Foreign Investment & Domestic Development: Multinationals and the State

EXCERPTED FROM

Foreign Investment and Domestic Development: Multinationals and the State Jenny Rebecca Kehl

Copyright © 2009 ISBN: 978-1-58826-633-0 hc

1800 30th Street, Ste. 314 Boulder, CO 80301 USA telephone 303.444.6684 fax 303.444.0824

This excerpt was downloaded from the Lynne Rienner Publishers website www.rienner.com

Published in the United States of America in 2009 by Lynne Rienner Publishers, Inc. 1800 30th Street, Boulder, Colorado 80301 www.rienner.com and in the United Kingdom by Lynne Rienner Publi,hers, Inc. 3 Henrietta Street, Covent Garden, London WC2E 8LU © 2009 by Lynne Rienner Publishers, Inc. All rights reserved ISBN: 978-1-58826-633-0 Library of Congress Cataloging-in-Publication Data A Cataloging-in-Publication record for this book is available from the Library of Congress. British Cataloguing in Publication Data A Cataloguing in Publication record for this book is available from the British Library. Printed and bound in the United States of America The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Printed Library Materials Z39 . 48-1992. 54

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1

Contents

List of Illustrations

ix

1 Introduction: The Political Economy of Development 2 The Politics of Profit: Foreign Investment as a Development Strategy 3 Roadblocks: Ineffective Bureaucracies in Kenya 4 Corruption: Impeding Pioneer Industries in Nigeria 5 Growing Pains: Securing the Benefits of High Tech Investment in India 6 Joint Ventures: Developing a Business Class in Malaysia 7 Adelante: Government Commitments to Reduce Investment Risk in Chile 8 After NAFTA: Attracting Multinationals with Free Enterprise Zones in Mexico 9 Looking Forward: The Trajectory of Foreign Investment and Domestic Development Appendix: Research Notes Bibliography Index About the Book

1 11 47 59 71 85 97 105 117 133 143 155 163

vii

III ustrations

Table 2.1

T he Interaction Effects of Political Institutions, Political Economy, Foreign Investment, and Economic Growth

30

Figures 2.1

Worldwide Increase in Foreign Direct and Portfolio Investment

16

2.2

Total Foreign Investment in World Regions, 1970-2000

17

9.1

Comparative Levels of Democracy and Government

9.2

Comparative Levels of Direct and Indirect

126

Effectiveness Benefits from Foreign Investment

ix

127

1 Introduction: The Political Economy of Development

THE DEVELOPING WORLD RELIES ON GLOBAL markets to stimulate growth and generate wealth. Yet, in this time of great global opulence, trillions of dollars flow through the developing world without altering its reality of poverty and scarcity. At the turn of the century, the world’s fifty largest foreign investors in the developing world held $1.8 trillion in foreign assets and $2.1 trillion in sales.1 Amartya Sen, Nobel laureate in economic sciences, contrasts this unprecedented amount of wealth in the international economy with the “remarkable deprivation, destitution and oppression” observed in most of the world.2 There is a growing discrepancy between the substantial foreign investment in the developing world and the sparse resources available for domestic development. The global market alone has failed to reverse this trend. However, the size of the global economy is expected to quadruple in the next fifty years, with the majority of the growth in foreign direct investment (FDI). This growth has the potential to increase the financial and capital resources available to promote development in poor countries. The expansion of FDI offers developing countries the opportunity to increase their integration into the global market and to develop investment patterns that maximize their possibilities for economic growth. In this book I examine the crucial relationship between foreign direct investment and domestic economic development. Foreign direct investment can be an asset to developing countries by providing employment, capital, revenue, trade, and technology. Most underdeveloped countries, however, lack the institutional capacity to negotiate mutually beneficial investment arrangements with multinational corporations. Weak political institutions and perverse economic policies make developing countries easily exploitable. Nevertheless, as this study

