THE ROLE OF FOREIGN DIRECT INVESTMENT IN DEVELOPMENT

The reigning orthodoxy in neo-liberal economics on FDI boils down to five canonical “truths”:
• FDI is necessary for the development of the Third World.
• Without FDI there will be no growth.
• FDI brings inter alia efficient management of resources, technology, a culture of competition, and access to global markets.
• Nobody is forcing the South to seek FDI; the governments themselves want it.
• The private sector is the engine of growth; hence countries in the South must deregulate their economies, and privatise state assets as fast as possible.

More than 90% of literature, and third world government policies, are dominated by this view. In a brief paper, it is not necessary to repeat the arguments. The principal argument, simply stated, is the following: Aid and loans in the 1960s and 70s created “aid dependency” and the debt crisis in the 1980s and 90s. FDI is the best source of development finance, on the grounds, among other, that it is self-liquidating since foreign investors have to show profits for the host country as well as for themselves; and it does not lead to debt overhang.

b) FDI is neither good nor bad; it all depends on how you deal with it

A more qualified proposition is made (e.g. in the Oxfam Briefing paper) that “properly regulated” FDI can bring growth, jobs, technology, skills, market access and development; that its negative effects must be balanced with its good effects; or that FDI must be "sequenced", or be subject to some kind of Tobin Tax. FDI is neither good nor bad; it all depends on how you deal with it. This view is now becoming popular in many circles, including some reformed neo-liberal economists, especially after the East Asian and Argentina crises of 1997 – 2001.

c) Aid Created Debt Crisis; FDI Will Create An Even Greater Crisis Of Development

More recent empirical evidence suggests a completely different picture. Analysts like David Woodard argue that if aid created the debt crisis, FDI will create an even greater crisis of development, looming not in too distant future. This view challenges both the reigning neo-liberal orthodoxy, and the above stated more qualified perspective. The view is further explored below in the next section.

d) FDI is Not a Development Tool at all; it is a Response to Systemic Crisis of the Developed Countries

A more radical alternative view is presented in a separate SEATINI Fact Sheet (What is FDI? ). It argues that FDI, essentially, is a tool (one among many) in the economic arsenal of the developed industrialised countries in their overall strategy to control the resources and markets of the South. This control is necessary in order for Western corporations to counter against the downward pressure that is continually exerted by workers on Corporate profitability. FDI is a means to resolve the West’s own systemic contradictions. Contrary to its claim, it is not a means to assist the developing countries. However, FDI is well marketed by the West through “development” literature and through institutions such as the IMF, the World Bank, the WTO, and even the UNCTAD.

2. Does FDI Bring Development ? The Experience of Mexico, East Asia and Argentina

Mexico, Thailand, Indonesia, the Philippines, Malaysia and Argentina are among the countries often cited by the World Bank, the IMF and mainstream economists as model countries that opened their doors to free trade and free flow of capital on the assumption that these would bring development to them. What has been their experience?

In 1995, Mexico faced a payments crisis, and there was a run on the banks. The economy took a downward spin, and the middle classes took the brunt of the crisis. As for the “distressed” American banks, they were baled out by the US Treasury. The “tequila factor” reverberated disconcertingly for several months in the region. Since 1995, Mexico liberalised further its trade and investment regimes. It is now facing massive deindustrialisation and joblessness.

Then came the 1997/8 East Asian crisis. In the 1990s the Thai government had liberalised capital flows partly as a result of pressure from the IMF. Much of the funds came through the banking system on short call (ranging from overnight calls to six months duration), and were lent long to the private sector enterprises. The collaterals offered by the private sector turned out to be extremely questionable in terms of value because they were largely based on inflated property prices. So when the crunch came following a speculative run on the Baht in August 1997, the foreign investors panicked and started withdrawing their funds from Thailand; so the banks began calling back their loans, and of course the private sector could not pay them. They defaulted. In trying to shore up the Baht, the central bank depleted most of the country’s reserves. In the follow-up many of the banks were liquidated, or consolidated, and the state decided to take over the burden of repaying the loans. In other words, private debts were transformed into public debts. Soon the Thai crisis rippled across to Indonesia, the Philippines, Malaysia and Korea. According to the Economist,

For much of the region, the crisis destroyed wealth on a massive scale and sent absolute poverty shooting up. In the banking system alone, corporate loans equivalent to around half of one year's GDP went bad - a destruction of savings on a scale more usually associated with a full-scale war. (The Economist, February 8 2003)

David Woodward, an erstwhile technical adviser to the British Executive Director at the IMF and the World Bank, studied the Mexican and Asian crises in some depth and drew the general conclusion that FDI has a tendency towards precipitating a crisis.

