by agriculture,
with rice the main crop. Since the country re-established a constitutional monarchy in
1993, the economy has grown rapidly, except for a period between mid-1997 and late
1998, when it suffered from political instability and the spillover effects of the Asian
financial crisis. It began to rebound in late 1998, with the establishment of a coalition
government, but foreign investment in most sectors has lagged. Since early 1999, the
government has intensified its economic reform program, a process that donors and
international financial institutions participate in and monitor closely.
Development assistance to Cambodia from the donor community,
including multilateral and bilateral donors and international organizations, has
averaged about $500 million every year since 1993. At the Consultative Group
meeting of June 2002 in Phnom Penh, Cambodia secured $US 635 million and 2004
received more than $US 400 million from donors.
Real GDP grew well in 1995 and 1996 but declined in 1997 and
1998. It has picked up again to grow strongly (table 2.6). GDP increased by 6.3% in
2001 and 5.5% in 2002 and is expected to grow by 6% in 2003 (RGC, 2003).
54
Table 2.6: GDP growth rates Country GDP Growth Rate (Percentage) Average
Annual
1995 1996 1997 1998 1999 2000 1990-2000
Cambodia 7.6 7.0 1.0 1.8 5.0 5.0 4.6 Lao PDR 7.0 6.8 7.0 4.0 7.3 5.7 6.5 Myanmar 6.9 6.4 5.7 5.9 10.9 N/A N/A Thailand 9.3 5.9 -1.4 -10.4 4.2 4.3 4.2 Viet Nam 9.5 9.3 8.1 5.8 4.8 5.5 7.9 China 10.5 9.6 8.8 7.8 7.1 7.9 10.3 LDCs 6.1 5.2 4.9 4.5 4.7 4.8 N/A Source: UNTAD, based on the World Bank, World Development Indicators,2002, http://publications.worldbank.org/WDI/, and World Development Report 2002
(a) Tax rates
The rate of the VAT is 10% of the “taxable value” of the goods
or services. The taxable value is the sum of the sale price of the goods or services,
including any charges for transportation or additional service provided at the time of
the sale services. Imported goods are assessed at their customs value including
insurance, freight, customs duties and specific tax. Used goods are assessed a taxable
value of the difference between their selling price and their purchase price.
Table 2.7 : Summary of taxes relevant to business Tax Rate Profit tax 20 % (Unless investment incentive rate of 9% or 0%) Advance profit tax 1% of turnover Withholding tax 15% to 20% or salary, 20% of fringe benefits VAT 10% Import duty Varies Export duty Varies Specific tax on certain Merchandise and service
4.35%, 5%, 15%, 25%, 33.33%, 45%, 80% or 110% depending on the item
Source: DFDL, 2002
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(b) Tax structure
As elsewhere, taxes in Cambodia fall into two broad categories,
direct and indirect taxes.
(1) Direct taxes
Corporate profit tax
A profit tax is levied on all businesses and calculated on the
basis of either actual profit or estimated profit, depending on the tax regime applicable
to the taxpayer. Under the amended Laws on Investment and on Taxation, which were
adopted in March 2003, the tax on profits is 20% for all taxpayers, excluding certain
natural-resource-development projects, but including all qualified investment projects
(QIPs: those registered with the CDC). Only pre-existing QIPs that have already been
granted a 9% rate will be eligible for the reduced rate for a transitional period ending
in 2008. QIPs granted a profit tax exemption would receive a maximum tax holiday of
up to 6 years plus a trigger period, resulting in the possibility of an exemption from
profit tax for up to 9 years.
Taxpayers are required to make a prepayment of profit tax on
a monthly basis, equivalent to 1% of monthly turnover. However, QIPs registered
with the CDC are exempted during the profit tax exemption period. There is also a
minimum tax for real regime taxpayers, equivalent to 1% of annual turnover, but QIPs
registered with the CDC are exempted from it.
Additional tax on dividend distribution
A new tax that affects investment companies and QIPs was
introduced with the Law on Amendment to the Law on Taxation. Companies that
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enjoy a tax rate of either 0% or 9% are subject to an additional tax on profits that have
not been taxed at 20%, upon the distribution of dividends. The additional tax moves
the effective tax-on-profit rate up to 20%.