1

2

Foreign Investment and Domestic Development

demonstrates, developing countries can in fact gain greater benefits from hosting foreign investment, without deterring future investment. The essential strategies for gaining greater benefits from foreign investment are political, not economic. Political institutions mediate the conflict of interest and the disparity of power between multinational corporations and host governments in order to maximize benefits and minimize externalities. In the chapters that follow, I provide crossnational evidence that domestic benefits from foreign investment are contingent on government capacity, democratic accountability, regulatory standardization, and development policies that maximize freedom of production and consumption. I also compare the distinct investment arrangements of General Motors Corporation, one of the world’s largest foreign direct investors, in Mexico, India, Nigeria, Kenya, Chile, and Malaysia. This innovative multimethod approach exposes the negotiation strategies of host governments and General Motors, and provides a much-needed assessment of the outcomes of investment arrangements for developing countries and multinational corporations. Not all developing countries have been able to benefit from the promise and prosperity of foreign investment. Poor countries cannot rely on the altruistic intentions of foreign investors to promote domestic development. Most multinational corporations are more highly organized and have more money than the countries in which they invest. This gives them leverage to negotiate lucrative, and often exploitative, deals with fledgling governments in poor countries. There is an important ongoing narrative about how foreign investment leads to exploitation. But that is not the narrative of this research. My purpose is to demonstrate how developing countries can manage foreign investment to promote domestic development. The benefits and externalities of hosting FDI are largely a function of how well governments negotiate initial investment arrangements. Accordingly, I address the following questions: What specific strategies are successful in negotiating mutually beneficial investment arrangements between countries and corporations with asymmetrical bargaining power? Are there discernible differences in domestic political institutions and economic policies that generate distinct patterns of foreign direct investment? What determines the success or failure of developing countries to utilize foreign investment to promote domestic development? Previous research has focused almost exclusively on how to attract foreign investment. This study focuses on how to utilize it.

Introduction

3

The Role of Political Institutions Political institutions provide incentives and impose constraints on foreign investment. Governments rely on institutions to resolve political problems, coordinate economic activities, and implement strategies to promote development. In the case of foreign investment, the capacity of developing countries to negotiate mutually beneficial investment agreements is contingent on the ability of political institutions to achieve specified goals.3 Political institutions must be able to manage resources, react to political and economic challenges, predict and prevent crises, and achieve policy results. The World Bank’s Global Development Finance Report suggests that good policies and good governance, along with strong institutions, are critical to using private foreign investment inflows productively. 4 When governments decide to host foreign investment as part of an economic development strategy, political institutions often determine the success or failure to maximize domestic benefits and minimize negative externalities. Political institutions moderate competing interests, mediate asymmetrical power, develop codes of conduct, and specify the rights and responsibilities of foreign corporations and host governments. Recognizing the explanatory value of political institutions challenges the alternative explanation of economic determinism. The relationship between foreign direct investment and domestic development cannot be explained entirely by economic variables. Chapter 2 elaborates on the alternative economic explanations. However, as Frances Hagopian and Samuel Huntington argue, “economic forces are indeterminant [sic]; their influence on outcomes must be filtered through political institutions.”5 The political institutional framework suggests that institutions are central to good economic governance. Governments develop institutions to raise revenue and stimulate economic growth in response to political and economic interests.6 To satisfy these interests, institutions have become “larger, considerably more complex and resourceful, and prima facie more important,”7 particularly in developing countries. There is, however, wide variation in the capacity of governments to establish effective institutions to meet political demands and economic needs in the developing world. In this study I analyze several indicative political variables—including regime type, accountability, transparency, political stability (political risk), regulation of production practices, performance requirements, and government effectiveness—in order to determine what specific institutional

4

Foreign Investment and Domestic Development

arrangements are successful at achieving good economic governance in developing countries.