Financial crisis such as those of Mexico in 1994 and East Asia in 1997, like the 1980s debt crisis, arise because of capital inflows are insufficient to cover current account deficits. When this is reached, capital inflows fell sharply, compounding the problem.... (However) vulnerability to financial crisis is primarily associated with large current account deficits, the associated accumulation of foreign exchange liabilities (which in turn add to the deficits), and a resulting acute dependence on foreign capital to finance the deficits. (p.13)

The truth about FDI is that, like drug addiction, it creates dependency – the more FDI a developing country secures, the more it needs to service it and keep the system going. Woodward writes:

Simplistically, FDI flows may be seen as equivalent to borrowing at an interest rate of 16-18% p.a. for developing countries as a whole, and 24-30% in sub-Saharan Africa, so that net outward resource transfers can only be avoided by allowing inward FDI stocks to grow at this rate. This implies a rapid expansion relative to the ability to meet the foreign exchange costs. (p.19)

Drawing from the experience of Malaysia, Woodward reckons that when the FDI stocks (as opposed to flow) in a developing country reaches 48% of GDP (which in many African countries it has), then it is in the crisis zone. Indeed, “…the danger point for other developing countries may be significantly below 48%” (p.18)

Woodward, at the time of his study, had not considered the case of Argentina, which it turns out, proves his point. Argentina has long been modelled by the IMF/WB experts as the paragon of the Washington Consensus, an exemplary country that had abolished trade barriers, had opened itself up to the free inflow and outflow of capital, had tied its currency to the US dollar (the Currency Board Automatic Adjustment Mechanism), had privatised practically everything, from banks to malls, to attract FDI. In December 2001 the “model” collapsed like a pack of cards. The country simply disintegrated in a morass of economic, social and political chaos following the default on $155 billion of debt - the largest in history.

If the developing countries do not take heed of the evidence before their very eyes, and their leaders continue to peddle the idea that somehow FDI will get their countries out of the poverty trap, then one of two conclusions follow. Either they are persuaded by the incessant misinformation by Bretton Woods institutions and neo-liberal economists among their own ranks, or they are too desperate, and cannot think of any alternative way out of their poverty trap.

3. The Truth About FDI in Africa

There is an argument that Africa has “fallen behind” other countries because it does not have conditions adequate to attract FDI.

The truth is that Africa has done more to oblige overseas investors than almost any other continent, and yet investments have gone to other continents. In Africa, it has gone primarily to countries like Angola - because of its oil and in spite of over three decades of instability. Nothing has come to those countries, such as Zambia, that have almost fully liberalised their investment regimes – far more than say China or India.
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The New Economic Partnership for Africa’s Development (NEPAD) recorded that in the 1990s, regulatory and other reforms have been introduced by a number of governments to make their economies more attractive to foreign investors. Today, these regulatory conditions are on a par with those in other developing countries. For example, many more countries now allow profits to be repatriated freely or offer tax incentives and similar inducements to foreign investors. Many African countries have investment promotion agencies (IPAs), to assist these investors. And yet, no FDI has come to Africa (in fact, capital has flown out of Africa – see below). A former Minister of Finance of an African country said: “We have removed our shirt and trousers to attract FDI; what more do they expect us to do?”

As for South Africa that has rapidly liberalised its trade and investment regimes since independence, capital has left the country rather than coming in. As the London Economist, in a special survey of South Africa in 2001, recorded:

And by the standards of other countries, South Africa has lured relatively little foreign direct investment: $32 per head in 1994-99, compared with $106 for Brazil, $252 for Argentina, $333 for Chile. At the same time, money has been leaving South Africa: the $9.8 billion it invested abroad in 1994-99 exceeded the inward flow by about $1.6 billion. … And its big companies, long confined by apartheid's isolation, are now anxious to seek stock-exchange listings abroad. … So in the past few years, Anglo American (mining), Billiton (mining), Old Mutual (insurance), South African Breweries and Dimension Data (a hugely successful information-technology company) have all sought primary listings elsewhere.

4. FDI is an Answer to West’s Profitability Crisis, Not an Answer to Development Countries’ Development Crisis

The truth of the matter is that FDI is an answer to systemic crisis of profitability in the global capitalist system. An explanation of this is given in SEATINI Fact Sheet on What is FDI? It is necessary, however, to reiterate the main argument.

The essential underlying force that depresses profits in the system is the pressure from the working classes to improve their wages and conditions of life. One of the measures corporations take in their own countries in order to restore profitability is to depress wages, sack workers (or introduce labour flexibility), and replace them with machinery. There are also other measures they take – such as rationalise production through mergers and acquisitions; bring prices of stock closer to real value of assets (asset stripping); and create new instruments to cushion risk (for example, derivatives). Their states help the process by measures such as controlling the unions; privatisation (public asset stripping); pass the burden on to the weaker sections of their society (for example, commercialise pensions so that these funds are usable by the corporations to boost their profitability); and promote a war economy (for war instantly destroys existing weapons and boosts production of replacements amounting to billions of dollars).

