Issue 5, October 2008
|Foreign Direct Investment|
LDCs are caught in a cycle of poverty where they are unable to grow their economies, despite aid and assistance with economic policy and governance reform. The global marketplace is held out as their salvation, yet international trade policies marginalize and disadvantage them. They need a complex combination of free trade and preferential trade to produce the incentives for domestic growth and export-diversification. Doha’s failure to date suggests that these terms will be difficult for them to negotiate in the face of OECD and growing BRIC domination of trade policy. Moreover, they are often caught up in rivalries between these two powerful blocs that have little to do with their own varied economic predicaments. What other tools can be brought to bear to increase their prospects for development? How can private money be brought to bear, and how can governments encourage and leverage private capital flows?
Foreign Direct Investment (FDI) is a powerful development tool, illustrated by the dramatic growth of China. FDI can be in the form of public money (governments investing in projects in other countries), but, more frequently, it comes in the form of private funds, often from Multinational Corporations (MNCs). FDI is money used to set up operations or buy assets in another country. This is not aid; rather, it is a business transaction on which investors expect a return. Investment costs can be relatively low in LDCs because these counties are so undeveloped that costs such as labor remain low. Consequently if things go as planned, the returns can be very lucrative. In this sense, LDCs are a largely untapped market for private capital, and getting there first with your dollars, Euros, or yen can translate into extraordinary success and advantage. However, LDCs are also an enormous risk for investors because of the very factors that make them poor in the first place. Often, FDI doesn’t come to LDCs because of these very risks, and the lack of FDI only reinforces lack of growth in a globalized economy. Capital is often more likely to flow out of LDCs than into them.
However, if an LDC can attract FDI, the development effects can be dramatic. For this reason, Greg Mills has written that LDCs should ask the dignitaries of developed country dignitaries and officials who visit “to pack your plane not with just the… press corps, but with business people who come to strike deals. And let these deals, not new aid initiatives, be the centerpiece of your speeches.” Theoretically, if the significant risks can be managed, LDCs should be the new frontier of global business investors, especially as the cost of doing business in the BRICs is expected to rise in-step with increasing development in those countries.
In a recent article, financial analyst Justin Muzinich and Harvard Business School professor Eric Werker advocate for the US and other developed nations’ governments to provide less ODA and more incentives for FDI. They write that the simplest way to reconfigure the “aid architecture” is to bypass traditional ODA channels, and instead provide tax credits to private companies who invest in developing nations. This is seen as being more conducive to development among LDCs, as it provides incentives for LDCs to build “growth-friendly institutions,” and, in the process, introduces LDC entrepreneurs to Western and OECD business expertise and practices. Muzinich and Weker suggest that these tax credits be subject to oversight and disbursed only to companies who qualify based on an application detailing how the investment dollars are to be used. They also suggest criteria for determining which countries qualify for tax-credited investments, based on their level of poverty, their current levels of FDI, their commitment to civil and political liberties (as measured by Freedom House), and their level of progression toward democracy. Essentially, only the poorest, most FDI-neglected, yet “freest” and most democratic countries would qualify in order for the dollars to have the most impact. This type of program is technically considered aid because it would require US tax dollars to fund the tax credits, but it is seen as being a less traditional “transfer” of money because it “creates value” in LDCs, while simultaneously opening investment opportunities for US companies.
Is FDI a Panacea for What Ails LDCs?
The answer to the above question is both yes and no. Investment is key for growth and growth attracts more investment. However, many experts believe there are serious downsides to be considered. Multinational Corporations (MNCs) are for-profit organizations and their shareholders require that they act as such. Most investments are not likely to be made according to the criteria described above. As a result, experts cite that much of the FDI in developing countries occurs on terms that are ultimately exploitative to LDCs, especially those with natural resources. Oil, diamonds, and copper are cases in point; one doesn’t have to look far to find articles bemoaning the effects of booming investment in energy in Nigeria or mines in Sierra Leone and the Democratic Republic of Congo. Extractive industries seek to extract resources at the lowest possible cost. By their very nature, MNCs involved in the extractive industries do not have incentives to be charitable or to negotiate deals that transfer any advantage to LDCs, where the resources are located. Some corporate social responsibility usually enters into the equation in the form of aid that accompanies investment to redress environmental and/or social ills in the areas where these companies operate. But FDI is not philanthropy, and investors would not be in LDCs if they were not able to negotiate terms favorable to their own shareholders. A fundamental conflict of interest often exists between the bottom line of investors and the well-being of the LDC.