The Role of Political Economy The political economy approach argues that development is driven by a combination of market mechanisms and government decisions. On a spectrum from laissez-faire to command economies, governments often make deliberate political decisions for economic reasons.8 Government policies may have calculated effects on the market through rules of commerce, fiscal policy, regulation, taxation, expenditure, production, and consumption. I examine these economic indicators in Chapter 2, in accordance with the new institutional economics theory established by Douglass North, Ronald Coase, and Robert Fogel.9 This theory suggests that it is the underlying institutional framework that determines the success or failure of efforts to establish market-oriented strategies that promote economic growth. In the case of using foreign investment as part of a development strategy, governments may choose to intervene in production or consumption in order to maximize the profitability of the investment. The liberal theory of political economy suggests that governments must determine their level of intervention in the economy based on the consequences for the market. Pure laissez-faire liberalism advocates a minimal level of government intervention in the economy. However, most political economy theories of development acknowledge that the state is clearly a key actor for countries in the developing stages.10 The political economy framework suggests that governments intervene, minimally, in market systems to provide an environment that is conducive to economic growth, to arbitrate between government policy goals and those of individuals and firms, 11 and to compensate those adversely affected.12 Political economy theory parallels political institutional theory regarding the “coordination” of market forces. However, political economy emphasizes the importance of factors such as market access, market size, trade practices, taxation, and the level of intervention in market forces, while the political institutional approach focuses on variables such as institutional accountability, political stability, government capacity, and policy implementation. The political economy framework advocates for economic neoliberalism as the guiding principle for coordinating market forces. Although neoliberalism has been

Introduction

5

hotly debated at the theoretical level, the evidence in support of free trade is almost undisputed in the industrialized countries. The picture in the developing countries, however, is quite different. As political economist A. F. K. Organski argues, the poorer the country, the more important are political factors.13

A Mixed Reception for Foreign Investment Foreign investors receive a wide variety of receptions in developing countries. India is an emerging economy that welcomes foreign investors into government-financed High Tech City buildings that are designed to impress modern multinational corporations. These buildings have backup energy sources to compensate for the regular power outages in India, as well as emergency flight plans to transport employees to the nearest High Tech City if their computer systems collapse. The facilities allow foreign investors to conduct business without disruptions in energy supplies or computer communications, which is a luxury that most domestic businesses do not have. Foreign companies have been highly successful in High Tech City locations in India. For example, General Motors has orchestrated the Chevrolet Indian Revolution, “a love affair with the Chevy”14 that has generated hundreds of millions in revenue. This illustrates a warm reception for foreign investors from the Indian government and consumers. But not everyone shares the love affair with foreign investors. The train bombings in Mumbai in 2006 specifically targeted business commuters on their way to work in modern High Tech City locations for foreign firms such as IBM, Nestlé, Nokia, and General Electric. Malaysia has developed technology corridors, similar to India’s High Tech City buildings, and Mexico has designated maquiladora zones as free enterprise zones to welcome foreign investors. Multinational corporations often receive tax breaks, corporate subsidies, labor concessions, toxic-emission exemptions, and other incentives to conduct business in technology corridors and maquiladora zones. However, political officials and business leaders in both countries have accused foreign investors of creating expensive externalities and failing to honor their initial contracts. In Mexico the outcomes of these disputes are determined largely by the North American Free Trade Agreement, which favors the foreign firms. In Malaysia the central bureaucracy normally governs over foreign investment, but the bureaucracy’s power is limited

6

Foreign Investment and Domestic Development

in free enterprise zones. Similar arrangements exist in free enterprise zones worldwide to maximize the freedom of production and consumption for multinational corporations. Even with free enterprise zones, African countries have had trouble marketing their economies as destinations for FDI. They have been scrambling to receive foreign investors and have undercut each other in a race to the bottom—promising to minimize benefits for the host country in order to maximize profits for the foreign investors. Many African countries agree to forego tax revenue; allow profits to be repatriated rather than reinvested; give away resource rights, mining rights, drilling rights, and valuable raw materials; and absorb the cost of negative externalities in order to attract foreign investors. Despite these concessions, there are sectors that gain benefits from hosting foreign investment, such as oil in Nigeria, agriculture in Kenya, and manufacturing in South Africa. Although the relationship between foreign investment and domestic development is tenuous throughout the continent, African countries continue to welcome foreign investors because they need the capital, employment, technology, and revenue that those investors generate. It is unrealistic and counterproductive to discourage African countries from receiving foreign investment as part of a development strategy. It is more productive to examine a variety of strategies that poor countries can use to improve their investment arrangements by maximizing benefits and minimizing negative externalities.

