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