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MAI-type rules would impede development and won't benefit TNCs

Multilateral investment rules that protect the rights of TNCs
as foreign investors, but without the corresponding
obligation to promote the development of host developing
countries, will fail to add to global welfare. Any
multilateral agreement that restricts the ability of
governments to manage foreign investments will render the
host developing country vulnerable to adverse terms of trade
and export-price volatility. These views emerged at a TWN-
organized seminar on Trade and Investment.


by Chakravarthi Raghavan



GENEVA: Any multilateral rules on investment that protect the
rights of transnational corporations as foreign investors, but
come without obligations and provisions that would increase
employment, productivity growth and per capita incomes in host
developing countries, will result in the TNCs competing among
themselves for a global pool of profits, and there will be no
addition to global welfare, experts at a seminar on 29
September on Trade and Investment said here.
And any multilateral agreement that restricts the ability of
governments to manage foreign investments so as to ensure full
integration of production, that is, with horizontal or
geographical specialization, within the host country, but
facilitates instead vertically specialized and geographically
integrated production capacity, will result in the
"commoditization" of manufactured exports of developing
countries - with constantly declining terms of trade and
extreme volatility in export prices, the experts said at the
seminar, "Trade and Investment: Development Perspectives,"
organized by the Third World Network for developing countries.
The seminar had been organized at the request of some key
Third World countries, who have found a clear development focus
to be lacking in the studies and discussions on the issue at
the WTO and UNCTAD.
Among the experts were: Prof. Jan Kregel of the University
of Bologna (Italy); Mr. Yilmaz Akyuz, UNCTAD's chief
macroeconomist and chief author of the annual Trade and
Development Report; Mr. Bhagirath Lal Das, who was formerly
India's Representative to the GATT and Director of UNCTAD's
Division on Trade Programmes, and Mr. Martin Khor of the Third
World Network. UNCTAD Secretary-General Rubens Ricupero,
speaking at the opening, underscored the need for considerable
further research and empirical studies on the whole range of
issues raised in the moves for negotiations.

No enhancement of global welfare


Responding to some questions from trade negotiators at the
WTO, Kregel said that the outcome of countries not joining a
multilateral agreement, but competing with each other to
attract the available pool of FDI, would be a zero condition on
foreign investment as when everyone joins a High Quality
Multilateral Agreement on Investment (envisaged for the OECD
process).
But any multilateral agreement to protect the rights of TNCs
as foreign investors without ensuring conditions and
obligations that create employment, productivity growth and
rising real per capita incomes, would result in the TNCs merely
competing with each other for a fixed pool of global profits,
and thus would neither be in their interest nor enhance global
welfare, Kregel said.
And in periods of crisis, preserving global demand would
mean preserving global investment, making foreign investment
more permanent. The equivalent of anti-protectionist trade
regulations on the capital side would be rules to require
foreign investors to retain their foreign investments in a
country, even if there are no profits to be withdrawn or
foreign exchange to pay them, Kregel said.
In periods of crisis, Kregel noted, regulations to prevent
trade protectionism play a positive role: if all countries try
to reduce imports and increase exports, there can be no net
gain, but a reduction in the level of expenditure and
employment and a deficiency in global demand, since the surplus
countries fail to spend their surpluses and deficit countries
have to contract expenditures. Trade protection cannot resolve
this problem, which is one of getting surplus countries to
expand. And preservation of free trade thus implicitly means
that deficit countries continue to permit their residents to
purchase foreign goods despite the fact that they have no
foreign currency to pay for them, and that exporters continue
to sell even if they do not receive domestic currency for their
exports, but only promises to pay. By implicitly providing
financing, preservation of free trade thus supports demand in
a period of turbulence.
But it would be difficult to argue, Kregel said, that a
similar regulation in the form of an Agreement on Investment
would produce similar results since such an agreement would
contain not only the right of a foreign investor to enter a
country, but also the right to withdraw the investment.
But since it is the withdrawal of investment that is the
cause of the turmoil and the fall in demand, formal similarity
with enforced free trade would then require just the opposite.
"The foreign investors should be required to retain their
foreign investment, even if there are no profits to be
withdrawn or foreign exchange to pay them, just as deficit
countries are forced to continue to allow free imports of goods
from abroad, even if there is no foreign exchange to pay for
them."
"Preserving global demand implies preserving existing levels
of global investment, which means making the investments more
permanent. This is what the Chilean controls are intended to
do, that is, to bias foreign investment towards more permanent
commitments."
One has also to be careful in distinguishing between FDI and
portfolio flows when making the symmetry argument between the
WTO and the MAI, Kregel said. "If we accept that FDI flows are
permanent and share of FDI flows to total flows would be higher
in the presence of an Agreement, then this argument holds."
"But there is no reason to believe that FDI is more
permanent, nor for FDI to be a high proportion of total flows
in the event of an Agreement. A simple reference to FDI flows
is out of place, since it is the reversal of short-term flows
that usually causes the difficulties, and these difficulties
have been felt by countries irrespective of the share of FDI in
their total capital inflows."

