Free investment regime may not help South

A policy brief by the South Centre which examines the risks and implications associated with FDI flows to South countries suggests that rather than accepting any or all FDI, these countries should pursue a policy of selectivity and adopt a coordinated and integrated approach on various future FDI-related matters.

by Chakravarthi Raghavan

GENEVA: "The South countries need to take a coordinated and integrated approach to the various FDI-related matters on the international agenda," the South Centre has suggested in a Policy Brief on Foreign Direct Investment, Development and the New Global Economic Order.

The Policy Brief is in the process of being sent to South countries by the Chairman of the South Centre, Mwalimu Julius Nyerere.

How to "foster an enabling environment" to attract FDI has become an important question, and in this context "the key issue is whether such an enabling framework should embody a free investment regime".

This issue assumes special importance in an era of increasing global economic liberalization, with the advanced industrial countries of the North making considerable efforts to persuade the developing countries of the virtue of removing the remaining constraints on FDI.

FDI, the paper says, has the potential to help achieve development objectives and plays a key role in the integration of a country into the global economy.

However, underlines the paper, in the current climate of enthusiasm over FDI, the costs tend to be overlooked.

It cannot be presumed that the net socio-economic impact of FDI will in all circumstances be positive and there are reasons for questioning whether, in all cases, FDI is the cheapest and most appropriate means for obtaining foreign financial resources and desired technology.

FDI, the document says, can and does make an important contribution to development in a number of ways, provided certain conditions are met with respect to; (a) the nature of the projects which are undertaken, and (b) the timing of these projects and setting prudent limits for total amount of FDI.

The experience of the successful countries in East Asia, where FDI has played a significant role shows that these countries have, by and large, used such investment in a purposeful way, as part of the government's national and technological development policies.

But these countries have been selective in their use of FDI, the paper points out.

"The current inclination of many developing countries to accept any and all FDI gives cause for concern in that such an approach may harbour trouble for their future development prospects."

"Not all FDI is conductive to development; some kinds may do more harm than good."

FDI can create special hazards for South

FDI, the paper says, creates special hazards for developing countries in the context of financial liberalization and increasingly sophisticated markets.

The potentially serious problems posed for the recipient countries in respect of balance-of-payments, the exchange rate and macroeconomic management are frequently overlooked or underestimated by the international financial institutions and those advocating free flows of FDI, the South Centre paper adds.

From the point of view of the long-term financial stability and therefore, economic development, "there is an optimum level of flows and stock of FDI, which depends in part on its sectoral allocation, for any particular developing country, just as, by analogy, there is an optimum level of sustainable debt," the paper adds.

The paper calls for further careful in-depth empirical research to be carried out by UNCTAD, WTO and UN regional economic commissions on key issues relating to FDI flows and economic stability and financial frugality.

Many countries, developing and developed, are now offering investment incentives to attract FDI, but there is overwhelming evidence that such incentives are a relatively minor factor in locational decisions of TNCs relative to other locational advantages - such as market size and growth, production costs, skill levels, political and economic stability and a regulatory framework.

But the way the competitive game in incentives is being played by governments, no country can afford to refrain from offering investment incentives for fear of losing out to similarly placed countries.

"Developing countries as a whole lose collectively from competition among themselves in offering ever greater incentive packages to attract FDI. Collectively and individually, developing countries would gain from cooperation rather than competition in this sphere."

The paper challenges the arguments that an OECD-type multilateral investment agreement would generate greater FDI flows, where the paper notes that the huge increase in FDI in the last 15 years has taken place without any multilateral investment agreement and, more importantly, there does not seem to be much correspondence between the liberality of a country's FDI regime and its FDI inflows.

The present era of liberalization and globalization, with freer financial flows and increasingly sophisticated financial markets carries opportunities, but also significant hazards for developing countries, the paper warns.

The international financial institutions (IFIs), it complains, draw attention only to the opportunities, and largely, if not altogether, overlook the hazards.

The view that developing countries are not constrained by BOP and should not be concerned with foreign exchange implications or other foreign capital inflows, the paper says, is based on a theoretically legitimate but empirically erroneous economic doctrine that has come to hold sway in IFIs for a while in the 1990s, the paper points out.

For developing countries, the current account balance still does matter and governments are obliged to intervene to correct the imbalances using fiscal, monetary and other policies to restrict consumption and increase investment.

"The costs of government inaction in this area may be very high," the paper warns and adds, "it is therefore important to assess the implications of FDI projects for a country's current and prospective balance of payments."

There are in-built instabilities connected with FDI flows, in particular with respect to profits retained by subsidiaries and, under certain circumstances, these can generate financial crises.

The volatile nature of FDI flows and their possible procyclical nature also give cause for concern.

The best way therefore, to limit the risks associated with FDI, avoid its undesirable effects, and increase the likelihood of it making a positive contribution to a country's socio-economic development efforts is to pursue a policy of:

* Selectivity with respect to the magnitude and timing of capital inflows including FDI.

This implies that governments should be able to determine the composition of capital inflows and formulate appropriate policies of government intervention to manage capital inflows, including those of FDI.

* Selectivity with respect to specific projects, with preference for those with large technological spill-overs or other important socio-economic benefits.