Moreover, the benefits of FDI can be easily exceeded by its destabilizing effects on LDCs when these benefits are unequally distributed within the recipient society, as the “resource curse” illustrates. Corruption and bad governance is often exacerbated in the presence of what development economists call “honey pots,” or “external rents,” as special interest groups in the LDC scramble to reap the rewards of FDI. In other cases, MNCs come to wield disproportionate influence on societies, as was the case in the 1960s and 1970s in Brazil, where GDP tripled as a result of an increase in FDI, but wealth became consolidated in foreign-owned industries while the real income of 80% of the population declined.
This is not intended to paint MNCs as inherently evil. Again, they are investors, not agents of charity, and as such, they must watch their own bottom line. MNCs are a diverse group, some more socially conscious than others. Fundamentally, foreign investors should have an interest in the growth and stability of the countries in which they invest – they gain little from extreme pathology and poverty on the ground. Many are realizing that the more developed the country becomes, the safer and more lucrative their investments are, and they are acting accordingly. The Extractive Industries Transparency Initiative and the Kimberly Process for diamond certification are examples of this trend on a more macro level.
Corporate Social Responsibility and Social Businesses
Corporate social responsibility is a hot topic today. As several experts have pointed out in the new Brookings Institution book, Global Development 2.0: Can Philanthropists, the Public, and the Poor Make Poverty History, many MNCs are now considering their “double bottom line” and trying to balance their profit motives with their responsibilities to the countries in which they invest. Similarly, socially responsible investing is a hot new sector in the financial portfolios of many developed nations, and many MNCs stand to attract shareholders by burnishing their benevolent images abroad.
For-profit technology, pharmaceutical, and engineering companies are seen as having special social roles to play in the field of development assistance. In the words of Eric Brewer, they have the capacity to address “concrete, solvable problems” that are of utmost importance to LDCs. Providing LDCs with cell phones, computers, medicines, improved irrigation mechanisms and water wells, and more productive strains of crops is not solely the province of aid. Someone has to make the initial innovations. Sometimes this involves simply extending technology used by the developed world to the developing world; however, it often it requires significantly adapting the technology for developing world uses. Solar powered computers, drugs for tropical diseases, alternatives to modern plumbing – these are not necessarily products in high demand among consumers in wealthy nations, yet, they are matters of life and death for those in many LDCs. Putting resources to bear in developing and adapting these technologies is an important contribution that can often be best made by private sector companies who employ engineers and scientists for other purposes.
Taking this impulse one step further, Nobel Prize winning economist Muhammad Yunus (see the Microfinance section) and others have called for the establishment of social businesses, for-profit companies that operate as such, but for the purpose of providing a social benefit. Profits that are made are then invested back into the company to either extend services further to those who need them or to decrease the cost of socially beneficial services. No dividends are paid out to investors; instead, the company is self-supporting and not dependent on (nor eligible to receive tax-deductible) donations. Social businesses do not exist to dispense aid, but rather to provide, through the private sector, goods and services that might otherwise be covered by aid. It is thought that this encourages better management, administration, and delivery. Social businesses can exist completely independently, but can also be found alongside other ventures of a larger corporate conglomerate. Furthermore, some companies dedicate one or more sectors of their business to social purposes. Crop insurance for poor farmers in drought or flood-prone areas is an example of a badly needed service that is often not provided by the traditional for-profit insurance industry or by the government. Some experts believe that this, like special banking services (see the Microfinance section) and the development of technologies for LDCs, is an area in which social businesses can make a big contribution.
