The Real Issue Is Development, Not FDI

The issue is not FDI, but finance for development. Whether FDI is a source of development finance, and how significant it is, is an open question. Sometimes the issue of FDI is presented as a closed book; there is no debate on the subject. It is taken as an axiomatic truth that FDI is the hen that lays the golden eggs of development. To interrogate this axiom, it is necessary first to understand what FDI really is, for there is much misunderstanding about the matter. One of the closest secrets of our times is the myth about FDI. The myth needs to be exposed before we come to a policy issue of how to deal with FDI in relation to development.

This Fact Sheet focuses on the issue of FDI only. A companion Fact Sheet takes up the policy question of how to deal with FDI in relation to development.

The Truth About FDI

The truth about FDI is more complex than made out in neo-liberal economics. It is not properly understood by those informed by neo-liberal economics that contrary to the received wisdom, it is the Western economies that need to export capital for their own survival rather than the countries of the South that need to import capital. This is so because the Western economies continually face crisis of profitability, and one of the principal means to fight against this tendency is to export capital. This needs explaining.

a) The inner logic of capital is still driven largely by tension between capital and labour

The value of a good or commodity in market or price terms, comprises basically of capital plus wages, plus of course profit. If you leave out the other details, e.g.. transport, etc, this is what the price of a commodity boils down to. Even in neo-classical literature production graphs show labour on one side and capital on the other. To clarify issues, let us use some simple equations. The arithmetic might turn off some people, but it is really very simple. The arithmetic helps to understand why capital moves across frontiers as loans or as FDI. Following from what was stated earlier, we get:
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Value = Capital + Wage+ Profit.

Let us put some numbers to the equation:

120 = 50 (capital) + 50 (wages) + 20 (profit) (1)

In this equation profit is 20, say Euros. The rate of profit - profit of 20 divided by 100 (50 for capital + 50 for labour) is 20%. People always think that the capitalists try to maximize profits. That they do. But even more important than profits is the rate of profit, profit in relation to investments – how much profit the entrepreneur makes for every Euro he invests.

If the workers are strong and succeed in securing higher wages, the entrepreneur might find himself in the following situation.

120 = 50 (capital) + 60 (wages) + 10 (profit) (2)

So his profit has fallen to 10, and his rate of profit to 9% (10 divided by 110). It has fallen from 20% to 9%.

In a capitalist system, there are many reasons for the entrepreneur to apply machinery to production (for example, to improve the quality of the product), but the most important reason is to replace labour power with capital in order to reduce his wage bill. This is called capitalization of production – application of more capital to replace labour power (misleadingly called “increasing the productivity of labour” in neo-liberal economics).

Faced with a situation where his rate of profit has fallen from 20% to 9%, the entrepreneur must reduce his wage bill. Typically, the entrepreneur sacks some of the workers, thus reducing his total wage cost, and replaces labour with more productive machinery, adjusting production to something like the following:

120 = 70 (capital) + 30 (wages) + 20 (profit) (3)

What the entrepreneur has done is to reduce wages (to 30) and increase capital (to 70). He has restored his profit back to 20, and his rate of profit comes back to 20% (20/70+30).

The entrepreneur tries as far as the technology would allow to replace labour with capital, but there is a limit. At some point the wage labour is difficult to replace with capital. Also the workers’ unions may resist either sacking or reduction in wages. Here is where the entrepreneur might need the intervention of the state. The state might come in either to curb the unions (as in the USA, for example), or to negotiate a “social contract” between labour and capital (as in many European Social Democratic countries).

But the pressure from the workers remains incessant, and the entrepreneur might find himself in the following situation.

120 = 70 (capital) + 40 (wages) + 10 (profit) (4)

He is back to where he was represented in equation 2 above. His profit is down to 10, and his rate of profit to 9% (10/70+40)

This, simply explained, is the famous theory about the inevitability of profits to decline under the capitalist system. It is no mystery. It is within the very logic of the system of social relations between the capitalist and the workers. The more the workers demand as returns to labour the more downward pressure they put on the returns to capital.

One way to counter this is through political means – put pressure on the workers, and break their unions. This is indeed what Margaret Thatcher did in the UK in the mid-1970s and 80s, followed immediately by Ronald Reagan in the USA, and then in the 1990s by the rest of Europe. That was the era of “de-regulation”, when all state-protected labour and social policies and instruments were removed in order that the owners of Capital recuperate their profitability. There are other things that were done under the policy of “liberalisation” of the economy, but to these we come later.

So one way to fight against the declining rate of profit is the Margaret Thatcher way - the political way – that is, by curbing the workers and driving down their wages, and by deregulating the economy.

b) Movement of Capital and International Trade

A second way out for the entrepreneur when faced with depressant wage pressure on his rate of profit is to take his capital to countries where either the wages are lower and/or the unions are weak. So he takes his capital from say Germany to China. What does this mean for international trade?

