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| The
Next Crisis? Direct and equity investment in developing
countries |
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| Author
: David Woodward |
Published
by: Zed Books, London and New York, 2001. |
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| Review by Jayati
Ghosh |
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Click to Enlarge
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Foreign
investment illusions
One of the myths that appears to be indestructible,
despite growing evidence to the contrary, is that
of the generally positive and desirable nature
of direct foreign investment. It is certainly
seen as preferable to other forms of foreign capital
inflow, such as commercial borrowing and portfolio
investment. Even more, it is considered to be
eminently advantageous in its own terms, and something
to be actively sought by governments of developing
countries. In fact, access to more foreign direct
investment is now touted as one of the |
major benefits
of recent economic globalisation, which is supposed
to outweigh the many negative effects. This important
new book shows just how problematic such an assessment
can be. Woodward's penetrating and occasionally
startling analysis lays bare many of the current
myths about FDI in a succinct way.
One of the myths that appears to be indestructible,
despite growing evidence to the contrary, is that
of the generally positive and desirable nature
of direct foreign investment. It is certainly
seen as preferable to other forms of foreign capital
inflow, such as commercial borrowing and portfolio
investment. Even more, it is considered to be
eminently advantageous in its own terms, and something
to be actively sought by governments of developing
countries. In fact, access to more foreign direct
investment is now touted as one of the major benefits
of recent economic globalisation, which is supposed
to outweigh the many negative effects. This important
new book shows just how problematic such an assessment
can be. Woodward's penetrating and occasionally
startling analysis lays bare many of the current
myths about FDI in a succinct way.
To start with, Woodward reveals how little we
actually know about even the extent of FDI, and
especially stocks of FDI, into different countries.
It emerges that official data – including
those produced by the IMF and the World Bank –
almost certainly underestimate to a substantial
extent, the true value of inward FDI stocks and
their absolute rate of increase. Far from trying
to improve this state of affairs, the Fund and
the Bank have instead promoted the liberalisation
of foreign investment regimes, which actually
tends to reduce the availability of data and even
the possibility of collecting it.
This matters not only because it is useful for
a host country to know the exact stocks of inward
FDI, but because inadequate assessment of their
extent may lead to policy misjudgement and failure
to anticipate potential crises. As Woodward points
out, the lack of information on the extent of
external liabilities contributed to the external
debt crisis of the 1980s, and a similar process
may be under way with respect to private investment
today. Further, since FDI is not unambiguously
positive, such lack of knowledge of the extent
of inwards FDI stocks can even be dangerous in
other ways.
Consider, for example, the foreign exchange effects
of FDI, which are often simplistically assumed
to be positive. In actual fact, the foreign exchange
effects are much more negative than what emerges
from an idealised view of FDI. Woodward shows
that positive effects arise only where new productive
capacity is created in the export sector, or in
very strongly import-substituting sectors. If
the FDI takes the form of purchase of existing
capacity, even in the export sector, it will have
a negative foreign exchange effect even if export
production goes up, unless the productivity of
capital increases enough to offset the other increased
foreign exchange costs. At lower levels of important
substitution, the effects of "greenfield"
FDI in new capacity are much more ambiguous, and
may be negative.
Similarly, Woodward indicates how misleading it
may be to assume that FDI necessarily contributes
to increased employment. In fact, the employment
effect will depend on a whole range of variables,
including : the balance between greenfield FDI
and the purchase of existing assets; the labour
intensity of new productive capacities or new
organisational techniques; the extent to which
FDI-based production substitutes for existing
production and their relative labour intensities,
and so on. In general, therefore, it is not the
case that FDI creates much more net employment
unless it is really very large in scale and heavily
involved in greenfield activities, and even such
cases it need not be more employment-intensive.
Large-scale flows of FDI also have effects on
other domestic economic policies. To begin with,
reliance on such flows imposes severe constraints
on domestic government policy because of the fear
of withdrawal, and of course the potential impact
of disinvestment increases as the FDI stock grows.
Further, FDI is embodied in the presence of MNCs
who tend to be large and powerful lobbies for
domestic policies.