Risks of specialization


Earlier in his presentation on the development perspective,
Prof. Kregel said that few question the potential benefits to
developing countries of increasing their integration into the
world product and financial markets. But there was disagreement
about the causes of such benefits and the best way to achieve
them.
Increased openness of domestic markets and increased
production for export through international trade were usually
justified by arguments of comparative advantage and benefits to
domestic consumers of competition from an increased choice of
goods in the domestic market. But these arguments imply
increased specialization in production towards comparative-
advantage goods for export, increased diversity in consumption
through increased imports, and gains from better terms of trade
on comparatively advantaged goods and reduced costs due to
competition from imported goods.
But it has long been recognized that specialization in
production carries risks, although the arguments along this
line have generally been restricted to the negative impact on
incomes of the declining terms of trade of economies dependent
on primary commodity exports. The declining terms of trade in
export goods eliminate the comparative- advantage gains
required to balance the increased variety of imported goods. As
a result, opening the trade account is often accompanied by
persistent balance-of-payments difficulties, exchange-rate
instability and stop-go domestic policies to keep the foreign
account in balance. In such conditions, it is often tempting to
use fiscal policies to offset income losses, leading to fiscal
instability and inflation.
But whatever policy is used to ensure payments balance, it
will require income reductions, which generally make it
impossible to achieve full employment. Yet, this is an
assumption underlying the argument for the gains from free
comparative-advantage trade.
This difficulty can be eliminated by specializing in goods
that are not characterized by declining terms-of-trade over
time. Since terms-of- trade gains are primarily linked to
productivity growth, and since productivity growth is greater
in manufacturing than in the primary- products sector,
development has been linked to increasing exports of
manufactured goods - where the trend decline in terms of trade
and the cyclical nature of prices associated with primary
products, are considered to be absent, as a result of which
manufactured exports are said to provide more stable export
earnings.
In addition, there would also be a reduction in imported
manufactured goods, and hence a reduction in imports. Thus,
diversification of the export basket to include manufactures
should lead to a more stable and more sound balance of payments
(BOP).
While natural resource-based exports are based on natural or
indigenous factors, independent of the degree of integration of
a country in the world trade and payments system,
diversification into manufactured-goods production requires not
only integration into the world trading system, but also the
acquisition of technical knowledge and/or capacity from
developed countries.
This can be done in a number of ways. Japan, in the 1950s,
chose to import the technology through direct purchase of
patents and development rights to be implemented in domestic
firms. However, few countries in the 1980s, in the aftermath of
the debt crisis, had the possibility of taking a long view of
their integration. Thus, the alternative mechanism of
increasing manufactured-goods exports was through FDI, usually
by TNCs setting up production facilities in a developing
country. This way, a developing country could offset both the
technological gap as well as shortfalls of domestic savings.

Vertical integration


The improvements in the import side of the BOP come about
because of the increased variety of goods that can now be
produced domestically by the plants of the TNCs, rather than
being imported. This is just another aspect of the argument
that FDI may be a substitute for trade. But these depend on a
particular type of FDI - one where production is fully
vertically integrated within the host country. Most of the
initial FDI that took place amongst the developed OECD
countries, particularly inward investment into the EEC, was of
this type. Domestic inputs were used within a full production
process in which final outputs were either sold into the
domestic market or exported.
While this type of FDI exploits the specific managerial or
production knowledge of the TNC, it also produces domestic
forward and backward linkages, creates local skills and
domestic infrastructure and allows foreign investment to
substitute for trade, reducing developing-country imports of
manufactured goods and improving the structural position of the
BOP.
If all FDI were of this sort, then the rapidly increasing
FDI flows, in particular to developing countries, should lead
to a decline in the growth of world trade if foreign plants are
primarily set up to serve host developing-country markets, and
a decline in the share of exports in developed countries
relative to developing countries. Since this has not been the
case, exports must exceed domestic production globally, and
trade growth should track global output growth with roughly
stable shares of exports in GDP. Yet, the growth of trade has
exceeded global growth for some decades, and the share of
exports in GDP has been rising in both developed and developing
countries.
Recent studies suggest that the FDI that has accompanied the
rapid increases in world trade and the integration of
developing countries into this system has not been of
vertically integrated or geographically integrated production.