Organization of the Book This book is designed to demonstrate how developing countries can manage foreign investment to promote domestic economic growth. “The Politics of Profit: Foreign Investment as a Development Strategy,” Chapter 2, examines the political institutions and economic policies that affect the benefits and externalities from hosting foreign direct investment. Here I examine FDI arrangements using a cross-national analysis of 147 developing countries across 35 years (1971–2006). I test the significance of three competing explanations—political institutional, political economy, and a synergistic model—and examine globalization, diffusion, and the learning process across states. The dynamics of diffusion and the causal mechanisms of change are illustrated in the case studies of Kenya, Nigeria, India, Malaysia, Chile, and Mexico. Chapter 3, “Road Blocks: Ineffective Bureaucracies in Kenya,” and Chapter 4, “Corruption: Impeding Pioneer Industries in Nigeria,” analyze the consequences of weak political institutions and inconsistent

Introduction

7

economic reforms in the African region. The case of Kenya demonstrates how ineffective bureaucracy and political instability can result in divestment, while the Nigerian case exposes the debilitating effects of corruption. Chapter 5, “Growing Pains: Securing the Benefits of High Tech Investment in India,” and Chapter 6, “Joint Ventures: Developing a Business Class in Malaysia,” demonstrate how institutional capacity has expedited the process of foreign investment and domestic development. India’s arrangements with General Motors reveal successful strategies for attracting and utilizing foreign investment to achieve rapid economic growth, despite contradictions between a large labor pool and a small tax base, as well as hidden costs of increasing inequality. The case of Malaysia’s contracts with General Motors illustrates the impact of centralized government on investment arrangements, which has allowed Malaysia to enforce requirements on employment and technology transfer. Chapter 7, “Adelante: Government Commitments to Reduce Investment Risk in Chile,” and Chapter 8, “After NAFTA: Attracting Multinationals with Free Enterprise Zones in Mexico,” focus on the importance of reducing political risk and the dynamics of foreign direct investment in Latin America. They also correct several of the inaccurate myths about what foreign investors consider to be compelling incentives and constraints. Mexico’s arrangements with General Motors also highlight the effects of superstructures on the relationship between foreign investment and domestic development, showing how the North American Free Trade Agreement has determined most of the interregional incentives and constraints for foreign investment. The concluding chapter of the book, “Looking Forward: The Trajectory of Foreign Investment and Domestic Development,” provides a synopsis of the research and offers projections about the modernization of investment negotiations and development strategies. The research findings demonstrate that the quality of the investment environment, rather than the quantity of investment, determines profitability for both investors and host countries. The findings also highlight the discernible differences in political institutions that result in distinct patterns of investment.

Notes Thank you to Rutgers University–Camden, faculty colleagues I have thanked in person, and the Office of Sponsored Research and Programs for the support and resources to complete this project. Special thanks also to James Scarritt for his insight and expertise.