And then, of course, the very competition to attract
more FDI by governments with over-optimistic expectations
regarding such investment, means that all sorts
of concessions are offered which may turn out
to be very expensive for the economy in the medium
or long term. Woodward suggests that such FDI
promotion tends to focus heavily on the demand
side, in terms of requirements imposed on host
countries through changing their own policies
in order to make themselves more attractive. Such
unilateral concessions are increasingly sought
to be entrenched through international agreements.
Another interesting point that Woodward makes
is that much of the over-optimism surrounding
foreign investment stems from a tendency to look
at the host country in isolation from the developing
world as a whole. But in fact there are strong
negative spillover effects on other developing
countries, which may outweigh whatever limited
gains actually do accrue to the host country.
Woodward analyses the 1990s boom in FDI to developing
countries, to conclude that it has the elements
of a temporary surge similar to those affecting
the market for equity (or portfolio) investment.
While deregulation of foreign investment across
the developing world has played a role, this has
probably been less significant than the large-scale
privatisation programmes, which have been a major
source of both FDI and portfolio investment, and
the debt-equity conversions which were especially
common in Latin America. Further, some flight
capital may re-enter the country as FDI –
some estimates suggest that this has been significant,
for example, in China.
All these are clearly short-lived, or temporary
forces. Even the globalisation of production can
be seen as a finite conversion process, albeit
one which is more prolonged and complex. But it
is important to note that all these features make
FDI, along with portfolio investment, strongly
pro-cyclical in nature.
Even worse, FDI can contribute to the underlying
fragility of an economy and make it more susceptible
to balance of payments crises. Woodward considers
several ways in which this can happen. First,
as rapidly growing stocks of inwards FDI generate
similarly growing profits which form part of the
foreign exchange outflow. Second, when FDI fuels
an increase in imports, such as capital goods
for investment projects and other such payments.
Third, because current foreign exchange costs
of MNCs typically exceed the foreign exchange
they tend to earn through exports of import substitution.
Fourth, through the role played by foreign affiliates,
including those involved in retailing, in changing
patterns of consumption through advertising and
brand promotion.
For these and other reasons, FDI can contribute
to large current account deficits, which tend
to precede financial crises. They can also add
to both the economic shocks preceding crises and
to the process of contagion. Woodward provides
examples of a number of East Asian economies and
of Mexico prior to their respective financial
crises. He does not mention Argentina, whose major
crisis broke after this book was published, but
it provides even more of a classic example of
his argument.
The "fire-sale" of domestic productive
assets to foreign companies, which often accompanies
attempts to come out of such financial crisis,
may initially limit the reduction of FDI to the
affected countries, as indeed happened in South
Korea. But this occurs at a high long-term cost,
in terms of the build-up of more FDI stock and
further adverse balance of payments effects.
Once again, the case of Argentina over the past
two decades provides a stark if telling example
– indeed, it is almost as if this script
were written for Argentina, in terms of the pattern
of sale of public assets to foreign multinational
companies in the early 1990s, followed by very
adverse balance of payments effects which contributed
in turn to the external debt build-up which precipitated
the most recent crisis.
This more pessimistic – and more realistic
- view of the impact of FDI provides a very different
angle on the substantial and rapidly increasing
stocks of inwards FDI in a number of developing
countries. Far from being a source of celebration,
it may in fact be, as Woodward describes it, "an
accident waiting to happen". The latest round
of crises in emerging markets has perversely operated
to strengthen both the positive attitude to FDI
and efforts to promote it. But in the new climate,
in which developing country markets are seen as
riskier and international investors are becoming
more risk-averse, efforts to attract more FDI
will involve even more concessions on the terms
of such investment. "The result will be to
accelerate the build-up of liabilities without
a commensurate effect on the now seriously limited
capacity of national economies to bear them."
(page 207)
In fact, such a crisis appears to be almost inevitable,
since any serious efforts to prevent it would
require both a change in attitudes to foreign
capital and a change in political structures.
As Woodward says, "Only when governments
represent the interests of their populations and
both their business communities, and have (international)
political influence proportional to the populations
they represent, can we realistically expect to
achieve an international financial and economic
system which will genuinely serve the interests
of people, and not of transnational companies."
(page 215) Until then, it looks as if the world
will have to brace itself for the next round of
financial crises, this time probably emanating
from the balance of payments problems caused by
the current adulation of FDI. |
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| March 27, 2002. |
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