Sequential mode of production


As a study published by the New York Federal Reserve Bank
shows, instead of locating all aspects of the production
process in each location, a "sequential mode of production
arises in which a country imports a good from another country,
uses the good as an input in the production of its own good,
and then exports its good to the next country; the sequence
ends when the final good reaches its final destination". This
means that rather than concentrating production in a single
country, the modern multinational firm uses production plants
"operated either as subsidiaries or through arm's-length
relationships" in several countries, exploiting powerful
locational advantages, such as proximity to markets and access
to relatively inexpensive labour.
But it is less clear how these types of investments would
result in technology transfer to the host countries. Production
of such intermediate goods creates very few of the traditional
forward and backward linkages resulting from industrial
development.
The authors of the study note that computer production
requires a skill-intensive stage - designing and manufacturing
the chips - and a labour-intensive stage of assembling the
computer. Vertical specialization allows countries to unbundle
these stages so they can focus on those activities in which
they are relatively more efficient. But since the sequential-
production nature of vertical specialization - requires
intensive oversight and coordination of production, technical
advances (computers, communications and so on) would tend to
benefit trade based on vertical specialisation.
The various case studies show that in each case, a
relatively low-wage country engages in final assembly and a
relatively high-wage country engages in parts and components
production. This means that precisely those aspects which are
of interest to a developing country - the managerial skills of
oversight and production, the development and design skills,
and the marketing skills - will all be located in the
developed-country home-base of the foreign investor. And
developing countries will be attractive (for investment) only
as long as they remain low-wage countries, or happen to possess
some locational advantage.
"Such types of intermediate products that can be vertically
specialized," Prof. Kregel said, "have very similar
characteristics to primary commodities in the sense that they
are homogeneous goods with a high degree of substitution, and
thus sold and produced in highly competitive markets with
prices that are strongly influenced by global business cycles.
The volatility of prices and incomes of Asian producers of DRAM
semiconductors in the recent past has been little different
from that of coffee producers."
The studies estimate "a world vertical trade share on the
order of 20 to 25 percent" could well be likely, and the
analysis suggests that the increase in vertical trade is linked
to the growing trade share of output. This suggests that the
most rapidly growing areas of trade, which are in developing
countries, are in precisely the kind of trade which does least
to provide the benefits of specialization. It is precisely this
sort of trade that is engendered by FDI. The study concludes
that "it might not make sense to open a country to increased
FDI flows without also liberating import and export barriers",
since these are the greatest impediment to vertical
specialization. But from the point of view of developing
countries, Prof. Kregel said, it might be necessary to assess
the impact of opening trade accounts and reducing trade
barriers, along with liberalization of FDI, on the composition
of trade and thus on the trade balance. Apart from the
technological and other aspects, if the profitability of
foreign production turns out to be higher than domestic value
added - which may be the case if wages are extremely low or
transfer pricing makes it so - then the increased trade in
manufactures may cause the overall current account position to
worsen. An alternative method for resolving payments
difficulties would be to allow foreign capital to make up the
shortfall on the trade account. This is often represented as
using foreign savings to offset the shortfall in domestic
savings. Here again the composition of trade is crucially
important to the success of using foreign capital.
As has been repeatedly seen in Latin America, the use of
foreign capital inflows to finance the import of consumption
goods is a sure recipe for financial crisis. On the other hand,
in Asia, as long as foreign capital was used for the import of
investment goods, and the export content of production could
generate sufficient foreign currency earnings to offset the
profits generated, there was a positive contribution both to
the stability of the foreign balance and to domestic income and
employment growth.

