10:41 AM Apr 2, 1996


Geneva 2 Apr (Chakravarthi Raghavan) -- "Very little is known about repercussions of foreign direct investment (FDI) liberalisation on host economies," says a paper presented at the OECD-organised workshop on FDI last week at Hong Kong.

The workshop was organized by the secretariat of the Paris-based 25-member rich men's club, by the Organization for Economic Cooperation and Development (OECD), as part of the so-called OECD "dialogue" with the Dynamic Non-Member Economies (DNMEs). The non-OECD participants came from Malaysia, Thailand, Indonesia, India, China, Hong Kong, Taiwan, Brazil, Argentina, Korea, Singapore and Chile.

The avowed purpose of the workshop was for promoting full FDI liberalisation by developing countries and explaining the state of play on the on-going negotiations within the OECD on a Multilateral Agreement on Investment (MAI).

The OECD wants the DNMEs to join such an agreement, which would be 'free standing' and have "high standards" for rights of investors worldwide.

The paper on benefits of FDI liberalisation by developing countries was by the lead speaker for the workshop -- Dr. Stephen E. Guisinger, Professor of International Management studies, University of Texas, Dallas, USA.

It says: "very little is known about repercussions of FDI on host economies. There is a rich literature on the effects of trade policy liberalization on macro-economic variables. And considerable scholarly work has been done on the impact of FDI on host economies under existing investment regimes. However, for a variety of reasons... the link between investment liberalization and macroeconomic performance has received scant attention from researchers."

Guisinger while acknowledging lack of studies, and facts to judge benefits to host countries of FDI liberalisation, nevertheless has expressed "optimistic agnosticism" about the macro-economic consequences of FDI liberalisation in developing countries.

This Guisinger advocacy of benefits of FDI liberalization is based, in the absence of studies on FDI liberalisation effects on host countries, on a rather controversial World Bank-organized study on trade liberalisation in developing countries, and a simulation model exercise that did not take account of the effects of FDI liberalisation on Balance-of-Payments of the host countries.

The MAI negotiations within the OECD is driven by the United States which is seeking "high standards" of rights for foreign investors. The immediate focus of US are the EU members and Japan, who despite their acceptance of the current OECD guidelines, are felt to be restricting ability of US investors to invest and compete. The MAI negotiations are intended to be completed by middle of 1997 and thereafter the OECD hopes to "persuade" developing countries to sign on and join, and undertake these obligations. The Hong Kong workshop was purportedly to acquaint the non-OECD members about the progress of the OECD negotiations.

The OECD MAI drive is somewhat different from the EU Executive Commission's drive to get the idea of a Multilateral Investment Agreement (MIA) on the new agenda of the World Trade Organization (WTO), beginning with a work programme to be launched at the WTO's Singapore meeting and then moving on towards negotiating such a treaty, in a new round of negotiations in 2001, and for the MIA to be an integral part of the WTO and its integrated Dispute Settlement Mechanism.

The Guisinger paper, while advocating FDI liberalisation, and laying the ground on need for multilateral global rules to protect investors' rights, acknowledges lack of literature on repercussions of FDI liberalisation on host economies, but uses a highly controversial World Bank organized study on trade liberalisation by developing countries to suggest similar results should follow from investment liberalisation.

It also cites some simulation models to suggest benefits to host economies from FDI liberalization, but acknowledges that the model has excluded a crucial component of macro-economic effects, namely, the effects on the Balance-of-Payments (BOP) of the host country.

The World Bank organized study, 'Liberalizing Foreign Trade in Developing Countries' (1990), was led by Demetrious Papageorgiou, Armane Choksi and Michael Michaely. In six volumes of studies of 19 countries and 36 liberalisation episodes within them over the period 1950-1982, and a seventh of overall conclusions.

It outlined the design of a liberalisation policy to be undertaken against a politically stable backcloth and implemented gradually over a 6-7 year period, starting with dismantling of QRs and significant currency devaluation, followed by tariff liberalisation, to be followed by liberalization of capital markets.

Since its publication in 1990, the study, its methodology, and its conclusions have been the subject of serious challenges from other academics. These critiques challenged the episodes and country choices as being influenced by the desire to draw to certain preconceived conclusions.

But in a review of the seven-volume study, in 'The Economic Journal' of January 1993, British academic David Greenaway faulted the conclusions of the study in its seventh volume as not in line with the country-studies and facts assembled in earlier volumes.

