8:49 AM Jul 26, 1996

FDI NEEDS DIFFERENTIATED, STRATEGIC APPROACH

Geneva 25 July (Chakravarthi Raghavan) -- An industrialization strategy based on a universally liberal policy to foreign investment across all sectors may not be successful in the long run, and developing countries would do well to adopt a more differentiated and strategic approach.

In advocating this approach to FDI and TNCs, Ha-joon Chang, a South Korean economist on the Economics and Politics faculty at the University of Cambridge (UK), has said that it would be a "big mistake" for developing country governments to voluntarily give up all such room for manoeuvre by adopting a "universally liberal FDI policy across all sectors."

Chang's view is in a paper, "Globalization, Transnational Corporations, and Economic Development", presented at a conference (21-23 June) in Washington DC, organized by the Economic Policy Institute on "Globalization and Progressive Economic Policy".

While Chang's paper, does not deal directly with the issue of a multilateral investment treaty, one of the effects of such a treaty, with its provisions for right to invest and obtain national treatment, would be to eliminate the ability of host countries, in particular developing countries, to bargain with TNCs for promoting long-term development and industrialisation.

Chang argues that while inter-dependence between different parts of the world may be increasing, and while the role of TNCs is growing in that process, it is too early to say that "we now live in a totally new world where national policies are more or less ineffective" as some proponents of globalisation thesis seem to believe.

The TNCs do not have unambiguously superior bargaining powers in all industries in relation to all countries and their bargaining power ranges from being almost absolute (e.g. Nike looking for an investment site for shoe production) to being close to zero (e.g. automobile TNCs trying to curry the favour of the Chinese government for the people's car project) depending on the industry and the country.

This strengthens, and not weakens, the case for strategic industrial policy, because it means that governments should design their policy towards TNCs according to the particular sector concerned, rather than taking a uniform approach across sectors.

Discussing the "myths, facts and neglected details" about Globalization and Rise of TNCs, Chang says that many of the facts and figures and claims -- presented by neo-liberal commentators about the world economy becoming increasingly borderless and globalised, and that countries with open FDI policies have performed better than those with restricted -- are exaggerated and overly generalised.

The bulk of FDI, he notes, is only among developed countries, with a handful of developing countries taking part in the transnational investment story. Between 1983-1989, only 19.7% of world FDI went to developing countries. And between 1990-1994, it only went up from 19.7% to 29.2% during 1990-1994.

And, if the flows to China is excluded, the FDI flows to developing countries only went up from 17.8% to 21% -- and this despite the liberal FDI policies that many developing countries introduced during the period on the recommendation of Neo-Liberal economists.

Chang also notes that a large proportion of the flows to China are suspected by some commentators to be domestic investments re-routed through overseas Chinese communities to exploit the privileges extended in China to foreign investors.

While there is increasing 'globalization' of TNCs, it is at a much slower pace and in a more uneven pattern than proponents of the globalization thesis. Most TNCs remain international firms with a strong base, in terms of assets and production activities, in their home countries.

In addition, for most TNCs, the top decision-makers are still home-country nationals and even when they relocate their 'core' activities, it is usually to some other developed countries, and often with a "heavy regional bias."

The globalization of R & D, often regarded as "the indicator" of increasing globalization of TNCs, is basically a "regional" phenomenon: US and Japanese TNCs don't do much R & D outside their home bases (except in Canada in the case of US firms), while European TNCs do substantial amounts of R & D outside their home base, but mostly in other European economies.

The attempt to support pro-TNC policies in countries by citing the examples of East Asian countries is also misleading. Only Malaysia and Hong Kong among them had liberal attitudes to TNCs. Singapore, which did rely very heavily on TNCs, deliberately directed FDI towards government-directed priority sectors. It was only in these countries that the contribution of FDI to capital accumulation has been exceptionally high. In Korea, Taiwan and Indonesia, the contribution of FDI to capital accumulation has been below the developing country average. In Thailand, usually regarded as a model "FDI-driven" economy, the ratio of FDI to gross fixed capital formation was not much above the developing country average.

Those who argue for liberalization of policies towards TNCs, Chang points out, have a strong belief that "what is good for TNCs is good for the host country", that recent trend in globalization is eliminating "whatever minor conflicts of interests which may have existed between the two", and view the restrictive policies popular in the 1960s and 1970s as "ideologically motivated".

But while there were few justifications for the extreme anti-TNC view that was once popular in developing countries, this does not mean that TNCs are "unambiguously beneficial for economic development".

While some of the earlier concerns about "inappropriateness" of production technology, or the product mix of TNCs, were often misconceived or exaggerated, "the problem itself is real and can be important in certain circumstances."

Chang says: "Earlier criticisms of 'surplus extraction' through transfer-pricing or excessive royalty payments may have been sometimes out of proportion. But the practices do exist and can be quite significant and damaging in cases. Predatory behaviour or manipulation of consumer preference by TNCs may not necessarily be more severe than by their local equivalents, but are practices that have to be reckoned with. Restrictions by TNC headquarters on exporting or R & D activities of subsidiaries may not be as widespread or important as sometimes believed, but nevertheless have to be minimised, especially if the hose country government is keen on technological spill-overs from TNCs..."

More recent, careful analysis of certain empirical cases have shown importance of domestic technological capabilities in sustaining long-term growth and "thus have raised further doubts whether inviting TNCs is the best way to promote industrialization".

"There is a growing consensus that accepting a 'package' of finance technologies, managerial skills, and other capabilities offered by TNCs may not be as good for long-term industrial development as encouraging the national firms to construct their own packages, using their own managerial skills - with some necessary outsourcing."