Confining FDI to priority sectors

This may involve confining FDI to economic sectors and sub-sectors regarded as priorities in the country's overall socio-economic development.

To the argument that while it might be good if investment goes to priority sectors, but that no harm will be done if it goes also to non- priority sectors, the South Centre brief points out that taking account of all relevant costs and benefits and macro-economic implications, "there may well be FDI projects where the costs to the economy and society exceed the benefits" and such projects should be screened out or certainly discouraged by developing country policies that are mindful of the aggregate effects of FDI.

* Prudence with respect to total FDI flows as well as FDI stock so as not to render the economy financially more fragile in the context of future economic shocks.

"A global investment regime which took away a developing country's ability to select among FDI projects, and to regulate inflows for macro- economic reasons, would hinder development and prejudice economic stability," the paper stresses.

"Indeed, the now advanced industrial countries built up their present economic strength under a regime, of strict controls over inflows and outflows of capital, which lasted for several decades, relaxing them only gradually and, in some cases only relatively recently."

"Such an erosion of government autonomy in decision-making with respect to FDI as implied by current North proposals can have serious economic and political consequences for developing countries."

All developing countries lose from competition among themselves to offer ever greater FDI incentives and hence a policy conclusion to be drawn is that, in addition to being selective in their acceptance of FDI, developing countries would benefit collectively from cooperation on the matter of investment incentives rather than competition in this sphere.

A "development-friendly" policy framework for FDI

Outlining the broad contours of a "development-friendly" policy framework for FDI, the paper says that a framework should at least include elements which:

* allow countries to be selective with regard to the timing of FDI and to actual FDI projects, according to current development levels and needs;

* legitimize "qualified" market access so that a potential host country could specify the degree to which it would give national access, in terms of percentage limit on foreign shareholding, or the total value of individual or aggregate foreign investment;

* prevent abuse of monopoly power by large transnationals, encouraging, as far as possible, level playing fields between large foreign investors and small domestic companies so that the latter can survive and flourish;

* permit limitations to national treatment, giving governments scope to stipulate performance requirements and similar measures, TRIMs notwithstanding, in order to encourage foreign enterprises to contribute to development objectives, including a healthy BOP; and

* establish rules of conduct for foreign investors to prevent bribery and corruption and tax avoidance through transfer-pricing among other things.

To provide a credible and predictable environment for foreign investment, whether by the North or the South, ground rules would be needed to guarantee the protection of investment and provide an appropriate dispute settlement mechanism, suitably designed to take account of the circumstances of developing countries.

And if it be concluded that there has to be a multilateral regime for FDI, rather than the current bilateral and regional agreements, an approach worth considering, is that based on a "positive" list approach to liberalization of FDI - whereby each country specifies the economic sectors and industry, if any, in which it is willing to open up to FDI and willing to assume treaty obligations.

This would give each developing country the scope to determine its own pace and approach to the liberalization of FDI.

The paper notes that competition policy issues would become critical if developing countries were to engage eventually in negotiations on an "ultra-liberal" multilateral FDI regime of the sort envisaged by the OECD.

Competition policy issues

"In any case, what is at issue is the kind of competition policies, national and international, which are necessary for the development of the South. Developing countries as a group will need to promote their own ideas on 'development-friendly' competition policies."

While the US sees competition to be an objective in itself, the Europeans have viewed it to be an integral part of their industrial policy, assessing its success according to whether or not it leads to greater efficiency or in a dynamic sense, more productive growth. The Japanese on the other hand, have tried to avoid allowing too little or too much competition.

The paper suggests that developing countries should adopt a "Japanese- type" of competition policy which promotes both cooperation and competition between firms.

In view of their state of under-development and lack of competitive capabilities of most domestic firms in developing countries, the domestic competition authorities may, for example, promote mergers among domestic companies, while prohibiting takeovers of domestic firms by large foreign enterprises.

"This implies the need for discretion on the part of competition authorities in the implementation of domestic competition policies."

"Agreement on domestic competition policies, as part of a broader multilateral investment agreement, which enshrined the concept of national treatment would clearly be inappropriate for developing countries," the paper says. Thus, agreement and action are required both on competition policies that developing countries themselves should implement and on an international policy to deal with issues which domestic competition policies cannot tackle.

In the short- and medium-term, developing countries have to contend with the impending discussions and negotiations on the Uruguay Round in- built agenda; the discussions on the results of the UNCTAD and WTO studies on investment and competition matters and, importantly, the evolving OECD multilateral investment agreement.

"It will be essential for the South to take a coordinated and integrated approach to the various FDI-related matters on the international agenda," the paper adds.

But the suggestions in this regard seem rather weak:

* The G77 in Geneva should set up a small working group on FDI matters, and meet regularly to review related issues and the report to the G77;

* Undertake various FDI-related studies in different parts of the South, and for South experts and institutions involved to link themselves electronically via internet; and

* Set up an expert group to monitor the OECD MAI-related proceedings, study in depth the OECD draft agreement and its implications for the South, and report its conclusions to the G77. - Third World Economics (16-31 October 1997)

Chakravarthi Raghavan is the Chief Editor of the South-North Development Monitor (SUNS)