Salary tax
Salary payments to an employee in Cambodia give rise to the
salary tax. There is a distinction between residents and non-residents in relation to the
calculation of the salary tax. Residents are taxable on their worldwide salary income,
irrespective of where paid, whereas non-residents are subject to salary tax only on
Cambodian-source salaries.
Employers are required to pay a fringe benefits tax on
benefits provided to employees. The rate of the tax is 20% of the market value of the
benefit, inclusive of all taxes. (UNCTAD-ICC).
Withholding tax
A series of withholding taxes were introduced by the 1997
Law on Taxation. Withholding taxes are the responsibility of the payer and are
applicable to the following payments to residents of Cambodia:
• 15% on payments made to individuals for the provision
of services (this covers most services, including
commission, brokerage, transportation, repair,
construction, management, consultancy and professions);
• 15% on the payment of royalties for intangibles, interest
in minerals and interest (except interest paid to domestic
banks or savings institutions);
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• 10% on the rental of movable or immovable property;
• 6% on interest paid by a domestic bank or savings
institution to a resident taxpayer having a fixed-term
deposit account;
• 4% on the interest paid by a local bank to a resident
taxpayer with a non-fixed-term savings account.
No withholding tax is levied on payments of tax exempt
income, which may include payments to non-profit organizations approved by the
Ministry of Economy and Finance. There is also a withholding tax of 14% on the
following payments to non-residents:
• Interest;
• Royalties, rent and other income connected with the use
of property;
• Compensation for management or technical services; and
• Dividends.
Indirect tax
Import and excise duties and the value-added tax (VAT) are
the most important indirect taxes in Cambodia. Import duties come in four bands: 0%,
7%, 15% and 35%. Export duties are levied on only a limited number of items, such
as timber and certain animal products (including most seafood). Excise duty is called
“tax on specific goods and services”, and applies to a wide range of imported or
domestically produced goods and services, including petroleum products, tobacco
products, beer, soft drinks, vehicles and entertainment.
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Value-added tax
VAT was introduced on 1 January, 1999. It is chargeable on
a wide range of goods and services supplied in Cambodia and on the import of goods.
The basic principle of VAT is to tax each stage of production, allowing each supplier
credit for the tax paid, so that the ultimate impact is on the final consumer. Taxable
items attract VAT either at the standard rate of 10% or at the zero rates. Zero-rating
applies to the export of goods and services, and certain charges related to international
transport. On imports, VAT is payable at 10% of the value of the import, including
any customs duty, insurance and freight charges.
4) Currency and foreign exchange
Cambodia is primarily a cash based economy with checks and credit
cards only infrequently accepted commercially. The national currency of Cambodia is
the Cambodian Riel which has remained fairly stable since the 1998 at about 3,900
per U.S Dollar.
In spite of a 1992 Sub-Decree prohibiting transactions denominated
in foreign currencies, the U.S Dollar remains in common circulation and is freely
traded throughout the country.
There are currently no restrictions on the repatriation of profits or
capital derived from investments made in Cambodia or on most transfers of funds
abroad. The 1994 Investment Law guarantees that investors may freely remit foreign
currencies abroad for the purpose of:
• Payment for imports and repayment of principal and interest on
international loans;
• Payment of royalties and management fees;
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• Remittance of profits; and
• Repatriation of invested capital on dissolution of an investment
project.
Under the Foreign Exchange Law of 1997, foreign currencies may be
freely purchased through the banking system. The law specifically states that there
shall be no restrictions on foreign exchange operations, specifically including the
purchase and sale of foreign exchange, transfers and all types of international
settlements. However, the Law does require reporting to the National Bank of
Cambodia transactions is excess of US$ 10,000. There is no requirement that the
investor sending or receiving the funds make a report on the transaction. The burden
rests solely on the bank as the authorized intermediary.
It is important to note that while foreign exchange transfers are not
currently restricted; the law does allow National Bank to implement exchange
controls in a foreign exchange crisis.
5) Culture
Cambodia is a largely homogeneous nation with a Khmer majority of
about 90% and small ethnic minorities of Chinese, Cham and others. About 90% of
the population is Buddhism is recognized by the Constitution as the national religion.
Followers of other religions, mainly Islam and Christianity, are allowed to practice
their faiths without restriction.
Cambodia’s border is bordering to Thailand and Loa in the west and the north,
and Vietnam the east and south. Cambodia has culture closeness with Thailand.
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