In international trade it means that this entrepreneur can now produce a commodity (say a car) in China with a fraction of the cost he’d have to incur in Germany. He may invest only 45 Euros in capital goods, and a further Euro 05 as wages (because the wage difference between China and Germany is enormous). So what you have is:

70 = 45 (capital) + 05 (wages) + 20 (profit) (5)

The foreign entrepreneur operating from China with low wages invests much less than in Germany to retains his profit at 20. But his rate of profit (and this is even more important) has jumped to 50% (20/45+05). For a smaller amount of capital investment, he makes a larger profit than if we were to deploy that capital in Germany. For every Euro invested in China he gets a higher rate of profit.

Furthermore, he can now produce the same commodity (say a car) at a much lower price in China than in Germany. If you add his profit, then what was priced at 120 in Germany is now priced at only 70. Now he can export the car to Germany and compete against those who are still using German high wage labour.

Much of what passes in the name of “globalization” is, in essence, precisely what is described above – concrete measures taken by the Western states to deregulate their economies and by western corporations to globalize their investments – all aimed at the same phenomenon, namely, to counter the inherent tendency within the system for the tension between labour and capital to depress the rate of profit. “Globalization” is a euphemism for what at bottom is a policy decision by capitalist countries to help their corporations from declining profits that they faced within the system.

The implications of the above analysis are profound. One of these is to explode the myth about FDI

Myth about FDI exploded

It should be clear from the above that it is not so much China that is looking for FDI, but it is investors from the West that go looking for investment opportunities in China. However, the matter is always presented in the media and by neo-liberal economists in a one-sided manner – as if it is China (and the rest of the third world) that are looking like beggars at FDI to come to their countries. Many leaders in the third world have not understood the point about the declining rate of profit, and the pressing need for Western investors to push their capital to countries where labour is cheap and controlled. These investors need the third world badly, even desperately, to counter against their own working classes, and the declining rate of profit.

Those who say “poor Africa has only 2-3% of global FDI” have got the wrong end of the stick. They are simply lamenting the fact that conditions are not good enough in Africa for them to bring more of their capital so that they can reap higher rates of return than what they get in their own countries or in other parts of the third world.
Multinationals seek to average out the profit globally. In Europe and America they make a profit of 1-3%, in Latin America profit of 10-15%, in Asia about the same, Africa about 30%. Western corporations would like to put their money into Africa, because profit is very high, especially in the extractive industries. But they are not able to do so – why not? Because, they argue, the conditions are not safe for investments, there is “so much corruption” in Africa, etc. They turn it into a moral issue – one of corruption and bad governance. But it is not a moral issue. Let us examine this argument a little bit closely in the light of the following.

Measures to Shift Burden of Declining Profitability to the South

One of the measures corporations take in their own countries in order to restore profitability is to depress wages, sack workers, and replace them with machinery. There are other measures they also 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 used by the corporations to boost their profitability – one of the main reasons for the present crisis in the pensions systems in the West); 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 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, but also other natural resources); and to take advantage of cheap labour of the South with which to cut down their cost of production and survive globally.

The Central Role Investment – FDI – Plays in Countering Declining Profitability

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. Production, not trade, is the key to their effort to maintain control over the economies of the South.

Corruption and Governance are in Essence Economic Issues

It is in this light that the issues of corruption and governance must be viewed. For sure, control of corruption and democratic governance are inherently good values. But that is not the main reason why the states in the West are pushing these in the countries of the South.

The fact of the matter is that they use these values as a stick to bring a certain amount of direct control over the conditions in the South in which their corporations can function without interference from the states of the South. If one is looking for corruption, one does not have to go farther than the USA and Europe. Italy, for example, is a state that is run openly and unchallengingly by a robber baron. The seat of European bureaucracy – the EC Commission – is full of corruption and nepotism. But corruption is not the real issue. A very interesting example of this is what is called in the WTO parlance – “Transparency in Government Procurement”. The matter is presented as if it is to weed out corruption in the countries of the South in matters of public procurement of goods and services. When the outer cover is removed, it turns out that, in essence, it is a market question. Corruption is the stick the West uses to pry open the market of the South to Western procurement.

Where Do We Go From Here ?

The orthodoxy about FDI has become so ingrained in the psyche of policymakers in the South that rational dialogue about it is almost impossible. At its most crude, an opposition to FDI could provoke a reaction on the part of its protagonist, uttered with surprise and utter incredulity: "So where are you going to get capital from?" or, with a tongue-in-cheek irony, "Oh, so you think your country can develop without outside capital!" The one opposed to FDI is immediately made to feel as if she were living in a dream world.

However, like many aspects of South-North relations, the reality is reversed, presented up-side-down. The South is made to believe that it is they who need FDI, and that the North will “bring” FDI to the South, provided the South “learns” how to govern themselves “democratically” as laid down by their politicians and intellectuals in the North.

This raises the question of whether there is any role at all that FDI can play in development. Given the fact that FDI is primarily an instrument of control over the South by global corporations and their states, is there still some role that it can play in the South, and if so under what terms and conditions?

This question is considered in a companion Fact Sheet – “Role of FDI in Development”.