Referring to the Malaysian case (where FDI has been about 25% of domestic capital formation and 10% of GDP between 191-1993), Chang cites studies to show that if share of FDI in GDP for average developing countries were to reach the same level as that of Malaysia, the total world level of FDI would have to increase seven times or 1.7 times the total manufacturing investment in OECD countries.

Thus the belief of neo-liberal commentators that what is good for TNCs is also good for the host economy is unwarranted.

"While some earlier criticisms of TNCs may have been misconceived, over-generalized, and exaggerated, there are many important areas where there exist an obvious conflict of interest between TNCs and the host country. These include the issue of 'appropriateness' of technology, transfer pricing, monopolistic practices, restrictions imposed on the subsidiaries particularly regarding exports and R & D, and even their ability to manipulate the overall national policy regime.

"More importantly, recent theoretical developments and empirical studies suggest that long-term productivity enhancement may be better achieved by an industrialization strategy that puts emphasis on building local managerial and technological capabilities and uses TNCs in a selective, strategic manner to accelerate the process.... The policies employed in Korea and Taiwan suggest that, while TNCs can and should be used, their role needs to be clearly defined in relation to the overall industrialisation strategy and with reference to the specific needs that exist for the particular industries concerned."

On the view of some proponents of globalisation that a serous erosion, if not total elimination, of national policy autonomy is only a matter of time and that it is no longer possible for developing countries to use strategic or industrial policy,

Chang argues that the relative bargaining strengths of TNCs and national governments depend on which industry and which country one is talking about. While there are some industries where many countries qualify as investment sites, there are others where feasible investment sites are limited.

Depending on the case, it is not just that governments compete for FDI, but also that TNCs compete with each other to enter an attractive host country, Chang stresses. While many developing countries have few attractive productive assets or locational advantages for which TNCs will compete with each other, there are many others who can play this game and have some 'bargaining chips'. And once TNCs are interested in a country, their political vulnerability as 'foreign firms' can make them even more responsive than their domestic equivalents to the demands of government.

As for the arguments that TNCs are footloose and can move elsewhere if their freedom of action is restrained, Chang notes that while there are some industries (garments, shoes, toys) where the 'sunk' costs are low and firms can be footloose, there are others with a high element of sunk costs (chemicals, pharmaceuticals) and sub-contracting networks. In these latter cases, TNCs once they have made an investment will not be able to pull out at slightest adverse change in host country policies. This does not mean that governments can do anything, but that the larger TNCs are able and often willing to accommodate a lot of restrictive policy measures.

On the considerations behind FDI decisions, Chang notes that evidence available suggest that "growth leads FDI rather than the other way around, and that "it is questionable whether adopting a more liberal FDI policy will lead to increase in FDI flows, in the absence of policies that will substantially improve the economic prospects of the country". So long as host country policies do not involve asset appropriation and other measures threatening basic capitalist property relations, FDI policies seem much less important than other factors, such as the growth prospect of a country's domestic market, or the country's political stability, in determining TNC investment decisions.

"Overall, the regulatory regime visavis TNCs is, as far as it is not impossibly restrictive, only a minor consideration in TNCs' choice of investment sites, when compared to things like market growth prospect. Promoting growth seems to be a more effective way of attracting FDI than liberalising FDI policies."

In terms of policy options, Chang suggests that intelligent governments should try, as some East Asian countries have done, their best to use TNCs in a strategic way to acquire the necessary capital, technology, marketing networks etc.

"An intelligent government pursuing a strategic industrial policy will not have a 'uniform' policy towards TNCs across industries -- unlike what is recommended by many Neo-Liberal economists. Each industry serves different functions in the greater scheme of industrial development and it will be foolish to have either uniformly restrictive or uniformly liberal policies towards TNCs across different industries. This also means that the same industry may, and indeed should, become more or less open to FDI, depending on the changes in various internal and external conditions that affects it.

"A government could initially have a liberal FDI policy for a new industry in order to establish it, but subsequently impose tougher restrictions on TNC subsidiaries when it is deemed that the industry have developed sufficient technological capability and therefore local firms will be able to stand on their own feet with a little extra help and push. Alternatively, when there is a major technological change in a certain industry which makes the country's present technological capability inadequate for international competition, the government may relax rules concerning TNC participation in the industry."

But it is one thing to use TNCs in a strategic manner, and another to be able to afford to play such a strategic game. The poorest developing countries will have weak bargaining power with TNCs in most industries, since those where they are attractive investment sites are those where TNCs are most mobile.

But many developing countries do have some 'bargaining chips' in relation to some industries -- especially where transportation costs (to supply the market) are relatively high and proximity to consumers are important for marketing -- such as China, India, Brazil and the rapidly growing East Asian economies. Others -- east Europeans, Vietnam and China -- because of their anticapitalist path have a relatively well-educated and well-trained labour force. Yet others have locational advantages -- e.g. Mexico visavis USA and central European and Southern Europeans visavis the richer West Europeans.

Having a potential bargaining power does not directly translate into the right amount and composition of incoming FDI, unless general economic conditions are right, and the government is administratively capable of actually exercising such power.

"However, adopting liberal FDI policies across all sectors and industries," Chang said, "will mean giving up one's potential bargaining power in those sectors where one has it before even exercising it, and therefore does not seem particularly wise. Even if many developing countries have relatively little bargaining power visavis TNCs and that such power may be diminishing with globalization, this does not mean they should give up what little bargaining power they still have, as what the national governments do still matter greatly for the determination of the costs and benefits of FDI."

Chang adds: "The current argument for liberal policies for TNCs in developing countries, based on the 'globalization' thesis, are at best distracting attention from more important issues, or at worst being used, if unconsciously, as a stooge in scare tactic to drive more developing countries onto a Neo-liberal 'reform' path."