Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism

national firms is usually more productive than the latter. But the level of productive capability that the country can attain in the long run becomes lower as a result.

This is because TNCs do not, as a rule, transfer the most valuable activities outside their home country, as I will discuss in greater detail later. As a result, there will be a definite ceiling on the level of sophistication that a TNC subsidiary can reach in the long run. To go back to the Toyota example in chapter 1, had Japan liberalized FDI in its automobile industry in the 1960s, Toyota definitely wouldn’t be producing the Lexus today – it would have been wiped out or, more likely, have become a valued subsidiary of an American carmaker.

Given this, a developing country may reasonably decide to forego short-term benefits from FDI in order to increase the chance for its domestic firms to engage in higher-level activities in the long run, by banning FDI in certain sectors or regulating it.[31] This is exactly the same logic as that of infant industry protection that I discussed in the earlier chapters – a country gives up the short-run benefits of free trade in order to create higher productive capabilities in the long run. And it is why, historically, most economic success stories have resorted to regulation of FDI, often in a draconian manner, as I shall now show.

‘More dangerous than military power’

‘It will be a happy day for us when not a single good American security is owned abroad and when the United States shall cease to be an exploiting ground for European bankers and money lenders.’ Thus wrote the US Bankers’ Magazine in 1884.[32]

The reader may find it hard to believe that a bankers’ magazine published in America could be so hostile to foreign investors. But this was in fact true to type at the time. The US had a terrible record in its dealings with foreign investors.[33]

In 1832, Andrew Jackson, today a folk hero to American free-marketeers, refused to renew the licence for the quasi-central bank, the second Bank of the USA – the successor to Hamilton’s Bank of the USA (see chapter 2).[34] This was done on the grounds that the foreign ownership share of the bank was too high – 30% (the pre-EU Finns would have heartily approved!). Declaring his decision, Jackson said: ‘should the stock of the bank principally pass into the hands of the subjects of a foreign country, and we should unfortunately become involved in a war with that country, what would be our condition? …Controlling our currency, receiving our public moneys, and holding thousands of our citizens in dependence, it would be far more formidable and dangerous than the naval and military power of the enemy. If we must have a bank … it should be purely American.’[35] If the president of a developing country said something like this today, he would be branded a xenophobic dinosaur and blackballed in the international community.

From the earliest days of its economic development right up to the First World War, the US was the world’s largest importer of foreign capital.[36] Given this, there was, naturally, considerable concern over ‘absentee management’ by foreign investors[37] ; ‘We have no horror of FOREIGN CAPITAL – if subjected to American management [italics and capitals original],’ declared Niles’ Weekly Register, a nationalist magazine in the Hamiltonian tradition, in 1835.[38]

Reflecting such sentiment, the US federal government strongly regulated foreign investment. Non-resident shareholders could not vote and only American citizens could become directors in a national (as opposed to state- level) bank. This meant that ‘foreign individuals and foreign financial institutions could buy shares in U.S. national banks if they were prepared to have American citizens as their representatives on the board of directors’, thus discouraging foreign investment in the banking sector. [39] A navigation monopoly for US ships in coastal shipping was imposed in 1817 by Congress and continued until the First World War.[40] There were also strict regulations on foreign investment in natural resource industries. Many state governments barred or restricted investment by non-resident foreigners in land. The 1887 federal Alien Property Act prohibited the ownership of land by aliens – or by companies more than 20% owned by aliens – in the ‘territories’ (as opposed to the fully fledged states), where land speculation was particularly rampant.[41] Federal mining laws restricted mining rights to US citizens and companies incorporated in the US. In 1878, a timber law was enacted, permitting only US residents to log on public land.

Some state (as opposed to federal) laws were even more hostile to foreign investment. A number of states taxed foreign companies more heavily than the American ones. There was a notorious Indiana law of 1887 that withdrew court protection from foreign firms altogether.[42] In the late 19th century, the New York state government took a particularly hostile attitude towards FDI in the financial sector, an area where it was rapidly developing a world-class position (a clear case of infant industry protection).[43] It instituted a law in the 1880s that banned foreign banks from engaging in ‘banking business’ (such as taking deposits and discounting notes or bills). The 1914 banking law banned the establishment of foreign bank branches. For example, the London City and Midland Bank (then the world’s third largest bank, measured by deposits) could not open a New York branch, even though it had 867 branches worldwide and 45 correspondent banks in the US alone.[44]

Despite its extensive, and often strict, controls on foreign investment, the US was the largest recipient of foreign investment throughout the 19th century and the early 20th century – in the same way strict regulation of TNCs in China has not prevented a large amount of FDI from pouring into that country in recent decades. This flies in the face of the belief by the Bad Samaritans that foreign investment regulation is bound to reduce investment flows, or, conversely, that the liberalization of foreign investment regulation will increase foreign investment flows.Moreover, despite – or, I would argue, partly because of – its strict regulation of foreign investment (as well as having in place manufacturing tariffs that were the highest in the world), the US was the world’s fastest-growing economy throughout the 19th century and up until the 1920s. This undermines the standard argument that foreign investment regulation harms the growth prospects of an economy.

Even more draconian than the US in regulating foreign investment was Japan.[45] Especially before 1963, foreign ownership was limited to 49%, while in many ‘vital industries’ FDI was banned altogether. Foreign investment was steadily liberalized, but only in industries where the domestic firms were ready for it. As a result, of all countries outside the communist bloc, Japan has received the lowest level of FDI as a proportion of its total national investment.[46] Given this history, the Japanese government saying that ‘[p]lacing constraints on [foreign direct] investment would not seem to be an appropriate decision even from the perspective of development policy’ in a recent submission to the WTO is a classic example of selective historical amnesia, double standards and ‘kicking away the ladder’[47]

Korea and Taiwan are often seen as pioneers of pro-FDI policy, thanks to their early successes with export-processing zones (EPZs), where the investing foreign firms were little regulated. But, outside these zones, they actually imposed many restrictive policies on foreign investors. These restrictions allowed them to accumulate technological capabilities more rapidly, which, in turn, reduced the need for the ‘anything goes’ approach found in their EPZs in subsequent periods. They restricted the areas where foreign companies could enter and put ceilings on their ownership shares. They also screened the technologies brought in by TNCs and imposed export requirements. Local content requirements were quite strictly imposed, although they were less stringently applied to exported products (so that lower quality domestic inputs would not hurt export competitiveness too much). As a result, Korea was one of the least FDI-dependent countries in the world until the late 1990s, when the country adopted neo-liberal policies.[48] Taiwan, where the policies were slightly milder than in Korea, was somewhat more dependent on foreign investment, but its dependence was still well below the developing country average.[49]

The bigger European countries – the UK, France and Germany – did not go as far as Japan, the USA or Finland in regulating foreign investment. Before the Second World War, they didn’t need to – they were mostly making, rather than receiving, foreign investments. But, after the Second World War, when they started receiving large amounts of American, and then Japanese, investment, they also restricted FDI flows and imposed performance requirements. Until the 1970s, this was done mainly through foreign exchange controls. After these controls were abolished, informal performance requirements were used. Even the ostensibly foreign-investor- friendly UK government used a variety of ‘undertakings’ and ‘voluntary restrictions’ regarding local sourcing of components, production volumes and exporting.[50] When Nissan