host country government regulates it.
Foreign financial investment brings more danger than benefits, as even the neo-liberals acknowledge these days. While foreign direct investment is no Mother Teresa, it often does bring benefits to the host country
Therefore, foreign direct investment can be a Faustian bargain. In the short run, it may bring benefits, but, in the long run, it may actually be bad for economic development. Once this is understood, Finland’s success is unsurprising. The country’s strategy was based on the recognition that, if foreign investment is liberalized too early (Finland was one of the poorest European economies in the early-20th century), there will be no space for domestic firms to develop independent technological and managerial capabilities. It took Nokia 17 years to earn any profit from its electronics subsidiary, which is now the biggest mobile phone company in the world.[57] If Finland had liberalized foreign investment from early on, Nokia would not be what it is today. Most probably, foreign financial investors who bought into Nokia would have demanded the parent company stop cross-subsidizing the no-hope electronics subsidiary, thus killing off the business. At best, some TNC would have bought up the electronics division and made it into its own subsidiary doing second-division work.
The flip side of this argument is that regulation of foreign direct investment may paradoxically benefit foreign companies in the long run. If a country keeps foreign companies out or heavily regulates their activities, it will not be good for those companies in the short run. However, if a judicious regulation of foreign direct investment allows a country to accumulate productive capabilities more rapidly and at a higher level than possible without it, it will benefit foreign investors in the long run by offering them an investment location that is more prosperous and possesses better productive inputs (e.g., skilled workers, good infrastructure). Finland and Korea are the best examples of this. Partly thanks to their clever foreign investment regulation, these countries have become richer, better educated and technologically far more dynamic and thus have become more attractive investment sites than would have been possible without those regulations.
Foreign direct investment may help economic development, but only when introduced as part of a long- term-oriented development strategy. Policies should be designed so that foreign direct investment does not kill off domestic producers, which may hold out great potential in the long run, while also ensuring that the advanced technologies and managerial skills foreign corporations possess are transferred to domestic business to the maximum possible extent. Like Singapore and Ireland, some countries can succeed, and have succeeded, through actively courting foreign capital, especially FDI. But more countries will succeed, and have succeeded, when they more actively regulate foreign investment, including FDI. The attempt by the Bad Samaritans to make such regulation by developing countries impossible is likely to hinder, rather than help, their economic development.
CHAPTER 5
Man exploits man
John Kenneth Galbraith, one of the most profound economic thinkers of the 20th century, once famously said:‘Under capitalism, man exploits man; under communism, it is just the opposite.’He was
Since its rise in the 19th century, the key goal of the communist movement had been the abolition of private ownership of the ‘means of production’ (factories and machines). It is easy to understand why the communists saw private ownership as the ultimate source of the distributive injustice of capitalism. But they also saw private ownership as a cause of economic inefficiency. They believed that it was the reason for the ‘wasteful’ anarchy of the market. Too many capitalists routinely invest in producing the same things, they argued, because they do not know the investment plans of their competitors. Eventually, there is over-production and some of the enterprises involved go bankrupt, condemning some machines to the scrap heap and laying perfectly employable workers idle. The waste caused by this process, it was argued, would disappear if the decisions of different capitalists could be co-ordinated in advance through rational, centralized planning – after all, capitalist firms are islands of planning in the surrounding anarchic sea of the market, as Karl Marx, the leading communist theorist, once put it. Therefore, if private property were abolished, communists believed, the economy could be run as if it were a single firm and thus managed more efficiently.
Unfortunately, the centrally planned economy based on state ownership of enterprises performed very poorly. Communists may have been right in saying that unfettered competition can lead to social waste, but suppressing all competition through total central planning and universal state ownership exacted enormous costs of its own by killing off economic dynamism. Lack of competition and excessive top-down regulation under communism also bred conformism, bureaucratic red tape and corruption.
Few would now dispute that communism failed as an economic system. But it is a huge leap of logic to go from that conclusion to the proposition that state-owned enterprises (SOEs), or public enterprises, do not work. This judgement became popular in the wake of Margaret Thatcher’s pioneering privatization programme in Britain in the early 1980s, and acquired the status of a pseudo-religious credo during the ‘transformation’ of the former communist economies in the 1990s. For a while, it was as if the whole ex-communist world was hypnotised by the mantra, ‘private good, public bad’, reminiscent of the anti-human slogan, ‘four legs good, two legs bad’, in George Orwell’s
Why do the Bad Samaritans think state-owned enterprises need to be privatized? At the heart of the argument against SOEs lies a simple but powerful idea. The idea is that people do not fully take care of things that are not theirs.We see the corroboration of this notion on a daily basis. When your plumber takes his third coffee break of the morning at 11am, you begin to wonder whether he would do the same if he was fixing his own boiler. You know that most of those people who throw away litter in public parks would never do so in their own gardens. It seems to be human nature for people to do their best to take care of the things they own while maltreating those things that they do not. Therefore, it is argued by the opponents of state ownership, you have to give people ownership, or property rights, over things (including enterprises) if you want them to use them most efficiently.[1]
Ownership gives the owner two important rights in relation to his property. The first is the right to dispose of it. The second is the right to claim the profits from its use. Since profits are, by definition, what are left to the owner of the property after he has paid for all the inputs he has bought in order to use his property productively (e.g., raw materials, labour and other inputs used in his factory), the right to claim the profits is known as the ‘residual claim’. The problem is that, if the owner has the residual claim, the amount of the profits does not concern those suppliers of inputs who get fixed payments.
By definition, state-owned enterprises are properties collectively owned by all the citizens, who hire professional managers on fixed salaries to run them. Given that it is the citizenry that has the residual claim as the owner of the enterprise, the hired managers do not care about the profitability of their enterprises. Of course, the citizenry, as the ‘principal’, can make its ‘agents’, or the hired managers, interested in the profitability of the SOEs by linking their pay to it. But such incentive systems are notoriously difficult to design. This is because there is a