8

Foreign Investment and Domestic Development

1. United Nations Conference on Trade and Development. World Investment Report. 2003. FDI Policies for Development: National and International Perspectives. New York: United Nations. 2. Amartya Sen. 1999. Development as Freedom. New York: Random House, p. xi. Sen was Nobel laureate in economic sciences in 1998. 3. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity and Economic Behavior: The Political Economy of Global Interdependence. Boulder, CO: Westview Press; David Leblang. 1997. “Political Capacity and Economic Growth.” In Political Capacity and Economic Behavior, edited by Marina Arbetman and Jacek Kugler. Boulder, CO: Westview Press. 4. World Bank. 2004. Global Development Finance Report 2004. Washington, DC: World Bank Group, pp. 64–65. 5. Frances Hagopian. 2000. “Political Development, Revisited,” Comparative Political Studies 33: 893; Samuel Huntington. 1968. Political Order in Changing Societies. New Haven, CT: Yale University Press. 6. Margaret Levi. 1997. “A Model, a Method, and a Map: Rational Choice in Comparative and Historical Analysis.” In Comparative Politics: Rationality, Culture, and Structure, edited by Mark Lichbach and Alan Zuckerman. Cambridge: Cambridge University Press; Margaret Levi, 1988, Of Rule and Revenue. Berkeley: University of California Press; Avner Greif, Paul Milgrom, and Barbara Weingast. 1994. “Coordination, Commitment, and Enforcement: The Case of the Merchant Guild,” Journal of Political Economy 102: 745–776. 7. James March and Johan Olson. 1984. “The New Institutionalism: Organized Factors in Political Life.” American Political Science Review 78: 734. 8. Kenneth Arrow. 1951. Social Choice and Individual Values. New Haven, CT: Yale University Press; Anthony Downs. 1957a. “Causes and Effects of Rational Voter Abstention.” In An Economic Theory of Democracy. New York: Harper; Anthony Downs. 1957b. An Economic Theory of Democracy. New York: Harper; William Riker. 1982. Liberalism Against Populism: A Confrontation Between the Theory of Democracy and the Theory of Social Choice. San Francisco: W. H. Freeman and Mancur Olson. 1971. The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge, MA: Harvard University Press; Douglass North. 1981. Structure and Change in Economic History. New York: Norton; Douglass North. 1990. Institutions, Institutional Change, and Economic Performance. New York: Cambridge University Press; Margaret Levi. 1988. Of Rule and Revenue. Berkeley: University of California Press. 9. Douglass North. 1999. Understanding the Process of Economic Change. London: Institute of Economic Affairs and the London Business School. Douglass North and Robert Fogel are 1993 Nobel laureates in economic sciences; Ronald Coase, 1991 Nobel laureate in economic sciences. 10. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity and Economic Behavior: The Political Economy of Global Interdependence. Boulder, CO: Westview, p. 15. 11. Ibid. 12. Peter Katzenstein. 1985. Small States in World Markets. Ithaca, NY: Cornell University Press.

Introduction

9

13. A. F. K. Organski. 1997. “Theoretical Link of Political Capacity to Development.” Pp. 47–66 in Political Capacity and Economic Behavior, edited by Marina Arbetman and Jacek Kugler. Boulder, CO: Westview. 14. Sandeep Raj Singh. January 29, 2007. “General Motors India on a Roll,” Company News, New Delhi, General Motors India, p. 5.

2 The Politics of Profit: Foreign Investment as a Development Strategy

INTERNATIONAL INVESTMENT CAN SERVE AS AN engine for growth and economic development in the Third World by increasing global inte­ gration, employment, technology, skills training, infrastructure develop­ ment, and revenue from taxation. The world's poorest countries lack sufficient amounts of these assets and thus cannot reverse chronic underdevelopment. Although it is not a panacea, foreign investment may provide a modicum of the capital and technology necessary to spark domestic economic growth and development. The modern concept of development is both ambiguous and ambi­ tious. Development incorporates the broad processes of democratiza­ tion, marketization, and globalization. Scholars who study development are charged with the complex, and often contentious, task of identifying the goal s and strategi e s for development. As S amuel Huntington explains, studies of development focus on sequences in the choice of development goals, institutional structures for reconciling development goals, and governmental strategies to promote the s i multaneous achievement of development goals.! The goals of development include a wide range of political and economic indicators such as legitimate and effective government, economic growth, i ndustrialization, international trade, improved standard of living, public health and safety, education, and poverty reduction. It is difficult to achieve academic consensus on the exact goals of development, but it is even more problematic to try to achieve agreement on the most effective strategies to expedite growth and foster development. The role of foreign investment in development is becoming i ncreas­ ingly important as the amount of international assets increases exponen­ tially and the wealth disparity between rich and poor nations widens.