But even more important are the measures the Western governments take to shift the burden of depressing profitability over to the countries of the South. These measures include:
• Force the South to liberalise their trade. This is aimed to capture the markets of the South for their corporations (the main role of the WTO).
• Force the South to liberalise the flow of capital. This is aimed to capture investment opportunities in the South, especially access to natural resources (the main role of the IMF and the World Bank, and Investment and Competition issues in the WTO).
• Force the South to privatise and liberalise their public services, such as water, health, energy, education, etc. and government procurement (the main role of GATS provision of the WTO, and the so-called “new issues”).

All these are measures taken by the Western states in order to counter against depressant wage pressures that their own workers bring to the profits of their corporations. Instead of being the engine of growth, the private sector corporations are perpetually seeking state intervention to help them survive. Without their states helping them they would be at the mercy of the workers, and they would not survive. And without state intervention (through agencies like the IMF, the World Bank and the WTO), the corporations would not be able to break down the barriers to their further infiltration of the markets of the South (for goods, services and government procurement); to get access to resources (especially oil and gas); and to take advantage of cheap labour of the South with which to cut down their cost of production and survive globally.

In all this investments play the most critical role. In the commodities market, the Western corporations and their governments know that they may not be able to hold on for too long. The very pressures that they themselves have created in liberalising trade will hit back at them. Why? Because they cannot compete against “cheap” products and services from countries like India and China. In the short term they may play for time – for example, through subsidising their agriculture (especially Europe), protecting their steel manufacturers by high tariff walls (especially the USA), and preventing “outsourcing” of their services to countries like India and Brazil (USA). But eventually they will have to reckon with the fact that on an even playing field they are no match against the producers from certain industrialising countries of the South. Hence, their best option is to create conditions so that they can export their capital in order to control production in these countries. Direct participation in production (through FDI and other investment measures), not trade, is the key to their effort to maintain control over the economies of the South.

Analysts such as Woodward have done good service by showing how FDI will inevitably lead to deeper crisis of development. But then development (in spite of what the leaders of third world countries might believe) has never been FDI’s objective. Although the export of capital helps to counter the perpetually downward pressure on the rate of profits, there is a limit. It seems that with the crisis in Mexico, East Asia and now Argentina, FDI is nearing its historical limit.

5. Conclusion: Implications For Third World Policy on FDI

FDI is falsely marketed to the developing countries as a “solution” to their underdevelopment. Development itself is a complex phenomenon. To single out FDI (as most third world governments tend to do) as the principal means to development is reductionism pushed to its absurdity.

There is in fact no evidence that FDI brings development. There is also no evidence that FDI transfers technology. All that happens is a pseudo-transfer of technology (see SEATINI Fact sheet on Technology). If anything, the evidence shows that FDI leads to increasing vulnerability to crisis, and - like aid in the 1970s - to increasing dependency. Why do third world governments then seek FDI? Partly because they don’t know better; partly because of the influence of International Financial Institutions (IFI); partly because their own bureaucrats are largely educated in neo-liberal economics; and partly because like a shot in the arm FDI can restore the health of a dying economy. But like drug addiction, the more you have it, the more you are in need of it.

Furthermore, contrary to received “wisdom” of IMF/WB “experts”, Africa does not suffer from "low savings rate", leaving an "investment gap" that has to be filled by FDI. On the contrary, Africa's savings rate is high. However, those savings are not described as "savings" in the dominant economic literature. They are described, by some accounting convention, as dividends, interest on loans, debt payments, etc. These then are externalised, and when they come back, in another guise, they are described as "fresh investments", or "FDI". As the South African example shows, capital leaves Africa by the drove.

FDI is no solution to Africa’s development – except for temporary periods in some very specific situations, for example, when joint ventures bring definite and concrete gains for the country. In general, however, FDI is a problem. The issue is not FDI but finance for development. And the primary source of development finance is the savings of the people. These must be prevented from leaving Africa, especially in the form of massive debt payments (US$200 billion were transferred by poor to rich countries in 2000 alone), excessive profit remittances, and losses through such measures as transfer pricing and declining terms of trade.

Selected Readings:

Oxfam Briefing paper no 46, April 2003

The Economist, February 24 2001 - Special Survey of South Africa

The Economist, February 8 2003

David Woodward, Financial Effects of Foreign Direct Investment in the Context of a Possible WTO Agreement on Investment, Third World Network, 2003

Martin Khor, “Monterrey Sprit in Search of a Body to Avoid Being a Ghost”, New York, 31 October 2003 (A report on the Monterrey Conference on Finance for Development)

Yash Tandon, Fallacies About The Theory of FDI: Its Ideological And Methodological Pitfalls, SEATINI publication, 2002.

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