In the article, "Liberalising Foreign Trade through Rose-tinted Glasses', Greenaway noted that there was ambiguity in what the authors were measuring as effects of liberalization, and lack of consistent empirical framework for assessing what constituted a 'liberalization episode' and its economic impact. The liberalisation indexes for countries were based not on objective quantitative indicators, but mostly subjective impressions,

Referring to the various inconsistencies, and differing yardsticks used in the country studies, and the overall conclusions drawn in the final volume, Greenaway said: "the conviction with which the summary results are stated may have more to do with prior beliefs than with convincing evidence"

While the scale of the study was 'truly impressive' and asked interesting questions, unfortunately it "does not always respond with convincing answers", Greenaway notes. While large multi-county projects are inevitably somewhat "looser", methodologically, than formal cross-country exercises, and it is a price that has to be paid for detailed country-analysis, one has to proceed with caution in interpretation of results, he points out.

Greenaway concluded: "Although much of the analysis in the individual country studies is analytically sound, the claims made for the generality of the results are extravagant... It would be unfortunate if these results became the justification for 'off the shelf' reform programmes."

One would expect that an FDI liberalisation advocated in a paper of 1996, which acknowledges lack of literature on the effects on host economies, but attempts to draw conclusions on the basis of trade liberalization, and cites the Papageorgiou et al study, would have taken note of the critiques of the study.

The Guisinger paper for the Hong Kong workshop assumes that trade liberalization benefits the liberalizing country in all circumstances and conditions, and on this basis goes on to advocate FDI liberalization for development, without establishing a nexus between trade and the FDI, and between FDI and development.

The paper says the effects of investment liberalization on macroeconomics of developing countries, it asserts that investment liberalization and trade liberalization could be summed up fairly succinctly. Trade liberalization, it says, creates opportunities for foreign investors by expanding possibilities for goods exports, while investment liberalizations create opportunities to expand exports by bringing in new investments. Lessons can be learnt from trade liberalizations that have relevance for governments contemplating investment liberalizations, it says.

While the Guesinger paper draws favourable conclusions for FDI liberalization from Trade Liberalizations and trade theories, a recent UNCTAD Report (by Yilmaz Akyuz) for the UNCTAD co-sponsored seminar on East Asian Development at Kuala Lumpur in February notes that there has never been a happy marriage between theory of international trade and analysis of determinants of FDI.

The theory of comparative advantage and international trade is based on assumptions of perfect competition, while FDI is explained in terms of imperfections and market failures.

The neo-classical theory of capital movements based on international differences in thrift and productivity makes no explicit reference to theory of comparative advantages.

It does not also contribute to understanding of determinants of FDI since it leaves open allocation of excess savings between portfolio and productive investment.

The link between FDI and domestic investment is an implicit one. While conventional approach to international capital flows sees no trade off between the two, where FDI is treated as a substitute for exports, there is an implicit trade off between domestic capital formation and FDI.

It is not possible, says the Akyuz paper for the KL seminar, to determine the relations among trade, FDI and domestic investment, independently of macro-economic factors that influence decisions of firms to invest at home or abroad -- such as growth of and access to markets, and factors that influence overall competitiveness.

On the other hand, investment decisions themselves alter macroeconomic conditions and competitiveness, and exert an important influence on macro-economic performance, including growth, employment and external balances.

While the Guesinger paper says FDI liberalization creates opportunities to expand exports through new investments, a World Bank-IFC study (by A. Estache and J. Morriset), cited in the Akyuz paper, on the correlation between FDI and exports in developing countries, concludes that Asia is the only region with pro-trade effects of FDI.

And all the Asian countries, even the highly successful Asian economies that created high domestic savings, investments and exports, all (except the territory of Hong Kong) had regimes under which the host governments retained the right to allow or disallow FDI, and direct it to particular sectors and specify the conditions.

None of these are possible if FDI is to be fully liberalized, and investors are to have the full freedom to invest wherever they want - in whichever country and whichever sector gives them high profits.

All the beneficial experiences of FDI liberalisations that the Guesinger papers (and other like it) cite are based on those among the OECD countries - and even there the experiences of the poorer economies among them (Ireland, Turkey and Portugal) have not filled all the expectations of the host governments.

Perhaps the Guesinger paper, presented at Hong Kong to encourage the developing countries to liberalise FDI and join the OECD rules, unwittingly, makes a strong case for developing countries to encourage and allow the OECD countries to go ahead with their own MAI on the basis of faith, and neither join them nor agree to an MIA in the WTO, providing as it would trade cross-retaliations for enforcement.