Evaluating FDI


In his comments as a discussant, Mr. Yilmaz Akyuz said he
believed more investment was better than less investment, since
investment was a way to create wealth and jobs, and to generate
productivity and growth.
But some quarters in Geneva applied this view on investment
to FDI, and argued that FDI should be promoted, since it has
the ability to generate productive capacity with spillovers in
technology, trade and so on.
But, for this, one has to examine where FDI achieves these
and where it does not. There is nothing inherently good or bad
in FDI. The proposition about the beneficial effects of FDI
applies to "greenfield" investment which creates additional
production capacity in a country. But it does not apply to FDI
that acquires existing assets, though in some circumstances
such foreign acquisition of existing assets could promote
productivity growth through better management.
The issue revolves around whether the FDI is greenfield
investment, whether it brings in capital and technology, and
what the alternatives are for developing countries.
One problem relates to the difficulties in defining FDI, and
the way statistics are gathered and made available.
According to Martin Feldstein, an economics professor at
Harvard, for every $100 of assets acquired by US TNCs, $20 was
by reinvestment of profits abroad, another $20 by capital
transferred from the US, while $60 related to acquisition of
assets abroad by borrowing on local or foreign markets. Thus,
60% of assets acquired abroad by US TNCs had nothing to do with
FDI and were not financed by capital flows. Only 50% of actual
FDI was from retained profits and the other 50% was from
capital flows. This picture of US investment also seemed to be
true elsewhere.
In the FDI statistics, it is assumed that the retained
profits invested are in capital stock. But current statistics
do not show to what extent the retained profits are reinvested
in the form of greenfield investments and to what extent for
acquisition of existing assets, or whether the retained profits
are used to acquire government bonds and other paper, and
whether they are staying in the country or going out in a
different form, that is, whether this FDI which does not exit
as "bricks and mortar" does so as financial flows.
Akyuz said that the data also raise questions about net
transfers - a concept developed in the 1980s in Latin America
by governments and economists in relation to the debt crisis.
After some initial resistance, the Bretton Woods institutions
recognized this concept in their international debt
measurements and this enables judgement on how much deficit or
surplus in the trade account is needed to generate a surplus to
make net-transfers (for debt servicing) possible. But the net-
transfer concept, as far as he was aware, has never been
applied to FDI. There is no concept of net resource flows in
FDI data. If such a concept were developed, "we will have a
better idea of what FDI is contributing to the BOP problems of
developing countries."
As for transfer of technology and the contribution of FDI to
the economy, the problem is one of how to reconcile the profits
sought by investors with the kind of social benefits that
developing-country governments are seeking.
In the case of foreign investment in extractive and primary
industries, it becomes a question of bargaining power between
the TNCs and state firms - balancing any environmental problems
and social costs with the profits sought. But when it comes to
value-added components of trade, and employment-creating trade,
the benefits of FDI cannot be automatically assumed.
The pattern of investment is very much determined by
economic growth and productivity growth. In the past, countries
that have benefited from FDI have pursued policies like those
of Singapore, unlike Hong Kong.

"Commoditization"


In what has now come to be called the "commoditization" of
manufactured exports, said Akyuz, the TNC-led manufactures
exert a downward trend on the terms of trade of such exports.
"In the past, development economists used to distinguish
between manufactures and commodities in terms of the price
rigidity or flexibility in the face of supply and demand. We
now need to study much more about this vis-a-vis manufactured
exports of developing countries, in relation to increase in
labour force and growth in flexibility of labour markets as a
result of which wages of labour employed by TNCs have become
more volatile than it used to when FDI and TNCs were used in
extractive industries.
"The present globalized pattern of production has created a
tendency for redistribution of wealth between capital and wages
- from wages to capital. It is a global tendency and is
reflected in the declining terms of trade of manufactures
produced in the South. The volatility of the prices of such
products has grown and is related to the nature of the labour
market flexibility in the South."
The slicing of the production process at various locales,
and the flexibility of labour markets and wages mean that
production can be shifted from one developing country to
another, bringing about considerable flexibility in wage costs.
"As more and more developing countries open up to FDI and
create flexible labour markets, the terms of trade on
manufactures from developing countries is becoming like what
Prebisch wrote about terms of trade on commodity exports,"
Akyuz pointed out.
"There is no inevitability in any of these things. It
depends on how governments manage FDI. But much more research
is needed before we plunge into undertaking more multilateral
or international negotiations and commitments on FDI."
(Third World Economics No. 194, 1-15 October 1998)


The above article was originally published in the South-North
Development Monitor (SUNS) of which Chakravarthi Raghavan is the
Chief Editor.

 


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