11

13

Foreign Investment and Domestic Development

The Politics of Profit

Foreign investment accounts for $ 1.8 trillion of capital assets in the developing world, more than the total domestic capital assets of all developing countries combined. 2 This indicates an immense discrepancy between the potential and reality of foreign investment as a stimulus to economic growth in the developing world. For this reason, the scholarly debate centers around whether foreign investment helps or hinders eco­ nomic development. The most highly contentious aspect of this debate is whether the intent of foreign investment is exploitative and extractive or contributory and facilitative of economic growth. Scholars disagree fun­ damentally about the balance of costs and benefits of foreign invest­ ment. Advocates of using foreign investment as an economic development strategy argue that it promotes production and consumption, introduces new technologies, and thus stimulates economic growth. The specific benefits of foreign investment include the ability to increase the volume of world trade, increase investment capital, finance loans, lobby for free trade, underwrite research and development, introduce and dispense technology, use comparative advantage to reduce costs of goods, gener­ ate employment, train workers, disseminate marketing and mass-adver­ tising methods, i ncrease access to international m arkets, promote national revenue and growth, and accelerate global integration of the economy. Foreign aid, such as grants and loans, has also provided a sig­ nificant amount of funding for these development proj ects. However, the amount of foreign grants and loans has been decreasing in absolute terms. This trend continues downward based on government and inter­ national finance organization audit reports regarding the misuse of aid and default on loans. The decrease in foreign aid has turned the develop­ ing world toward foreign investment as an additional source of econom­ ic growth. Opponents of using foreign investment to foster domestic develop­ ment argue that it is a form of exploitation and extraction that curtails or distorts economic growth.3 The distortion of the economy is often a reflection of the divergence of interests between domestic governments and foreign investors. Foreign investors make demands that may contra­ dict the development goals of host countries. The specific negative effects of foreign investment include monopolies that reduce domestic competition, deprive local industries of investment capital, export prof­ its to home countries, increase dependence through debt and external donor decisions, monopolize production, control distribution, inhibit the growth of domestic infant industries, create cartels, exploit l abor, monopolize raw materials, limit international supply of raw materials,

and limit domestic control over resources. Foreign investment has also been known to widen the gap between rich and poor on the national and international levels, increase the wealth of local elites at the expense of the poor, support and rationalize repressive regimes, erode traditional cultural values and replace them with homogenized "world culture" based on consumer-oriented values , and challenge the autonomy of domestic governments.

12

The Divergent I nterests of Foreign I nvestors and Host Governments

Foreign investment exemplifies the paradox of dependence on foreign finance to promote domestic development. There is a clear divergence of interests between foreign investors and domestic governments. The primary interests of foreign investors are to increase profitability, com­ petitiveness, and access to international markets. The primary interest of developing countries is to foster domestic economic growth. The dilem­ ma is best articulated in the World Investment Report by the United Nations Conference on Trade and Development (UNCTAD), which specifically discusses the relationship between domestic development and foreign direct investment: Governments need to counter two sets of market failures. The first arises from information or coordination failures in the investment process, which can lead a country to attract insufficient FDI. The sec­ ond arises when private interests of investors diverge from the eco­ nomic interests of host countries. This can lead FDI to have a negative effect on development, or . . . benefits that are not sustainable over time.4

Considering this divergence of interests, how can foreign invest­ ment be used as a strategy to promote domestic development? The divergence of the private interests of foreign investors from the domes­ tic interests of host governments can be moderated or mediated to avoid the negative effect predicted by the World Investment Report. The mod­ eration of interests is possible because foreign investors and host gov­ ernments have a few basic mutual interests such as increasing produc­ tion, consumption, trade, and competitiveness in the global market. The primary goal of foreign investors, however, is not to serve as philan­ thropic financiers of development in poor countries. Their objective is to maximize profits by decreasing the cost of labor, raw materials, industri-

14

Foreign Investment and Domestic Development

al waste, and other externalities. Despite the proverbial bottom line, negotiations between investors and hosts can establish mutually benefi­ cial investment arrangements. Developing countries, however, exhibit wide variation in the capacity to execute such negotiations. The proces s of bargaining illustrates the problems of divergent interests and asymmetric power between foreign and domestic forces. The bargaining power thesis argues that the actors' relative capacity and leverage in the negotiation process determines the balance of benefits and concessions in using foreign investment as a development strategy. The central foundations of bargaining theory were established as early as 1945 by Albert Hirschman i n his book National Power and the Structure of Foreign Trade, which argues that outcomes are contingent on the level of asymmetry of power.s Interest in this work was revived w h e n Robert Keohane a n d J o s e p h N y e p u b l i s h e d Power and Interdependence.6 The current literature on bargaining theory focuses on vertically integrated investments that are characterized by risk, sunk costs, government learning, and rivalry among dynastic or oligopolistic conglomerates. 7 The divergence of interests and the outcomes of negoti­ ations are a function of relative power.s There is also a time dimension to negotiating the benefits and con­ cessions of foreign investment. The original bargain may need to be renegotiated over time if the power structure is altered or the political and economic conditions change substantially, making the original bar­ gain obsolete. An optimistic view believes bargains made as a result of unequal power will ultimately need to be renegotiated. A more realistic perspective suggests bargains may need to be renegotiated as a result of structural change over time. The initial concession agreement may not be satisfactory to retain foreign investment or domestic support for host­ ing foreign investment. The large variation in governments' capacity to negotiate can be explained i n p art by differences in political institutions and political economy, which are indicative of bargaining power. Political institutions impose structure on negotiations and investment arrangements. They provide incentives and constraints to cooperate or defect. Democratic accountability, for example, serves as a mechanism through which con­ stituents require governments to procure benefits from hosting foreign investment, minimize corruption, and promote domestic economic growth. Government officials make deliberate decisions about economic policies such as taxation, trade, government intervention, access to mar­ kets, and economic liberalization that directly affect the success or fail­ ure of foreign investment to expedite economic growth.