For-profit corporations can also provide expertise and consulting to LDC entrepreneurs. Some experts have proposed a Peace Corps-style operation made up of professionals whose employers donate or subsidize the cost of their time to help people in developing countries start advanced businesses. In addition, universities are entering the field and are well-suited to providing not only educational opportunities for students from LDCs, but also the knowledge and expertise of their faculty and students on the ground in a similar Peace-Corps model of consulting. They are seen as furthering the development of what Brewer has called “bottom-up technology.” These particular types of endeavors by the private sector can be considered, in a sense, charity, because they involve the transfer of private resources (money, human capital, sacrifice of profits). But their place in the development field is unique from that of traditional charities as, in most cases, the services they provide confer some benefit to their investors and constituents as well – in the form of sales of related products, ethical credentials or brand advancement, and experience for employees and students. It is also hoped that, in providing pro-bono or subsidized services, these private sector entities will utilize the best aspects of for-profit-style business practices – injecting accountability and outcomes-oriented solutions into the realm of development assistance.
One last caveat about the participation of the private sector (from traditional MNCs to social businesses) in development assistance bears mentioning. In addition to the collateral damage that can occur from strictly profit-motivated FDI, any type of foreign presence in a country can be volatile. Most experts agree that LDC economies, perhaps more than anything, need to be protected from sudden financial or social crises. In a sense, a stagnant or slowly-growing economy is better than a boom and bust economy among fragile LDCs. The American Political Science Association Report on Inequality, Difference, and the Challenge of Development points out that speculation by foreign investors can often involve rapid divestment as well as investment, a shock LDCs cannot easily absorb. Similarly, social businesses come and go, and the problem becomes that volatility exposes countries to additional risks. Generally, like other types of development assistance, FDI is seen to be useful as one of many tools, providing opportunities for growth while balancing the downsides of the other tools.
China and FDI in the LDCs
The influence of China in the matter of FDI is significant. On one hand, the economic activities of China make it more difficult for LDCs because Chinese products are tough to compete with in the global marketplace and China has long been one of the primary destinations for foreign investment that might otherwise have come to LDCs. On the other hand, the Chinese example is an inspiring one to many LDCs, and many are attempting to emulate the Chinese FDI model of growth. Interestingly, China is itself a major player in LDCs as a foreign investor, especially in Africa. There are close to one thousand Chinese state-owned enterprises invested in Africa today, and more privately-held investments in addition to that. Because many investors are state-affiliated, they are better able to manage the risk involved in businesses in LDCs; the Chinese government can bail out projects that go bust. In addition, because the Chinese tend to proffer both their aid and their investment with no strings attached, in terms of governance or accountability, they are a favorite source of investment for savory and unsavory LDC leaders alike. China is also proving very adept at managing the logistics of investment projects – if anything, Chinese companies come under fire for being too efficient, preferring to use their own nationals to do the work on the ground instead of hiring indigenous workers.
Other Private Flows of Investment
Tax incentives for FDI are not the only way for public money to leverage the impact of private money. Many experts have called for government-facilitated remittance flows to LDC families and communities from migrant workers in developed nations. Remittances actually make up a significant portion of private capital flows from the developed world to the developing world – they represent money that is personally sent back home from both skilled and unskilled workers who have migrated from LDCs to nations throughout the world. Much of this money is unaccounted for and falls under the umbrella of the informal economy. However, it seems appropriate that Muzinich and Werker consider it in their article along with FDI, because it is, in a very real sense, a private foreign capital investment, albeit not the kind most people consider when thinking about FDI.
Remittances help on a micro level, too, often providing the primary source of income for many impoverished families in LDCs. They also have the potential to help on the macro level if recipients use them to start businesses. Moreover, many experts have pointed out that any connection between the citizens of LDCs and their ethnic or national diasporas in developed nations is generally a positive one. The growth of Israel is perhaps the most dramatic example of what remittances and private donations from a diaspora can do for the development of a foreign country. China and Taiwan have also benefited enormously from their respective diasporas in wealthy nations. Being able to make these contributions with pre-tax dollars would encourage more remittances and would not require a large leap in public policy. Individuals in the US are already able to make tax-deductible cash contributions to international NGOs, faith-based institutions, and charities in other countries. At the very least, many believe the governments of developed countries could pressure banks to make these transfers less cumbersome, while still monitoring transactions for the purposes of money laundering, drugs, or support for terrorist organizations. Any of these steps to increase the ease and number of remittances could be yet another valuable development assistance strategy.