The Politics of Profit

15

Contrary to most existing theories, this research does not suggest that money flow is the bottom line. Inflow is not the determinant factor of development. B illions of dollars flow through the developing world every year, and the amount has been increasing logarithmically for decades . Yet over 100 countries are poorer now than they were thirty years ago.9 It is still important to ask what attracts foreign investment, but the question no longer stands alone. The more profound and pre­ scriptive question is this: how can developing countries succeed in uti­ lizing foreign investment to promote domestic growth? The opportunity is increasing as the overall size of the global economy increases. The size of the global economy is expected to quadruple in the next fifty years, with an estimated worldwide gross domestic product of $ 140 trillion. to The substantial expansion of the global economy offers devel­ oping countries the opportunity to increase their level of integratio� i�to global financial flows and to develop investment patterns that maXlmize their potential for economic growth. The greatest promise for increasing global integration and economic growth lies in the acquisition and effec­ tive utilization of foreign investment. However, as evidenced in the past fifty years, the inclusion of developing countries in the promise and pros­ perity of FDI is not automatic. Small and weak economies are often pum­ meled by the momentum, competitiveness, and volatility of the global economy. In contrast, a more optimistic view is justified by the fact that twenty-four developing countries have increased their integration into the world economy over the past three decades. These countries have achieved an average economic growth rate of 5 percent, compared with an average growth rate of 2 percent in wealthy industrialized countries. I I Despite the apparent contradictions between succes s stories and failed experiments, there are distinct empirical trends in foreign investment.

Trends in Foreign I nvestment

The overall amount of foreign investment is increasing worldwide with five indicative trends. The first, and most apparent, trend is the dramatic increase of both foreign direct investment and portfolio investment dur­ ing the past thirty years. However, there is wide variation in the amount of foreign investment in developing countries. The lowest levels of for­ eign investment are a few million dollars, such as in the Highly Indebted Poor Countries (HIPC), mostly in Africa and South Asia. In comparison, the highest levels of foreign investment in developing regions total tens of billions of dollars, such as in Brazil, Russia, India, and China (BRIC

16

Foreign Investment and Domestic Development

countries). In contrast to developing regions, investment in well-devel­ oped regions is more predictable, exhibiting only minimal variation. A second notable trend is the relatively consistent growth pattern of for­ eign direct investment in contrast to the volatile pattern of portfolio investment. Figure 2.1 compares the temporal increase of foreign direct investment and portfolio investment worldwide during 1970-2000. A third important trend is the substantial increase of foreign invest­ ment in Asia during the 1980s and 1990s. This includes the sharp decline corresponding to the East Asian Financial Crisis in 1997 and the ongoing economic recovery. The fourth trend is the rise of investment in central Europe and Russia in the early 1990s after the fall of the Soviet Union. The final distinctive trend is the comparative lack of foreign investment in sub-S aharan Africa. The overall level of investment in sub-Saharan Africa is low and stagnant relative to other developing regions. Figure 2.2 shows the variation of the total amount of foreign investment in developing regions.

The Politics of Profit

Total Foreign Investment in World Regions, 1970-2000

Figure 2.2

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